S&P Analysis of Australia P/C Insurers

Standard & Poor’s has published an analysis of the current state of the Australian P/C industry. The rating agency noted: “The softening insurance cycle has entrenched itself in commercial lines in Australia. Premium rate reductions between 5 percent and 20 percent have been recorded across various lines of commercial business renewed in the first quarter of 2005.

“Large corporate risks, particularly property and liability lines, have already experienced rate reductions of between 5 percent and 20 percent, and rate pressures are now becoming evident in midsize commercial risks.”

S&P said, however, that “despite these rate reductions, policy terms and conditions remain strong, and the extensions of cover and reduced excesses, apparent in the last softening cycle, have not yet appeared in the local market.

“Reported profitability remains very strong for the industry for results up to December 2004, and, importantly, many insurers show continued signs of lower claims frequency across many lines of business and, in particular, liability lines. The industry in total reported a very good underwriting profit of A$838 million [U.S.$635 million] in the quarter to December 2004, and a very low combined ratio of 83 percent (as per the Australian Prudential Regulation Authority’s ‘Quarterly General Insurance Statistics’). This stretches the industry’s consecutive quarterly underwriting profits to three years, after more than seven years of consecutive quarterly underwriting losses.”

While noting the relatively mild adjustments the declining rates have on the Australian market, S&P stressed that they “are a global issue, with rate reductions in the key London market also prevalent. The fact that rates have reduced across all lines in the first half of 2005, starting with large corporate risks, and now spilling into small-to-midsize commercial business, suggests that rate reductions are not fully accounted for by the improved underlying claims experience. Rather, rates are now influenced by competitive issues, and are being pressured across all lines of business.” S&P added, however that not all lines are enjoying equal improvement in claims experience.

S&P said it “believes that premium rates in Australia currently remain at a profitable level, and are likely to continue to do so for the remaining part of this fiscal 2005 year, with technical rates still being achieved to date. Recent lower claims frequency, for example in the compulsory third party (CTP) class, and some reserve releases by insurers, together indicates an underlying improvement in claims experience and supports a level of reduction in commercial lines premium rates.”

The rating agency also indicated that “personal lines rates remain robust, and are unlikely to see premium rate reductions; rather increases up to CPI are expected. Increasingly intense competition, however, will limit growth in this segment as insurers find it increasingly difficult to write new business. Personal lines claims frequency and severity has reduced over time, given generally dry weather conditions, lower crime rates, and initiatives such as reduced speed limits. This is despite a handful of medium-level storms through the eastern states.”

S&P warned, however, that as the cycle takes hold, maintaining financial strength will require “pricing discipline.” Comparing the current situation to the last down market in 2001, when many insurers incurred large underwriting losses, S&P noted that “insurers have implemented extensive changes to their underwriting practices, so as to align rates charged with profit objectives and expected losses. Industry participants have also introduced better underwriting tools since that time, which should enable underwriters to better assess pricing profitability as competition pressures rates.

“Furthermore, a more rational softening insurance cycle should be underpinned by the shareholder profit objectives of most of the Australian nonlife industry, less reliance by participants on investment returns for profitability, and key groups already having attained critical mass and cost efficiency. How well these factors influence behavior of industry participants will be key in limiting possible fallout of a softening rate cycle on balance sheets.” This ability should help the industry hold in check any too drastic downside reduction.

S&P cited the “pressures of an increasingly onerous corporate governance and compliance environment” as an additional factor weighing on the market, referring to the ongoing investigations of the “inappropriate use of financial reinsurance, and its accounting treatment.”

Lastly S&P observed that while New York Attorney General Elliot Spitzer’s probe into insurance broking practices in the U.S. has so far had “little local effect,” it “continues to focus the industry’s attention on appropriate operating practices, and underscores the crucial part that the highest corporate governance standards play in the day-to-day operations of a successful insurance company. Court penalties imposed in Australia as a result of recent local regulatory investigation into the use of financial reinsurance and related accounting issues make it clear that appropriate operating practices and suitable corporate governance are now a permanent part of an insurance companies’ operations globally and locally.”