The insurance cycle is set to become wildly unpredictable, claims a controversial report.
Insurance analyst First Consulting says the traditional underwriting cycle of regular peaks and troughs could be a thing of the past.
The UK insurance market is at its softest for more than five years – rates are 20% below the 1994 peak – and many insurers have seen underwriting results plunge, notes the report, “The Underwriting Cycle Lives On?”.
But the report stresses, that while premium rates appear to be on an upswing again, chronic overcapacity in the market means the regular cycle of six to ten years is becoming increasingly erratic, as First Consulting's graph reveals. Motor is the only class to show a steady rise.
For example, since 1948 the length of underwriting cycles at Lloyd's has varied from five to 11 years, with upturns lasting two to six years and downturns slightly longer at three to six years.
But the intensity of these cycles has increased in more recent times and the height and depth of each successive cycle has deepened.
At the bottom of the cycle in 1974, the underwriting result was
-5% of total net premiums although premiums later climbed back to +11%.
By 1990, when the market plumbed the depths of a -48% loss, its subsequent bounce back was much larger at +59% five years later.
The report says that recent structural changes in the insurance market have made the shape of future underwriting cycles almost unpredictable.
“There are fewer barriers to entry and large, highly mobile funds can be moved rapidly into the industry in times of high margins,” says the report.
“For example, when Lloyd's significantly cut back its capacity following the extreme losses suffered in 1991, premium rates and returns on capital shot up.
“The high margins attracted large funds into the industry and companies such as XL Capital and ACE began writing reinsurance from Bermuda.”
Such supply fluctuations rapidly feed in to the retrocessional market and soon transfer into the primary market via reinsurance rates.
First Consulting argues that this increasing global movement of capital is the cause of almost permanent soft market conditions. These have made investment income more important that underwriting profit to insurers.
But as insurers benefit from higher returns on investments, so they are more willing to accept less profitable underwriting, the report argues.
The report speculates that mergers and acquisitions have produced larger insurers that are sizeable enough to sustain unprofitable underwriting for longer periods. This means the large firms can concentrate on building up their market share in preparation for recovering their losses during a subsequent upturn.