2020 has been an “annus horribilis” for many nations, and as a new report shows, Australian insurers have not been immune from its impacts.

Finity’s annual state-of-the-industry Optima report shows insurer return on equity (ROE) collapsed to just 4% in the last financial year – down from 13% the previous corresponding period.

“After three good years in a row, the luck ran out,” Finity says. “This is the lowest industry ROE in over 20 years.”

Many might assume almost $6 billion in claims from the bushfire-ravaged Black Summer and unprecedented disruption from the global COVID-19 pandemic are the cause.

But while they undoubtedly contributed, they are not the main offender. Instead Finity points the finger primarily at flagging investment returns, which “tell a sorry story”.

“Total investment return fell by two-thirds to $1 billion (by far the lowest level over the past decade). This lopped 8.5 points off industry ROE and was the major driver of the FY20 profitability collapse.”

Top-line growth was “reasonable” in FY20, but Finity explains that while market hardening is in theory good for industry margins, insurers are essentially running in order to stand still.

“Much of [the hardening] was in response to ongoing claims inflation in property classes, which only serves to maintain, rather than expand, margins,” it says.

“In certain commercial lines classes, while rate increases are helping to push margins upwards, this is necessary to move currently poor profitability closer to target levels.”

Claims experience was two points worse in FY20 than FY19, driven by a combination of lower reserve releases and higher than average natural perils losses (almost double FY19 levels).

Expense ratios increased by one point and the combined operating ratio was 100% – three points higher than FY19 and eight points higher than FY18.

Finity predicts “a small bounce back” in FY21, but ROE will “languish” at about 7%, still some distance behind target, which Finity believes could be in the “low double digits”.

In FY21 premium growth is likely to be flat, “based on a combination of declining exposures offset by rising prices”.

Commercial lines will continue to lead the way on pricing, but the collapse of the travel insurance market is a “big blow” to industry premium volumes.

Claims cost inflation is expected to be more than offset by rating improvements leading to an improved underlying loss ratio in FY21.

But predictions are based on an “average” weather year. “The wildcard here is the recently identified possibility of a La Nina system over the summer,” Finity says.

And the issues with investment returns will continue.

“It is very hard to see insurers matching even the low returns made in FY20,” Finity says.

“Favourable returns from the industry’s small holdings of growth assets along with the credit risk margins earned on corporate bonds will be necessary for insurers to reach our forecast of an investment return of less than 2%.”

As a result, the pressure on underwriting margins will continue to mount.

Click here to see the report.