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Insurance industry profitability remains sound despite competition

Nov 08, 2007

"These levels of competition are also driving premium rate reductions," said Shane Fitzgerald, Senior Insurance Analyst at the launch of the JPMorgan Deloitte 2007 General Insurance Industry Survey.

He said, "Combined ratios in the commercial classes will continue to drive competition, constraining future top-line revenue growth and putting pressure on margins."

The survey revealed that premium rates in commercial classes fell by an average of 8% this year on top of the 9% reduction seen last year.

"Rates reductions across the various segments of the market were fairly consistent with commercial market rates falling on average by 10%, by 9% in the middle market and by 7% in SME," he said.

Industry participants nevertheless indicated that the loss ratio for the industry is better than expected and in line with what was reported in the 2006 survey.

"This has helped keep profitability levels attractive," said Deloitte partner, Elaine Collins, who co-launched the survey.

She said, "Although premium rates in the commercial lines have continued to fall, the survey does not show a commensurate deterioration in profitability with the level of rate reductions."

She explained, "It would appear that this buoyancy in commercial lines is due to some extent to support from reserve releases which, with hindsight, were conservative, although they may not have appeared so at the time. Underwriters for instance are all at different stages of their reserve release cycle and in some cases, their prior period reserve releases are supporting the current results."

Nevertheless the market is expecting loss ratios to deteriorate, possibly as reserve releases start to expire.

"One of the challenges facing the underwriters is how they manage the pace of reserve releases," said Fitzgerald.

"As the gap between accident year and financial year profitability continues to widen, even if premium rates turn in two years time, it could take considerably longer for the gap to close, particularly as the time lags involve movements in premium rates and their impact on profits.

"It is far more likely that the true sustainable profit base of the industry is somewhere in between current financial year and accident year profitability.

"The critical issue is that accident year results recover back up to the same level of financial year results before the reserve releases run out.

"Should the downturn in the cycle be more severe than expected or the recovery more protracted than anticipated, any excess reserves could run out before accident year results have recovered, which would see financial year results deteriorate materially," he said.

Fitzgerald pointed out that the next two years will be critical in the cycle. The survey shows that the industry expects the cycle to turn over the next two years.

He said in the past he has not agreed with the industry's general outlook but "this year we also expect the commercial cycle to turn sometime in 2009."

Expense ratios

Elaine Collins said that the industry had reported an essentially flat expense ratio relative to last year. "This year's ratio came in at 27% compared to 26% in the 2006 JPMorgan Deloitte General Insurance Survey. It is interesting to note that many in the industry indicated that they still have room for efficiency gains with underwriters intending to obtain efficiency benefits from distribution, IT and claims handling procedures in the coming year.

"In agreeing to make their underwriting processes more efficient, insurance companies are investing significantly," she said.

"They need the tools and technology to support their growth plans and at the same time they are looking for ways to reduce costs.

"In this cycle, insurers and more particularly underwriters are under significant pressure to meet bottom-line targets through containment of claims and expense ratios," she said. "They are considering and accessing more sophisticated strategies such as a more focused analysis of existing data which offers a "single client view" across the lines of business and geographies. This will help considerably," Ms Collins said.

The most important issues affecting the industry

This year the JPMorgan Deloitte General Insurance Industry Survey asked survey respondents to nominate and rank the five most important issues impacting their business. Two issues were raised with equal frequency, the lack of skilled staff and the highly competitive environment.

Skill shortage: A number of underwriters noted that a tight labour market has made it increasingly difficult to attract and retain skilled employees. With unemployment in the Australian economy at a 33-year low, it is expected that the skills shortage would remain a primary concern to the industry.

Competition: The high level of competition continues to be an issue. This observation is demonstrated in each of the commercial lines of business where premium rates remain under downward pressure. A number of underwriters have again indicated that pricing is at unsustainable levels with price led competition now appearing in the traditionally more stable personal lines. Underwriters have also noted that the industry would benefit from more consistent pricing. Some respondents have indicated that the industry would benefit from longer term pricing rather than short term, growth-driven pricing.

Fitzgerald noted that "some of the underwriters in the survey are still generating attractive combined ratios, whereas others are experiencing very poor combined ratios. As such, there is a risk that while some underwriters will be seeing the need to lift premium rates, this view will not be universally shared across the industry."

Regulation: Respondents noted that increased regulation remains a financial burden with some commenting that the industry had become overregulated.

Climate Change: Climate change has become a more dominant issue in the minds of underwriters, with a number of respondents noting the increase in the frequency and severity of weather related events. The industry has noted that the availability of accurate data is a roadblock in accurately pricing flood cover. A number of underwriters have called for the Government to set up a pool to cover future flood losses and top up potential flood claims costs.

