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‘Perfect storm’ blows insurance industry off course

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Australian general insurers are facing a “perfect storm” of challenges that has put the industry on an “unsustainable trajectory”, a new report from Oliver Wyman warns.

The consultancy says the Australian insurance industry has been “one of the most profitable in the world” over the last two decades.

But over the last five years annual market volume growth has been almost flat, with 75% of premium growth driven by price increase, while cost growth (6%) and claims inflation (5%) have outpaced premium growth of 4%.

Competition has also intensified with “large incumbents” losing 6% market share and experiencing more than a 50% decline in profitability.

“Despite consistent and significant premium increases, industry profitability is just over a third of the level in the early 2000s,” the report says.

“This trajectory is unsustainable. The industry is now experiencing a perfect storm of growth contraction, intensifying competition, and worsening cost and claims profiles.”

Oliver Wyman also warns that the risk landscape has “shifted dramatically” with “common risks becoming more frequent and intense, while new risks are continually emerging”.

The report says insurers need to make “bold strategic choices” and highlights three key steps.

• Clarify the investor thesis: be clear about current and future sources of competitive advantage and communicate these clearly to investors

• Scrutinise investments: be surgical over investment in the business, reallocating resources towards the one or two big bets that have the potential to transform, while stopping other projects

• Enhance the operating model: inject new talent from outside the sector in contemporary capabilities, and enforce accountability via customer centric metrics.

Oliver Wyman Partner and Head of Asia Pacific Insurance Angat Sandhu told that the Australian economy and financial services sector has been “the envy of the world”.

“It has been performing well, and therefore the catalyst for radical change has not been as strong,” he said.

“It is hard to argue why you should fix something that is not really broken.

“But if you look at a 10-20 year period the profitability of the sector has been trending down. 20 years ago it was high to mid-teens, over the last couple of years it has been around the 6% or 7% mark. That is quite a radical shift.

“If you look at growth, a significant proportion of the growth has been driven by price increases rather than underlying growth in customer numbers.

“If you look at the cost side of the equation, and most insurers have run big cost programs, the degree of efficiency is certainly nowhere near where it needs to be and there is still a high degree of cost inflation across different business lines.

“So, growth is slowing, costs are still a challenge, profitability is coming down, and the last five to six years, particularly in the personal lines space, there have been a raft of these challenger insurers who are winning share.

“These are the catalysts for a fairly challenging environment and players should reassess their sources of competitive advantage and re-examine whether they are making the right strategic bets and executing as well as they can.

“Even if there is some temporary bounce-back, which naturally there would be, we still think a lot of the structural drivers we are speaking about need to be considered.”

The report also acknowledges a “value shift” towards distribution, with brokerages outperforming insurers. Insurers may need to “reassess and optimise” their distribution strategies to drive sustainable growth, it says.

Mr Sandhu says brokers have a different business model and so their enhanced performance is expected.

“There will be a camp of insurers that have no issue with that at all and think, ‘well, they are our main distribution partner and they are a big source of volume for us so it’s great they are doing well’,” he said.

“There will be others who are thinking ‘ok, what is the best way for us to maximise shareholder return whilst meeting policyholder obligations, and are there aspects of what brokers are doing that we can perhaps replicate? Are there perhaps segments of customers where we should rethink or revisit whether we need to go via an intermediary?’

“At mid-market level and large corporate level that is not going to happen because it is complex, it is not feasible. But segments like SME will be the spaces where some of that introspection will happen.”

Click here to read the full report.