In late October 2019, the Federal Reserve announced they would lower the Federal Funds Interest Rate by a quarter of a percent. This was the third such decrease of the year. What impact does this have on the commercial property & casualty insurance market and the annual premium paid by a business? In general, when interest rate falls, insurance premiums tend to rise. The rationale behind this is tied into the two ways that commercial insurance companies typically generate revenue; Underwriting Operations and Investment Activities.
Underwriting operations account for most of the revenue of an insurance company, Simply put, it is collecting enough premium dollars to pay for claims and operating expenses, with enough left over for a reasonable profit. To supplement the underwriting activities, insurance companies will invest that premium to attempt to earn additional revenue.
When premium is paid by a business to a commercial insurance company, there is usually significant lag-time between premium collection and payment of a claim (weeks, months or sometimes even years for some liability and property claims). Insurance carriers take advantage of this lag-time by investing those premium dollars. Consequently, when interest rates are low, insurance companies expect lower investment profits. With these lowered expectations, the underwriting department feels more pressure to operate profitably, and thus the trend for premiums to rise. For an in-depth analysis of your current insurance program, contact us here.
*Please note that while there are many factors that go into premium determination and pricing models developed by insurance companies, the above is the commonly accepted principle regarding the impact of interest rates on the insurance market.