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How investment returns affect insurance premiums

At a glance

  • If their premiums are increasing, customers quite rightly want to know why
  • We are keen to help everyone understand the factors that can influence the size of premiums
  • One of the most important factors is the level of returns that insurers get from their investments

In an ideal world, the size of a customer’s insurance premium would always correspond directly to their individual risk profile.

However, just as customers are affected by political and economic developments beyond their control, so too are insurers, and such factors can have an impact on the way insurance premiums are calculated.

To take two examples from this year – on 1 June, a 2% increase in Insurance Premium Tax (IPT) will come into effect.

This rise follows a series of increases to the tax in recent years and comes on the back of a major adjustment to the Ogden rate, which will result in insurers having to pay significantly higher compensation awards to personal injury claimants. These and other factors are discussed in more detail in our recent Insider article on how insurance premiums are calculated.

The impact of low investment returns on insurance premiums

One of the most significant external factors that can influence the size of premiums is the return insurers get from their investments.

Nick Kitchen, Head of Technical Casualty and Motor Lines, Zurich, says: “Historically, insurers have made money in two ways – returning an underwriting profit, and investing premiums and making money on the investment returns.

“When investment returns are high, insurers have been able to operate at an underwriting loss and still return a profit to shareholders, but in times of low investment returns, underwriting has to make a profit.”

Over the past decade, consistently low interest rates have reduced investment returns and left insurers with little choice but to increase premiums in order to make an underwriting profit.

Why long-tail lines suffer the most

Not every line of insurance is affected equally. Investment returns are particularly important in so-called ‘long-tail’ lines of insurance, such as Employers’ Liability, Public Liability and Motor, where insurers have traditionally been able to make money by investing premiums before claims are settled. These are the lines of insurance most affected by a drop in investment returns.

Nick says: “The greatest impact is on Employers’ Liability, where a 1% movement in yield curves can affect an insurer’s Combined Operating Ratio by up to 3%, which can lead to a corresponding increase in premiums.”

While it is difficult to predict when investment returns will pick up, there is unlikely to be any significant change in interest rates in the foreseeable future.

Is there anything, therefore, that insurers can do to protect their customers against the impact of such economic factors?

Nick says: “As an insurer, we have tried not to pass the price on to our customers by managing our expense base, and through better underwriting and claims handling to reduce loss ratios. But there is only so far we can push those areas.

“Customers will often see their premiums going up and not understand why. We are doing all we can to keep premiums sustainable, however it is important that brokers and customers understand all the factors that influence premiums.

For more information please speak with your local Zurich contact

Image © Getty

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