Australian conference highlights role of capital markets in insurance markets

Market pendulum swings to capital

The insurance market has seen a significant shift from reinsurers into capital markets, says AIG Australia CEO Chris Townsend.

He told an insurance panel forum at the Risk Management Institution of Australasia’s annual conference on Queensland’s Gold Coast last week that convergence between the capital and insurance markets was illustrated by the “dramatic” increase in securitisation. The capital market offered “a different level of security and comfort for insurers”.

Having different sources of capital available had reduced reinsurers’ monopoly. Townsend predicted the lower risk tolerance from new capital providers could contribute to a potential flattening of the cycle.

“Lower risk tolerance from new capital providers could contribute to a potential flattening of the cycle

But Lambros Lambrou, Aon’s national manager, market services, Australia, said the softening market would not turn unless insurers’ return on equity fell below 15%. There would be no turn in the market “until we see mediocrity in insurers’ results”.

Lambrou said because insurers globally were reporting profitable results, the market would continue to soften, barring catastrophes. In the US, commercial lines were softening at a greater pace than Australia, with Q3 2007 seeing the highest rate of decline of any quarter in the last seven years.

In the UK, all commercial lines, except motor, were softening. While Bermuda had a reputation for being “one of the more disciplined and rational markets”, Lambrou said it was “awash with surplus capital looking for growth”.

Lambrou said insurers’ four main concerns were slow premium growth, pricing and underwriting discipline, surplus capital and managing the cycle. With net negative growth in all major classes in Australia, there was intense competition and continuing price reductions.

“Much of the industry's current profits were coming from reserve releases, which masked the underlying profitability of classes

However, the level of data available to insurers had improved, so they could identify under-performing sections of portfolios or risks and eliminate those, rather than entire classes. Managing the cycle was problematic, as “no one has written the Bible on how to do it”. Each insurer was different, depending on their bias towards long or short-tail business, the type of business they wrote, their investment strategies, and their level of aggression with reserve releases.

Lambrou said much of the industry’s current profits were coming from reserve releases, which masked the underlying profitability of classes, making it hard for brokers to assess insurers’ results.

He said the reinsurance market was softening, but not as much as the primary market. The pricing power pendulum was moving from reinsurers to insurers. The reinsurers’ premium pool was under pressure because insurers could increase retentions or use in-house captives. Although natural catastrophes were increasing, as were the insured losses they generated, the effect was regional, not global.

Townsend said there were some positive signals about how the cycle was being managed. Previously a carrier collapse was required to force change, but the market was now more sophisticated, there was increased regulation, more risk management from insurers and clients, and better risk modelling. But he predicted the market would continue to soften, at least until mid 2009.

David Bidmead, Pacific regional head for Marsh, told the forum the risk of a pandemic was greater than that of a terrorism event. A pandemic was “the perfect storm that we are unprepared for”. He said there was concern that, without an industry-wide response, there would be a significant effect on consumer confidence if a pandemic occurred.