Australian insurers are earning inadequate returns from professional indemnity (PI) and directors’ and officers’ (D&O) cover, according to Tim Andrews, a principal with actuarial and insurance consultant Finity.

“In the long term they have not made sufficient profits to cover the cost of capital,” he told insuranceNEWS.com.au. “In recent years insurers have been affected by the global financial crisis (GFC).”

“The impact of the GFC has varied between insurers depending in particular on their exposure to the financial services area.”

He says the low returns come from under-pricing.

“In my view rates are probably not adequate on average to cover the full claims cycle,” he said. “We’ve had some poor years but it could potentially have been much worse.”

A presentation Mr Andrews gave to the Australian Professional Indemnity Group conference in Sydney last week shows gross premiums in PI and D&O peaked at about $1.4 billion in 2003 and 2004, falling to about $1.1 billion today.

Finity says the overall reported net loss ratio peaked at about 120% in 1999 and fell to 40% just before the GFC, when it hit 60%, according to Australian Prudential Regulation Authority statistics.

Mr Andrews says gross loss ratios were higher and “reserve releases distort the recent profitability. For example, we estimate that the 2008 gross loss ratio for PI claims reported in 2008 was in excess of 100%.”

While claims rose dramatically during the GFC, reinsurers carried the burden, with the reported reinsurance loss ratio rising above 300% in 2009. Most of the effects of the GFC have now washed through the system, Mr Andrews says.

D&O rates are falling across most industries and the premium pool is probably above $300 million.

“The pool for D&O continues to look small relative to claims exposure and claims emerging but that can’t be confirmed due to lack of data,” Mr Andrews said.

PI rates have fallen significantly over the past eight years and average loss ratios at current rates have been almost 70%.

“At this level insurers are probably losing money when commissions and expenses are considered,” he said.

Mr Andrews says PI in some industry sectors “appears very profitable” but it is unclear if this applies across the full claim cycle.

Both PI and D&O have seen modest increases in penetration of industry groups in the past 20 years, but “the premium pool has not changed much in recent years and in real terms it has probably reduced”.

The number of large D&O claims stood at 39 in June, compared with 49 in May last year.

Making adequate case reserves for large claims is challenging because claim-size estimates are based on incomplete information, Mr Andrews says.

“Ultimately this flows through to pricing decisions made by the insurers.”