Commercial insurance article archive
Commercial insurance outlook 2007 - the impact of regulation, climate change, terrorism & war
The 2006 summer heatwave and terror alert have increased attention on these risks and the outlook for the commercial insurance markets as businesses strive to ensure continuity.
During 2004 and 2005 the hurricane season caused $75 billion in insured losses – including $45 billion from Hurricane Katrina alone. It is thought that rising sea temperatures are increasing the chance of hurricanes – while other effects attributed to global warming include floods, drought, wildfires and other extreme weather events around the world.
A report into the insurance industry from Ceres, a US coalition of investors, environmental groups and other public interest organisations, has highlighted 190 innovative products and services available or in the pipeline from insurance providers in 16 countries – many aiming to both reduce financial losses and greenhouse gas emissions.
Dr Evan Mills, co-author of the report said: "The insurance sector is poised to make a major contribution to long-term national and international efforts to curb the growth of greenhouse gas emissions, while helping to fortify society against the near term impacts of climate change.
"Last year's hurricanes were a real wake up call for the industry and many US insurers are creating programmes to help businesses minimise future losses. Many of these strategies represent new profit centres for insurers, rather than simply symbolic and charitable activities."
Lloyd's has also moved to take on the business threat of climate change, after admitting the insurance industry has ignored the threat.
A new report – entitled Climate Change, Adapt or Bust - published this year by Lloyd's warns that insurers must act to understand and actively manage risks from emerging threats such as greenhouse gases and rising sea levels.
Rolf Tolle, Lloyd's director for franchise performance, said at the report's launch: "Although it's almost two decades since the UN recognised that climate change was a catastrophic threat to earth, it’s clear that the insurance industry has not taken catastrophe trends seriously enough.
"Today's risk environment is changing and evolving – more rapidly than ever before. So at Lloyd's, understanding and anticipating major risk trends is at the heart of all we do."
The report found that recent natural disasters have revealed the inadequacy of capital and pricing models. It advised that catastrophe models should be updated regularly to keep pace with the latest scientific evidence.
It also suggested that underwriting should factor in climate change scenarios - rather than simply basing decisions on historical records – especially with extreme windstorm seasons set to continue.
Jonathan French, of life insurance, pensions and savings at the Assocation of British Insurers (ABI), said: "Over the long-term this is something which could have a big impact, as climate change potentially brings on more and more extreme weather events.
"Then we could be seeing in the global insurance market the potential for greater and more frequent claims."
He added: "Immediate or short-term impact is pretty negligible, there are potential associated issues such as flooding."
Graeme Trudgill, technical services at the British Insurance Brokers' Association (BIBA), concurred, but also said the government should step in and play a role.
He said: "Climate change is likely to have implications for insurance cover in the future.
"If there are an increased number of claims due to flooding or subsidence, for example, then clearly insurers will wish to take some underwriting action which could result in increased premiums or terms, or ultimately a withdrawal of cover entirely.
"The government must assist by continuing to invest in flood defences."
Terrorism & war
In the UK the threat of terrorism to the insurance market is somewhat mitigated by Pool Re, the mutual reinsurance company set up by the insurance industry with government backing in 1993 to cover losses from terrorism attacks.
Pool Re allows insurers of commercial property and earnings in the UK to reinsure their terrorist liabilities. With potential looses from terrorist attacks being high this allows companies to take out policies and for insurance companies to be able to cover losses, with the Treasury acting as reinsurer of the last resort.
However, terrorism cover is not a standard part of commercial property cover so firms have to specifically ask for it from insurers.
Commercial property terrorism cover normally covers risks such as biological, chemical, radiological and nuclear contamination, and the consequential business interruption losses. However, it does not include e-risks or losses due to hoaxes.
Since September 11th and the July tube bombing last year the interest in terrorism cover has grown substantially as firms try to cover themselves from losses. However, smaller firms are generally ignoring the threat.
Graeme Trudgill, of BIBA, said: "Businesses need to make special arrangements to include cover for terrorism under their insurance policies.
"Whilst many large corporate businesses will recognise the importance, perhaps due to their location, or to retain the confidence of their stakeholders, there is evidence which suggests that few small businesses carry any cover for terrorism."
Impact of FSA regulation
In January 2005 the Financial Services Authority (FSA) took over regulation of the insurance market from the General Insurance Standards Council. The impact was wide ranging as sellers of products from motor insurance to payment protection insurance (PPI) for credit cards and all companies selling or advising on the sale of insurance had to be authorised by the FSA.
Trading without authority also became a criminal offence with FSA given the power to close businesses, fine executives or in extreme cases impose jail sentences.
Around 40,000 firms became liable to the FSA rules.
A study by Datamonitor earlier this year found 70 per cent of brokers said that FSA regulation has had a considerable or very considerable affect on their business.
Steve White, BIBA head of compliance and training, said: "For most BIBA members regulation was not new at all. But the weight of FSA regulation caused a lot of head scratching."
Furthermore, research by Lloyd's and BIBA released in August found almost 90 per cent of brokers questioned said that they were actively addressing increased regulation.
