In this conference issue of Resolve, editor Kate Tilley covers presentations at the inaugural APIC17 conference in Singapore in October and the New Zealand Insurance Law Association's September annual conference.

Price gymnastics challenge industry

Insurers have been told to “be brave” and resist the downward pricing spiral.

Matthew Jackson, head of casualty underwriting Asia for Liberty International Underwriters, told APIC17 the industry's "price gymnastics" were a challenge. Prices were cheaper in Australia than a decade ago and in Asia renewal negotiations began with demands for discounts.

"It feels like the late 1990s when pricing was too cheap and some insurers were reporting illusory profits, which culminated in failures," he said.

After soft pricing for a decade, the market was reaching a point where prices could go no lower. Although some classes were seeing moderate increases, for example, D&O in Australia, construction workers' compensation in Hong Kong, property in New Zealand, and Gulf of Mexico catastrophe cover.

Recent catastrophes were still earnings events, not capital reducing. "New investors are still interested in coming into the market. Surplus capital sees prices go down."

Mr Jackson said new entrants to the Singapore market were putting pressure on pricing and new investors, like hedge funds, were attracted to the industry's sustainability in a low-interest-rate environment. There was structural overcapacity, mainly in north America, fuelled by sidecars, cat bonds and insurance-linked securities, which now represented 18% of the global insurance market.

Mr Jackson detailed then-F&G president Paul Ingrey's 1985 clock that explained the cycle. At 1 o'clock, pricing starts to drop; 2 o'clock, companies compete to increase market share; 3pm, prices fall dramatically; 4pm, profits slide; 5pm, results are 'horrible'; 6pm, pricing can go no lower; 7pm, AM Best writes a 'letter of concern'; 8pm, crunch; 9pm, prices go up sharply; 10pm, capacity becomes expensive; 11pm, all companies flourish; midnight, euphoria; then the cycle starts again.

Mr Jackson said the industry was currently at 5pm and heading to 6pm where results would get so bad that rates could go no lower. Rates would eventually have to increase, but it would not happen in an organised way. "Insurers will experience horrible losses and there will be nasty surprises."

In Berkshire Hathaway chair Warren Buffett's 2004 letter to shareholders, issued in February 2005, he said: "Insurers have earned generally poor returns for a simple reason – they sell a commodity-like product. Policy forms are standard and the product is available from many suppliers … most insureds don't care from whom they buy. Customers by the millions say 'I need some Gillette blades' or 'I'll have a Coke' but we wait in vain for 'I'd like a National Indemnity policy, please'. (You could drop in any insurer's name). Consequently ... price competition in insurance is fierce. Think airline seats."
Mr Jackson said that piece of wisdom was written a dozen years ago.

In the same letter to shareholders, Mr Buffett talked about how National Indemnity (NI), which sold commercial auto insurance in a very competitive landscape, had been a star performer for Berkshire Hathaway.

"How had it achieved its competitive advantage? Don't forget, for many years before 2004, the market had been soft and prices overall were not enough. This was the landscape globally and the situation in Australia leading up to the era of the HIH, Underwriter Insurance Co, and Independent Insurance Co failures that culminated in the fallout of 2001," Mr Jackson said.

"So, how did NI do it? They had one clear advantage in the late 90s – they priced for a profit. Sounds simple, doesn't it? They priced to make a profit and didn't try to match their most optimistic competitors. NI never left its customers – but  its customers left the insurer.

"Many insurers like to believe their product is better, but it's all pretty much the same. It's like airlines – price determines who you fly with." Mr Jackson said NI "had the guts to stand firm on price" and eventually it got competitive advantage.

But insurers today were shying away from the NI view. Pricing was "becoming insane". "How many products do you buy that offer automatic discounts?"

Mr Jackson said it was hard to price for profit because:

• GWP (top line) was difficult to achieve because shareholders wanted growth and gross domestic product was stagnant in most countries
• Insurance was inelastic. Just because it was cheap, didn’t mean people would buy more
• Competition meant there was less premium pool to go around
• The rising cost of claims. CPI was low and claims inflation was higher than CPI
• Super-imposed inflation, because of class actions, new areas of compensation, more plaintiff lawyers and litigation funders
• Fraud – estimated at 8%-9% of claims in Australia, 15% in Canada
• Anticipating claims costs was “a black art”. “You can’t just add a few percent to last year’s claims. Do we have the tools to do it correctly?”

Insurers were facing slimmer margins as they felt the combined impact of pressure from brokers for increased commissions; a greater focus on expenses management; and lower investment income. Investment income would "once rescue you from bad underwriting performance" but today it was "not pretty".

Mr Jackson warned against continued underpricing. "It takes a long time to fix an underperforming book."

Senior managers must give underwriters the ability to stand firm. While insurers' results still looked healthy, they did not truly reflect the market's status.

"To ensure sustainability, we must write for profits and not just write to hit top-line targets," he said.