By Dan Eisner, Employee Benefits Advisor
A number of years ago I had the opportunity to attend an insurance seminar which focused on bringing together three of the top reinsurance underwriters from around the world to share their perspectives on the state of the market. Note that reinsurers are effectively insurance companies that provide insurance to insurance companies to help spread risk. While that seminar focused on the general insurance industry, I believe the findings apply equally to the employee benefits industry. These reinsurers shared with attendees a concept that they called the “Cycle of Stupidity” as it pertains to underwriting and insurance pricing and what I learned that day has stayed with me for years and seems to be very relevant as of late in the employee benefits industry.
Essentially their concept focused on aggressive marketing efforts by insurance companies during times of strong investment market returns versus sound long term underwriting, where premiums equate to the cost of claims plus the cost to run the insurance plan. So long as the insurance companies can make investment returns on their “reserves” in a strong investment market, they can essentially price their insurance products at a loss (based on the true underwriting cost) in order to secure more business. The idea sounded quite revolutionary but these underwriters were able to support it with lots of empirical data showing that, at that time, the general insurance industry had not run an underwriting gain in quite some time. Intuitively it makes sense – secure more business (even at a loss) to gain access to more revenue and required insurance reserves that are invested to offset the underwriting loss.
This appears to have been true these last couple of years as we have experienced strong investment markets, prior to COVID-19, and as the “Cycle of Stupidity” suggests, we saw very aggressive quotes that were clearly unsustainable, when employee benefits plans were marketed. Depending on the group being marketed, we saw quotes that were generating anywhere from 20% to 30% up-front savings for the plan sponsor. Sounds very much like the “Cycle of Stupidity” described above. Unfortunately, many employee benefits plan sponsors may not have fully understood what was going on when they marketed their plan, only to experience a significant increase in premiums at renewal.
At the end of the day, your employees combined with your plan design drive your claims and thus your benefits plan costs. There can be slight differences between insurance companies in terms of the expense charges they apply within their underwriting processes and their rating of the life and disability risks of your employees. However, the differences between insurers from a pure underwriting perspective are often relatively small, in the range of 5%, as compared to the 20-30% savings that we saw quoted, and thus those quoted savings would not be sustainable.
Insurers typically provide significant “marketing discounts” up front to win your business which drive underwriting losses. These discounts then evaporate over the first two renewal years as the insurer works to eliminate the underwriting loss. So it is important for plan sponsors to understand what portion of the quoted savings are actually sustainable. Benefits advisors should be quantifying the “real savings” in the long term versus the short term marketing discounts. Without this internal information, plan sponsors will certainly be questioning annual renewal increases of 15% to 30% and they will often have forgotten about the savings that were generated a couple of years prior.
Now we find ourselves in the time of a global pandemic and the uncertainty that has come with COVID-19. Just as everything is changing for us in our personal lives, everything is likely about to change in the insurance industry, particularly with the short term changes in claiming patterns driven by reduced dental and other practitioner services. We are entering into a new phase of the “Cycle of Stupidity” and employee benefits plan sponsors should expect changes. For those groups that benefited from short-term marketing discounts, you should expect to see them evaporate sooner rather than later given that insurance companies are dealing with the significant losses experienced in the investment market. All other plan sponsors should expect to see pressures on the renewal rates as underwriters will need to move towards more appropriate pricing (to achieve an underwriting gains) while the investment markets are in turmoil. For those plan sponsors that were looking to market their benefits plans, it is an uncertain market – some insurers may still look to be aggressive in order to gain market share but others may have to re-evaluate their underwriting programs to drive profitability.
The results will certainly vary by organization for any plan marketing but the key message here is that plan sponsors should be aware that we appear to be in the midst of a critical transition in the “Cycle of Stupidity” for the employee benefits industry. You may still benefit from aggressive quotes from insurers but, given that the “bull” investment markets appear to have come to an end, insurers will ultimately have to refocus on underwriting profits and we could see a significant reversal and increase in employee benefits plan costs.
Here is a special note for small and medium size businesses (i.e., less than 50 employees). You have a choice to continue to participate in the “Cycle of Stupidly” working direct with an insurance company or you could consider having your plan priced through a “Pooled Buying Consortium” program as there may be significant benefits. These programs allow plan sponsors to customize their employee benefits programs, reduce the cost of benefits by leveraging the size and savings of the Buying Consortium, and stabilize pricing from year to year through a pooled rating methodology. At ZLC Financial we have brought together the significant purchasing power of approximately 250 plan sponsors within our proprietary small business solution and have taken this group to the insurance industry as one client to achieve a better deal resulting in sustainable savings.
We would be pleased to discuss your specific situation with you to identify the best strategy with respect to your employee benefits and retirement programs. Should you have any questions on the above, please don’t hesitate to contact me or a member of our team.
This information is designed to educate and inform you of strategies and products currently available. As each individual’s circumstances differ, it is important to review the suitability of these concepts for your particular needs with a qualified advisor.