Temperature up, profits down

Temperature up, profits down

Profitability in property classes is set to take a big hit from catastrophes, the latest Barometer research shows

By Wendy Pugh

Insurers’ steady recovery back to underwriting profitability via premium rises wasn’t based on the expectation that the industry would encounter several months of natural catastrophes – hailstorms, bushfires, floods and possibly a cyclone or two before this summer is over.

The long list of catastrophes has led to a hasty recalibration of industry profitability and premium rise expectations.

The annual JP Morgan and Taylor Fry General Insurance Barometer collected views from underwriters, reinsurers and brokers last year as early bushfires in Queensland and New South Wales were sounding alarm bells for the catastrophe season ahead.

Bushfire losses later escalated across the country and insurance losses also rose as large hailstorms pelted Canberra and storms hit parts of Melbourne and Sydney.

The Barometer researchers subsequently calculated the catastrophes could have a 15% negative impact on the combined operating ratios of commercial and personal property classes, before reinsurance. For motor the impact could be 3%.

Premiums are also likely to rise more than expected as adjustments are made, but for this financial year the greater impact will come from the extent of the losses, Taylor Fry Principal and Senior Actuary Kevin Gomes told a briefing on the Barometer.

“So 2020 is going to be a very poor year, even though we expect premium rate increases,” he said.

Before the disasters, the trend in commercial line premium hardening was set to continue, while improvements were more muted in the personal lines home and motor side of the market. And the report still doesn’t envisage insurers imposing huge rises on consumers – not yet, anyway, and not across the board.

JP Morgan Insurance Analyst Siddharth Parameswaran says while commercial lines are likely to post further increases as insurers seek to improve their returns, the catastrophes are unlikely to trigger the sort of personal line price hikes triggered by the cyclone and flooding disasters in 2011.

“The pressures are strongest in commercial because we have significant underperformance in property classes,” he says. “This is just another bad event for a class that has been unprofitable for many years.”

The scenario in personal lines is more nuanced, with major insurers like IAG and Suncorp being forced to balance their ambitions for greater volumes with the risk of pushing consumers away with price increases, Mr Parameswaran says.

The Barometer shows the recent catastrophes in Australia are part of an upward trend in natural disasters that’s been happening since 2003. Insurers have already been looking at pricing strategies as they adapt to impacts from climate change-induced rising temperatures.

Mr Gomes says its unlikely personal lines will escalate across the board following this season’s experience, but with bushfires and other threats there is the prospect of more targeted price rises for specific locations.

“There is just a greater need to understand those properties that could be in harm’s way, and those ones would, I suspect, cop the greatest increases.”

The potential for price hikes may also be muted by the abundance of reinsurance capacity, with global disaster costs last year well down on 2018 levels and lower than the 10-year trailing average.

But there is still likely to be a cost for insurers come reinsurance renewal time.

Mr Parameswaran says it has been a good period for reinsurers and they tend to take more than a one-year view, but aggregate covers designed to protect profit and loss statements are likely to rise quite sharply and natural catastrophe covers will see some gains.

“My expectation is that prices will go up for the industry,” he says.

The geographic spread of the bushfires and the rolling nature of outbreaks over several months raises other reinsurance questions that may affect the recovery levels.

“It is difficult sometimes to define what is an actual event,” Mr Gomes says. “It is a very real problem that insurers have to face when they are trying to claim against their reinsurance cover, to say ‘how much have I actually lost in this one event, and is it one event or is it many events’.”

From a macro-economic perspective the insurance industry has faced pressure from a subdued environment, with unemployment ticking up and gross domestic product growth weaker than normal.

JP Morgan economists forecast improvements in growth this calendar year, driven by the housing market, but expect the Reserve Bank of Australia will further cut interest rates to new lows.

“A stronger economy should help drive demand for insurance, although low yields will add considerable pressures to products such as workers’ compensation,” Mr Parameswaran says.

For the global economy, a “sub-par” start to the year is likely to be followed by a later improvement, and a turn in the insurance cycle is set to become more evident.

US commercial premiums are rising, European rates are starting to gain and the pace of increases overall is likely to pick up.

The Barometer shows that in Australia the overall domestic classes’ combined operating ratio improved significantly between 2016 and 2019, dropping from 90% to 83%.

Before the bushfire and hail catastrophes, the ratio was forecast to be 84% this year, with motor expected to improve, home to remain static and compulsory third party to move backwards to more normal levels.

For commercial classes, the combined operating ratio increased to 102% last year but was forecast to post a modest improvement to 100% this year, with some improvement in most classes.

Survey participants expected premium rate increases over the forecast period to rise strongly for commercial classes, with gains of 10% tracking similar increases last year. A rise of 11% was expected for commercial property, while professional indemnity was expected to increase 14%.

Commercial rate gains have accelerated since averaging 2% in 2017 and 2018, but the Barometer says profitability has been “stubbornly poor” despite the improvements.

Domestic class premium rates were expected to increase 2% overall, compared to 4% last year, with compulsory third party dragging down the weighted average. Motor and householders rates were expected to increase 4%.

The tougher financial reporting scenario caused by the catastrophes comes as insurers are less able to release reserves built up from previous over-estimations of claims. In recent years that has allowed them to absorb disaster costs without sharp reductions in profitability.

“That situation, in our view, has completely changed,” Mr Parameswaran says.

In NSW, compulsory third party reforms are likely to limit releases going forward, while changes have also been underway in Queensland. Professional indemnity and public and product liability insurance had significant reserve releases a few years ago, in contrast to little movement more recently.

“A noticeable feature of past years is that long-tail classes have been particularly good at hiding overall weaker trends in short tail business, but we think the days of those large releases are nearing an end,” the report says.

Climate change action becomes the industry’s problem

Respondents to the latest JP Morgan Taylor Fry General Insurance Barometer have ranked climate change, along with regulation, as their highest priority issue.

Other top concerns include customer expectations, with the Hayne royal commission said to be creating a “trust deficit” that needs to be overcome. Technology and cyber, the claims environment and emerging risks are also key issues.

Taylor Fry Principal Scott Duncan says survey responses indicate “significant pressure” is being placed on the industry in dealing with climate change, while insurers are also in a unique position when it comes to understanding and communicating the impacts.

“Respondents said that politicians are reluctant to address the politically sensitive issue of climate change and the three-year election cycle really doesn’t support longterm action,” he says.

“Participants are really calling for a need to consider climate change when it comes to regional and state planning, certainly in terms of land use and construction standards.”

A breakdown of natural peril risks since 1967, adjusted for inflation and exposure, shows that cyclones have accounted for 30% of costs, hail 21% and bushfires 13%.

Typically, heavy rainfall years and those with increased cyclone activity represent the greatest challenge to insurers and are more likely to threaten densely populated areas.

But this year’s bushfires will rank with exceptional years that include the Black Saturday and Ash Wednesday catastrophes, which affected some more populous areas, and show the heightened risks from prolonged drought.

“It could have been worse from an insured losses perspective, given how dry it has been,” Mr Parameswaran says.

IAG research cited in the report suggests three degrees of warming will trigger a 52% increase in Australian natural perils costs. Bushfires are forecast to be more intense and extreme cyclones and thunderstorms to pick up.

Mr Parameswaran notes catastrophe costs accelerate in a steepening curve as temperatures rise, and the industry is continuing to look at how to manage the risks over the long term.

Insurers are increasing natural perils allowances, and have time to adapt their pricing signals over future years to account for specific loss risks, he says.

“All the messages are, the costs are rising.”