sigma 4/2018: Profitability in non-life insurance: mind the gap
The latest sigma promotes the need for improved underwriting margins in most non-life primary markets. Pricing dynamics may have reached an inflection point with some moderate rate increase since late 2017, but it is too soon to declare a return to hard market conditions.
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Worldwide, most major non-life insurance markets are in a phase of below-average profitability. The analysis in this sigma 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. 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.
2017 cat season may have triggered an inflection point
Figure 1 shows current shortfalls in profitability in the major non-life markets.
Underwriting conditions remain 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, but 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. However, more work to improve underwriting performance needs to be done if current shortfalls in profitability are to be redressed.
Premium rates need to increase substantially to restore profitability
Underlying economic growth improved strongly in 2017, and we expect this to carry over into 2019, putting upward pressure on inflation and interest rates. Central banks in many countries are already withdrawing monetary stimulus to ward off overheating. 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.
However, macroeconomic developments alone are unlikely to generate sustained improvement in non-life sector profitability. While the trend of declining investment yields has bottomed, we do not foresee a substantial increase in long-term interest rates. Also, tighter labour markets will likely push up general and claims inflation, which will likely further offset gains in investment returns. To achieve sustainable improvement in sector profitability, insurance premium rate increases in excess of rising claims trends will be needed.
Long-run performance in line with other industries
The pressure on the industry has heightened interest in innovation. Over the long run, investments in data and advanced analytics improve efficiency, underwriting and the insurability of increasingly complex risks. Further, this report finds that over the long run, insurance companies have delivered a level of profitability comparable with firms in other sectors. In line with these profit trends, a two-decade comparison of non-life insurers' stock market performance suggests at par or even above-par valuation. Furthermore, insurance stocks demonstrate low correlation of price returns with other industry sectors and thus offer value to investors in the form of diversification benefits.