Study Says Life Insurers Overhead Expenses Spurted In 2001

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U.S. life insurance companies overhead expenses were 11.3% of direct ordinary life premium income in 2001, a significant increase from the average of 10.7% in 2000, says a recent study by Milliman USA, Seattle.

At least part of the increase was due to a significant downtrend in the face amount of life policies issued during the year, a Milliman spokeswoman says. In general, Millimans study found, there were only slight cost increases in 2001 for companies of all sizes over average 2000 levels.

The study defines overhead expense for life insurers as the difference between general insurance expense and variable costs.

General insurance expenses increased about the same percentage as in prior years, notes Susan L. Hunt, a co-author of Millimans overhead expense analysis.

That would mean expenses did not fall fast enough to compensate for declining sales, Hunt notes. “Maybe the industry has become too reliant on fixed costs,” she concludes.

Among the findings of the study was a significant difference between the overhead costs of firms selling through career agents and those selling through independent agents. There was a similar overhead cost gap between mutual companies, which are owned by policyholders, vs. those of publicly owned companies.

However, some experts in the field suggest such disparities may be a case of comparing oranges to apples.

For all insurers studied, the average companys overhead expense ratio was 231% of variable expenses in 2001, Milliman found, up from 215% in 2000. This ratio had previously ranged from 205% in 1996 to 218% in 1998 and 1999.

As in its previous studies of insurer expenses, Milliman found that overhead expenses as a ratio of premium was on average significantly higher for insurers distributing through career agencies than for those distributing through personal producing general agents (PPGAs) and brokers.

For career agency companies, the weighted average of overhead expense was 13.6% of premium in 2001 for ordinary life policies (excluding single-premium income), up from 12.5% in 2000. For PPGA/broker companies, this average was 9% of total direct premium income, up from 8.1% the previous year.

Hunt believes much of the difference stems from the fact that many career agency expenses go through the parent company, including office expenses and other support. Firms selling through PPGAs/brokers instead cover some of those costs by paying a higher commission rate.

Experts differed on the possible reasons for the mutual company/stock company differences. Those differences hold true when distribution systems and company size are considered, Milliman notes.

For instance, among large companies (over $100 million in ordinary life premiums), the overhead expense as a ratio of total direct premium income was 6% for 74 stock companies studied vs. 14.7% for 54 mutual firms.

Looking at medium-sized companies (between $25 million and $100 million), Milliman found a 10% expense ratio for 64 stock firms in 2001 and 15.7% for 49 mutual firms.

For small companies (below $25 million in premium), the expense ratio was 17.4% for 53 stock companies, while for 21 mutuals, it was only slightly higher–18.2%.

A spokesman for one large mutual declined to comment. Calls seeking comment from several other mutual companies and former mutuals that recently converted to stock companies were not returned.

Experts were uncertain about the reasons for the mutual/stock company disparity, but most believe the differences were due to distinct ways in which costs are accounted for by the two types of firms.

Hunt notes that Millimans analysis, which is based on figures released by insurers to state regulators, does not always clearly point to reasons for changes for year to year.

“We dont have enough information from the public data to see which specific expenses have increased,” she explains.

For that reason, the causes of the differences between stock and mutual companies are unclear, says Hunt.

She adds, however, that much of the difference may actually be due to the recent trend for mutual companies to go public.

“Demutualization is an expensive process,” she notes. “Theres a lot of consulting work and a lot of data-gathering involved,” all of which drive up their expenses in the period immediately before demutualization, she says.

One observer says he suspects a possible conclusion from the data is that stock companies are more efficient than mutuals because they have to answer to shareholders.

“I would think stock companies are more in tune to watch expenses, vs. traditional mutual companies, where management only has to answer to itself,” says Peter M. Wilson, president of Mystic Insurance Intermediaries, Hartland, Wis.

Other experts think different factors may be at work.

Julie Burke, managing director, Fitch Rating Service Inc., Chicago, says a likely reason for the disparity was the holding company structure of many stock companies, which is seldom used by mutual insurers.

“Often, [stock company] expenses are assigned to the holding company, but for mutuals, all costs are absorbed at the parent company level,” Burke says.

“Its hard to determine what might be the true discrepancy” between the two types of companies, says Cynthia Saccocia, senior analyst, TowerGroup Inc., Needham, Mass. “It could be a couple of things–for example, the costs associated with servicing their different kinds of customers. In addition, stock companies had to forge ahead and reduce operating costs to address needs of Wall Street. Mutual companies dont have the same pressures.”

Another issue may be mutual companies imposing stricter underwriting rules, says Saccocia.

“Mutual companies need to provide value for policyholders and traditionally are more conservative in pricing and underwriting risk.”

Then, too, she adds, perhaps stock companies tend to focus less on insurance because they usually offer a variety of other financial products. “If we look at firms that have demutualized, they have done so to become more diversified,” she says.

Thomas Upton, an insurance company analyst with Standard and Poors, New York, points out, too, that some expenses that mutuals classify as operating expenses are classified as commissions by stock companies.

Hunt says many of the companies Milliman categorized as mutual insurers have since demutualized. For consistency of data, Milliman includes in its mutual company data any firms that demutualized after 1995.

Millimans own analysis found that when data from the three largest mutual insurers are left out the study, the differences between the two types of companies are reduced.

With the top three mutuals excluded, the weighted average expense ratio for all large life companies was 8.9% and 11.8% for large mutuals.

Looking at just the 20 largest companies, the expense ratio average was 12.6%, compared to 8.4% for the same group without the three largest mutuals, Milliman says.


Reproduced from National Underwriter Edition, May 5, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.