General insurers face the strategic challenge of maintaining profitability in a climate of lower interest rates, higher reinsurance costs and new forms of competition, Australian Prudential Regulation Authority (APRA) Chairman John Laker says.

Writing in APRA’s newly released annual report, he says the general insurance industry remained profitable and well-capitalised during the year.

Its combined underwriting result reflected fewer natural disasters after last year, “but this was more than offset by falls in interest rates that increased the value of long-tail insurance liabilities”.

However, lower interest rates did provide significant realised and unrealised gains that boosted investment income.

Dr Laker says that over the five years of the global financial crisis, companies have strengthened their resilience through higher capital levels and improved capital management.

“The institutions are battle-hardened but, fortunately, very few have been battle-scarred.”

He says boards and managements have “lifted their sights beyond survival” to the strategic challenges of operating in a post-global financial crisis environment.

These include choosing a business model for a setting of low investment returns and global uncertainties that may persist for some time.

Companies have to respond to changes in the competitive environment as industries consolidate but innovation spawns new participants, and they must adjust to a more robust regulatory environment emerging from global and domestic reforms.

Dr Laker says some insurers are retaining more property risk on their own balance sheets due to higher reinsurance premiums and this may increase future earnings volatility.

The report says that while flood cover is more widely available after last year’s floods, “the challenges involved in pricing riverine flood risk are significant, particularly for small and medium-sized insurers that may not have the volume and range of data that are available to the larger insurers”.

The regulator is also assessing insurers’ catastrophe modelling governance practices.

“APRA is concerned that boards and senior management may rely too heavily on catastrophe modelling output and the model’s ‘black box’, without sufficient challenge and debate,” the report says.