Mystery of life insurance companies

Since their earliest days, life insurance companies have been some-thing of a mysterious black box to analysts, advisers and the public.

The mystery of the life insurance company can make life difficult for financial planners looking to select the best insurance policy for a particular client. For instance, how can an adviser determine whether a company will sustain these products at the leading edge for the long term, while having the cheapest life insurance rates or the best disability qualif

By Simon Solomon

Since their earliest days, life insurance companies have been some-thing of a mysterious black box to analysts, advisers and the public.

The mystery of the life insurance company can make life difficult for financial planners looking to select the best insurance policy for a particular client. For instance, how can an adviser determine whether a company will sustain these products at the leading edge for the long term, while having the cheapest life insurance rates or the best disability qualifying conditions? The very nature of a life company means that information on reserve strengths, expense rates and prof-itability does not emerge naturally, nor is it easy to understand when it does emerge. This makes the job harder for financial advis-ers, who need to understand how sustainable various life products are.

Similar problems arise for the investment analyst. How can one ana-lyse the profitability of life products or project the future profit-ability?

As consulting actuaries and analysers of life insurance offices, Plan for Life is critically interested in understanding these issues. We are also acutely aware of the

the need to provide an incisive service to the life companies who are our clients, as well as to advisory firms and rating agencies, who have to form an evaluation of the companies they deal with.

In order to meet these demands, we set ourselves a task 15 months ago of developing, extending and maintaining a set of key benchmarks, which would make the job of interpreting life companies crystal clear. In doing this, we worked closely with 17 life companies, ob-taining data and feeding back each company the results of our analy-sis.

Two critical benchmarks are well worth considering when looking at the sustainability of pricing and features for life insurance prod-ucts. These are the excess asset ratio and expense ratio.

Excess assets simply means the amount of free assets that the life insurance company has available to meet unexpected contingencies or sudden shocks, such as very high claim rates, extraordinary expendi-ture or development of new products and markets. Using an industry standard factor of 1.00 as the benchmark, we found that in the year ending December 1997, the 17 companies in the study had individual excess asset ratios which varied from 0.22 to 1.89 (the higher the ratio the better).

In other words, some companies were well above the industry average and others were well below it. All of these companies complied with the ISC (now APRA) requirements for free reserves and assets, but the degree of this excess varied widely. While judgment on the life com-pany's sustainability (its ability to sustain particular products or business operations) should certainly not be made solely on the basis of this one factor, it does provide a powerful insight into each com-pany's financial strengths.

Expense ratios, which compare each life insurance company to an in-dustry standard of 1.00, also have been developed. These tell us how efficiently the company is processing its policies (for new and re-newal business). In this case, the lower the ratio the better. The ratios range from a low of 0.48 to a high of 1.32. Again, these ra-tios must not be judged on their own, but when coupled with the ex-cess asset ratio, an increasingly rounded view of the company emerges.

As we add other key benchmarks, it will become possible for rating agencies to develop their methodology for better rating and the crea-tion of sound sustainability factors.

Until we can objectively judge factors such as these, we will not get a full picture of how sustainable individual life insurance products are. And until we are able to do this, advisers will remain in the dark about the real choice they are making for their clients. Ulti-mately, life insurance companies, advisers, analysts and customers will benefit by being able to peer into the black box and form proper opinions based on fact.