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Year of the Fire Monkey – An insurer’s perspective

Year of the Fire Monkey – An insurer’s perspective
One of the most pronounced “Goat” traits is generosity and as we reach the end of the Year of the Goat that has certainly been the case. Oil, copper, steel and capital have been in plentiful supply and in a world of stable demand this has had a truly depressing effect on prices.

This has led to a “Hunger Games” scenario where every supplier is continuing to produce (or even increase production) in the hope that their competitors will go out of business before they do. Then, as the “last man standing” in a world of reduced supply they will take the prize of increased prices.

The insurance industry has also joined in this “game” with great enthusiasm. The commodity that fuels insurance is capital and the Goat has certainly been generous with that. With equity dividends, bond yields and interest rates at historic lows capital providers have turned to insurance as a way to maximise their returns. The recent decline in natural catastrophe losses has also given the industry a very attractive, though entirely false, perception of low volatility.

With all of this cheap raw material available insurers have looked to grow and expand and this has led to fierce price competition across all lines of business. At reducing prices insurers also tend to take on more exposure so as to maintain their dollar income which will ultimately lead to more claims but with only the same amount of premium to pay them. With insurers taking larger exposures this leaves less room at the table for them all further driving price competition. This combination can offer great savings to insurance buyers and the opportunity to reduce the number of insurers they deal with but squeezes insurers’ margins to a frightening degree.

With pressure being applied on incomes through price competition, in order to maintain profitability the future outgoings also come under pressure. The unique challenge (and raison d’etre) of the insurance industry is the line item that makes the largest contribution to costs, claims, is not known for years (and sometimes decades) after the financial year closes. To account for these future “Incurred But Not Reported” claims (IBNR to use the industry terminology) insurers must make cash reserves. The higher the reserves the lower the profit margin and whilst insurers’ reserves are subject to external scrutiny, there is a great deal of scope for either aggressive or defensive reserving.

So with margins being relentlessly squeezed from all angles and with catastrophe and attritional losses at historically low levels what does that mean for the insurance industry in the year of the Monkey? Well, this year is very likely to bring us more claims activity to further load some already stressed balance sheets which combined with the unlikelihood of all insurers voluntarily stepping back from the ‘fight’ is recipe for trouble. As the economist Herbert Stein said “If something cannot go on forever, it will stop” and that is very much where we are.

So will the mischievous, practical joking Monkey have us all laughing by the end of the year? Unfortunately for the insurance industry that is very unlikely. All of the ingredients are there for a large scale abandonment of some insurance sectors and even the failure of a large insurance company with the subsequent fall out for their policy holders. Intelligence is the Monkey trait that insurance buyers will need the most, when one buys a promise is the cheapest option always the best?

Contributed by Matthew Cannock, managing director & principal officer, Markel International (Singapore)