Higher premiums that insurers should subtract

Major insurers are likely to increase rates for consumers and businesses as the sector tries to salve its bruised balance sheet.

Largely because of government capital injections, the global banking sector has raised enough capital to nearly offset the amount of writedowns it has taken. But the insurance industry has only raised a fraction of what it has lost to recent financial hits.

"The implication of that is that it reduces capacity, and a reduction in capacity leads in the end to higher prices," said Daniel Hofmann, the chief economist of Swiss-based Zurich Financial Services Group.

Soft markets and souring economies typically lead to price increases, but the challenges faced by the industry are far worse this time around.

Broadly, soft financial markets hurt insurers' investment portfolios. And a declining economy tends to cause a rise in claims for automobile accident coverage, because cash-strapped consumers are less likely to pay for the damage themselves, and for disability coverage, because people sometimes claim disability to evade an impending job loss.

"You tend to see, in times like this, either some price increases or features being removed, a retooling of products," said Neil Skelding, chief executive officer of RBC Insurance. "And we have seen that in the industry as a whole."

Many experts expect that trend to pick up.

Property and casualty insurers, already coping with high claim levels, have taken severe hits because of exposure to troubled assets. The U.S. industry earned $2.4-billion (U.S.) last year, compared with $62.5-billion in 2007, according to its association. The Canadian industry earned $1.5-billion (Canadian), down from $3.3-billion the previous year, according to information filed with regulators.

A number of forces, from rain-related damage to wildfires, conspired to boost claims across Canada last year, said Dan Danyluk, CEO of the Insurance Brokers Association of Canada. The industry has two basic sources of cash to pay out claims: premiums that customers pay and investment income. Since investment income has tanked, there will be an impact on premiums.

Life insurers aren't faring any better. Their large investment portfolios have been walloped by stock market declines, and margins are being squeezed on interest-rate-linked products such as term life insurance.

"Life insurers, mainly in North America, have written some policies that had implied options [guaranteed returns] that turned out to be very costly in the current market environment," Mr. Hofmann said. "So, they need to backtrack from that, change their product mix, and come back with products that are not as exposed to market fluctuations."

Dominic D'Alessandro, CEO of Manulife Financial Corp., said insurers are being required to set aside unreasonably high amounts of capital for their variable annuity and segregated funds businesses. "It's very simple what is going to happen," he said. "We're going to price the product up and remove some of the features, and possibly not even make it available any more down the road.

"The industry will adjust to whatever environment exists," he added. "If we need to have $100 of capital instead of $50, we'll adjust to $100. Everybody will, everybody has the same requirements, so the pricing just gets passed on."

Variable annuities are similar to private pension plans. A consumer gives money to an insurer, which in turn invests it in the markets and promises to make regular payments to the customer down the road. The amount of the benefits is guaranteed in return for a fee.

The products were once derided as a licence to steal for the insurance industry, Mr. D'Alessandro noted. But customers who held them when markets tumbled last year have made out handsomely. The insurers, meanwhile, have been scrambling to raise capital to meet the requirements that regulators place on them when the value of the investment portfolios decline. To mitigate the damage, life insurers are now cutting back the benefits they offer - for instance, raising the minimum age for withdrawals - and increasing fees, as well as looking at ways to reduce the exposure to stocks.

"It's a beautiful product," Mr. D'Alessandro said, but "it's likely to be far, far less attractive in terms of the features" from here on out.

"Our guaranteed products help people address what is probably the single biggest financial risk they face in their lives, having enough money through increasingly longer lifespans," said Sun Life Financial spokesman Michel Leduc. "The U.S. industry has undertaken a relatively comprehensive repricing of these products and we expect this to happen in Canada as well."

Mr. Skelding said RBC Insurance is in the midst of launching a guaranteed product, and "we actually have modified the features as we've seen the market unfold.

"There is a place for this product in a financial plan, and we intend to meet that need," he said. "But the important thing, and I can't overstate it, is it has to be sustainable."

Mr. D'Alessandro said he doesn't see how insurance pricing, could go anywhere but up. "The industry relies on investing in financial assets that are long term in nature to satisfy its obligations. So, we've got a period of downturn like this, there is income that's got to be replaced somehow."