• Sharebar
Short term Industry
Thursday, February 1, 2007
Reality setting in

I won’t go so far as to say the party’s over for the short term insurance industry. But the heady period of exceptional profits from 2003 to 2005 is certainly over. As the final figures for last year’s high level of claims and large losses continue to trickle in some underwriters are already talking of a second round of rate increases – at least selectively.

As Bruce Campbell, MD of Mutual & Federal, has already noted on several occasions, luck played a big part in the pre-2006 bonanza; there had been little skill or science to it. Profits rose on the back of “abnormally favourable conditions characterised by lower claims, a lack of industrial fires or huge weather-related damage, low inflation and a strong rand making replacement costs cheaper.”
In those times, as Mike Dickinson, MD of Regent Insurance notes, “The industry had an air of invincibility about it. No matter what business was underwritten the companies would make money.”
Such benign claims environment was bound to come to an end. But when the market started to normalise during 2006 he says insurers did not react soon enough, and “were caught by surprise.” Indeed, he still thinks that some companies in the market are “not as tuned in to their portfolios as they should be.”
Mr Campbell and some of his colleagues had been warning for about a year that things “were returning to normal.” Despite M&F’s desire to maintain a balanced book in line with its long term underwriting strategy (it said it had achieved the “ideal mix” last year – see Insurance Times & Investments Vol 19.5 October 2006 page 3), this would not be maintained at any price. Indeed, the company is no stranger to shedding unprofitable business. Nor is it alone.
Mr Dickinson says his company has lost in excess of R100m in gross premium income (GPI) the last six months because of churning. “We may be perceived as a niche player, but in actual fact we are a large company with a diversified portfolio.” Its total GPI is around R2 billion.
Like the larger operators it can afford to lose some business as a result of a sensible re-rating of certain risks. “Whereas other companies might work towards a ‘balanced book’, we look toward ‘balanced channels’,” he explains. Regent’s book is roughly made up as follows: financial institution motor dealers 42%; commercial vehicle and goods-in-transit 15%; broker division and direct traditional business 25%; aviation 5%; Imperial Group 5% (proving Regent does not get much captive business!); and, a bit of engineering and marine the rest.
M&F’s and Santam’s mix was published in the October article referenced above.
That some operators continue to seek market share by offering sub-economic premium levels suggests the level of ‘churning’ will accelerate this year  — whereby clients and brokers replace their polices with cheaper alternatives. Usually when this happens, the risk pool they join becomes a serious problem and they end up paying more than on their previous policy. All kinds of other things can go wrong too (see our story on a FAIS Ombud ruling on page 15 this issue).

In any case, competition is set to increase further as new underwriters join the market. According to the most recent report by the Financial Services Board (31st March 2006), it licenced nine new short-term insurers (although two others lost their licence). Only three had been registered the year before. The table shows the breakdown of the licenced companies in terms of general insurers, niche players, and so on. It suggests the specialist market, at least, will see more competition.

Gross premium written by the market to the end of 2005 was R46,2 billion, of which general insurers controlled 75% (see pie).

According to the FSB’s analysis of net premium income (that is, after all reinsurance placements have been taken) the business class breakdown is shown in the second pie chart.

The top four companies command 66% of the insurance business

In terms of gross premium income as a percentage of total market share:

