Insurance Prices Will Sky Rocket in 2009
There are three reasons why insurance prices are likely to soar in the next 12 months.
Here's a little bit about how insurers make money, and why, unfortunately, this means we can expect insurance premiums to soar over the next year.
Making money as an insurer: method one
The first way insurers make money is the most obvious. It's called underwriting and works like this:
1. The insurer charges us insurance premiums.
2. It pays claims using the money it receives in premiums.
3. It pays its other bills, such as heating, lighting, rent and so on.
4. And what's left is their `underwriting profit'.
However, in many cases this profit is negligible or they even make an underwriting loss - meaning insurers lose money on insurance. Take car insurance, for example. The latest results are for 2007, and in that year insurers made a loss on car insurance for the 13th year in a row! Do you still think car insurance is too expensive?
How much money do insurers make from selling insurance? Actually not very much. In most of the past 15 years the general-insurance market, for example, has made quite close to zero profit. (The `General-insurance market includes such things as car insurance, home insurance, travel insurance, and accident and health insurance.) In roughly half of those years, general insurers have made a small loss. In the other half, just a small profit.
There is usually, quite simply, too much competition for insurance to be profitable. That's why insurers don't just rely on insurance...
Making money as an insurer: method two
In addition, insurers make money by investing the premiums we pay them. Here insurers have been more successful. By combining the underwriting profit (or loss) with the amount they've made on their investments, they have been in profit every year for the past 15 years. In six of those years, they've made around 12% to 18% profit on the premiums they've received. Not bad at all, so there's no need to cry for the insurers.
Life insurance and pensions
In a separate class of products from general insurance is `life insurance and pensions'. (Note: insurers also sell us our pension funds.) The underwriting and sales results here are holding up more steadily than general insurance.
On the downside, insurers have already seen a decline in the return on their investments in this area and we could easily expect a lot worse when 2008's results are announced. Like general insurance, life insurance and pensions providers invest for themselves the premiums and commissions we pay them. Returns are now significantly below the high point of 1990. Also, whilst they're just slightly lower than the average over the past ten years, they have declined for two years in a row up to 2007. I dread to think how the results will look when they announce the investment performance for 2008!
Three reasons we can expect higher premiums
1. The underwriting cycle
Insurers are currently in a low point in what's called the underwriting cycle. This is a time when they make less money. This results in some insurers merging and others failing. This means there is less competition and, when there is less competition, premiums rise faster again.
The general insurance market already made an underwriting loss in 2007 of around 3%. At the last low point in the underwriting cycle insurers made an underwriting loss of over 10%. At the beginning of the 90s underwriting losses reached 30%. Whilst I don't expect this to be repeated in 2008, another underwriting loss is not wholly unlikely.
2. Plummeting investment returns
We can expect that insurers' investment returns will have been calamitous this year, so far. The extent of the damage will dramatically eat into their profits (or hugely worsen their losses) for the year.
The insurers' business model of relying on investments to be profitable doesn't work very well in a falling market. There is only one way to survive: reduce the benefits in their insurance policies and increase insurance premiums.
3. The economic downturn
With everyone fearing the worst for the economy there will be more people who try to save as much as possible by cancelling unnecessary insurances. What's more, those who are most at risk in the current times will actually take out more insurances, e.g. to protect their income from redundancy. Furthermore, the likelihood of any of us claiming on protection policies has drastically increased for all of us, thanks again to the economy.
So, insurers can expect a much higher number of claims. With that in mind, insurers will need to raise the prices of some of their insurers to keep the status quo.
What should we do now?
As premiums will almost certainly rise (in many areas, I think, dramatically so) it's a good time to lock in your premiums now if you can. As I explained in It's Time To Buy PPI, you may even find some good bargains, considering the higher risks we all face.
Don't overdo it though. Take stock of your existing insurance policies and ask yourself what you really need. Can you `self-insure' for some of these risks by saving more money instead? Is the policy worth the price?
Finally, as always, read the small print before you buy!