Insurance investors believe premium rates must rise further to reflect the increasing costs of doing business and higher levels of risk in the sector.

Bank of America Merrill Lynch senior insurance analyst Andrew Kearnan says higher reinsurance costs and claims inflation – particularly across the property classes – are prompting the markets to question whether the recent increases in premium rates have been sufficient.

“One of the key questions at the moment is whether premium rates have gone up enough,” Mr Kearnan told the General Insurance Exchange conference in Sydney last week.

“It’s very hard to see how premium rates have gone up enough to cover the claims inflation coming through, let alone the reinsurance costs.”

While each company’s reinsurance program is structured differently, a year-on-year comparison by Mr Kearnan shows IAG’s reinsurance costs have risen by 56%, Suncorp’s by 31% and QBE’s by 18% from 2011 to 2012.

He says a 2-3% increase in rates is needed just to cover these increased reinsurance costs.

In the recent half-year reporting period, IAG showed an average premium rise of 7% across its book, while Suncorp’s premiums were up an average of 9%.

Rate increases to date have predominantly been on home building and contents policies, with smaller increases in motor, compulsory third party and commercial rates. But Mr Kearnan says no real increases have been noted in the liability classes, and he expressed surprise that the SME sector has not experienced larger rate rises across the board.

He describes the recent rate rises as “barely enough” to cover the increasing costs, let alone improve the profitability of insurers, which is required because of “how the risk profile of these companies has changed and how the capital requirements of the sector have changed”.

A knock-on effect of the higher cost of reinsurance is that the companies are now retaining more risk themselves, and Mr Kearnan says that the changed risk profile of insurers is the second key question that’s “keeping investment market analysts awake at night”. 

“The sector most likely has more volatile earnings and lower returns as a consequence of that market backdrop and of the capital requirements going forward,” he said.

A change in the global rating cycle is unlikely to push Australian rates up, he says, describing a “two-speed market” in other parts of the world where only catastrophe-exposed risks are experiencing higher rates.

Mr Kearnan says there is still too much capital in the market globally, and in that context it is “hard to see a sustained upswing in global commercial pricing”.