issue TWO | 2014

Life insurance industry overview

General insurance industry overview

issue two | 2014
II

Insight issue two 2014

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 III

Insight issue two 2014

Contents

4
Life insurance industry overview
This article provides an overview of the life insurance industry (including
friendly societies) together with an update of the key prudential risks that
face the industry.

24
General insurance industry overview
This article provides an overview of the general insurance industry together
with an overview of recent developments and key prudential risks.
4

Insight issue two 2014

Life insurance industry overview

Life insurance
industry overview
This article provides an overview of the life insurance industry
(including friendly societies) together with an update of the key
prudential risks that face the industry.1

1 Unless otherwise stated, the period covered is the 12 months to 30 June 2014.
 5

Introduction
The 12 months of 2013/14 for the life insurance
industry could be characterised, on the one hand, as
one of stability in terms of industry structure after
a long period of years of merger and acquisition
activity. It was also a period where the industry
successfully bedded down the revised capital
framework that commenced 1 January 2013.

On the other hand, 2013/14 has also been a

period of significant instability and uncertainty,
where the cost of a slow weakening in business
and risk management practices over a number
of years finally became evident, crystallising into
substantial declines in the performance of risk
insurance business.

The industry is nonetheless well capitalised and

is financially well placed to work through the
current challenges. Life insurers have been making
considerable efforts to remediate their pricing
and risk management practices for insurance risk
business while recognising that much still needs to
be done. There are some early signs that profits
may be returning to more ‘normal’ levels but it
will take a few years yet before it is clear that
industry actions have achieved sustainable
premiums and profits.
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Insight issue two 2014

Life insurance industry overview

The integration of life insurance with broader Future of Financial Advice (FOFA) and Stronger
wealth offerings in many institutions meant that Super reforms were also key areas of focus during
the adjustment to regulatory changes such as the 2013/14 for both the industry and APRA.

Figure 1: Life insurers – Assets by industry sector (at 30 June 2014)

Large diversified (6) - 82%

Insurance risk specialists

and reinsurers (10) - 7%

Annuities (1) - 4%

Small/niche (9) - 1%

Other diversified (2) - 4%

Friendly societies (12) - 2%

Source: Life Insurance Institution-level Statistics publication

 7

Industry structure Measured by gross assets at 30 June 2014, the

largest three and five life insurers account for 76
As at 30 June 2014, there were 28 registered and 85 per cent respectively of industry assets.3
life insurers, which is unchanged from the This level of concentration has been relatively
previous year.2 Life insurers are characterised static for a number of years and is not particularly
by a heterogeneous mix of business profiles different to that in the general insurance industry.
and strategies, comprising six medium to large
life insurers (four of which are members of the Many life insurers are, however, strategically
major banking groups) selling a diversified but centred on regular insurance risk premium
similar range of product types, together with a revenue and its growth. From this perspective,
larger number of smaller but diverse life insurers life insurance business is more evenly distributed
specialising in niche products or markets. Seven across the industry, with the largest three and
reinsurers (all subsidiaries of international groups) five life insurers writing 35 and 55 per cent of the
provide essential support for the risk insurance industry insurance risk premium respectively over
market in Australia. An additional 12 friendly 2013/14.
societies, accounting for around two per cent of
industry assets, complete the mix. See Figure 1.

3 AMP and NMLA, being part of the same group, have been
2 One life insurer and one reinsurer are inactive. combined for the purpose of these measurements.
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Insight issue two 2014

Life insurance industry overview

Financial performance Life insurers, as a vehicle for the superannuation

investment, continue to lose market share
Life insurer statutory funds held approximately to increasingly popular alternatives such as
$279 billion of assets at 30 June 2014 ($252 billion investment platforms, industry superannuation
at 30 June 2013), a growth of 11 per cent. funds and self-managed superannuation
Repeating the pattern observed in 2012/13, funds (SMSFs). At 30 June 2014, life industry
the primary driver of the asset growth over superannuation assets under management
2013/14 was the continuing strengthening of now account for 13 per cent of aggregate
equity markets. superannuation industry assets compared to
17 per cent and 40 per cent five years and 20
Stronger equity markets also may have been a
years ago respectively. This trend shows no signs
key driver of the growth in investment-linked
of abating.
premium inflows (primarily superannuation based)
— investment-linked premium revenues were $28.8 Insurance risk premium growth during 2013/14
billion during 2013/14 compared to $21.7 billion in was 12 per cent and 19 per cent for individual and
2012/13. It is noted though that this remains barely group business respectively. Automatic contractual
sufficient to cover outflows of $27.8 billion. See age- and inflation-related premium increases make
Table 1. Likewise, after taking account of insurance up a significant and regular part of risk insurance
claims, insurance risk premium revenue adds little to premium growth in any year. For 2013/14, most
the aggregate asset base. particularly for group risk insurance, premium
growth was nevertheless well above usual levels,
reflecting insurers’ responses to recent poor
disability claims performance.
 9

