Bad to worse to...better?

Bad to worse to…better?

The expected profitability recovery didn’t materialise, but the annual Optima report says the rebound may be back on track

By Wendy Pugh

The COVID-19 pandemic muscled aside natural catastrophes as the profitability wildcard for insurers in the past year and, after dashing expectations for an overall performance improvement it remains a key risk in the outlook.

Profitability, measured by return on equity (ROE) and margins, went from “from bad to worse” last year as the anticipated recovery failed to materialise, the annual Optima report produced by actuarial firm Finity shows. And it identifies the main culprit as the pandemic.

Business interruption claims related to COVID triggered court cases and led to reserves bolstering, while supply chain disruptions added to pressures in householders’ insurance and travel premium volume slumped.

Motor lines benefitted from lighter traffic and fewer collisions during lockdowns, while companies are still adjusting to pandemic repercussions that are influencing operational activities and investment results.

“There is not a class of business that is not affected, nor is there any business in the world that is not affected by what is happening,” Optima report lead author Andy Cohen tells Insurance News.

The Optima report, now in its 14th year, reflects premium increases, investment returns, reserve releases, natural disaster impacts and other influences on personal and commercial lines.

COVID emerged during the previous reporting period, but its impact is heightened in this latest snapshot.

Overall ROE fell to a two-decade low of 2% in the past financial year, slipping from an already poor 3%. The reported insurance margin contracted to 0.2% of net earned premium, essentially just a break-even result, compared with 2.6% previously.

A two-percentage-point deterioration in the net loss ratio was driven by the strengthening of COVID-19 business interruption loss provisions. That was partly offset by a return to average catastrophe claims and a favourable discount rate.

Gross earned premium growth was “just north of 5%”, similar to the previous period. If figures were normalised for the loss of 80% of the travel premium, growth was a “surprisingly solid” 7.5%.

The elusive profitability improvement is still expected to take place, with the current period tipped to be better for the industry overall. Nevertheless, profitability levels are likely to remain below desired levels, with significant divergences between classes.

Motor in personal and commercial was the best performer last year and is expected to still lead the pack, while travel and standalone liability are likely to be loss-making. Other lines are set to remain below target, but at least will not be in the red.

“If you look through into the detail you really find it is the motor classes doing all the heavy lifting and delivering the goods,” Mr Cohen says.

“They are above target ROEs and are making up for the struggles the rest of the classes are having in terms of profitability.”

Overall premium growth of 6% is likely to be supported by volume gains as well as rate strength as the market continues to harden in most lines, while the reported loss ratio may improve six points to 69%, stemming largely from an absence of shock COVID-19 business interruption impacts.

The insurance margin is anticipated to rebound 5.5 points to 5.7% and the return on equity should improve to 7.2%, although remaining short of the 10-15% target range.

Profitability will be “very much all about underwriting margins” with avenues that have often burnished results in the past providing little assistance in the current environment.

Prior-year reserve releases, for so long a useful tailwind, have dwindled and investment return expectations continue to edge lower with yields approaching zero.

“Favourable returns from the industry’s small holdings of growth assets along with the credit risk margins earned on corporate bonds are now virtually the only way for insurers to make a significant positive return,” the report says.

The release of some of the business interruption reserves set aside for pandemic-related claims is possible if legal matters conclude in favour of insurers, but the report makes no assumptions given an industry test case and other actions are running their course.

“There is still a process to go through with the appeals,” Mr Cohen says. “Anything can happen and there is a wide variety of wordings out there. It won’t be a complete get out of jail card, but if it goes well I think some of those reserves could be written back.”

Expense ratios increased only 0.3% last year, with data showing large insurers covering both personal and commercial lines are continuing to see an erosion of a once-significant ratio advantage, while at the same time their market share has reduced.

“Even back 10 years ago the large insurers were clearly benefitting from economies of scale,” Mr Cohen says. “Now there really is a much lower expense advantage that the large insurers are enjoying over the others.”

Looking ahead, COVID-19 uncertainties will continue to touch the various insurance classes, while societal and business environment repercussions are evolving.

Workers’ compensation is an area where COVID-19 did not have a significant impact on claims last year, but it may face much greater risks as states begin to “live with” the virus.

“We are moving into a post-COVID world and we have some idea perhaps of what that will look like, but maybe not a complete idea, and there is a lot of water to pass under the bridge,” Mr Cohen says.

“One thing that is unknown, or a wildcard, is the economic trajectory and changes that may come about as a result of changes in ways of doing business and the way we are working.

“Against that backdrop there are expectations of inflation pressures that may come through.”

Inflation has implications for long-tail classes, while in the short-term supply-chain pressures are a major issue for repairs as costs increase for materials, parts and labour. The ultimate strength of that COVID-induced inflation remains unclear and it’s also uncertain how long it will remain.

“If it is temporary, we don’t know if it will resolve itself in the next few months or whether it will take a few years,” Mr Cohen says.

“I am leaning towards a longer time to resolve and during that time you will get extra inflationary pressures on some classes.”

The Optima outlook assumes an “absence of any further large COVID-19 surprises” and average weather-related claims. A La Nina system that could bring a wetter-than-normal summer, somewhat similar to last year, is noted without any conclusions being drawn.

Amid the uncertainties, the report anticipates that insurers can look forward to better times as the delayed recovery actually arrives.

But COVID-19 has joined natural catastrophes as a potential joker in the pack.