Insurers buoyed by a benign year for catastrophes, rising premiums and subdued claims inflation may find the business outlook is about to become more challenging.

Finity Consulting describes last financial year as a bounce-back period. The insurance trading result grew to a healthy 16% and the industry’s return on equity (ROE) increased three percentage points to hit the elusive 15% target for the first time since 2014.

But Finity’s annual Optima report does not see the industry climbing to even greater heights. Instead it provides a cautious outlook, with ROE possibly below the target level in the next few years.

“I think we will see we are coming off a high point for returns in 2017/18, but it is not falling off a cliff,” Finity Principal Andy Cohen told insuranceNEWS.com.au.

Large reserve releases, particularly in compulsory third party, have bolstered returns in recent years but will inevitably decline, while claims inflation may tick up next year.

An unusually benign period for natural disasters was a bonus last year, with Insurance Council of Australia-declared catastrophe losses reaching about $620 million, about one-third of the long-term average.

The Bureau of Meteorology last week flagged a 70% chance of El Nino developing in the next few months, which typically increases the drought and bushfire threat in the south while reducing the likelihood of tropical cyclones in the north.

On balance, El Nino is generally associated with better claims outcomes for insurers nationwide, but it is still unlikely last year’s favourable experience will be repeated.

The industry’s main tailwind is the hardening commercial market, although Finity says significant multi-year rate rises are necessary to bring commercial short-tail classes back into the black.

Commercial motor premiums are tipped for a second year of 10% growth, shifting the business class’ profitability outlook to “poor” from “loss-making”.

Corporate property is achieving gains of 7% overall, with increases focused on high-risk locations and industry groups as some insurers develop more quantitative and granular pricing approaches.

Business package premium growth picked up to 6% and a similar pace is expected as insurers seek to return the class to profitability. “If the current price increases continue, we would expect this class to meet target profitability within 2-3 years,” Finity says.

Challenges will come from new entrants. Insurers need to improve pricing sophistication and ensure they have a clear view of profitability in different distribution channels, and have a longer-term strategy for engaging with customers across the multiple options.

Standalone liability was one of the few commercial products to achieve target profitability last year, although it may lose ground a little with increased claim pressures.

In financial lines, professional indemnity is performing in line with targets, while directors’ and officers’ continues to be a market in turmoil. Rate rises of 20-400% were quoted for June renewals, and further material increases are expected.

“One can only expect that further claims pressure will arise from the financial services royal commission, privacy regulation, workplace exploitation, child sexual abuse, and now the [forthcoming] aged care royal commission,” Finity says.

Management liability cover for small and mid-market businesses is also vulnerable.

Private motor, which accounts for one-quarter of industry net premium, rebounded last financial year with strong premium growth and contained claims inflation, while householders’ insurance, which is highly susceptible to weather events, benefited from the catastrophe environment.

Regulatory impacts arising from the Hayne royal commission are still unclear, but Mr Cohen says it is likely general insurance will be affected by changes in response to misconduct elsewhere in financial services.

“We think the general insurance industry will get caught up in any legislative or regulatory reaction to what is happening in the life industry,” he says.

The royal commission follows a number of other inquiries and measures, such as new product distribution rules, that have required additional focus and resourcing.

The Optima report also highlights shifts in market share, and the emergence of increasing competition to major players in the commercial space.

IAG, Suncorp, QBE and Allianz accounted for 68% of all gross written premium last year, down from 74% six years ago, while rival commercial insurers represented 16% of the market after holding about 14% for the previous six years.

“While for the past few years the large insurers have shed market share to smaller personal lines challengers, it appears that this year it has been their commercial portfolios that have not fared as well,” the report says. “This is not surprising given their commercial portfolio remediation over the past year.”

Overall, market participants are likely to continue benefiting from an improved pricing environment, even as they face plenty of other challenges.

“We still see rate increases coming through, particularly on commercial short-tail, which will help the industry, but we have some headwinds,” Mr Cohen says.