Improved economic momentum alone will not close current profitability gaps in major non-life insurance markets, sigma says

Worldwide, most major non-life insurance markets are in a phase of below-average profitability. The latest sigma report from the Swiss Re Institute, “Profitability in non-life insurance: mind the gap”, assesses the existing earnings gap in the non-life insurance sector. The analysis shows that insurers in major western markets and Japan need to improve underwriting margins (underwriting profit as a percentage of premiums) by around 5 to 9 percentage points if they are to deliver desired return on equity (ROE) of 10% in the future. Current economic momentum will benefit future profitability through higher interest rates and investment returns but it won’t be enough to close the gaps. At the same time, tighter labour markets are expected to push up wage and claims inflation. Thus, premium rates need to increase more than claims trends to achieve sustainable improvement in profitability.

The global non-life insurance sector is at a weak phase of the profitability cycle, reflecting soft underwriting conditions, weak investment performance and the high level of capital funds. Sector ROE slipped further to 6% last year, from 7% in 2016 and the roughly 9% achieved annually between 2013 and 2015.

Underwriting conditions are still soft in 2018, particularly in commercial insurance, but seem to be passing through an inflection point. This is on account of the large hurricane losses in 2017 which set the stage for a price correction. Commercial line premium rates started to rise at the end of 2017.

“The catastrophe losses in 2017 sparked a modest change in market dynamics”, says 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.” In personal lines, there has been moderate rate hardening in several key markets for a few years already.

In spite of the modest premium rate hardening, the sigma shows that 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.

Interest rates and non-life insurers’ underwriting results are interrelated in the long run. In the past, during periods of higher interest rates, stronger investment returns were offset by larger underwriting losses. By contrast, in the current cycle underwriting results have deteriorated without the benefit of compensating rising yields, as the slow post-crisis recovery has led to a prolonged backdrop of low interest rates.

Underlying economic growth improved strongly in 2017, and this is expected to continue in 2018, putting upward pressure on inflation and interest rates. Central banks in many countries are already withdrawing monetary stimulus to ward off overheating. This signals a changing operating environment for non-life insurers.

“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”, says 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.”

Moreover, tighter labour markets are projected to push up general and claims inflation, creating an offsetting effect on profitability. The accelerating claims inflation will have the added impact of eroding the adequacy of claims reserves and further affirms that, in order to achieve sustainable improvement in sector profitability, insurance premium rate increases in excess of rising claims trends will be needed.