Table 1: Life insurers – Net premium revenue by product group (12 months ending June)*

2010 2011 2012 2013 2014

$b $b $b $b $b

Investment-linked^ 22.3 25.4 19.5 21.7 28.8

Other non-investment-linked investment^# 4.8 5.0 7.7 5.7 5.3

Traditional whole life/endowment 0.4 0.3 0.3 0.3 0.3

Total investment business^ 27.5 30.8 27.4 27.7 34.3

Death/disability lump sum 4.3 4.8 5.1 5.7 6.4

Disability income 1.4 1.6 1.7 2.0 2.2

Individual Risk 5.7 6.4 6.9 7.7 8.5

Death/TPD lump sum 2.3 2.5 2.9 3.0 3.6

Disability income 0.5 0.6 0.7 0.8 0.9

Group risk 2.9 3.0 3.6 3.8 4.6

Total insurance risk business 8.5 9.4 10.5 11.5 13.1

Total net premium revenue 36.0 40.2 37.9 39.2 47.4

Source: APRA Statistics

* Rounding may cause differences in totals.
^ Excludes policy conversions.
# Total and permanent disablement.
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Insight issue two 2014

Life insurance industry overview

Life insurer aggregate profits have been in steady the progressively deteriorating claims experience
decline for the last five years. See Figure 2. of risk insurance business (including associated
significant reserve strengthening) has been a
The decline in the early part of this period could be prominent and unmistakeable driver (visible in the
attributed, in some part, to highly variable year-on- non-investment linked line).
year investment market returns but, more recently,

Figure 2: Life insurers - Net profit by business group4 (12 months ending June)

3,500

3,000

2,500

2,000
$ million

1,500

1,000

500

0
2010 2011 2012 2013 2014

Total entity Investment- Non-investment Profits on retained earnings,

linked policies -linked policies capital and general funds

Source: Life Insurance Quarterly Performance publication

4 Amounts for investment linked and non-investment linked relate to insurance policies only, not total statutory funds.
 11

Table 2: Life insurers – Relative capital performance 2013/14

Non-investment linked Investment linked Ratio Ratio

$b $b June 2013 June 2014

Total assets 88.0 191.2 0.5 0.5

Net profit 1.4 0.7 2.7 1.9

Prescribed capital amount (PCA) 5.4 0.7 6.4 7.8

Source: Life Insurance Quarterly Performance publication

By its nature, non-investment linked business is Non-investment-linked business assets were 0.5
far more capital intensive than investment-linked times that of investment-linked business but
business but the revenue, cost and risk drivers of the business generated 1.9 times the profit in
the two forms of business are very different making 2013/14, down from 2.7 in 2012/13. However,
comparison of capital costs and performance more relevant was that it required 7.8 times the
difficult. A return on capital measure is not Prescribed Capital Amount (PCA) to generate
particularly insightful in these circumstances. One that profit, which was up from 6.4 from 2012/13.
alternative and perhaps more informative approach In other words, non-investment-linked business
is to consider the trade-offs between profit and became even more capital-expensive over
capital. See Table 2.5 2013/14 relative to investment-linked business
due to a combination of the deterioration in
claims experience and increases in prudential risk
capital requirements as business has grown.

5 A return on capital measure only tells half the story since it hides the
relative contributions of these components.
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Insight issue two 2014

Life insurance industry overview

Investment business The figure also shows that annuities, while also a
material contributor to aggregate profits, generate
Apart from its lower relative capital cost, many a significantly more volatile return, being sensitive
life insurers remain attracted to investment- to movements in interest rates and credit spreads.
linked business because, historically, it can bring
some performance diversification and stability. The rate of surrender and withdrawals for
It contributed 30 per cent of aggregate industry investment-linked business over recent years has
profits in 2013/14 (18 per cent in 2012/13) and been trending upward. While there are clearly
therefore played an important role in this period. seasonal cycles, the trend appears not have
This is further evident in Figure 3 which shows net abated during 2013/[Link] is partly a function
profits of investment products (both investment- of transfers to the increasingly popular alternative
and non-investment linked) broken into major vehicles for superannuation mentioned earlier,
product groups. including an increasing preference by investors and
retirees for SMSFs.
 13

Figure 3: Life insurers — Net profit by major investment product groups (12 months ending 30 June)

1,400

1,200

1,000

800

600
$ million

400

200

-200

-400
2010 2011 2012 2013 2014

Total investment Traditional business Investment linked Annuities Other investment