Current market conditions

Ian Ross, Chief Risk Officer at Hollard Insurance, says that although there had been relatively little activity in terms of events and losses in 2006, “This year already has seen massive European windstorms, which are likely to influence reinsurance costs, ultimately affecting insurers. And this comes at a time when insurers are seeing a deterioration in local results particularly in crime related covers and motor insurance.”  
In theory this should further arrest the move toward softer rates in commercial lines business, which depends far more on reinsurance, than do those in the personal lines sector.
Though the rating levels in commercial business have been coming down more recently there seems to be a levelling off, confirms Mr Campbell. Commercial consists largely of property, crime and motor classes, this last suffering the same problems as personal lines. Mr Campbell says because of the increased numbers of fires on the property side there hasn’t been enough to cross-subsidise commercial motor. “Whereas we were extremely lucky during 2003-2005, last year saw a more normal fire loss picture with a number of large claims coming through. And I do not think any company is making money on the crime classes, particularly as a result of burglary losses and fidelity guarantee,” he observes.
So one way or another all classes of business will face ‘challenges’, meaning higher premium rates and stricter terms and conditions (in policy wordings); and that may fuel the competition. Though to what degree will be determined by the sheer force of claims costs.
Caroline da Silva, head of portfolio management at Santam, suggests the following as the most significant challenges facing insurers this year:
Motor repair costs. This is through high numbers of accidents, increased usage of a deteriorating road system; and the high import costs of spare parts. As many as another 50 000 new vehicles are coming onto our roads every month (this affects commercial and personal lines).
Theft and hijacking especially of higher valued vehicles. Cost per claim is more a problem here than frequency, as there seems to be some levelling off in the actual numbers of vehicles stolen (this also affects commercial and personal lines).
Unpredictability of weather related losses. This may reflect the oft quoted references to climate change (of concern to commercial and personal lines sectors and the specialist agriculture account).
Infrastructural threats. Eskom is the main worry here, leading to increased business interruption claims (from commercial and corporate classes of business).

Comments Nick Beyers, managing director, SA Eagle, “A rigorous underwriting discipline will have to be adopted by insurers. Proper risk assessment skills will be vital in insuring these risks. Appropriate rating models will have to be developed for the so called “high risk” geographical/land terrain in order to address natural climatic changes and human intervention.
“The motor account has been negatively impacted due to an increase in the number of accidents and vehicle hijackings. New car sales, including imported models, have reached record levels, which puts further pressure on the account due to the cost of repairing such imports. Pricing appropriately for this risk will continue to be a focus for the industry and corrective action will have to be taken to address profitability.”
Apart from protecting their books, or shedding loss making blocks, there are new markets out there. As Da Silva notes, more companies will be seeking to market personal lines to the lower LSM sectors of the population. That is a challenging area of competition. The FSB hopes there will be an emphasis on “addressing the needs of the low-income market for appropriate products.” Likewise the saturated markets, specifically the specialist insurance covers and corporate sectors will prove tricky in terms of strategy. Higher losses could arise if competitors under-rate the risks.
For its part the FSB is concerned about “effective management of costs”. Other topics to watch out for are: compliance with regulatory requirements; black economic empowerment; international financial reporting standards; and, reinsurance capacity. There will also be other challenges, it says, such as the possible legislative changes focusing on a risk-based capital approach.”
Notes Mr Ross, “A move toward Financial Condition Reporting (FCR) is an exciting development, which will see governance and capital requirements relating directly to the risk profile of individual insurers.
“If implemented correctly, FCR will enhance industry profitability by improving capital allocation costs and, of course, insurers utilising sophisticated risk analysis tools such as Dynamic Financial Analysis will have greater insight into essential risk profits. 
“However, with the introduction of FCR, there is the potential to create an over burdensome structure that will make entry into the insurance market prohibitively expensive. This could have a negative impact on the drive to a more inclusive industry. Regulation must balance the need for good corporate governance.”
Meanwhile, the South African economy has continued to grow, comments Mr Beyers, “and should continue to do so until at least 2010.
“A hardening of the insurance cycle is evident and this is expected to continue in 2007. As far as growth is concerned, there are many opportunities for the industry, among them the emerging market.
“While there is a slow general upliftment of living standards, this is mainly improving through debt financing. The industry will need to emphasise the benefits of purchasing insurance to the buying public and develop affordable insurance products to meet their needs.”
He refers to a report by PricewaterhouseCoopers in which was discussed ‘joint ventures and alliances’, which industry players are investigating as possible growth areas. “Another would be tailoring products to meet the needs of niche markets and leveraging on those that are already in existence by actively marketing these.
Concludes Mr Campbell. “The industry learnt some sharp lessons when it struggled with the last downturn in its business during 1997-1998, And I think we now have a more mature industry, and corrective action being taken seems more purposeful.” By Nigel Benetton

Copyright © Insurance Times and Investments® Vol:20.1 1st February, 2007
808 views, page last viewed on August 13, 2020