How to explain insurance rate increases

Permanent life insurance is underpriced—and companies know it.

Since the last quarter of 2010, most insurers have increased their prices; with some hinting at a third round of rate hikes. And the product itself may actually be heading for extinction, since some providers are removing their permanent products and focusing on adjustable insurance rates or term insurance.

So, what do we tell clients?

Explain the insurance companies are increasing their fixed premium rates for two reasons:

1.

Interest and bond rates have remained low for an unusually long time.

Insurance companies need to invest their money in order to make a profit. Premium rates are calculated based on mortality, expenses and interest. If interest rates go down, the company needs to invest more to turn a profit and ensure it has sufficient reserves to pay claims. (By law, insurers must maintain a certain level of reserves—see “Margin of Safety,” this below.) To have that extra investment capital on hand, they need to charge higher premiums.

2.

Insurers must have at least 120% of liabilities in their capital reserve, also known as Minimum Continuing Capital and Surplus Requirements. But regulators become concerned when it dips below 150%. Companies must report their reserves quarterly to the Office of the Superintendent of Financial Institutions. When Union of Canada Life went bankrupt this year, it actually had more than 100% of liabilities in reserve.

Insurers now must report using a new accounting standard.

The International Financial Reporting Standards (IFRS) became mandatory for most publicly accountable, profit-oriented companies last January, but life insurance companies were able to defer implementing the reporting standard until this year, 2012. (Investment and segregated funds can defer to 2013.) The intent of these rules is to present a reporting standard that’s understandable, comparable and relevant. They do not, however, take into account the fact that businesses with very long-term liabilities—like insurance companies—operate differently.

The insurance companies have claimed adopting IFRS will lead to higher capital charges, which means they’ll need to divert more funds toward capital reserves to ensure they can pay policyholders.

Time to switch

Suggest your term insurance clients convert their contracts to a permanent fixed-rate plan before the next round of increases. This might also be the time to lock in the rates for their spouses or even to start an insurance portfolio for their children.

By locking in rates today, clients can save thousands of dollars over their lifetimes.

Industry concerns with IFRS

The Canadian Life and Health Insurance Association Inc. has provided the chairman of the International Accounting Standards Board with the following three concerns:

All viable options related to determining the appropriate discount rate methodology should be thoroughly assessed.
Due to the complexity of the topic, the assessment should include Quantitative Impact Studies.
Getting the accounting standard right for our industry is of strategic importance.