Source: Life Insurance Quarterly Performance publication

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Insight issue two 2014

Life insurance industry overview

Insurance risk business For example, the impact on profit recovery of

the recent steep increases in premium rates for
Figure 4 contrasts the profit performance of a number of industry superannuation schemes
insurance risk business (both in aggregate and clouds the ability to draw any inference that the
by major product classes) with that of investment underlying deterioration in the claims trend has
business shown in Figure 3 (the axis scales are been arrested. In principle, so long as premium
the same). rate settings align with actual claims experience,
Large swings in profits and losses over the five then the business will be profitable. We expect
year period are evident as is the further sharp though that both premium rates and mitigation
deterioration in 2013/14 for individual disability strategies will take some time to take full effect,
income and group death/TPD insurance (most and profitability returns to reasonable and
particularly for industry superannuation fund sustainable levels.
schemes). Some part of that deterioration is Over a number of years, lapse rates for individual
due to a strengthening of claims reserves in risk business have risen and are significantly
anticipation of ongoing higher claims experience. higher than those which prevailed several years
The most recent quarterly data suggests that ago. There has been no sign of any reversal of
industry insurance risk profits might be at the this trend during 2013/14. The worsening lapse
start of a recovery. Should the turnaround be experience has been attributed to a number
confirmed in due course, it will be important of factors including a declining need for risk
to identify the underlying reasons and where insurance by ageing ‘baby boomers’, stronger
structural problems might still remain, and thereby competition in the market, pressure on household
make an assessment of its long term sustainability. budgets leading to some pruning of discretionary
expenditure, and the longer-term impact of
premium rates that automatically increase each
year with age.
 15

Figure 4: Life insurers — Net profit by major insurance risk product groups
(12 months ending 30 June)

1,400

1,200

1,000

800
$ million

600

400

200

-200

-400
2010 2011 2012 2013 2014
Total Risk Group Group Disability Individual Individual Disability
Insurance Death/TDP Income Death/TDP Income

Source: Life Insurance Quarterly Performance publication

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Insight issue two 2014

Life insurance industry overview

It is also possible that consumers are recognising Capital

that the life insurance cover they hold may no
longer meet their changing needs, and that The industry’s capital position remained strong
product ‘churn’ by financial advisers in light of the in 2013/14. As at 30 June 2014, the aggregate
attraction of very high up-front commission rates capital base held for life insurers was 1.87 times
for new business has contributed to lapse rates. the PCA, the regulatory minimum capital (before
Consistent with the Australian and Investment supervisory adjustments). See Table 3.
Commission’s (ASIC) recently completed review
Since 2013, APRA’s revised capital requirements
of industry sales practice, APRA has highlighted to
have allowed two general tiers of capital to form
insurers the significant reputational risk attached
the capital base. Some life insurers have taken
to inadequate oversight of sales practices.
advantage of this flexibility, with Tier 2 capital
representing eight per cent of total life insurer
Friendly societies capital at 30 June 2014.
The net profit of friendly societies declined to
$260 million in 2013/14, after a strong result
in the previous year of $350 million (and $101
million in the year prior to that).6 The volatility
The industry’s capital position
in friendly society profits is associated with its remained strong in 2013/14.
investment-linked business, which, forming
about two thirds of business and broadly tracking
Australian share market performance, is the key
driver of overall friendly society profits. Non-
investment-linked business tends to be supported
by more conservatively invested assets and returns
for this business tend to be more stable.

6 For friendly societies, ‘profit’ is not shareholder profit; rather, it is

the total profits of the benefit funds and management fund before
allocation to policyholders.
 17

Table 3: Life insurers - Capital strength (at 30 June 2014)

Surplus over
Capital Base PCA Capital
PCA
$m $m Coverage Ratio
$m

Investment-linked 1,340 690 650 1.94

Non-investment-linked 9,346 5,353 3,993 1.75

Total statutory funds 10,685 6,043 4,643 1.77

General fund 1,418 404 1,014 3.51

Total life insurers 12,103 6,485^ 5,618 1.87

Source: Life Insurance Quarterly Performance publication

^ The total entities PCA is adjusted for the minimum entity PCA of $10 million where applicable.
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Insight issue two 2014

Life insurance industry overview

The make-up of the PCA is generally in alignment While capital ratios vary considerably across
with expectations with respect to two general individual life insurers, in overall terms, the
forms business written. For non-investment- industry is well capitalised and capable of
linked business, 69 per cent of the PCA is the withstanding significant headwinds. Nevertheless,
aggregate of asset and insurance risk charges. The some forms of life insurance (and friendly society)
operational risk charge accounts for a further business remain exposed to sudden shifts in
11 per cent. In contrast, for investment-linked investment market returns, most particularly
business, the PCA is largely made up of the those with long term investment guarantees. For
operational risk charge (67 per cent) with most of example, low interest rates across the yield curve
the residual being the asset risk charge on surplus have reduced investment income and the outlook
assets.7 While these ratios, at an industry level, for fixed interest markets remains decidedly
align with general expectations of the relative risks uncertain. An unexpected but significant change
for these business classes, they vary significantly in official cash rate settings, credit spreads or
by individual insurer reflecting the diversity of market sentiment would exacerbate asset-liability
business profiles and risk management practices. investment matching, at least in the short term.
The resilience of life insurers and friendly societies
in times of increased uncertainty and market
volatility will always need to be closely monitored
by both entities and APRA.

