There’s no doubt Australia’s general insurance industry has undergone a massive amount of change in recent years. Now, with softening markets, new regulation, increasing competition and a more demanding client base, general insurers are facing up to big challenges, writes Stuart Fagg
To those outside the industry, general insurance may have appeared to be something of a paradox in recent years. In 2001, HIH Insurance, Australia’s second largest insurance company became Australia’s largest corporate collapse. Since then, however, strong premium growth and a hard market have seen general insurers, particularly in the past three years, deliver record financial result after record financial result.
Indeed, for the year to 2006, the Australian insurance industry as a whole scored another record result with operating profit after tax increasing by 3.1 per cent to more than $3.5 billion, according to KPMG.However, things are changing. Experts warned last year that the industry’s performance was not sustainable and said that the situation then had only come about due to “all the planets being in alignment”, those planets being a relatively benign environment for claims, strong share market performance and premium growth.Despite the recent record profit, the challenge is on for insurers to sustain their growth, a challenge some believe may be a real test of post-HIH market discipline. “Yes, it is a test of the industry’s discipline because what we’re seeing is a market characterised by healthy margins which in turn is leading to greater than expected pressure on price as insurers don’t want to give up market share,” said Bruce Watters, CEO of AIG Australia. “Subsequently, anticipated pricing discipline that was expected as a result of the structural reform brought about by the FSRA [Financial Services Reform Act] will certainly be tested in the foreseeable future.”While the market has been softening for some time – particularly in some corporate lines – most experts agree that the traditional softening or hardening market cycle has been irrevocably altered by structural and regulatory changes. “We are emerging from one of the hardest markets for many decades, and it is softening particularly in the commercial classes,” Dr Andries Terblanche, chair of KPMG financial services, told Risk Management. “But it’s also softening in the personal lines. It is the first real test after we’ve had all the tumultuous events of HIH, corporate collapses overseas, the new regulatory developments and the listing of so many insurance companies here. It’s the first time after all those events that we are facing a softening market. So now the jury is out – how is the industry going to behave?”While regulatory reform was inevitable following the collapse of HIH, what followed – and is ongoing – produced arguably one of the tightest regulatory environments for insurance globally. And despite some complaints over compliance costs, many insurance industry figures believe the changes brought in by the Australian Prudential Regulation Authority (APRA) have improved risk management practices among insurers.
“It’s [regulatory reform] been a good thing for the industry,” Watters told Risk Management. “It’s forced better risk management practices on insurers operating in the Australian marketplace. Our experience has been that going through the process of strengthening our own internal risk management strategy over the past five years has been very good for us as an organisation.“We are now in a position where we have a very robust risk management philosophy throughout the company. The more companies that are also in this position, the better regulated the industry obviously becomes, which means a decreased chance of companies failing, which in turn of course means a lower chance of clients being left out of pocket.”
Terblanche agreed, adding that refocusing the industry on capital adequacy after HIH has been a key benefit. “There is no doubt that the regulatory changes brought in after the collapse of HIH have had a huge impact on the insurance market,” he said. “Most people would agree that by and large that impact has been for the better. It has re-established the capital adequacy of the industry and put solvency in much sharper focus. It’s also facilitated the industry in looking at its business in a much more scientific and considered way than it has done before.”
Australia’s regulatory framework for insurers is now seen as a global leader, but issues remain, particularly with foreign insurers operating in Australia. The industry has been pushing for them to be subject to the same regulations as a domestic insurer, but that is yet to come to fruition.
“DOFIs [Direct Offshore Foreign Insurers] are not operating on a level playing field when they come into Australia because APRA [Australian Prudential Regulation Authority] has no jurisdiction over them,” Watters said. “They’re not paying the same amount of taxes as locally licensed companies and so they are essentially taking money and job opportunities out of the country.”
Despite the concerns, some experts believe DOFIs are responding to market demands and, in some cases, writing risks in niche markets where capacity may be limited. “There’s no doubt that industry is concerned about foreign insurers, but it is still a relatively small part of the overall market,” said Kim Smith, Australia insurance leader at PricewaterhouseCoopers. “Insurance is a supply and demand market so those players may be responding to market needs.”
The combination of regulation, the softening market, improving risk management techniques and skills within corporates and intense competition has meant insurers need to look for new avenues of growth. That is changing the relationship between insurers and their clients, observers said.
“If one looks at the current state of the market, if you know that competition is increasing by virtue of the concentration, and if one knows premium rates are decreasing – in some corners not so much and in others considerably – how do you hold onto your policy holders? Well, one avenue is to give them the best service so they don’t want to move. That’s one incentive for re-examining the whole service provider/customer relationship and asking ‘are we really doing everything we can for our customer base?’ When you start to improve those processes you start to realise it’s possible to deliver a better service than some of your competitors and that can be your avenue for further growth without reducing premiums.”
Watters agreed, adding that the relationship between insurers and their clients will move closer to mirroring the relationships banks and law firms have with corporate clients, less price-based and more relationship-based.
“We have changed our business model substantially to a more customer-focused one, shifting from
being a pure manufacturer and seller of product, to a provider of insurance solutions,” said Watters. “With large corporate clients, our focus is very much on getting to know the client better on a tripartite basis with their broker to get a comprehensive understanding of what their insurance needs are. That includes finding out what areas of coverage they really need, what areas they are prepared to forgo, what they are doing to strengthen their risk management and loss control procedures. In other words, we are looking at it as a business partnership where the better we understand their needs and how they manage risk themselves, the better overall deal we can offer them.”
Terblanche acknowledged the shift and said the market is becoming less price driven than previously. “Policy holders have been very price sensitive and see the product as a commodity rather than a relationship,” he said. “If they can find the commodity at a lower price, then they would move their insurance very quickly to the lower price. Insurers are now trying to establish the kind of relationships where customers stay with them even though they may not necessarily be the lowest priced premium. It’s quite the opposite in the insurance world to that in the banking and legal worlds.”
In turn, insurance buyers are responding by going to greater lengths to educate their insurer about their business in a bid to get a better deal. “When corporates tour the global equity markets raising investor capital, generally speaking they are very actively involved in selling their business, their values, their people and their future,” said Lambros Lambrou, national manager, market services at Aon. “The analogy is that if you view insurance as contingent capital, which is ostensibly what it is, why would you not take the opportunity to replicate the same process? The [insurance] markets are very attracted to buyers that are responsive in terms of the questions they have. If they are talking to a buyer they have a whole heap of questions around their particular risks and the buyer is there to answer, then it gives an air of confidence to the underwriter that this person knows what their risks are, that they have the ability to manage those risks.”
However, that has required insurers to raise the bar in terms of their evaluation of their clients’ internal risk management strategies. “From our perspective in Australia, it is something we’ve been strengthening and working on and it’s an area of greater focus for us than it was four to five years ago when it was fair to say we were more of a manufacturer and seller of product as opposed to a client solution provider,” Watters told Risk Management.
Going forward, the insurers that can best weather the quantum shift in the market will be those who can provide the best service and the best-priced products, and that’s good news for corporate insurance buyers who, at this stage, look to hold all the cards. “Domestically, insurers will have to pursue optimum capital efficiency at the lowest cost base imaginable with the highest level of customer service if they want to stay in the game going forward,” Terblanche said.