KARACHI, May 22: Insurance companies may have to charge higher premiums if the interest rates do not stabilize and they continue to get lower return on their short-term bank deposits.

Officials of insurance companies say the declining returns on bank deposits are bound to lower their investment earnings this year compelling them to charge higher premiums on fresh insurance schemes.

“Many insurance companies now have a diversified portfolio but almost they continue to keep temporary surpluses also in short-term deposits,” says a key official of Adamjee Insurance Company. He fears that falling bank deposit rates may force many insurance companies to charge higher premiums on fresh insurance schemes. “That is one sure way of making up for the fall in our interest incomes.”

In March 2003, the weighted average deposit rate of all banks combined fell to 2.81 per cent or 58 basis points lower than the consumer inflation of 3.39 per cent. The deposit rate fell to this shocking low as almost all the banks flooded with excessive liquidity made downward adjustments in lending rates.

Since the banks were forced to lower their lending rates after a massive cut in the yield on treasury bills and long-term bonds — 0and since the lower yield on bonds also triggered rate cuts in national saving schemes — the insurance companies are also bound to earn lesser returns from investment in government securities.

“This is a very disturbing situation,” remarks an official of another local insurance company. But he says whereas falling returns on bank deposits and government securities do threaten to erode investment earning of insurance companies the rising prices of equities may keep their overall investment income from falling too low.

Insurance companies in Pakistan — less than 30 in number — have learnt over the years to maintain a well-diversified investment portfolio. They do invest their funds both into quoted and un- quoted shares; government securities; term finance certificates; certificates of investment; mutual funds and bank deposits, etc.

Some of them also invest in physical infrastructure projects. Insurance companies officials say the soaring prices of equities

Low deposit return may take toll on insurance are not only going to enhance the face value of investments but dividend incomes would also add to overall investment earnings.

That is why whereas some officials fear that they may have to charge higher premiums on fresh insurance policies to make up for lower returns from bank deposits and government securities the others think it may not happen. “Not only overall investment earnings are going to stay where they are but the competition within the industry also does not allow us to make insurance policies more expensive,” argues official of a leading insurance company. But he says that with macroeconomic fundamental showing signs of recovery the insurance companies may see a surge in their business this year — and the volumes and not necessarily the rates of insurance premiums may rise.

Competition among insurance companies has intensified after 9/11 terrorist bombing on the US and consequent increase in reinsurance charges. The recently introduced laws by the Securities and Exchange Commission of Pakistan requiring insurance companies to be more disciplined and open have also advanced the case for the survival of the fittest.

Insurance companies with a market capitalization of more than Rs16 billion represent an important sector of the Karachi Stock Exchange with its overall market capitalization of Rs670 billion.