7 Full details are provided in APRA’s statistical publication Quarterly Life

Insurance Performance.
 19

Internal Capital Adequacy Stress testing

Assessment Process (ICAAP) Stress testing is a quantitative ‘what if’ exercise
An important part of the package of revised capital aimed at assessing vulnerabilities and resilience
standards for insurers introduced by APRA on 1 in the face of ‘severe but plausible’ shocks.
January 2013 was the requirement for insurers If implemented effectively and with expert
to have an Internal Capital Adequacy Assessment judgement, stress testing can be a useful analytical
Process (ICAAP). APRA undertook a detailed tool to complement other risk management
review of ICAAP Reports in 2014 including peer approaches and capital assessment models.
comparisons to identify examples of better
practice and potential areas for improvement.

While most of the ICAAP Reports reviewed were Stress testing is a quantitative
of a reasonable standard there were some areas
where insurers fell short of APRA’s expectations
‘what if’ exercise aimed at
with regard to the content and quality of the assessing vulnerabilities and
reports. These areas included the comparison of
actual versus planned ICAAP outcomes, description resilience in the face of ‘severe
of changes in risk profile, commentary on drivers
of future capital needs and the use of stress testing but plausible’ shocks.
outcomes in decision making processes.
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Insight issue two 2014

Life insurance industry overview

Stress testing is now a common component of Industry risks

the risk management tool kit of most life insurers
and APRA has been placing more emphasis on Group risk insurance
it during 2013/14. Apart from insurers’ own
stress testing modelling and scenarios, APRA is In response to the poor claims experience discussed
developing a standardised stress test for the life earlier, by the end of 2013 three major reinsurers
insurance industry (now standard practice in the had ceased quoting for new Total and Permanent
Authorised Deposit-taking Institutions (ADI) Disablement (TPD) business, and quotations for
industry). Eight life insurers will be participating TPD renewal business were generally conditional
in the initial test to be undertaken in the middle on minimal changes to contract terms. Given that
of 2015. The stress test will focus on ‘severe but group risk business is typically a ‘bundled’ package
plausible’ scenarios in the areas of investment of TPD and death cover, this effectively meant a
market and insurance claims risk. significant reduction in reinsurer capacity available
to group risk insurers. While there appears to be
APRA-led stress testing will play a role, some interest from additional foreign reinsurers in
complementary to ICAAP stress testing, in writing business in Australia, the recent reduction in
informing APRA about entity and industry-wide capacity has posed challenges for group risk insurers
capital vulnerabilities. It is also one way to ensure seeking competitive reinsurance quotations,
that appropriately demanding severity tests are resulting in significant premium increases for many
considered by life insurers in their capital planning. group policies.
While not all insurers will be directly participating
in this initial program, APRA will be encouraging
to all insurers and friendly societies to consider the
standardised stress test in their ICAAPs.
 21

Factors contributing to this situation include the Despite a number of warnings from APRA,
following developments over recent years: group risk insurers have been slow to accept that
significant price reductions combined with softer
• record amounts of default cover being made
underwriting practices and enhancements to
available without underwriting;
benefits would ultimately affect profitability. Nor
• a weakening of underwriting controls for was the emergence of other underlying headwinds
optional levels of cover, and automatic recognised in a sufficiently timely fashion or
acceptance of incremental increases in cover allowed for in pricing assumptions.
without the need for medical evidence;
The immediate response of affected life insurers
• the growth in complexity of TPD benefit has been to lift premiums sharply to redress
definitions, resulting in some types of losses. Not only has this led to adverse outcomes
claims being admitted that arguably may not for superannuation fund members, it does not
have been intended to be covered by the address the structural problems that caused
policy wording; the situation. APRA supervisors are therefore
• changing community attitudes to mental coordinating closely across the life insurance and
health, leading to a higher prevalence of superannuation sectors to ensure that life insurers,
claims for stress-related illness; reinsurers and superannuation fund trustees are
working together to identify and resolve the
• more claims now being subject to the underlying causes of the strains in the group risk
involvement of lawyers on behalf of claimants; insurance market. Throughout, APRA’s message
• superannuation fund member awareness to life insurers and reinsurers has been that boards
of life insurance cover provided through must ensure they understand adequately the risks
superannuation, leading to a higher they incur in group insurance business, and that
propensity to claim; and risk management processes are adequate for the
uncertainties in this line of business.
• failure to match the greater complexity of the
claims environment with development of an
adequate pool of experienced claims staff.
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Insight issue two 2014

