Two surveys have highlighted enduring concerns over the credit crunch
Brokers’ confidence in the insurance market has plummeted as a result of the continuing effects of the credit crunch, with expected problems in 2008 a further worry for most.
Also, corporations across the financial sector are defaulting on more loans than previously, while banks have become less willing to lend money – in the face of increasing demand.
These trends have been highlighted by two surveys released this week: a joint financial services survey between the CBI and PricewaterhouseCoopers (PWC), and a Bank of England credit conditions survey. Both aimed to take a snapshot of the financial services market at the end of 2007.
According to the CBI/PWC survey, the increased pessimism regarding market conditions in the financial sector has only been higher on two occasions since the survey began in 1989: following the pile up of corporate accounting scandals in 2002/03, and when a quarter of the globe was in recession in 1998.
At the end of 2007, 70% of financial institutions expected the credit crunch to last for more than six months and 89% saw a medium to high likelihood of further deterioration in that period.
However, when compared to other financial services, general insurers (as distinct from brokers) appear to be less worried about credit problems, with a neutral outlook. Also, the optimism regarding the business situation in the sector remained at the same level over the last quarter of 2007.
But this is not to say that participants in the insurance market are ignoring the crisis, nor are they denying the impact it may continue to have. In fact, brokers thought there was a high risk of further deterioration in financial market conditions over the next six months – even though insurers believed there was only a medium risk.
Also, when asked how long they expected ‘normal’ market conditions to resume, around 90% of brokers and 100% of insurers thought the crisis would last beyond six months, compared to an average of 70% across the entire financial services sector. Indeed, across all financial firms, only 3% believed the crisis would be resolved within three months.
In the aggregate across all financial sectors, the ability to raise cash topped the table of worries. Nevertheless, capital investment plans were still poised to go ahead – although this was attributed to an increased drive for efficiency rather than the expansion of capacity.
Increased funding costs were the greatest worry for brokers, followed by reduced sales/revenue growth. For insurers, there was no single worry that stood out, as asset devaluation/impairment; increased funding costs; reduced sales/revenue growth and increased operational costs were all moderate concerns.
But drilling down a bit deeper into the current conditions for insurers reveals a difference between commercial and personal lines.
According to the report, personal lines are performing better than commercial lines, and as personal lines insurers tend to be bigger, large-scale cost-cutting projects are made easier – for example, by offshoring and reducing staff costs. The ability of larger companies to adapt in this way should provide them with a buffer against poor credit conditions.
Clare Thompson, UK insurance lead at PWC, said: “The overall message is that the insurance market is still feeling reasonably confident.
“The life and general insurance markets have remained relatively unaffected because insurance companies use different methods of funding compared to other financial services.”
Thompson also noted that the general insurance market benefited from a continued fall in operating costs and an increase in profitability during the fourth quarter of 2007 – which again went against the trend in other financial sectors, where costs have risen at their fastest rates since 1990.
However, there is one notable area in which costs are increasing in the insurance market: compliance spending. Firms have been forced to bring in new staff to cope with an increasing regulatory burden – although this has been partly offset by an improvement in efficiency thanks to an increase in IT spending.
According to the Bank of England survey, lenders reported significant reductions in corporate credit availability – with further reductions expected over the first three months of 2008. This is despite a significant increase in demand for credit by financial corporations.
Also, defaults on medium-sized corporate loans had increased, although the default rate on large corporate loans remained stable.
The reduction in availability of corporate loans was blamed on “increased concerns over economic conditions and sector-specific risks, together with a reduction in risk appetite and tighter funding conditions.”
According to analysts, an offshoot of the crisis will be a reduction in the value and frequency of mergers and acquisitions through 2008.
Ian Clark, corporate finance insurance partner with Deloitte, said: “Broker acquisitions have been funded by acquiring entities taking on major debt. Banks have been reining in on debt capacity and this will likely impact the value of acquisitions.
“Banks are lending in smaller multiples and therefore the pace of consolidation will slow. There is still a lot of good business out there but we will see them grow organically.”
Clark said that acquisitions currently in the pipeline were likely to still go ahead but he said that new activity would slow.
Improving the confidence of insurance brokers in their business conditions depends on getting some finality in the credit saga – and clearly, it is uncertain when this will arise.
Meanwhile, the relative confidence of insurers is likely to be a reflection of the fact that, according to PWC, they are shielded somewhat from turmoil in the financial markets.
However, the lingering uncertainty over claims arising from a range of professional liability policies linked to the subprime crisis – the precursor to the credit crunch – will surely temper any optimism as insurers, like brokers, hope for a rapid end to the crisis.