The good times are becoming little more than a memory for the Australian insurance industry, and dealing with a more difficult economic environment is proving no simple task.

Investment returns have slumped, premium growth is barely keeping up with inflation due to competition and surplus capacity, and cutting expenses is a work in progress.

The industry has averaged a return on equity (ROE) of 15% in the past decade, but this profit measure likely struggled to reach double digits last financial year, according to the latest Pendulum report from Finity Consulting and Deutsche Bank.

An ROE of about 10-12% is forecast for this year.

Insurance industry investment income has taken a hit due to interest rates that are at record low levels and seem unlikely to gain ground soon.

“The long-term view for interest rates is they are going to be in the low single digits,” Finity Consulting Principal Andy Cohen tells insuranceNEWS.com.au.

“So if you are an insurer, and you want to get margins and ROEs back up into the teens, that means you have to really focus on the underwriting side to make up the difference.”

Mr Cohen says expense ratios tend to be flat at best or creeping up slightly as the premium line fails to grow quickly enough to absorb normal increases in costs. Still, insurers are pursuing programs to cut expenses and improvements are on the way.

Different classes of insurance face various challenges, with the Pendulum report giving the following assessments:

Personal lines: For the first time in 10 years there was no increase in the average premium for buildings last year, despite a 4% increase in the average sum insured.

This year average premiums are expected to increase marginally as market leaders face pressure from challenger brands, which have almost doubled their market share to 7% in the past year.

Reinsurance costs are expected to remain steady. And despite the increased competition, home insurance is still expected to produce a reasonable return.

Personal motor is also a relative bright spot, with the portfolio expected to maintain a loss ratio below 70% amid a good outlook for profitability.

However, challenger brands are now estimated to account for more than 10% of the car insurance market, and intense competition, plus an expected increase in average claim size, is expected to drive a decline in profitability in the long term.

Commercial property: Premiums fell 5% on average last financial year, and rates are forecast to remain soft this year as intense competition continues.

Profitability deteriorated during the year, and after normalising for natural peril claims the class is failing to meet profit targets in either the SME or larger corporate risk areas.

“While some have expressed the view that rates have bottomed out, rate increases averaging about 15% are needed if profitability is to be restored,” the report says.

Liability and professional indemnity: Competition has intensified in liability, with rates expected to continue falling this year and next, but with some slowdown in reductions.

“While the class is still profitable, it is now not meeting return-on-capital targets,” Finity says. “We don’t see this weaker profitability position changing for at least another year.”

Professional indemnity is currently profitable, but over the coming year the class may be borderline if rate reductions, even at a small level, continue.

Recent judgements on natural event class actions, child abuse and proportionate liability are a key risk for the class.

Directors’ and officers’: There was some top-line growth last year through an increase in demand for directors’ and officers’ cover and newer products such as cyber and warranty indemnity, but class actions are the key contributor to poor claims experience and the class remains “very unprofitable”.

“While we see some signs of the soft market bottoming out, it will take significant rate increases to bring this class back to profitable levels. An unfavourable outlook remains.”

Compulsory third party and workers’ compensation: Meeting profit targets will be “fair to challenging”, with current loss ratio estimates of 82% for NSW and 78% for Queensland.

NSW compulsory third party (CTP) reforms are expected to reduce claims volatility and legal costs significantly, but will also apply pressure to insurers’ profit margins.

SA is opening up its CTP arrangements. Four insurers started writing policies this financial year, with premiums set by the regulator during the transition.

Workers’ compensation premium growth has slowed over the past three years and profitability remains an issue.

Despite claim frequency reductions, loss ratios remain about 75%, and the report estimates current ratios will be unlikely to deliver target profit margins for a “typical” insurer.

The big picture: Overall insurance margins are unlikely to hurry back to the 18-20% highs experienced a few years ago, with the 10-12% estimated for 2015/16 described as “satisfactory”.

For industry participants, the challenge is to pursue the range of measures available to ensure the profitability they require, and to stop the industry losing further ground.

The possibility of pushing through premium rate increases is perhaps higher than it has been over the past couple of years in some classes, giving some cause for optimism.

“At the end of the day, we are seeing profit margins that are much lower, but they are still in double digits,” Mr Cohen says.

“It is not as good as we have seen in the recent past, but it is not a disaster.

“Nevertheless, we do see a need for rate increases in many classes if target profitability is to be achieved going forward.”