Heavy insurance losses have been followed by a sharp rebound, helped by robust regulation, improved claims experience and consolidation, writes Peter Falush
After four years of traumatic losses and major bankruptcies, the Australian non-life market - helped by far-reaching regulatory reform - is regaining confidence, recovering profitability and a much improved capital base.
The extent of the recovery in profitability is supported by information published from several sources, including the Australian Prudential Regulatory Authority, the insurance industry's trade body - the Insurance Council of Australia, as well as from the major companies' latest reports.
Legislative reform has been triggered by the collapse of several major insurance and reinsurance companies in 2001, of which HIH Insurance was the largest, but the failures of reinsurers New Cap Re, ReAC and GIO Re followed in its wake. New legislation and stricter prudential standards, laid down by the General Insurance Reform Act, effective from July 2002, lifted minimum capitalisation to A$5m (£2.1m), doubling the previous benchmark.
The law also stipulates more rigorous reserving requirements, creating strengthened financial security for the whole industry. Relicensing of all the insurers thinned out the weaker players and 20 companies either merged or exited the market. Additional supervisory measures are in the process of implementation. These include requiring all general insurers to appoint a chief actuary for non-life, employ senior managers meeting 'fit and proper' standards as well as annually filing of their board-approved risk-management strategy.
The alertness of APRA's prudential vigilance can be seen in its recent scrutiny of lenders' mortgage insurance against the background of a booming mortgage market. The supervisor has been 'stress testing' the balance sheets of LMI insurers and may require those active in this segment to increase their capital bases. This is proactive supervision, which may raise eyebrows in more traditional markets but in Australia - bearing in mind earlier failures - it is thought to be appropriate.
Another regulatory approach promoted by APRA is attention to insurers' disaster planning; they must prepare contingency plans to cope in the event of terrorist attack, computer system failure or the loss of key personnel.
Although private sector insurers are generally content with the direction of legislative reform, they would like to be rid of the remaining regulatory overlaps between Commonwealth legislation and other government watchdogs, such as the Australian Securities and Investment Commission and the residual powers of some of the seven member states and territories.
In political terms, there were few concerns raised about the insurance industry in the recent general election, which saw an increase in the majority of Prime Minister John Howard's Liberal Party. This is reflected in the comments of Rod Frail, ICA's corporate affairs manager: "The only insurance issue that got a mention during the campaign was the Australian Democrats' proposal for a New-Zealand-style no-fault injury scheme. To publicise this, the Democrats' leader, Andrew Bartlett, did a bungee jump, which resulted in widespread media comparing this stunt with the party's diving electoral fortunes - and hardly mentioned the policy itself."
The sharp improvement in claims experience in the past couple of years, in both commercial and personal lines, is undoubtedly helpful and even large events late last year, such as the Canberra bushfires and Melbourne flood costs, have been absorbed without much difficulty.
Steep rate rises and the disappearance of capacity experienced after 2001 - especially in liability classes - have abated in bread-and-butter lines, such as household and domestic motor. But professional indemnity, directors' and officers' and covers for medical indemnity are still experiencing double-digit increases. There is a fear, however, that the hard market may not last much longer, especially if foreign players stimulate competitive pressures.
As a consequence of earlier domestic capacity problems, coupled with the impact of the events of 11 September 2001 on international reinsurance prices, Australian insurers now rely more on foreign reinsurers. The resulting rise in the proportion of business placed abroad from 24% to 34.8% is a concern for the ICA. Lloyd's appears to be a beneficiary of this trend - the amount of business placed with its agents reached A$834m in 2003, a rise of 237% in four years.
The climate of confidence is underpinned by recent (albeit not comprehensive) figures published by APRA, after a long period of absence of detailed market data following the HIH debacle and the relicensing of companies.
Although 'rolling statistics' for the 12 months to the September 2003 quarter are not strictly comparable with 2002 data, the latest figures give an adequate indication of the main trends (see table). According to Robert Drummond, ICA's general manager of member services: "The state of general underwriting is a lot more positive than it was even two years ago."
But, the industry's swing from an underwriting loss of A$2.25bn in 1999 to an underwriting profit of A$2.24bn in 2003 is undoubtedly something to smile about. After investment income and tax, the industry's profits reached A$3bn, against a loss of A$940m in 1999. The rapid growth in premiums - 34.7% at the net premium level and 35.2% at the gross premium level from 2002 to 2003 - helped to reduce the expense ratio by 3.3.
The most significant improvement has been in the net loss ratio, which dropped from 88.6% in 1999 to 64.7% in 2003. The leap in investment income from A$1.9bn to A$2.7bn in 2003, reflecting improved equity market conditions, has been another positive factor in improving balance-sheet strength.
