The general insurance industry escaped the worst ravages of the global financial crisis, Australian Prudential Regulation Authority (APRA) says in its 2010 annual report.

But it notes general insurance still needed some close monitoring, despite having almost twice APRA’s minimum capital requirements at the end of the financial year.

APRA’s concern with general insurance includes profitability and the industry’s ability to withstand shocks.

The profitability of the general insurance industry came under pressure during the global financial crisis due to weakening premiums, severe weather events and tort law reform.

“Industry profits in recent years have been significantly boosted by higher levels of prior-year reserve releases that may not be sustainable and are masking the deterioration in underlying accident year loss ratios,” APRA says in its report.

“This deterioration has been driven by both premium rate reductions and adverse claims experience.”

APRA notes strong increases in premium rates for most classes of insurance will help improve profits in the future but insurers are subject to active market competition negating some of its potential growth.

This is being compounded by a number of new entrants providing web-based motor and home insurance.

Against this background of profitability pressures, APRA says it continues to focus its supervision of general insurance capital management.

“APRA has emphasised to insurers the importance of understanding the drivers of profitability and the linkages between them so that they are well placed to withstand adversity and grow their business,” it says.

“APRA has been closely monitoring trends in claims experience across major classes of business to identify potential and industry pressure points and areas that may warrant closer oversight.”

During the 2010 financial year, the regulator conducted a survey of stress-testing undertaken by general insurers and found there was “room for improvement”.

“Many insurers only tested for stresses on individual risk factors and did not consider a combined set of stress factors that would have a material impact on their profitability or capita position,” it says.

“The level of the stresses considered by insurers was often not sufficiently severe to reflect a genuine stress scenario.

“Stress-testing in the general insurance industry has become an area of increased supervisory focus.”

One area of general insurance APRA thinks carried significant risk is the lenders mortgage insurance sector, despite being a small segment of the overall market. APRA says the sector carries significant exposure to the housing market and the macro-economic environment.

“APRA has always kept the sector under close scrutiny and it heightened that scrutiny during the global financial crisis as major offshore insurers came under intense pressures, particularly in the US,” the report says.

“Despite the challenging global backdrop and a fall-off in premium income, insurers operating in Australia reported an improvement in underwriting and operating performance during [the] 2010 [financial year].”

And it believes rising mortgage rates have the potential to increase defaults, eroding the capital base of these insurers.

The regulator also notes that life insurance companies have also weathered the global financial crisis well coming out with improved profitability and strong capital reserves.

“Industry profitability returned to more typical levels with an improvement in fee revenues, higher investment income attributable to shareholders and continued strong growth in life insurance premiums,” the report says.

“Group insurance, largely through superannuation funds, now accounts for one-third of these premiums.

“Life insurance assets rose moderately due to the recovery in asset values rather than any significant increase in cash flows.”

“These moves did see the capital position of life companies return to pre-crisis levels,” APRA says.

“This development allowed APRA to ease the intensity of it supervision which has throughout the crisis been focused on the capital strength of the industry and its capacity to withstand adverse financial market movement.

“That capacity had been subject in 2008 to detailed stress-testing by life insurers and by APRA which identified the more vulnerable institutions requiring closer oversight.”

The rationalisation of legacy life insurance products and product complexity affecting pricing risks has also been a focus of the regulator.

“APRA welcomes market innovation, but has been emphasising to life insurers that the risk management framework about complex products must be sufficiently robust to address the capital, pricing and hedging difficulties that can be created,” it said.

“APRA continues to support the development of a core effective mechanism for the rationalisation of legacy products in the life insurance industry.”