It is bad, but it could have been worse

The consensus is that the general insurance industry has not suffered the same extent of losses as other financial services institutions, such as banks and asset management companies in the current recession.

There are notable exceptions. AIG, for example, is still reporting losses. In May it reported a loss of $4.35bn (£2.9bn) in the first three months of 2009 and this follows its biggest loss of $61.7bn, reported in the previous quarter.

The general insurance sector is by no means immune from the impact of the global credit crisis but where the industry has suffered most is through unrealised losses in its investment portfolios, which in some instances, have resulted in a decline in policyholder surplus for 2008.

Allianz Insurance is the latest in the industry to admit a fall in investment income. For the first quarter of 2009 its investment income fell £5.4m to £26.7m (a fall of 17%) from the first quarter of 2008.

In a special feature on the global credit crunch, Willis asks what its impact has been on insurers.

• Access to capital is severely limited due to reduced activity on the debt markets. The added problem is that share prices are also trading significantly below book value, making rights issues an inefficient method for raising funds.
• The reduced level of available capital would normally be expected to result in a fall in market capacity, leading to rate increases. From 1 January 2009, rate increases were noted in specific pockets of business, but this was not consistent across all lines (see table opposite on Moody’s view on why there is a delay in rate increases). In fact, softening in some lines continued, although in a moderated way. It is largely anticipated by insurers that these lines will begin to harden during 2009 and 2010. Already the reinsurance market is hardening. Rate increases are occurring in most territories and classes, driven by continued pressure on reinsurers’ capital and increased demand from insurers looking to use reinsurance as an alternative form of capital. Reinsurance premium costs will be a key component in the calculation of insurance premiums.
• The large losses reported by financial services institutions have resulted in credit rating downgrades, leading to increased awareness and focus on risk management, including management of exposures to insurers. Although the large insurers have been subject to increased attention, they continue to carry strong ratings.
• The credit crisis has resulted in many insurance buyers reconsidering the level of diversification in their insurance portfolios. The so-called flight to quality appears to have benefited smaller specialist, niche markets, as buyers look to access alternative capacity. This trend could begin to explain why the expected increase in rates has been slower than many thought.
• On the underwriting side, difficult economic conditions increase the risk of moral hazard, including insurance fraud. However, for some lines of business the state of the economy will lead to a reduction in frequency and severity of claims. For example, the number of motor accidents may decline as the amount of travel falls. Disability insurers report that in recessions, the more experienced (and therefore less prone to accident and injury) generally maintain employment and claims are reduced.
• Furthermore, when policyholders look for ways to cut their premiums, one option may be to increase deductibles, resulting in a reduced cost for insurers when claims are made.
• Insurers will be aware that a potential consequence of initiatives by governments to revive their economies may be an increase in inflation, which could have a significant impact on claim costs.
• Insurers that have been involved in activities outside traditional insurance – activities that have generated significant losses – are scaling back or ceasing those business activities, and are focusing on underwriting discipline and adopting conservative investment policies.

It is also not easy to tell how the insurance industry will fare in the recession. Rating agencies have mixed views on the general insurance industry.

“"Reinsurance premium costs will be a key component
in the calculation of insurance premiums"

Moody’s has rated the European insurance industry’s outlook as negative, while AM Best is maintaining its stable outlook on the global reinsurance, US domestic and US commercial insurance sectors. Moody’s also has a stable outlook on the US personal lines sector, but S&P has assigned negative outlooks to both the US personal commercial lines sector since August 2008.

Fitch has awarded the US and UK life and non-life sectors negative outlooks too. The agencies’ cause for concern is the deterioration of capital due to losses on investment portfolios.

Jennifer Ellis, divisional director at Willis, says that the activities of general insurers will be further impacted as the UK recession continues through the year.

“The insurance sector will by no means be isolated from the impact. However, this impact on insurers is less severe than that experienced in other financial services sectors and for insurers with solid balance sheets and strong enterprise risk management the current climate may bring opportunities.”

She adds: “General insurers will need to monitor the exposure of capital to underwriting losses very carefully. Unable to rely on investment income, insurers will need to maintain underwriting discipline. Keeping combined ratios below 100% will be pivotal in achieving bottom-line profit.”