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INMAG OCT 16_page layouts 2/10/2016 11:38 am Page 11

Losing interest Insurers are grappling with a ‘new normal’ as benchmark rates and investment earnings stay low By Wendy Pugh

EIGHT YEARS HAVE PASSED SINCE THE COLLAPSE OF investment bank Lehman Brothers pushed the global economy deep into financial crisis, and insurers are still feeling the lingering shockwaves. The money from investments that once buoyed earnings is no longer flooding in. Interest rates are mired at record low levels, and there is little sign of change on the horizon. At the same time, premium levels are under pressure as competition increases. Results reported by Australia’s major listed insurers – IAG, QBE and Suncorp – show varying impacts from sliding interest rates, highlighting the new paradigm. “Ten years ago, classically, an insurer made two-thirds of its money from its investment returns and a third from underwriting,” QBE Group Chief Executive John Neal told a half-year results briefing. “That metric is reversed now.” Insurers can still make a return on investments, but it is far lower than in the past, he says. Companies are responding by trying to lift underwriting performance through pricing and cost cuts, while also tweaking investment portfolios to maximise returns. “Unfortunately, there’s no ‘free lunch’ in investment markets,” Suncorp Executive Manager, Investment Research and Economics Steven Milch tells Insurance News. “Improving returns is a challenge that involves trade-offs.” KPMG Head of Asia-Pacific Insurance Accounting Scott Guse says the latest problems are part of a longer history of interest rate cycles. In the 1980s and 1990s companies were making underwriting losses and investment profits on soaring interest rates, but the retreat of rates from the high teens and the collapse of insurer HIH in 2001 put the focus on improving underwriting performance. Since then the sluggish global economy has taken interest rates to unprecedented lows, and put ever more pressure on investment returns. Australia’s benchmark rate was at 7.25% in 2008 before the global financial crisis started shaking investment market foundations, triggering waves of global cuts. Forecasts two years ago that the market was about to turn have proved wrong. The Reserve Bank of Australia lowered the cash rate to 1.5% in August, its fourth cut since the start of last year. That is still high compared with other developed countries. In Europe rates have gone negative, in a sign of monetary policy desperation. Theoretically, if central banks charge for holding cash

reserves rather than paying interest, as is normally the case, more money will be pushed into the wider economy, spurring growth. Mr Milch says Suncorp is continually aiming to optimise investment returns in this environment, taking into account not only return prospects but also factors such as risk and liquidity, plus regulatory and capital requirements. “Suncorp has increased portfolio allocations to convertible bonds, property and infrastructure assets in recent times,” he says. The company’s general insurance profit fell 17.5% last financial year to $624 million, with investment income sliding 36.3% on insurance funds and dropping 38% on shareholder funds. Even if insurers were tempted, they can’t throw caution to the wind in a chase for high-yielding returns, given Australian Prudential Regulation Authority restrictions. They must maintain certain levels of capital as part of financial stability measures, and riskier assets are penalised when it comes to totting up the numbers. KPMG’s Mr Guse says there has been no major move by insurers towards alternative instruments such as hybrid convertible notes and shares. “It is not really in their best interests from a capital perspective to deviate from predominantly fixed-interest securities,” he tells Insurance News. IAG’s net profit fell 14.1% to $625 million last financial year, including a significantly lower contribution from investment income on shareholder funds amid relatively flat equity markets. The company’s $8.7 billion in technical reserves, which back insurance liabilities, were invested in fixed interest and cash as of June 30, while 48% of the $4.2 billion in shareholders’ funds was in growth assets, comprising Australian and international equities and alternative investments. IAG has increased its shareholder funds’ exposure to growth assets from 40% four years ago. Global insurer QBE had 9.5% of its investment portfolio in growth assets at the half-year, down from 14% early last year and up from about 0.5% at the end of 2012. Mr Neal says the current level is “incredibly conservative” compared with global peers, which often have growth allocations of 15-25%. The company has previously said it would be prepared to go as high as 15%, but Mr Neal says QBE plans to keep the level about 10% for the rest of this year, while still aiming to increase returns from its holdings. “Quite a lot of that is still in cash and short-term money markets, so you have almost got 20% of our investments earning very little money at the moment,” Mr Neal says. “That really is the area we are looking at, but it won’t be growth assets, it will be looking quite carefully at credit.”

“Companies are... trying to lift underwriting performance through pricing and cost cuts, while also tweaking investment portfolios.”


October/November 2016


Profile for Insurance News (the magazine)

OCT/NOV 2016 - Insurance News (the magazine)  

As interest rates plummet and investment earnings do much the same thing, Insurance News (the magazine) has taken a long look at the situati...

OCT/NOV 2016 - Insurance News (the magazine)  

As interest rates plummet and investment earnings do much the same thing, Insurance News (the magazine) has taken a long look at the situati...