We support level premiums as a strategy to help our clients manage their insurance premium costs over the long term. But with manufacturers amending level premium base rates, we thought it would be useful to share the key factors that drive level premium pricing.
What are level premiums for your personal insurances?
Stepped premiums are generally cheaper in the short term. They usually rise with age as the risks associated with the life insureds age increase. CPI or indexation increases are on top of any stepped premium changes.
Level premiums set a base rate price at the age of entry, and while this is generally higher in the short term, it provides a more stable premium experience over time. Some insurers, such as CommInsure, offer true level premiums. True level premiums use the level premium rates at entry age for both the initial sum insured and CPI increases each policy anniversary. Other insurers calculate level premium rates differently, using entry age on the initial sum insured, then applying the relevant age based level premium on the CPI increased component. CommInsures' true level premiums can save you money, compared to other insurer's level premiums, if you choose to accept CPI increases over the long term.
What are the key drivers of level premium base rates?
There are a range of factors that actuaries use to price level premiums. Three of the main drivers are:
- interest rates
- claims experience
Insurers follow the APRA prudential framework when they set prices. This includes calculating expected investment returns, which usually involve Government backed securities. When CommInsure started offering level premiums in 2004, interest rates for Government backed securities were higher than they are now in 2017.
During 2004, the Reserve Bank of Australia had a cash rate of 5.25(1) per cent, compared to 2017 where the cash rate is currently 1.50(1) per cent. In this low interest rate environment, the rates of return on the premiums are lower than in a higher interest rate environment.
The other significant change over this same time period is that our industry has reported an increase in claims experience, and in particular mental health claims. Mental health claims are usually of a longer duration than claims such as musculo-skeletal claims, and claims management programs incorporating rehabilitation and return to work have more limited impact than the rehabilitation and return to work programs related to musculo-skeletal claims. These longer duration claims are impacting industry profitability(2):
Lapses are the third key driver for setting level premiums. Lapses on level premium policies are lower than stepped premium policies. Insurers are generally holding more capital for these products.
What does this mean?
These three drivers have created a new environment for level premiums. With lower interest rates, and therefore lower returns from Government backed securities, and a deterioration of claims experience and lapse behaviours over the past decade, level premiums have been reviewed by many insurers. Some insurers have already announced level premium changes.
Insurers don't guarantee level premium rates, as outlined in the Product Disclosure Statements. It is important to understand how your premium may change over the long term and you should speak with a financial adviser that will take your personal circumstances into account before making any decisions on your insurances.
Timothy Donlea & Artemas Wealth Management have been providing advice to clients for over 20 years. Contact us by clicking here or alternatively by calling us for a confidential discussion on 02 9221 9699.
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