Life insurance industry overview

Many life insurers and reinsurers have APRA supervisors are reviewing the adequacy of
subsequently undertaken extensive reviews of trustees’ implementation of the new prudential
their group-risk pricing methodology, product standards. As noted below, the availability
design and claims management. Foreign-owned of sufficiently detailed, accurate and timely
reinsurers in particular have drawn on their global insurance-related data appears to be lacking
experience and expertise to seek better insights across the industry and APRA has informed life
into the Australian market so as to improve insurers and superannuation fund trustees of the
performance. need for improvement in this area. APRA has
issued guidance for superannuation fund trustees
On 1 July 2013, APRA’s new prudential standards and life insurers to assist them in meeting the
for superannuation — in particular, Prudential requirements of SPS 250.
Standard SPS 250 Insurance in Superannuation
(SPS250) — came into effect. Two critical new
responsibilities of trustees under SPS 250 are:
Foreign-owned reinsurers in
• for an insurance management framework
that reflects the risks associated with making particular have drawn on their
insured benefits available; and
global experience and expertise
• the need to maintain records of sufficient
detail that a prospective insurer can properly
to seek better insights into the
assess the insured benefits made available. Australian market so as to
improve performance.
 23

Other risks Apart from challenges with respect to the low

interest rate environment and worsening claims
Given the industry trends and issues outlined, experience referred to earlier, life insurers also
it is not surprising that APRA’s supervisory report continuing difficulties attracting and
intensity has lifted significantly in the past 12 retaining claims staff, which is putting pressure on
to 18 months. APRA supervisors have closely remuneration of experienced staff in this field. Most
monitored developments and taken steps to life insurers have commenced projects to address
highlight to boards and management the poor the cost of managing claims and improve their
business and risk management practices that have handling. In particular, early intervention in major
contributed to the current situation. Life insurers injury claims is acknowledged widely as a key factor
have also been urged to analyse claims trends so in reducing claims costs and supporting claimants.
as to identify and respond to the causes of rising However, managing such claims effectively requires
adverse claims. APRA strongly supports the use a specialist expertise that has been in short supply
of industry wide claims studies to this end. It is for some time. This suggests the need to better
evident to APRA that the quality of data held by develop and invest in the pool of capable and
life insurers is mixed, and that a lack of sufficiently experienced claims staff, which presents another
detailed, accurate and timely data impedes longer-term challenge for the industry.
appropriate analysis in many cases.
General insurance
industry overview
This article provides an overview of the general insurance industry
together with an overview of recent developments and key
prudential risks.
 25

Introduction
The general insurance industry maintained a
strong financial position during the year, driven
primarily by the profitability of personal lines
insurers in the absence of significant natural peril
events. In contrast commercial lines insurers
continue to face challenges in the current
operating environment due to strong competition,
excess capacity in the market and low interest
rates impacting profitability.

The risk of these pressures leading to inadequate

pricing by some commercial lines insurers is
currently being examined by APRA, with the
objective being to assist supervisors in their
engagement with insurers on pricing strategies
and processes. Reserving risk is also heightened
at present because pressures on insurers’ results,
through for example lower investment income
may prompt some to use reserve releases to aid
short term profitability, potentially compromising
reserving adequacy.
26

Insight issue two 2014

General insurance industry overview

A thematic review of insurers’ governance and Industry structure

risk management practices in catastrophe risk
management highlighted a number of concerns. There were 115 licensed general insurers and
These included the reliance by some insurers on reinsurers at 30 June 2014, with 18 of these
catastrophe model output used in reinsurance entities in run-off. At that date the 103 licensed
purchasing decisions and setting capital targets, insurers accounted for 90 per cent of the
without adequate challenge of this output. APRA industry’s $114.4 billion in total assets.
provided feedback from the review to industry in
Table 1 shows the steady decline in the
late 2013 as part of the focus on improving industry
number of licensed insurers and reinsurers in
practice in this area, and has been engaging with
the market over the past four years. Further
insurers during 2014 on the issues raised.
consolidation of insurance licenses took place in
On the regulatory front, insurers successfully 2013/14, with most of this being due to Suncorp’s
implemented the insurance concentration risk rationalisation of its insurance licenses following a
charge (ICRC) for a series of smaller sized loss group restructure.
events as from 1 January 2014. This part of the
package of revised capital requirements for general
insurers introduced by APRA on 1 January 2013 On the regulatory front, insurers
was deferred for one year to allow insurers time to
prepare for the change. successfully implemented the
insurance concentration risk
charge (ICRC) for a series of
smaller sized loss events as from
1 January 2014.
 27

Table 1: Industry structure

30 June 2011 30 June 2012 30 June 2013 30 June 2014

Number of licensed insurers 115 112 109 103

Number of licensed reinsurers 12 12 12 12

Total licensed insurers/

127 124 121 115
reinsurers
Source: APRA Quarterly General Insurance Performance Statistics publication

Insurance Australia Group’s acquisition of An important source of competition in personal

Wesfarmers’ insurance business took effect on lines is provided by a number of challenger brands
30 June 2014, strengthening the market share in the market, which continue to gain momentum
held by large insurance groups in the personal and are starting to erode some of the established
and commercial lines markets. Despite the brands’ market share. Personal lines on-line
increasing concentration in both markets, healthy ‘aggregators’ continue to have a small presence in
competition is evident among the large domestic the market.
insurance groups, APRA-authorised subsidiaries of
foreign insurers and other local insurers.
28

