The collapse in bond yields is a new threat to insurers’ profitability, according to a report from Finity Consulting and Deutsche Bank.

Their sixth annual Pendulum report on Australian general insurers says that having dealt with higher reinsurance costs last year, insurers are now faced with lower bond yields reducing their profit margins. 

Current yields imply the industry faces a 20% drop in after-tax profits, the report says.

“Since June 2011, the Australian Government three-year bond yield has fallen 235 basis points or 50%, a material issue considering investment income contributed 80% of normalised industry profits in 2011.”

But the report says prior year reserve releases should provide support, and with signs of more moderate catastrophe losses this year “the reported profit outlook remains robust”.

It says stock exchange-listed insurers may achieve higher margins from these factors, their lower interest rate exposure and their cost cutting.

The report says the domestically focused listed companies IAG and Suncorp remain better positioned and should outperform the broader industry.

It says liability rates should be higher to offset lower yields but returns are likely to compress further. This might spark more intense competition in short-tail lines, “a factor likely to stall rate hardening in home and commercial short-tail [lines] and keep motor rates under pressure”.

The report says property rate rises will moderate as reinsurance rates stabilise and competition picks up.

Finity/Deutsche Bank expect short-tail pricing to fall back next year to be in line with inflation.

The researchers say home and fire and industrial special risks (ISR) cover rose by double digits in the nine months to March.

They say underlying margins are likely to start recovering in 2014 if long-tail repricing takes place. Lower expense ratios have driven improved profitability in recent years and this is likely to continue.

Domestic motor insurance comprised the largest contributor of gross written premium (GWP) last year at 23%, followed by home insurance at 19% and commercial liability at 16%.

The share of GWP from commercial liability comprised 7% public and product liability, 5% professional indemnity and 4% employers’ liability.

Fire and ISR accounted for 12% of GWP, compulsory third party 9% and commercial motor 6%.

The report says none of these figures have changed substantially from 2010.