Forget fires and floods; the slowing economy looms as the largest threat to margin-challenged group insurance and reinsurance companies. The era of super fund supremacy in striking group insurance deals might just be coming to an end, as CATHERINE JAMES reports.

Like most financial markets participants, insurers have been watching with nail-biting anticipation for some normality to return to the markets. But the group insurance market is almost down to chewing on its fingers.

One senior reinsurer, who has worked in group insurance for 11 years, says the changing economic conditions have made the current group insurance situation a serious risk, the likes of which he has never seen. The reinsurer, who declined to be named, says competition has squeezed group insurance premiums to remarkably low levels that – while sustainable in a healthy economy – are potentially large liabilities in a recession.

While some may dismiss his fears as exaggeration, he pinpoints a number of concerning factors colliding. It’s a documented phenomenon that claims for total and permanent disability (TPD) and income protection rise as the economy falls. Coupled with the fact that group insurance is now insuring more people for greater amounts of cover at lower premiums, it is not hard to see why he thinks some insurers and reinsurers should be counting their pennies carefully.

Competition in the group insurance market has markedly grown in the last five years. More new players, such as MetLife, have entered the scene and they’re all vying for fewer, but much bigger, super fund clients. MetLife head of institutional business, Michael Burke, says there’s more at stake for one group insurance contract than in the past because the consolidation of the super sector has led to fewer players with understandably larger contracts. “They’ve got strength because their insurance premiums are very significant. No insurance company wants to lose a large super client, or even a small super fund client,” Burke says.

Margin squeeze is inevitable as insurers compete to retain these much sought-after super fund clients. Premiums are heading south and default cover is increasing as super funds are renegotiating their group insurance contracts as often as three times a year, up from every three years, according to deputy chief executive of the Australian Reward Investment Alliance, Paul Watson.

The group insurance market has grown at a rate of around 15 per cent a year in terms of total premiums being paid, at the same time as the premiums themselves have only decreased. In the 2007 fiscal year alone, group insurance saw rate reductions of 15 to 20 per cent while the market grew overall by 40 per cent, as funds increased their default level of cover and added a salary continuance option, according to a study by actuarial firm Rice Warner. Figures for 2008 are currently being finalised. Margin squeeze or not, group insurance is a profitable business.

Business development manager for reinsurer RGA, Rod Berry, says insurers with group business are finding “this segment is now making a significant contribution to their overall growth and profitability, whereas previous returns may have been marginal”.

Meanwhile, rising competition in the super fund sector itself has made insurance cover a point of differentiation – hence the flurry of activity around contract renegotiation. Choice of fund legislation and funds opting to go “public offer” has not only increased competition between the not-for-profit industry funds and retail super funds sector, but even within these sectors healthy rivalry is growing.

Hannover Re’s assistant general manager of marketing, actuary Damian Thornley, says he is worried by prices “on a couple of schemes” where the incumbent insurer has been beaten by a substantial margin by another insurance provider. “Today’s prices are sustainable – if TPD risk continues to hold up,” he says, meaning if TPD claim levels remain around where they are today.

However, while claims for TPD and salary continuance – which Thornley puts in the same basket – have been on a downward trend in the last five years, decreasing the risks and hence the premiums of insuring for such claims, the times are changing. “[TPD and salary continuance] risk is a risk correlated to economic fortunes,” Thornley says.

“If the economy does go into recession and there are job losses, it will give an upward knock on TPD claims – and that will hurt group life insurers, especially some of the insurers with larger accounts.” Conversely, Thornley says that typically in a strong economy, more people are employed and salaries are increasing, and “when people are making good money they don’t think about lodging a claim”. However, withdraw their disposable income and people start looking at all their potential sources of cash. “You only need a small change in behaviour to affect your margin,” he says.

“If you have a 1 in 1000 claim rate, and that increases to 1.5 in 1000 – you’ve just had a 50 per cent increase in claim costs.” However, Thornley says a small “upward knock” won’t necessarily be disastrous – it may even be good for group insurance as it will bring “a bit more discipline into the market”.

Berry agrees that super funds are powerful negotiators but must be careful of how much they demand. “Super funds with good [claims] experience are getting very competitive rates and increased cover levels are delivering very good value for members. What funds need to realise, however, is if they push too hard to loosen the risk controls the insurer has set, the experience may deteriorate and costs may increase again,” he says.

Not that Berry is trying to blame super funds for the decreasing premiums. He also cautions insurers and reinsurers to be careful about the risks they take on and the terms they allow, yet he says super funds need to be part of the discussion about concerns arising from the current environment. “Ultimately, the funds also need to be part of this discussion, since any downturn in experience may be met by insurers in the short term but in the long term will be met by an increased cost to members,” he says.

Only time will tell whether the economy reverses the decreasing claims rate. However, both the insurers and reinsurers reassure that they’re not about to have their money trees shaken free of all fruit. As Berry says, past experience serves to prepare the insurance market for what may lie ahead.

Recent analysis by RGA has shown that imperfect correlations exist between industries, so a group insurer can diversify its risk by diversifying across industries. Reinsurers also have a strong role in this regard, he says, apart from helping insurers spread their exposure on large or riskier schemes, “because our risks are spread across multiple industries, we may be able to offset a downturn in one industry with good experience in another”.

MetLife’s Burke is also confident of the insurance market’s preparedness for whatever lies ahead. “We can’t actually put prices up, so it is the skill of our overall financial strength, combined with our reserving that makes it very comforting for our clients and ourselves. All downturns are followed by upturns, and you can’t gamble with clients.” He says while it is not always easy to achieve the ideal mix for an insurers’ portfolio, as you can’t reconstruct your clients’ profile, he feels MetLife has a good spread of occupations and genders. “Insurers – I can only speak for MetLife – have been through the worst of recessions and depressions and downturns in the economy, which can’t naturally be forecast to any great accuracy,” he says.

“The industry has been through these situations in the past, we’ll go through them in the future. We’ve got more experience, greater controls, greater forecasting, and it doesn’t keep me awake at night.”

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