The inevitability of premium increases

Falling investment yields mean insurers have no choice but to push up premiums on group income protection explains Peter O’Donnell, chief financial officer at Unum

Economic analysts are expecting a further period of unprecedented low interest rates, with some predicting a further half a percent fall needed if borrowing is to be stimulated.

Nothing new there you may think, but this has driven investment yields and particularly long-term returns to extremely low levels.  At the same time, inflation remains high. Currently inflation stands above 5 per cent driving higher claims costs for insurers who have inflation-linked liabilities.

So, insurance companies paying out long-term claims need to make changes now if they are to continue to reliably pay claims.

For general insurance providers who only need to pay out short-term claims, and for whom an annual premium increase is commonplace, this is very manageable.  Long-term insurance providers, however, are far more reliant on investment income from assets backing reserves to pay those long-term claims and to plan far enough ahead to keep policy premiums as low as possible. For companies like Unum, lower interest rates mean lower investment yields, so less investment income with which to offset the cost of long-term claims. Income protection claimants can continue to claim right through to retirement, which can be 20, 30 or even 40 years.      

All investments that we make earn an income with a view to generating cashflow to pay out all future claims. Group income protection and group dependants products are disproportionately impacted by low interest rates.

This is because of their long-term liability, and the need to invest in long-term investment products, such as bonds, to ensure the security of these long-term claims.

A sustained fall in bond yields, as we are currently experiencing, means that less investment income is being generated. Insurers have taken many, if not all, actions available to them to minimise the impact of these falling rates. At this point for the industry, adjusting premium rates higher is required.

Over 2009 and 2010, companies were doing all they could to manage costs as they reckoned with the economic environment. As a result, the group income protection industry as a whole saw a 20 per cent fall in premium revenues during a time when exposures actually increased 10 per cent, according to Swiss Re Group Watch 2011.

Price competition was intense and providers allowed price to decline. During this period, Unum worked hard to match our expense structure to our revenues, and focused on creating as many efficiencies as possible to avoid having to increase our customers’ premiums.

In addition we focused on continually improving the effectiveness of our claims management process and return to work success.  In early 2011, Unum had to respond to falling prices and raised its premiums. This has been successful,  but the sustained fall in interest rates is forcing us, and the rest of the industry, to take further steps.

So low long term interest rates and higher inflation are putting the industry under pressure and could threaten its future if we don’t take action now. A premium increase is the only remaining solution.

We have reached a stage for the industry, where there is just one remaining solution – a last resort – if we are to ensure that we can continue to fulfil our long-term claims.  An increase in premiums is needed today. This is the only responsible action to make up the looming shortfall. While this means a greater outlay for our customers in the short-term, over 2 to 5 years, it is both more cost-effective and stable for the market. Price stability and the ability to predict costs are a key requirement from our customers.

In fact, if insurance providers selling long term products don’t increase their premiums in the next renewal cycle, shareholders, brokers and customers should worry, as it could mean they will need  to make riskier investments to try and hedge against long-term claims. This can lead to much greater price volatility – something that no customer wants and any chief financial officer or financial director should avoid.

So, 2012 will see a wave of price hardening for long-term insurance products – those insurance providers who don’t follow suit are setting themselves up for a time bomb they can ill afford.