ICA data shows that the industry's net assets reached A$20.1bn by 2003, a rise of 20% since 1999 and, when the figures for 2004 are collected, the total is expected to be much higher, reflecting the booming equity markets in Australia. Partial data for 2003 shows that the industry's return on equity reached 15% and the indications from individual corporate reports are that the figure for 2004 will surpass this level by a wide margin.
Company information from major insurer players covering recent periods shows significant further improvement. QBE reported a 61.3% profit rise for the first half of 2004 for its Australian business, while Promina Group (the holding company for the previously independent operating companies of Royal and Sun Alliance in Australia and New Zealand) produced a 30.9% increase in insurance profits for the same period.
Insurance Australia Group, which holds the separate operating companies of NRMA Insurance, CGU, SGIO, SGIC and Swann Insurance in Australia, scored a 38.7% overall advance in insurance profits for the year to June 2004.
The group's personal lines results were 47.7% better, although commercial lines profits declined by 21.1%. However, a 21.1% return in the company's equity is indicative of two factors coinciding - capital market improvement and a hard market for insurance trading. Arguably the best performance was posted by Suncorp-Metway, reporting a move from an underwriting loss of A$72m in 2003 to an underwriting profit of A$167m for the year ending June 2004 and a doubled general insurance result of A$465m for the same period. These results are reflected in the value of insurance shares during 2004. From their low points this year, the rise was 31% for QBE, 55% for Promina, 37% for IAG and 41% for Suncorp-Metway.
While rates have been holding firm during the first half of 2004, there are indications that competition is sharpening - with the help of broking intermediation - and no one would be surprised if rate cutting and a downswing in the underwriting cycle were to appear in 2005.
Another helpful feature is that tort reform is now in place, helping to moderate claims trends in liability lines. There will be a cap on general damages for gratuitous services, based on the present practices prevailing in New South Wales. In addition, damages for future economic loss will be limited to two times average weekly earning. Structured settlements will be permitted and a discount rate of 5% will be employed. This reform has also helped to curb the rapid rate of increased public liability.
And PI prices have diminished from 40% or more in earlier years to single-digit figures.
One area in which Australian private sector insurers are immeasurably better off than their US or UK counterparts is workers' compensation.
The bulk of this compensation is now placed with the public sector. The private sector has a workers' compensation role only in Western Australia, Australian Capital Territory and Northern Territory, which between them account for less than one-fifth of the market.
Workers' compensation experience has been poor, stemming from asbestos contamination in the mining, engineering and building and construction industries. Many of these state schemes are, therefore, in chronic deficit, with the largest in New South Wales amounting to A$3.2bn. Motor personal injury and compulsory third-party cover is exclusively underwritten by the governments in Victoria, South Australia, Tasmania, Western Australia and the Northern Territory. Overall, about one-third of Australian non-life business is written by government entities.
In the meantime, the government-initiated Productivity Commission is considering major reforms in the workers' compensation regime and occupational health scene - the direction of which is supported by the private sector.
A recently published government study recommended the establishment of a national workers' compensation scheme to operate in parallel to the existing state and territorial schemes in two steps. Firstly, a national self-insurance scheme, for corporate employers meeting certain prudential and claims management criteria, would be formed.
Following experience with the self-insurance approach, the second stage will see the establishment of an alternative national premium paying insurance scheme for corporate employers, which would be competitively underwritten by private insurers and incorporate the earlier self-insurance scheme.
However, ICA's Mr Frail is "disappointed that the federal government did not embrace the recommendations of the Productivity Commission. We realise that the stumbling block is that a number of the state schemes are under-reserved".
The industry is also keen to improve its services to policyholders on the basis of a draft code of self-regulation. New rules on claims handling, greater transparency on companies' decisions, improved disaster readiness and consumer education are promoted by ICA member companies. These improvements have already shown a dividend - in the form of a 20% drop in consumer complaints.
To give strength to the prudential regulation, ICA recommended that the Australian government exercises its full insurance power and that the states relinquish their nominal role in this area to enable APRA to be empowered as the sole prudential regulator. "This is not about asking APRA to be tougher. It is about removing the overlap so there is consistency in the regulatory environment so that APRA is empowered to do its job," says Mr Drummond. That said, there is much to do on harmonising the tax system in the six states of Australia, which are still significantly different.
In at least two states, fire-service levies may add more than 20% to premium levels.
However, some institutions are finding APRA's supervisory efforts - it being responsible for the financial sector, including banks and fund management companies - excessive. The authority's staff numbers have increased from 400 to 525 during the past three years and a further rise is expected.
'Oversight overkill' is the comment that some of the companies complain of, a tendency that seems to have left some managements distracted from running their businesses and leaving them fatigued by a series of on-site visits. APRA's response to such comments is that its purpose is to identify and fix problems - rather than wait for a crisis and work out who is to blame.
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