S&P Global Ratings expects this year to remain challenging for Australia’s property and casualty (P&C) insurers, citing potential COVID-related business interruption (BI) claims as among the key risks facing the sector.

Rising reinsurance costs and heightened market volatility, which can affect capital adequacy and investment returns, are the other threats that could materially affect earnings.

“It’s going to be a bumpy year,” Credit Analyst Craig Bennett told insuranceNEWS.com.au today. “They have been affected both in heightened claims and they have also been affected by investment earnings.

“On the flip side though, it is a hardening market and they are getting good premium rates. That is a positive.”

In an Asia Pacific outlook released today, S&P says the Australia P&C sector enjoys solid capital adequacy and prudent investment portfolios.

The industry has managed to produce “sound operating” performance despite the economy-wide disruption from COVID-19.

However the industry is exposed to a few key negative credit sensitivities. These include weakened earnings profile caused by material adverse claims, increased market volatility and subdued economic activities that will impact gross written premiums.

The industry has been “proactive” in addressing potentially adverse BI claims exposure, Mr Bennett says, referring to the actions taken by major insurers - IAG, Suncorp and QBE - to set aside significant provisions.

“The sum total is about $2.5 billion which is quite meaningful in size,” Mr Bennett said. “It has had a bigger impact on the earnings profile and they have put aside reserves for that. Their biggest exposure has been to business interruption.

“I think they have been proactive in terms of setting up provisions where there is that uncertainty.

“In terms of whether they are realised in terms of payouts, I guess that is a second question.”

The industry lost a BI test case last year after the NSW Court of Appeal ruled insurers could not rely on exclusions that referenced the now repealed Quarantine Act.

But it is seeking leave to appeal that decision in the High Court, and is also in advanced talks with the Australian Financial Complaints Authority over a proposed second test case that would look at issues such as the definition of a disease, proximity of an outbreak to a business, and prevention of access.