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Industry faces an economic storm

A new report by actuaries Finity Consulting and Deutsche Bank is the latest sign that the pressure is increasing for premiums to rise at a faster rate.

The global economy is slowing, inflation is growing and the rate of insurance claims growth is overtaking inflation.

While it’s not the job of insuranceNEWS.com.au to “talk up” the market – we’ll leave that to the experts – there’s increasing evidence that rates do have to keep rising.

The Finity and Deutsche Bank report is a bleak assessment of the industry’s immediate prospects, citing in particular their apprehension about margin pressure.

Pendulum 2008 predicts insurance trading margins will fall to 18.7% this year, 15.8% next year and the same amount in 2010. Deutsche Bank analyst James Coghill says the report’s compilers “can’t see a recovery in margins at all, particularly for the large general insurers and especially for Suncorp and IAG”.

The report suggests QBE is the only insurer with an established track record of trimming portfolios and forfeiting growth to maintain margins. QBE is also in the best position to take advantage of the turning economy.

Contrast that with the predicament of IAG CEO Mike Wilkins. He’s committed to still deliver a full-year insurance margin at the low end of the projected 6-8% when he reports IAG’s full-year financial results next month. However, the report expects IAG’s margin will grow to 10% over the next financial year.

The pressure on rates is coming from all sides. Indirect factors driving up inflation – such as fuel and commodity prices and trade skills shortages – are another significant factor in pushing up claims costs. This is regardless of whether increased storms and weather events continue this year and next year.

The Finity/Deutsche Bank report shows claims inflation is “spreading its tentacles” as the average claim size increases. Weather-related building and contents claims rose 32% and 27% respectively last year while non-weather claims only rose 10% and 7% – yet still at a rate well above the consumer price index.

The biggest risk factor for Australian insurers remains catastrophe losses, which could be particularly damaging for Suncorp with its exposures in Queensland.

The recent reliance on reserve releases to boost returns to shareholders may also be coming to an end. Releases this year – predicted to be $1.2 billion– are not as high as last year’s $1.8 billion. Mr Coghill, for one, believes CEOs are now showing “a strong element of caution” about reserve releases.

He says analysts “have a very strong view that releases are going to run out in the next year or two”.

“Suncorp is still dependent on quite a substantial release,” he said last week. “It will struggle to meet its forecast unless it drops its reserve release; but at least it has that option – IAG isn’t able to do that.”

But shareholders shouldn’t complain. The report says that apart from losses experienced this year, returns on equity will be up 15% in 2009 and 2010.

Deutsche Bank also believes this year will see higher growth in gross written premium (GWP), with forecasts of 5% across the industry due to rises in personal lines and “sound underlying exposure growth”.

GWP growth in 2009 and 2010 is expected to accelerate even further, which may be optimistic given the slowing economy. But it’s also not impossible – average top-line growth above 10% has been achieved at previous turning points in the cycle.

In summary, the industry won’t be able to avoid many of the negative impacts of a slowing – and perhaps stalling – global economy, coupled with increased climate risks. Competitive behaviour is one thing, but the gathering storm may have to be met with a sharper response on premiums. Their response to these challenges may well dictate their future places in the market.