Insurer profits remain high in Australia, but premiums continue to slide. Lindsay Marshall reports on an increasingly competitive landscape and a market still marred by the dramatic HIH failure

The past year has seen continuing high levels of profitability and competition in Australia’s general insurance industry. But industry observers suggest continuing pressure on premiums is causing underlying profitability to decline.

JP Morgan insurance analyst Shane Fitzgerald explains that, despite intense competition, profitability had been high, but was driven in part by the release of reserves. The annual JP Morgan-Deloitte 2006 survey of Australia’s general insurance industry (released in December) showed an average return on equity of 23.1%. Fitzgerald says the figure was at “an all-time high” given insurers he had spoken to had targets of 15%, but that current profits were likely to be eroded in the long term because the results were being supported “to a fair degree” by reserves. “We are beginning to see underlying profitability deteriorate because of the falls in premium rates in the past few years,” he says. “Premium rates have been under pressure for the past two to three years and that is unlikely to change soon. It’s ‘Economics 101’. If you are in an industry generating returns above normal profits, then competition will enter the market, so profits are eaten away. That’s what we are seeing now.”

The JP Morgan-Deloitte survey showed price cutting had continued in the commercial lines market with rate reductions of 9% and a 6% drop in D&O and professional indemnity (see table on opposite page). Asked to look ahead and describe the likely state of the industry in 12 months’ time, Fitzgerald says: “Pretty much as it is now. Premiums will continue to fall. Financial results will still look OK, but there will be more reserve releases driving those results.”

Prosecutions continue

The parade of former high-flyers through the New South Wales (NSW) Supreme Court on charges relating to the 2001 collapse of HIH Insurance has continued through 2006 and into 2007. In April, legal action instituted by the Australian Securities & Investment Commission (ASIC) saw former HIH chairman Geoffrey Cohen committed for trial on criminal charges relating to misleading information given to shareholders at the company’s December 2000 annual general meeting. On 10 May, former director and chief financial officer Dominic Fodera was remanded in custody to await a June sentencing. He had earlier been found guilty of omitting material information from a 1998 HIH prospectus to raise funds for a takeover of the FAI Insurance Group.

In February, former HIH company secretary Frederick Lo was sentenced to nine months’ jail on charges of making misleading statements and failing to discharge his duty as a company officer. Last December, Tony Boulden, a former financial controller with FAI Insurance, received a 12 month periodic detention term after pleading guilty to one count of being privy to fraudulently altering the company’s general ledger. Last June, former chairman of FAI Security Group, Bradley Cooper, received an eight year jail term. This was following his conviction in October 2005 on six charges of corruptly giving a series of cash benefits to influence an agent of HIH and seven charges of publishing false or misleading statements with intent to obtain a financial advantage.

In another legal wrangle, the NSW Supreme Court in March knocked back an investor’s bid to recover $40m lost in the 1999 collapse of New Cap Reinsurance. Duncan Saville took action against 14 individuals and companies associated with a New Cap prospectus released in November 1998 for a capital raising. Saville targeted former New Cap executives and directors, insurance and reinsurance brokers and advisers, accountant PricewaterhouseCoopers, law firm Phillips Fox, Macquarie Bank and two associated companies, and advisory firm John Trowbridge Consulting.

He alleged all had helped produce the prospectus that did not disclose New Cap’s true financial position. Justice Robert McDougall found a New Cap board meeting on 2 September 1998 had decided to pursue a $50m capital raising initiative and issue the prospectus. However, his verdict was that the board had no way of foreseeing the losses New Cap had sustained from a series of exposures from December 1998 onwards (the failed launch of a communications satellite, Swiss Air and Thai Airways plane crashes, and two US hurricanes) that ultimately led to New Cap’s collapse.

Regulation and mergers

The federal government announced in April that it intended to change the process used by financial sector regulator, the Australian Prudential Regulatory Authority (APRA), to disqualify industry operators. Treasurer Peter Costello said laws were being drafted to provide for a court-based disqualification process, bringing APRA’s powers into line with those of the other corporate watchdog, ASIC. Costello said the laws should be ready by mid-year.

“The annual JP Morgan-Deloitte 2006 survey of Australia’s general insurance industry showed an average return on equity of 23.1%

In May, the government foreshadowed changes to the Insurance Act, allowing APRA to regulate direct offshore foreign insurers (DOFIs) operating in Australia. Minister for revenue and assistant treasurer Peter Dutton said DOFIs would have to meet the same rules as Australian operators. Limited exemptions would cover products not available in Australia.

