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Interest rate environment could wreak havoc on long-tail claims


May 21, 2009   by Canadian Underwriter


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The current interest rate environment is a key systemic consequence of the credit crunch, the ensuing financial meltdown and the global recession, said Joel Baker, president and CEO of MSA Research Inc.
Baker spoke at a Property Casualty Underwriters Club luncheon in Toronto on May 20.
A major downside of the current, near-zero percent interest rate is that long tail claims — like those of the liability business — will have to be reserved at a higher level now, Baker said.
“For example, a $100 claim that you can expect to pay out in 10 years from now could have been reserved at $60 when interest rates were relatively high,” he said.
“With very low interest rates, the same liability will have to be carried at $90 — a huge hit.”
Insurers need to internalize this reality as they price long-tail risks in the current interest rate environment, Baker continued.
He noted that 80% of Canadian insurers’ investments are in bonds, roughly 70% of which are government bonds. “Interest rates in Canada are said to remain low for the next year, however they will eventually go up,” he said. “And when they do, the value of the bonds held by insurers will go down.
“The climb out of this fixed-income trap will be long and unrewarding.”
For underwriters, this means that in order for insurers to achieve acceptable rates of return on their capital, they have to consistently achieve combined ratios in the mid-80s.
“Personal lines writers are currently running at 106% combined, commercial writers at 102% combined,” Baker said. “The distance from these to the 80s is not really bridgeable in my view,” without rate significant rate increases and decreases on claims costs.


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