Thursday, March 13, 2008

Insurers ignore their own warnings

The Sydney Morning Herald points out that insurers in Australia and other countries are falling into a trap -- one that they've been warning about for years: Early this decade it was the insurance companies that broke from the generally conservative business pack and started making lots of noise about climate change and its potential to increase natural disasters. It coincided with the HIH insurance disaster - and the worldwide near collapse of the reinsurance industry. For insurers around the world this was a cataclysmic event, with many facing huge losses.

It also represented the return of sanity to the pricing of insurance premiums. During the boom period of the previous few years the cost of insurance had been whittled down to a point where the premium income didn't even come close to matching the claims made on insurance policies. The only reason insurance companies made profits was that they invested all that premium income in buoyant sharemarkets.

But post-HIH the bad old days of underpricing appeared to be over. In the industry they call this underwriting discipline. So why did the four major insurance companies combined report a 26.8 per cent fall in half-year profits for six months to December (compared with the 2006 December half)? Because, other than QBE, their premium income is once again not matching, or barely matching, the amount these insurance companies are paying out on claims. Which makes one wonder about where all the underwriting discipline has gone.

Insurance executives will claim it's simple enough. In Australia, in particular, there has been a litany of natural disasters - drought, floods and storms - all of which have contributed to a worse than expected claims experience. And although the pricing of premiums has held up pretty well for the past five years, it would appear that premiums have not been sufficiently high to account for this "aberrant" (or wetter) weather pattern called La Nina.

The insurance gurus who were predicting all this change in weather patterns seem to have failed to heed their own warnings. Their behaviour seems to have followed a more traditional insurance business cycle. This has certainly been the case in commercial insurance lines, where premiums have been particularly competitive and have fallen in recent years - enabled by reform in tort law.

….That's not the only challenge for insurers. The falling returns from investment markets over the past six months have taken away the industry's safety net. While insurance companies all make recent references to increasing the cost of premiums on their general insurance lines, there will be plenty of catching up to do in order to move back into profit.

Most are now also embarking on a cost-cutting drive - typical of cyclical businesses which are moving out of the good times. Greig says that in the longer term insurers need to make a call about whether the severe weather events are a symptom of permanent weather change or a two-year aberration. It's strange that this call needs to be made now, when five years ago these insurance executives (commercial greenies) were already calling it climate change.

Raphael's painting of the prophet Isaiah, shown here holding up an early insurance policy and calling for underwriting discipline. Photo by "PDArt," Wikimedia Commons

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