The federal opposition Labour Party will release its financial services policy in June in advance of a federal election expected later this year. The policy may confirm the Labour Party’s preference for a merger of APRA and ASIC. The opposition’s financial services spokesman senator Nick Sherry has floated the idea of an amalgamation.

The biggest corporate manoeuvre in the Australian insurance sector during the past year was the acquisition by insurance, banking and investment group Suncorp-Metway of Promina Group. 20 March saw the finalisation of the bid launched by Suncorp last October with an offer that valued Promina at $7bn. The deal brings under Suncorp’s control Promina’s nine direct and specialty insurers, plus financial planning and investment companies. Suncorp CEO John Mulcahy continues in that role in the merged group, with Promina’s former CEO Mike Wilkins being retained as a consultant for six months. Mulcahy has also announced a new senior management team, a mix of Suncorp and Promina executives.

Acquisitions costing more than $3bn have helped reinsurer QBE expand its reach in the US and Latin America. Last December, QBE bought the Praetorian Financial Group from Hannover Re for $1bn. QBE followed up in January with plans to spend $2.26bn buying US property-casualty insurer Winterthur US. In February, QBE bought Mexican commercial lines insurer Seguros Cumbre SA de CV for around $30m.

Insurance Australia Group has looked to the UK to expand, with major acquisitions of motor insurers and brokers there in the past year. IAG bought underwriter and broker Equity Insurance Group for $1.397bn and paid $350m for broker Hastings Insurance Services and insurer Advantage.

Legal landscape

Australia’s ongoing debate on the value and extent of tort law reforms has drawn comment from the judge who chaired the federal government’s review of public liability laws in 2002. Justice David Ipp, of the NSW Supreme Court, said reforms had gone too far – further than his review recommended. Some statutory barriers confronting plaintiffs were now “inordinately high” and small claims for personal injuries were “a thing of the past”. He said establishing liability in connection with recreational activities had become difficult and caps on damages made most plaintiffs think twice before suing.

Justice Ipp said it was unlikely public sentiment would allow all the reforms “to remain long-term features of the law”. A coalition of professional groups has launched a “fair go for injured people” campaign in the run-up to an election in NSW in March. The Law Society of NSW, NSW Bar Association, Law Council of Australia and the group representing plaintiff lawyers – the Australian Lawyers’ Alliance – all backed the campaign. Bar Association president Michael Slattery said sufficient evidence had surfaced to show changes to personal injury laws had created gross inequalities and inconsistencies. “The pendulum has swung too far in favour of defendants in personal injury cases and must be brought back to balance, to restore any sense of fairness to the system,” he said. But the Insurance Council of Australia said lawyers simply wanted a return to “the bad old days” when cover was out of reach for many. Insurance Council CEO Kerrie Kelly said all governments in Australia had decided reforms were necessary, and were working.

A report released in February by a federal government panel established to review medical indemnity said the reforms should stay. The panel, with representatives of insurers, doctors and the government, said tort reform and other measures introduced since 2003 had curbed “sharp rises” in medical indemnity premiums. Federal health minister Tony Abbott said the report showed the medical indemnity industry was “now more stable and viable” and insurance more affordable. The government also seized on a report released in April by the Australian Competition & Consumer Commission that showed average medical indemnity premiums in 2005-2006 continued a downward trend evident over the previous two years.

Lindsay Marshall is a freelance journalist.

Australia: Climate change on the agenda

The prolonged drought across much of Australia that has caused governments to restrict commercial and domestic water use has focused insurers’ minds on climate change. Industry leaders have spoken out, identifying it as a serious risk. Insurance Australia Group (IAG) CEO Mike Hawker says climate change is a threat nobody can afford to ignore. It is “one of the most significant risks currently facing the community, with the increase in catastrophic weather-related incidents representing a financial risk for customers”. Hawker acknowledged that the wider community will bear the costs, with insurers lifting premiums to cover increases in claims.

Visiting Australia in February, Lloyd’s chairman Lord Levene called for “a radical rethink of public policy”. He told a meeting in Canberra of the World Affairs Council that the number of natural catastrophes had doubled since the 1960s and, over the same time, insured losses, the majority weather-related, increased nearly seven-fold. Lord Levene said insurers must push for action to limit the potential threat of climate change. “The collective evidence says we can no longer remain in denial. We must stop relying on historical patterns [and] look to the future instead. And we must begin to factor in the increasingly accurate short-term predictions that are available for each season ahead. We need to take coordinated action on climate change.”