Deloitte notes that approximately $1,500 billion of Australia's wealth is locked up in homes, commercial buildings, ports and other physical assets (ABS, 2002) which is equivalent to nine times the current national budget or twice Australia's gross domestic product. The insurance industry currently underwrites the risk to the bulk of these assets from weather events, but climate change is threatening its ability to do so as effectively in the future.

Elaine Collins said that "the effect on Australia from climate change is quickly becoming a social, economic and political issue."

With more than 80% of Australia's population living within 50 km of the coast, concentrated in towns and cities along the coastal fringes of the east, south-east and south-west, floods are Australia's most common and most costly natural disaster and, over the past three decades, the cost of all flooding in Australia has ranged between $2.5 billion and $4 billion per decade.

Elaine Collins noted in her article in the report on Climate Change: its impact on insuring flood risk that the general insurance industry is investigating the collective development of a national flood mapping tool. This tool will be employed by all insurers to test the risk applicable to an insured's property and enable the insurer to offer flood cover if the risk is within its own calibrated limits. The responsibility for implementing the various methods of minimising flood risk according to Deloitte remains with four main groups namely, government, insurance regulators, insurers and property owners.

The JPMorgan/Deloitte 2007 General Insurance Survey outlook in summary

1. Industry profitability has deteriorated but remains attractive - The industry's overall combined ratio has increased from 91% in 2006 to 94% this year. However, combined ratios in the commercial classes remain attractive and as a result will continue to drive competition.
2. Premium rate in the commercial classes remain under pressure - Premium rates in the commercial lines have fallen by an average of 8% this year on top of the 9% reduction seen last year. Attractive levels of competition continue to drive rate reductions.
3. Personal lines rate movements tracking in line with inflation - In personal lines, rates increased in all classes except CTP. However, rate increases were in line with claims inflation so on an inflation adjusted basis, rates are down slightly on last year. CTP rates in NSW were impacted by the introduction of the Lifetime Care and Support Scheme.
4. Market sees the cycle turning in two years - The market is expecting the commercial cycle to turn in 2009. The market has been expecting a turn in the cycle for the last two years but this time we are more willing to concede that a turn in the cycle is in sight but still around two years in the distance.
5. Reserve releases are supporting current results - Premium rates in the commercial lines have continued to fall but with no deterioration in profitability commensurate with the level of rate reductions.
6. In the Commercial classes reported profitability is strong, but accident year profitability is weaker - The gap between accident year and financial year profitability continues to widen. Even if premium rates turn in two years time the gap between accident year and financial year profitability could take considerably longer to close.
7. The profitability of the domestic motor and home markets looks stable, but for CTP less stable - in CTP the gap between financial year and accident year profitability remains significant.

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Acknowledgments

The report has been produced with the support of the Australian insurance industry. The insurance industry's support has been generous and is greatly appreciated.

About the JPMorgan Deloitte General Industry Insurance Survey:

The JPMorgan Deloitte General insurance Survey has for the past 15 years provided a detailed overview of the current state of the Australian general insurance industry, by the industry, for the industry and covers the industry's expectations of the way ahead.

The report delivers critical information on the key elements of the industry from direct underwriters, reinsurers and brokers, including:

• detailed product information for the current period and industry expectations for the next two years covering issues such as premium rate trends, capacity changes, claims inflation, loss and expense ratios
• perceptions of product profitability
• distribution trends
• broker's perceptions of underwriters.

This year the Survey also gauges the industry's view of the impact of regulation and insight into those areas which insurers expect to obtain operating efficiency gains. Survey participants were also asked to comment on coverage of minimum regulatory capital requirements.

The Survey also provides editorial comments from JPMorgan and Deloitte on key industry issues as a commentary on industry developments to compliment the survey results and respondent feedback.

Sources of Information
All of the information in the report is sourced from a survey of the major underwriters, reinsurers and brokers in the Australian general insurance industry. JPMorgan and Deloitte estimate that the survey's participants account for more than 75% of the total industry, thus making the document a comprehensive review of the industry's expectations.

* Combined Ratio is losses plus expenses divided by premiums used by the industry to measure profitability

About JPMorgan

JPMorgan Chase & Co. is a leading global financial services firm with assets of $1.5 trillion and operations in more than 50 countries. The firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, asset and wealth management, and private equity. A component of the Dow Jones Industrial Average, JPMorgan Chase has its corporate headquarters in New York and its U.S. retail financial services and commercial banking headquarters in Chicago. Under the JPMorgan, Chase and Bank One brands, the firm serves millions of consumers in the United States and many of the world's most prominent corporate, institutional and government clients. Information about JPMorgan is available on the Internet at www.jpmorgan.com.au

About Deloitte

Deloitte is a member of Deloitte Touche Tohmatsu (a Swiss Verein). As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms have any liability for each other's acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names "Deloitte," "Deloitte & Touche," "Deloitte Touche Tohmatsu," or other related names. Services are provided by member firms or their subsidiaries and affiliates and not by the Deloitte Touche Tohmatsu Verein.