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Riding out the storms

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Insurers are adeptly navigating a treacherous environment that includes rising catastrophe risks, low investment yields and the threat from disrupters, a report from S&P Global Ratings suggests.

Rate increases are coming through in commercial lines and the threat from natural disasters is being mitigated through reinsurance, with plentiful global capacity curbing the cost of transferring risk.

S&P notes that in the first half of this year, gross written premium (GWP) growth was overshadowed by a 7.9% annualised increase in claims, mainly due to natural perils, but the net combined operating ratio was a respectable 92%.

The period included the impact of Cyclone Debbie, which caused damage in NSW and Queensland, plus a Sydney hailstorm.

The performance and approach to reinsurance augurs well for the future, with claims from natural perils likely to rise and population density set to increase in affected areas.

“Australian insurers have generally maintained robust reinsurance protection with high-quality counterparties, which limits their exposure to losses from extreme events as well as an accumulation of losses from a series of smaller events,” S&P says.

“We expect this practice to continue while reinsurance capacity is relatively high for Australian insurers and available at reasonable cost.”

S&P’s industry and country risk assessment also offers positive comments on reputational issues, in contrast to the criticisms that have triggered various reviews, including a recent Senate inquiry into the general insurance industry.

“In terms of the sector’s image, we believe it has strengthened since the introduction of flood cover. In addition, insurers have generally responded well operationally to large-scale events.”

On the revenue side of the equation, average annual industry GWP is forecast to grow by about 3% this calendar year and next. That is slightly stronger than in previous years due to a hardening for some lines, but still represents modest gains overall.

Analyst Craig Bennett says commercial lines, which have been soft for some time, are showing increases.

“Some of that has been recognised in the half-year to June,” he says.

“We feel, though, there is still quite a bit that has been put through that hasn’t been recognised, particularly in commercial property and to some extent compulsory third party as well, and commercial motor.”

Claims inflation, such as in the motor sector, is being addressed through various initiatives, while insurers have managed a challenging pricing environment in a relatively disciplined manner, according to S&P.

The turnaround story in pricing is supported by good retention since insurers have started passing on increases.

The Australian economy’s modest performance is expected to help underpin the market, with GDP increases having a strong correlation with general insurer earnings gains.

S&P’s base-case forecast is for real GDP growth of about 2.7-2.8% next year and in 2019, which it says will support similar growth in insurer GWP.

Low interest rates continue to present a challenge, but from a credit rating perspective, insurers have adapted to the environment without being tempted to raise the risk profile of investment portfolios.

S&P says Australian general insurers are expected to continue generating “robust earnings”, and for rated groups a weighted return on equity of about 14% is anticipated this year and next.

Overall, S&P expects a stable credit trend for the sector, with Australian insurers well placed to maintain strong creditworthiness through to the end of next year.

The ratings agency is also relaxed about the potential threat to general insurers from disruption, and says there are positives to be gained from cutting costs and increasing opportunities.

Companies are tackling the challenge from new entrants and technologies by engaging with disruptors, creating their own incubation labs, testing alternative distribution channels and exploring new risk management products.

Mr Bennett says the speed of change is increasing, but disruptors tend to focus on particular products or parts of the process, rather than presenting a wider-scale challenge.

S&P says disruptors face a tough task to gain material market share from larger players, particularly where specialist product and pricing knowledge is required, and where there are broad and well-established distribution networks and high-quality policy administration and claims systems.

These are not easy times, and the report does not forecast great leaps in performance and earnings, but insurers appear well placed to take on whatever challenges emerge over the next year.