Insight issue two 2014

General insurance industry overview

Financial performance The growth in gross earned premium in the year

ended 30 June 2014 was mainly reported in the
The industry reported a strong operating result personal lines classes of business – householders
in the year ended 30 June 2014, with a net profit and domestic motor, with premium growth also
after tax of $4.9 billion driven primarily by insurers’ reported in the complusory third party (CTP)
underwriting results. Table 2 outlines industry motor vehicle class of business. The impetus for the
performance over the past four years.1 premium rate increases in the householders class
was the rise in the cost of property reinsurance
which followed the severe natural catastrophe
The industry reported a strong claims experience of some property insurers in
2011. Recent data suggests a slowdown in premium
operating result in the year growth rates in the householders class, which
is consistent with the moderation in property
ended 30 June 2014, with a reinsurance rates experienced during the year.2
net profit after tax of $4.9 Premium growth in the commercial lines classes of
business continues to be subdued due to strong
billion driven primarily by competitive pressures. This is most evident in the
commercial property (Fire and ISR) and professional
insurers’ underwriting results. indemnity classes, with little or no growth in earned
premium reported during the year.

1 It should be noted that there is a degree of double-counting of data

such as gross claims in this table as the figures include data from
both insurers and reinsurers. 2 Insurance Council of Australia, GI Industry Trends to June 2014
 29

Table 2: Industry financial performance

$million
12 months to
30 June 30 June 30 June 30 June
2011 2012 2013 2014

Gross written premium 34,289 37,413 39,891 41,650

Gross earned premium 34,286 36,947 39,937 41,414

Gross incurred claims (current and prior years) 35,968 27,869 24,602 26,251

Reinsurance recoveries revenue (current and prior years) 15,788 5,815 4,638 4,585

Net incurred claims (current and prior years) of which: 17,740 19,659 17,836 19,135

Current period net claims expense 18,993 19,516 19,308 19,845

Non-recurring items that are part of net claims -1,254 143 -1,472 -710

Total underwriting expenses 7,016 7,562 7,878 8,024

Underwriting result 1,111 569 4,157 4,092

Investment income 4,657 5,411 4,091 3,684

Other operating expenses 1,737 1,748 1,883 2,008

Other items -138 -519 -1,107 -813

Net profit/loss after tax 3,893 3,714 5,257 4,955

Average net assets ($m) 29,799 30,274 31,024 29,806

Return on net assets* 13% 12% 17% 17%

Source: Quarterly General Insurance Performance Statistics publication
* Quarterly figures expressed as annual percentage rates
30

Insight issue two 2014

General insurance industry overview

Property insurers continue to benefit from Claims experience in the professional indemnity
relatively benign weather conditions resulting class, which includes Directors and Officers
in low claims costs. Claims costs from natural (D&O) covers, is sensitive to economic conditions
catastrophe events during 2013/14 were well and movements in financial markets. This was
below the twenty year average as shown in illustrated during the global financial crisis with
Figure 1, with the main events of note being significant claims costs being incurred by insurers
bushfires in New South Wales. and reinsurers in 2008 and 2009, particularly in
the financial services sector. Since that time claims
In contrast with the recent strong claims frequency in the professional indemnity class has
performance in the short-tail property classes of been declining. However an ongoing risk to the
business, the experience in the long tail classes claims experience in D&O covers is the increase in
such as CTP motor, professional indemnity and litigation funders and class actions evident in the
public and product liability has been mixed. market since the financial crisis.
The Motor Accidents Authority of NSW (MAA) Industry loss ratios in the public and product
has advised that claims frequency and propensity liability class continue to be at profitable
to claim continues to rise in the NSW CTP scheme levels with a relatively stable level of claims
mainly with minor severity and legally represented inflation, positively impacted by tort law reform,
claims.3 In contrast the Queensland CTP scheme underpinning results in recent years.
has experienced a largely stable claims frequency
in recent years.

3 MAA Annual Report 2013/2014

 31

Figure 1: Gross claims costs from Australian natural catastrophe events

5,000

Sydney hail storm

4,000
Queensland floods and cyclone Yasi

3,000
$ million

2,000 20 year average

1,000

0
5
6
97
98
99

01

03
00

02

04
05

09
06
07
08

10
11

13
12

14
9
9

20

20
20

20
20
20
19
19

20
19

20

20
19
19
20

20

20

20
20
20

Source: Insurance Council of Australia, Natural Disaster Statistics. Claims costs prior to March 2010 have been indexed to 2011 values.
32

