The current climate of high inflation, rising interest rates, low unemployment, poor wage growth, supply chain disruptions (leading to rising prices, stock shortages, and higher worker salaries), surging energy and materials costs, and increased volatility in the capital and debt markets all paints a grim picture for consumers and businesses. But how does this environment of rising interest rates impact insurance premiums and is there any hope on the horizon? We unpack how insurers might view particular insurance classes, manage these investments, and what this means for consumers and businesses.
RISK & RETURN
Insurers invest the premiums they receive from customers, which adds to their earnings. Typically, insurers try to match their investment profile with the type of insurance. This has been challenging for insurers in recent years as interest rates have been close to 0% in most markets and insurers have been forced to chase yields with riskier assets. In the current market conditions, insurers will be able to rebalance portfolios and revisit traditional investments, relying less on alternative asset classes.
SHORT-TAIL RISKS & RISING INTEREST RATES
A short-tail risk is a type of insurance in which most claims are notified and/or settled shortly after the date of exposure and/or occurrence. This is typically within one to three years. Health, Car, Home, and Property insurance classes are considered short-tail. Companies that offer coverage for short-tail risks are likely to have lower investment income ratios (net investment income / earned premiums) because more cash needs to be available for claims. This also results in investments in safe, stable assets, that include fixed interest securities and bonds.
Insurers specialising in short-term risks (such as Car, Home, Contents, and Property insurance) are impacted less by interest rate movements.
LONG-TAIL RISKS & RISING INTEREST RATES
A long-tail risk is an insurance class characterised by two key features; there is a long period between the start of the exposure and the resulting loss, and there is a long settlement period or lag between the incident and when the claim is completed. This is typically between three and seven years. Insurers offering long-tail coverage are likely to have higher investment income ratios than companies that offer coverage for short-term liabilities. As a result, long-tail insurance providers have more time to invest their premiums, allowing them more time to earn a higher rate of return, and often invest higher amounts in assets that have a riskier profile. Long-tail risks (such as Cyber, Directors & Officers Liability, and Life insurance) are influenced more by rising interest rates.
IMPLICATIONS FOR INSURANCE PREMIUMS
In short, as interest rates rise, we are more likely to see premiums decrease on personal lines insurance such as Home, Contents, and Car. Having said this, personal lines insurance pricing is likely to be impacted by losses from natural catastrophes (such as bushfires and the recent flooding events in NSW and QLD). This means that any pricing advantage consumers gain is likely to be offset by recent natural catastrophe losses and other factors such as claims inflation.
Professional type risks (Management Liability, Directors &Officers Liability, and Cyber) are longer-term in nature and impacted less by interest rate movements than short-tailed risk types. We anticipate premiums for these insurance lines will remain more stable in comparison.
WITH YOU ALL THE WAY
As the market conditions evolve at a rapid pace, we will continue to keep our community informed as updates become available.
Prepared by Laurence Basell