Steady progress

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Profits may dip but pick up next year, while volume should stay about the same. Overall, however, the first survey of Insurance Times’ Power Network shows there are reasons to be optimistic

Senior figures in the insurance industry are cautiously optimistic about the sector’s prospects for the next 12 months, according to the first survey of Insurance Times’ Power Network.

While most of the network’s members expected the sector’s profitability to decline over the next six months, business volumes were predicted to stabilise.

Over the next 12 months, more respondents expected volumes to increase than to decline.

There was also a growing prediction that the sector’s profitability would begin to improve next year as rates harden and investment returns improve.

There were warnings, however, that more staff would be cut over the next six months as companies tried to reduce costs.

The survey also revealed that rising claims costs, increased regulatory burden and high broker commission levels would pose the greatest challenges to the industry.

Falling demand for insurance was seen as one of the least challenging issues, alongside lack of underwriting capacity and erosion of capital.

Business volumes and profitability

Most respondents (65%) expected business volumes to remain stable over the next six months, although 25% predicted a decline.

The outlook was slightly rosier over a 12-month period, with more respondents (40%) expecting business volumes to increase rather than to decline (30%).

Half the respondents said the sector’s profitability would fall over the next six months, compared to just over a sixth that expected it to improve. But respondents were more optimistic about profitability over the next 12 months: 35% expected profits to rise compared with the 45% that thought they would decline.

Not surprisingly, respondents believed that economic conditions would depress demand for insurance as businesses went out of business and companies reduced their insurance spend. Rising claims inflation and negligible investment returns would adversely impact profitability. The speed at which premium rates increased and investment returns improved would be crucial in lifting the sector’s profitability.

“Business volumes will remain flat due to recessionary pressures until the market hardens. At that point, margins will improve but probably not before the third quarter of 2010,” said one respondent.

Another commented: “We are still on the downslope of the recession despite recent ‘green shoots’: unemployment still has a long way to go, and there are a huge number of firms in danger of breaching their banking covenants. Insurers cutting costs and some rate increases will ameliorate profit downside risk as these bite, but these effects are not instant.

“We see progressive improvements in volumes from both rating increases and new business, with resulting improvements over the next 18 months in profit margins.”

The challenges ahead for the sector

Respondents were asked to rate a number of potential challenges on a five-point scale from 0 (not a concern) to 4 (a major concern).

Rising claims costs were of greatest concern, with 75% of respondents ranking this 3 or 4. One respondent said: “The economic environment combined with poor underwriting discipline will increase claims costs significantly over the next six months.”

Another Power Network member said: “This is a major concern, as the recession is likely to drive up claims costs across just about every insurance class through fraud, vandalism and theft. Additionally, professional indemnity and D&O claims are already rising.”

Greater regulation

Broker commission levels and regulation were also areas of concern. Almost two-thirds of respondents ranked the challenge posed by commission levels as 3 or 4, while just over half gave regulation the same scores.

Respondents were concerned that the general insurance sector would face increased regulation as a result of the banking crisis.

“There is a real danger that insurers are caught in a wave of excessive new regulation driven by the banking crisis,” said one respondent. Another said: “The FSA will over-react and consequently over-regulate.”

It is not surprising that commission levels were seen as a challenge, given the conflict between insurers wanting to cut costs and brokers looking to maintain their revenues.

“This is a constant debate and brokers need to realise that they have to justify their levels of commission and have a duty to run efficient businesses,” said one member of the Power Network.

Another added: “Their levels of commission are going up, as brokers are not dealing with their inefficiencies and just papering over the cracks.”

Capacity, capital and falling demand were areas that were of least concern to many. Half the respondents scored capacity as 0 or 1 on the challenge scale, while 30% scored capital erosion and falling demand as 0 or 1.

This response must be put into context, however: 40% of respondents ranked falling demand as 3 or 4, while 35% scored capital erosion as 3 or 4.

Expenditure trends

Members of the Power Network were asked how they expected expenditure on areas such as staff, marketing and technology to change over the next six months.

Nearly three-quarters said staffing costs would be cut; none expected it to increase.

Half said that spending on the claims process would rise in the next six months, which is not surprising given respondents’ concerns about rising claims costs. Only one in ten said spending on this area would decrease.

Thirty-five per cent believed that investment in product innovation would rise, although 55% said that it would remain stable.

More respondents believed that spending on technology and marketing would decrease over the next six months than expected it to rise.

The Power Network

Insurance Times has assembled a group of some of the most influential people within the insurance sector to provide insight and leadership on the issues affecting the industry. The Power Network’s members are: