By Dan Eisner, Employee Benefits Advisor
Actual Inflation or Insurer Trend Factors
As an Employee Benefits Advisor I have the unfortunate duty to annually let my clients know about the costs of their employee benefits programs. And the reason I say “unfortunate” is that over my 17 years in the industry I have yet to see a year where we saw deflation and rate reductions across the industry. Instead we have seen actual inflation for Extended Health benefits run anywhere from a low of 4-5% between 2010 and 2015, when the majority of brand name drugs in Canada lost patent protection, to a high of around 15%, around 2002 when most provincial governments downloaded paramedical and other coverage to deal with government deficits. On average it has run between 6% and 12%.
The numbers referenced above are historical inflation levels but the insurance industry for employee benefits is based around the concept of “prospective rating”. Essentially we try to look in the crystal ball and project what the cost of claims will be in the coming year (incorporating inflation) and then determine what premiums are needed to pay those claims. As such, all insurers develop their “trend factors” to estimate future inflation but do those factors actually resemble true inflation?
Based on our recent experience, Canadian insurers are expecting Extended Health plan costs to increase by 10% to 12% for 2019, based on the trend factors they are using in their renewal calculations. We note that these trend factors have remained relatively steady for over a decade with few small deviations. But how do these insurer trend factors, used to develop insurance rates charged to plan sponsors, actually compare to projected inflation? As per ZLC Financial’s inflation projection for 2019, we are projecting inflation of only 6% to 10% for Extended Health, which is a relatively significant difference given the costs involved (Extended Health is usually 40-50% of the total benefits plan costs).
You may ask, what is going on here and why the big differences and what does it mean for you as a plan sponsor? Firstly, remember that these trend factors are used by insurers to develop their “proposed” rates and these can be subject to some analysis, differences of opinion and negotiations. Insurers may agree to negotiate lower rates depending on the arguments put forward by advisors working on behalf of plan sponsors, but, based on our experience, they will never admit that their trend factors are overstated. As such, the underwriting strength of your advisor is vitally important.
So why do insurers do this? The simplest answer is profit, which also means managing risk as an insurer. If they develop and use overly conservative (higher) trend factors, they develop higher proposed premium rates, which is their revenue base. This might sound like an appropriate business strategy to manage risk but insurers are already paid for that role, as an insurer, within their expense and profit charges, which are also built into premium rates. So it is likely more about “padding” the rates to insulate against unforeseen volatility, but isn’t that what they are meant to do as a core business model?
The intent of this article is not to vilify insurers or the broader insurance industry. Arguably, all businesses have differences in the “margins” charged to different customers, and that is essentially what the insurers are doing here. Those plan sponsors that have a strong advisor in their corner can typically do better than the broader market and negotiate lower rates. To do so, advisors need to arm themselves with an equivalent level of underwriting skills, market data and industry experience in order to speak the same language as the insurers and do battle on their terms.
At ZLC Financial we are proud to have one of the most experienced advisory teams in BC, almost 300 years of experience amongst our team of 16 specialists. Within that team, we have almost 100 years of experience working within insurance companies in leadership and underwriting roles. Our team has experience working on the insurer side and the plan sponsor side of the business, in addition to extensive experience as advisors. We have our own underwriting team and stay abreast of all industry issues impacting the underwriting of employee benefits plans.
Each organization’s needs are unique and warrant a customized solution. We would be pleased to discuss your specific situation with you to identify the best strategy with respect to your employee benefits program. 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.