Why Does Your Insurance Premium Change?
The trickle-down effect of insurance pricing
Insurance premiums are not direct reflections of the risks you insure. While inflation is a good start for anticipating changes in your rate each year, there are still other, more subtle factors you may be unaware of that affect the cost of insurance. Let’s start at the top and examine the trickle-down effect that determines your insurance rate.
Insurance pricing begins with reinsurance companies. Reinsurance companies accept risk from insurance companies in exchange for a premium.
Factors Impacting Reinsurance
So far 2015 has been a quiet year for catastrophes—below the recent 10-year and 15-year averages—which has boosted profits for reinsurance companies because they paid out fewer and cheaper claims. Additionally, innovative investment options have provided opportunities for reinsurance companies to generate new capital.
Having extra capital on hand means reinsurance companies can insure more people and businesses—raising the competition for customers. As a result, primary insurance companies are paying lower premiums for reinsurance, a savings they can pass along to consumers like you.
Insurance companies take on risk for you or your company in exchange for premiums. Your premiums are dictated by the amount of risk the insurer accepts on your behalf, as well as by the financial state of the insurer, which is determined by profits or losses in underwriting and investments.
Insurers measure their underwriting profits with their combined ratios. A combined ratio is calculated by dividing the sum of incurred losses and operating expenses by premiums. If insurers have a combined ratio of less than 100 per cent, they are making a profit. A combined ratio of more than 100 per cent reflects a loss.
Initial reports summarising the first half of 2015 from UK insurers show that, on average, combined ratios continue to improve. A small number of catastrophic losses for the remainder of 2015, as well as new methods of synthesising and analysing consumer data, will likely lead to reports of improved combined ratios again in Q1 of 2016.
Another way insurers make money is by investing policyholder surplus and cash reserves in the stock market as well as a variety of other investment vehicles. If investment returns are good, the insurer makes money.
Many UK insurers continue to report dwindling investment yields due to low interest rates, stemming from the United Kingdom’s sluggish but persistent economic growth since the 2008 financial crisis. In response, insurers are aiming to shift, grow and diversify their investment portfolios.
Increasing Interest Rates
Interest rates in the United Kingdom have been kept at historic lows since the aftermath of the financial crisis, but as economic recovery gains momentum, analysts are anticipating a rate hike sometime between the first half of 2016 and 2017. Rising interest rates are generally considered a sign of a strong economy, yet opinion remains varied on how rising interest rates will affect financial markets.
Insurer Priorities in 2015/16
This is an exciting and challenging time to be an insurance company. The ‘old way’ of doing business will no longer suffice for insurers, who are being forced to identify new priorities in light of the three big trends below.
Technology that enables insurers to harness large-scale consumer data in order to make better actuarial predictions is now available. More accurate predictions allow insurers to charge premiums that better reflect risk, which stabilises their income.
Hunger for new business is being tempered by subpar investment returns. Many insurers are becoming increasingly selective about which risks they target, with most preferring to target ‘safer’ risks. Companies with established safety and risk management programmes in ‘safer’ industries are more likely to contribute to underwriting profit, and are therefore a more desirable addition to the insurer’s book of business. These companies will be targeted heavily in 2016. Lean on your broker to navigate this ‘buyer’s market’ and find the most appropriate balance of premium spend and insurance cover for your company.
Finally, the insurer landscape has been impacted by a number of large mergers, which have triggered competition among insurers even further.
Insurers who respond to these market conditions proactively will find success. In the meantime, consumers will benefit from the added competition among insurance companies through stable or dropping premiums across most lines, increased policy flexibility, and enhanced consumer relationships.