Non-life insurance is becoming unprofitable and without significant improvement in underwriting margins, global reinsurance firm Swiss Re (OTCPK:SSREY) (OTCPK:SSREF) says that insurers will fail to deliver sustainable returns.
Specifically, Swiss Re states that non-life underwriting margins in major western insurance markets and Japan need to improve by around 5% to 9%, if the market is to generate sufficient profits to satisfy investors.
The reinsurance firm goes further by explicitly calling for premium rate increases, which Swiss Re says are required if the industry wants to restore its profitability to a sustainable level.
A new report from Swiss Re's sigma looks at what it calls an earnings gap that has developed in non-life insurance and explains that improved economic momentum alone will not be enough to help insurers get back to sustainable profitability.
As a result, the reinsurance firm says that, "premium rates need to increase more than claims trends to achieve sustainable improvement in profitability."
Swiss Re highlights that global non-life insurance is at a particularly weak point in the cycle, with soft underwriting conditions, weak investment performance and ongoing excess capital all helping to damage profitability.
This is best reflected in non-life sector return-on-equity (RoE) which slipped to just 6% last year, from 7% in 2016 and the roughly 9% achieved annually between 2013 and 2015.
The reinsurance firm highlights the 2017 catastrophes as creating an "inflection point" for pricing and it seems Swiss Re is expecting more sustained hardening of non-life insurance pricing as a result, with the hurricanes having "set the stage for a price correction."
"The catastrophe losses in 2017 sparked a modest change in market dynamics," explained Edouard Schmid, Swiss Re Group Chief Underwriting Officer. "However, it remains to be seen how strong and sustainable the market firming is. Rate increases for accounts and commercial lines of business not affected by the catastrophe losses, for instance, have been below initial expectations."
Economic improvement has helped re/insurers to better their margins in the past, but conditions globally are not expected to assist now.
"Under the current stronger economic conditions, we expect interest rates in mature markets to continue to rise moderately, which should support insurers' earnings through higher investment returns," said Jérôme Jean Haegeli, Group Chief Economist at Swiss Re. However, "macroeconomic developments alone are unlikely to generate sustained improvement in non-life sector profitability. The trend of declining investment yields has bottomed but at the same time, the increase in long-term interest rates that we foresee is not substantial."
"More work to improve underwriting performance needs to be done if current shortfalls in profitability are to be redressed. Underwriting margins need to improve by around 5 to 9 percentage points in major western markets and Japan to deliver the desired ROE of 10% to investors," the reinsurer explains.
The deterioration of underwriting results is of course also related to the pressures to increase efficiency, both operationally and in terms of the efficiency of underwriting capital, in order to increase margins.
It is by having a lower cost attached to each unit of capacity that a non-life insurance or reinsurance firm deploys that the resulting profitability can increase through higher margins.
Hence Swiss Re's calls for higher premium rates appear to put the onus on the customer to pay more for risk transfer, at a time when capital fungibility is perhaps at its highest and rising, while capital availability is also significant in the industry and from those interested in insurance-linked returns, on top of the fact re/insurers are attempting to add efficiency to their own business models.
But, the reinsurance firm says that efficiency increases, including through the use of technology, better claims management and expense management alone are not going to be sufficient to help non-life insurers meet their earnings targets.
Of course, technology initiatives and insurtech should push down price themselves, as the added efficiency must flow through to benefit the end-customer, not merely provide more margin. Many industries in the world have discovered this now, as they were disrupted by technology and the internet. Those who tried to hold onto the cash saved through efficiency gains tend to be quickly overtaken.
"What's needed is a substantial improvement in prices and underwriting results," Swiss Re says.
But is what's needed a change in strategy, rather than merely hiking prices to cover this margin gap?
Should non-life insurers be looking to find ways to tap into capital markets sources of capacity to back their non-life portfolios of underwriting risk, leveraging the lower-return hurdles of capital market investors to ensure that they can continue to deliver efficiently priced risk transfer to their customer base?
By compressing the insurance and reinsurance value-chain to bring the most efficient risk capital as close to the front-end customer as possible, can these margin gaps be narrowed or eliminated entirely?
Along with technological platforms for distribution, analytics, claims management and risk trading, could not a new market paradigm be created whereby pricing is based on loss-costs (risk commensurate) plus cost-of-capital plus cost-of-expertise, not based on the need to maintain margins for shareholder equity?
The margins in non-life insurance (and reinsurance for that matter) still suit many business models, and increasingly new initiatives and structures that bring ILS capital closer to primary non-life risks are destined to make these business models more sustainable and result in more risk finding its way to the most efficient route to capital.
That seems like progress and modernisation of the re/insurance business model, something that isn't going away and those embracing it will only capitalise on any efforts to push up premiums to suit other models where higher margins are required by growing their stakes.
This is an interesting conundrum though, given the newer and more efficient business models are not really all that widely adopted yet, while the more traditional business models where higher margins are required to sustain them are still the norm across global insurance markets.
As a result, there is likely to be a continued push for higher rates, which no doubt more efficient players will gladly accept some of (and why not).
But the premium rates may never get back permanently to the levels highlighted (5% to 9% hikes) as fully sustainable over the longer term, we believe, as increasingly there are better ways to channel risk to capital and these ways are becoming more efficient all the time.
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