Insight issue two 2014

General insurance industry overview

Reserve releases from prior accident years Capital

continue to make an important contribution to
insurers’ claims performance in some long tail The industry reported a prescribed capital amount
classes of business. However in recent years this coverage ratio of 190 per cent as at 30 June 2014
contribution at an industry level has been diluted (Table 3). Since the natural catastrophe events
because of the strong claims performance in the of early 2011, industry capital levels have trended
property classes of business. upwards with healthy industry earnings bolstering
retained profits. The industry’s capital base is
There was a relatively small movement in the predominantly made up of Common Equity
interest rates used by insurers to value their Tier 1 capital (93 per cent), with a small amount
long tail claims reserves in the year ended of Additional Tier 1 capital (two per cent) and Tier
30 June 2014. This contributed to an increase in 2 capital (five per cent).
claims costs relative to the previous year, because
increases in interest rates in 2012/13 had caused An important change for the industry was the
reductions in the value of these reserves and introduction of the ICRC for a series of smaller
resulted in lower long tail claims costs. natural peril events. This came into effect on
1 January 2014 following a 12 month transition
Most general insurers match the duration of their period which allowed insurers time to prepare for
assets and liabilities with the aim of minimising the change. The introduction of the requirement
the effect on earnings of movements in bond led to 26 insurers needing to increase their total
yields/ discount rates. This resulted in insurers’ ICRC, resulting in a $282 million (seven per cent)
recognising higher realised and unrealised gains increase in the industry’s total ICRC.
on fixed-income investments in 2013/14 when
compared to the previous year. Insurers continued
to report lower interest income on their fixed
income investment portfolios, consistent with the
low interest rate environment.
 33

Table 3: Industry capital adequacy

30 June 2011 30 June 2012 30 June 2013 30 June 2014

Minimum capital requirement ($m) 15,291 15,844

Prescribed capital amount ($m) 15,631 15,859

which comprises:

OCL insurance risk charge ($m) 4,079 4,172

PL insurance risk charge ($m) 2,638 2,766

Insurance concentration risk

4,848 5,116
charge ($m)

A sset risk charge ($m) 5,444 5,135

Other risk charge items ($m) -1,428 -1,376

Eligible Capital base ($m) 26,668 28,166 28,442 30,052

Solvency coverage ratio (%) 175 178

Prescribed capital amount

182 189
coverage ratio (%)
Source: APRA Quarterly General Insurance Performance Statistics publication
34

Insight issue two 2014

General insurance industry overview

The decrease in the industry asset risk charge While most of the ICAAP Reports reviewed were
component of the prescribed capital amount in of a reasonable standard there were some areas
the year was largely due to a fall in the reinsurance where insurers fell short of APRA’s expectations
recoverables resulting from the settlement of with regard to the content and quality of the
Christchurch earthquakes property claims though reports. These areas included the comparison of
these continue to represent a significant portion actual versus planned ICAAP outcomes, description
of the overall industry reinsurance recoverables. of changes in risk profile, commentary on drivers
Recoverables attract higher capital risk charges of future capital needs and the use of stress testing
when due from non APRA authorised reinsurers outcomes in decision making processes.
because of the time taken to settle the claims.4
An exception is if the affected insurers put in place
collateral, a guarantee or letter of credit to support
Operating environment
the reinsurance recoverables, in which case the
risk charges applicable to this support can be used,
Market conditions
provided they meet APRA’s requirements. Current market expectations are that local interest
rates will remain at low levels in the near term. The
An important part of the package of revised management of risks arising from a persistently
capital standards for insurers introduced by APRA low interest rate environment among a sample
on 1 January 2013 was the requirement for insurers of insurers was reviewed by APRA in 2013 with a
to have an Internal Capital Adequacy Assessment focus on governance practices, pricing, investment
Process (ICAAP). APRA undertook a detailed strategies and operational risk.
review of ICAAP Reports in 2014 including peer
comparisons to identify examples of better practice The review concluded that all of the insurers in
and potential areas for improvement. the sample have appropriate management and
controls in place. Insurers acknowledged in their
feedback that continuing competitive pressures
were constraining their ability to achieve adequate
price increases in some long tail classes to offset
the impact of lower investment yields.

4 These risk charges apply to reinsurance contracts incepting on or

after 31 December 2008 where the debt is outstanding on or after
the second balance date after the event giving rise to the debt.
 35

Insurers indicated they were not looking to APRA supervisors will continue to monitor
significantly change their conservative investment the effectiveness of insurers’ risk management
strategies. This feedback is consistent with frameworks to ensure they highlight areas where
the investment mix reported at an industry their risk profile is changing in response to the low
level during 2013 with insurers and reinsurers interest rate environment. These changes should
continuing to largely invest in cash and interest be monitored and expressly considered in insurers’
rate investments with highly rated counterparties governance and decision making processes.
such as authorised deposit-taking institutions and
Australian governments.5 In the review, insurers
indicated some increase in appetite for growth
assets and equities in their investment allocations
APRA supervisors will
for shareholder funds. The returns on shareholder continue to monitor the
funds impact the profitability of insurers and so
changes in investment risk appetite will continue to effectiveness of insurers’ risk
be monitored by APRA supervisors.
management frameworks to
The review also looked at whether the current
environment has influenced insurers’ focus on ensure they highlight areas
cutting costs, particularly through outsourcing and
offshoring activities, as this may increase insurers’ where their risk profile is
operational risk profile. The feedback from insurers
was that outsourcing and offshoring decisions have changing in response to the
been made to improve operational efficiencies
and leverage off group capabilities, rather than as a low interest rate environment.
response to investment market conditions.

