More work needs to be done if still-existing shortfalls in the profitability of the non-life insurance market are to be redressed, despite modest premium rate hardening since late 2017, according to the latest sigma report from the Swiss Re Institute titled "Profitability in non-life insurance: mind the gap".
Most major markets remain in a phase of below-average profitability. The decline in profitability of recent years reflects the soft underwriting cycle, weak investment performance, and the high level of capital funds.
Sector ROE slipped further to 6% last year, from 7% in 2016 and the roughly 9% achieved annually between 2013 and 2015.
The sigma estimates that underwriting margins need to improve by at least 6 to 9 percentage points in the major western markets, by 5 points in Japan, and by 1 point in Australia and China if insurers are to deliver an acceptable return to investors in the future. The assumed target return on equity (ROE) ranges from 10% for mature western markets to 15% for China, partly reflecting differences in interest rates and past performance.
The current economic momentum will benefit future profitability through higher interest rates and investment returns but it won't be enough to close the gaps, says the report. At the same time, tighter labour markets are expected to push up wage and claims inflation. Thus, premium rates need to increase more than claims trends to achieve sustainable improvement in profitability.
2017 cat season may have triggered an inflection point
Underwriting conditions are still soft in 2018, particularly in commercial insurance, but seem to be passing through an inflection point. This is on account of the large hurricane losses in 2017 which set the stage for a price correction. Commercial line premium rates started to rise at the end of 2017.
"The catastrophe losses in 2017 sparked a modest change in market dynamics", said Mr Edouard Schmid, Swiss Re Group Chief Underwriting Officer. "However, it remains to be seen how strong and sustainable the market firming is. Rate increases for accounts and commercial lines of business not affected by the catastrophe losses, for instance, have been below initial expectations." In personal lines, there has been moderate rate hardening in several key markets for a few years already.
Economic developments alone will not close the profitability gap
Underlying economic growth improved strongly in 2017, and this is expected to continue in 2018, putting upward pressure on inflation and interest rates. Central banks in many countries are already withdrawing monetary stimulus to ward off overheating. This signals a changing operating environment for non-life insurers.
"Under the current stronger economic conditions, we expect interest rates in mature markets to continue to rise moderately, which should support insurers' earnings through higher investment returns", says Jérôme Jean Haegeli, Group Chief Economist at Swiss Re.
However, "macroeconomic developments alone are unlikely to generate sustained improvement in non-life sector profitability. The trend of declining investment yields has bottomed but at the same time, the increase in long-term interest rates that we foresee is not substantial."
Moreover, tighter labour markets are projected to push up general and claims inflation, creating an offsetting effect on profitability. The accelerating claims inflation will have the added impact of eroding the adequacy of claims reserves and further affirms that, in order to achieve sustainable improvement in sector profitability, insurance premium rate increases in excess of rising claims trends will be needed.
The pressure on insurers' profits has heightened interest in innovation. Investments in technology have led to efficiency gains and compressed margins for the distribution system of commoditised business, and in some lines also to lower claims costs.
Initially, the benefits for insurers’ profitability are clouded by the gains being partially passed on to consumers, and also by the cost of the investment. In the long run though, investments in data and advanced analytics improve underwriting and insurability of increasingly complex commercial risks, be it through improved affordability, access or better ability to underwrite new and hard-to-quantify risk.