The insurance industry has made its first loss on investments in at least two decades leading to another year of low profitability as strong claims inflation also impacted results, the annual Finity Optima report says.

After a pandemic-induced collapse in return on equity (ROE) in the past two years, the outcome in fiscal 2022 was only marginally better at 3%, the report says. The result marks the third year in a row of returns below 5%.

The investment loss of more than $2 billion is the first since the Australian Prudential Regulation Authority began keeping records and reflects an unexpectedly rapid rise in interest rates and resulting paper losses on bond values as well as volatility across financial markets.

“It’s been quite an extraordinary year for investments, with an assault on all sides and that’s affected insurers’ investment performance,” Optima lead author and Finity Director Andy Cohen told insuranceNEWS.com.au. “The good thing is we don’t expect a repeat of this investment performance next year.”

Finity says in the report released today that it anticipates ROE will improve to 7.5 % with the investment result expected to swing to a $3 billion profit. Premiums will continue to increase as insurers respond to the inflationary pressures and further correct past under-pricing in some areas.

“We are forecasting a bit of a bounce back in return on equity, but it’s still below target, and it’s very contingent on those investment markets behaving themselves, and getting back to a more normal outcome without the wild swings we’ve seen,” Mr Cohen said.

Gross earned premium rose 10% in the past year mainly in response to claims inflation in personal lines and commercial property classes and the continuation of the hard market in commercial lines.

The industry’s net loss ratio improved 10 percentage points, but a large part of that was due to covid business interruption reserve releases.

Claims costs from declared catastrophes were almost three times long-term average levels and much worse than the relatively benign previous year, but the extra cost at a gross level was offset by additional reinsurance recoveries - to the point where the industry paid less to reinsurers than it received back, the report says.

The reported insurance margin improved to 3.2% from 0.1% supported by the reserve releases. A further $500 million in covid business interruption releases is assumed for this year following the recent High Court decision on the second industry test case, pushing the margin to 4.2%, but other issues are affecting industry performance.

“You can't ignore claims inflation coming through really strongly, which is not going to help, and the reinsurance costs are going up in a number of classes as well,” Mr Cohen said.

“I think on an underlying basis we’ve gone a little bit backwards, and we are suggesting that the underlying loss ratio is going to be three points worse next year.”

The report assumes a higher-than-average natural perils claims cost impact, as a result of a third La Nina in a row, and an unwinding of covid frequency benefits in the motor classes.

Gross earned premium is forecast to rise 12%, underpinned mainly by rate growth in response to inflation, while the travel class is forecast to account for a significant part of the volume growth.

“On the surface, the industry’s performance appears to have rebounded a little,” the report says. “But underlying that, the results are not as good, and there continues to be challenges ahead.”