5 Highly rated counterparties are defined as being rated APRA

Grade 1 or 2 which is the equivalent to an S&P rating of AA- or
better. Australian government counterparties are defined as the
Commonwealth, State or local government or public sector
trading enterprises.
36

Insight issue two 2014

General insurance industry overview

The low interest rate environment is one of the A review by APRA in 2014 found that there is
drivers of the recent strong growth of alternative little appetite at present from APRA authorised
capital in the global property reinsurance market insurers for alternative reinsurance products.
illustrated in Figure 2. Alternative capital refers to Insurers surveyed have a preference for traditional
the capacity provided to the reinsurance market reinsurance because it is readily available at
by investors such as hedge funds and pension favourable terms and conditions. Some also
funds through insurance-linked products such as mentioned the value of maintaining the long
catastrophe bonds because of the higher yields standing relationships with their traditional
on offer and these products’ historically low reinsurers as well as certainty of traditional
correlation with traditional assets classes. arrangements. APRA will continue to monitor
developments in this area and, where needed,
At present alternative capital is largely concentrated review alternative reinsurance arrangements
in various offshore property catastrophe entered into by APRA authorised insurers to ensure
reinsurance and retrocession markets such as in they adequately address APRA’s reinsurance and
the USA.6 The increased use of alternative capital collateral requirements.
has led to direct pressure on the pricing and
profit margins of traditional reinsurers operating
in those markets, while in other peak risk areas
such as Australia it has contributed to the excess
of traditional property reinsurance available. This
excess capacity has been a contributing factor in the
fall in reinsurance pricing in the local market.

6 To provide some context on the level of alternative reinsurance

capital in the reinsurance market, AON Benfield estimates that
global reinsurance capital from traditional reinsurers and alternative
reinsurance totalled $US540 billion at 31 December 2013.
 37

Figure 2: Alternative capital in the global property reinsurance market

50,000

40,000
$ US million

30,000

20,000

10,000

0
2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Swiss Re Capital Markets

38

Insight issue two 2014

General insurance industry overview

Insurance affordability Industry risks

Affordability of natural perils insurance remains The adequacy of the reserves held by general
an area of reputational and potential political risk insurers (and reinsurers) to meet their future
for the industry. It has received most attention insurance liabilities is critically important and is
in north Queensland where the cost of property an area of regular supervisory review. APRA is
insurance has increased since the flood and of the view that the risk of inadequate reserving
cyclone events of 2011 and some insurers have is heightened at present because challenges to
chosen to withdraw from that market. In instances insurers’ profitability in the long tail classes of
where the cover for such perils is a compulsory business may accentuate the risk that insurers
part of insurers’ policy offering, home and use releases from reserves to support short
contents insurance may be unaffordable. Equally term underwriting profits. These challenges to
where riverine flood cover is available on an opt profitability include falling investment returns in
out basis for properties at high flood risk, the a low interest rate environment and the strong
cost of that cover may be unaffordable leading competitive pressures in commercial lines which
policyholders to opt out of that cover. are restricting pricing increases.
In an attempt to increase competition in north The competitive dynamics in commercial lines
Queensland, the Government has announced have also led APRA to review pricing risk in this
it will establish a comparison website allowing market during 2014, with the concern being that
consumers to compare premiums and product inadequate pricing may negatively impact
features for home and contents policies offered insurers’ financial performance and, as a result,
by insurers. Furthermore the Government has their capital position. The review has involved
clarified that licensed insurance brokers can sell examining data reported by insurers to analyse
policies from foreign insurers where they offer a premium trends and pricing adequacy and in
consumers a better price. doing so aims to assist APRA supervisors in their
ongoing engagement with insurers on their pricing
strategies and processes.
 39

An area of ongoing focus by APRA is insurers’

governance and risk management processes in
their use of catastrophe modelling. A thematic
review by APRA highlighted a number of concerns
in this area, including the excessive reliance by
some insurers on catastrophe model output in
reinsurance purchasing decisions and the setting
of capital targets, and the absence of formal
processes to challenge this output. As part
of APRA’s drive to encourage better industry
practice in this area, a letter was sent to industry
in late 2013 setting out the conclusions from the
thematic review and highlighting issues APRA
expected insurers to address. Supervisors have
been engaging with insurers during 2014 on their
responses to the issues raised.
40

Insight issue two 2014

Notes
APRA offices
Head Office
Sydney Adelaide Canberra Perth
Level 26 Level 22 Level 4 Level 5
400 George Street 25 Grenfell Street 10 Rudd Street 5 Mill Street
Sydney NSW 2000 Adelaide SA 5000 Canberra, ACT 2601 Perth, WA 6000
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Info Line: 1300 55 88 49 Brisbane Melbourne

Web: [Link] Level 9 Level 21
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