It may at first seem a little disjointed. How could volatility and falling yields in
the bond market have any effect at all on your insurance rates? I mean weather yeah, bad driving record yeah,
but falling bond yields? The answer lies
in the way that insurance companies make a profit. And in times of intense completion, most of their profit comes from investment
income as opposed to underwriting income.
The intense completion for your auto insurance dollars is on display on
your television every day and probably in your junk email folder as well. And this competition on pricing has put a lot
of pressure on investment income. The options in that arena these days may
leave many insurance companies with no choice but to raise rates.
One very important metric that every insurance company
follows very closely is called the loss ratio.
This metric has several different iterations. The easiest to understand
is called the pure loss ratio. This is
simply a measure of all premiums taken in, divided by all losses paid out. Of even more importance is a metric called the
combined ratio which is all premiums taken in, divided by the sum of losses
paid out plus all other expenses. When
the combined loss ratio goes over 100%, then the insurance company has lost
money on their underwriting operations.
When this happens, they will need to find their profit in the income
that they generate by investing your premiums until they need them to pay for
losses.
Intense competition in the insurance marketplace has driven
down rates steadily for many years and the combined loss ratio of many
insurance companies is now up over the dreaded 100% level. To protect themselves their choices are to
cut expenses, increase investment income or increase the rates that they charge
for the various insurance products that they sell. As a rule, insurance companies invest in very stable and
safe government bonds. But the
volatility of the government bond market, along with dreadfully low yields has
driven some insurance companies to invest more in corporate bonds. The problem with this strategy is that it
exposes the insurance company to debt risk if and when interest rates
rise. If we see more corporate defaults,
then the insurance companies that have invested in corporate paper will suffer
losses and will have to raise their rates even further.
With high quality corporate bond now yielding below a 2%
return, corporate debt is no longer a viable option for helping to reduce the
combined loss ratio to produce a profit for the insurance company. This leaves insurance companies faced with
the choice between reducing expenses or investing in riskier investments to chase
higher yields. If they reject these
choices then they are left with one remaining option, raising rates. When yields ran at 6% for grade A corporate
bonds, then the insurance companies that took a chance on this type of debt had
4 additional points to play with on their combined loss ratio. At 2% the margin is getting pretty thin. Add in the risk of default by the corporations
that issue these bonds and you can see the dilemma that may lead more and more
insurance companies to raise their rates.
It is easy to see that while falling interest rates may be helpful to
you from a mortgage or car loan standpoint, they can have a counter effect on
your car insurance rates and your home insurance rates.
At Clinard
Insurance Group, we insure thousands of families all across North Carolina
with their auto
insurance, their home
insurance and life
insurance as well as their business
insurance needs. If you would like
to ask questions or receive help in any of these areas, I hope you will call
us, toll free, at 877-687-7557.
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