The possible penalties for those breaking FSA rules can also be tough and the FSA has not been afraid of using its powers. This month the body banned the sole director of one firm from conducting any further regulated business after finding him not fit and proper to work in the general insurance industry.
The FSA has also taken up an active role in the finding breaches of insurance rules with a mystery shopper programme
Mr White did, however, recognise the benefits, from FSA regulation.
He said: "Long-term benefits are firms will become fitter, keener and leaner."
For consumers, he explained, benefits came as they now have more information up front to help them make decisions and compare products, and also they have greater levels of protection when things go wrong.
The ABI's Jonathan French explained he hoped the burden of FSA regulation could be reduced for the industry.
He said: "We have been working with the FSA on ways of moving to a more principle-based regulatory regime – the insurance industry operates within the environment set through legislation and regulation but there's been a sort of feeling in some areas the regulation could be less stringent and the FSA are making some big strides on this and we hope over time the regulatory burden in general is something that is going to be reduced."
Commercial insurance cycle - harder market in prospect?
A Lloyd's and BIBA study found more than 80 per cent of brokers believe that maintaining profit throughout the insurance cycle is still the greatest challenge for the insurance industry on the whole.
Unexpected events such as Katrina make predicting the cycle even more complex.
Graeme Trudgill of BIBA explained that nothing much can be done to hold back cycles in the market.
He said: "It's been going since the Ark so is unlikely to stop – cycles may be different in length or have different levels of peaks and troughs though.
"Competition, regulation, new law, international events like 9/11, hurricanes, the global economy, the UK economy, new governments, collapse of a major player, new entrants – so many things can start a cycle – which is why there will always be one."
Julian James, director of Worldwide Markets at Lloyd's, said: "This research gives a clear indication that, to be successful, brokers need to tackle the challenges of changing distribution trends and embrace the opportunities they present.
"It also shows, quite rightly, that maintaining profitability throughout the insurance cycle remains a key industry challenge."
Eric Galbraith, BIBA chief executive, added: "The broking and intermediary channel is responsive to change, recognises the challenges and opportunities that exist and continues to be innovative. The impact of the market cycle on intermediaries and their customers, consolidation and other changes in distribution, regulation and technology all provide continuous challenges and opportunities."
However, a Datamonitor study into the future of the UK insurance market found that the underwriting cycle will be less volatile.
It predicts improvements in premium income for many lines in 2007 and while the current cycle seems to be affecting commercial lines particularly, nest year is expected to be the first year of significant premium income growth for many lines in the commercial and personal markets.
The report stated: "The volatility of the underwriting cycle has been reduced by the level of consolidation in the market, shareholder pressure and better technical pricing models also play a role. The less severe soft cycle will improve profit margins for insurers."
Distribution: Acquisitions & mergers, networks & online opportunities
For the insurance market consolidation is a key theme with acquisitions high on the list of many firm's priority.
A Datamonitor survey earlier this year found half of the brokers polled say that they are either definitely or maybe planning on acquiring other brokers in the next 12 to18 months.
However, only 1.6 per cent of brokers said they planned to join a broker network in the next year. Datamonitor claims this illustrates the extent to which broker networks have lost their appeal.
BIBA's Graeme Trudgill said: "This is one of the busiest ever times for broker acquisitions and mergers the industry has ever seen. With the increased costs and pressures brought along by FSA Regulation brokers are pooling resources and looking to increase in size."
He added that insurers were also looking to get bigger and be major players in not just the UK market but abroad too.
"Much is going on behind the scenes and takeovers like the failed Aviva-Prudential deal are constantly being rumoured," he said
Mr Trudgill went on to explain that broker network popularity peaked a few years ago.
"There are fewer new entrants now as the established players consolidate," he said.
Outlook for 2007
The outlook for 2007 in the commercial property market now seems to be down on previous expectations.
F&C Property Asset Management predicts that single digit returns are likely next year – after the good returns seen in 2006.
The Quarterly Investment Outlook states: "The UK property market continues to perform well with all property total returns remaining above 20 per cent per annum. Investment activity continues to be strong with institutions, overseas investors and private individuals all net buyers of property."
However, the report explains, the weight of the money invested in the sector led to a fall in yields across all sectors.
It added: "Quality stock remains in short supply and high prices are being obtained for prime property but there are signs that buyers are becoming more selective. Offices, especially in central London, have continued to outperform while retail has slipped to third place behind industrials."
In the coming year the office sector, buoyed by rental growth, is expected to outperform the whole sector.
Generally, the possibility for "high teen" performance is possible but "with yields now so low, the scope for further yield compression is limited, especially if interest rates move further upwards", F&C added.
It is predicted that the coming year will see more sustainable rates of total return, driven largely by income return and if Real Estate Investment Trusts (REITs) are successfully launched in 2007 there will be further potential for growth.
Standard Life Investment's Select Property Fund outlook for the coming year is encouraging performance globally – although the fund managers are reducing the exposure to the UK commercial property market.
This is being put down to high levels of return enjoyed over the last three years tailing off, following the market cycle.
Research prepared for Stride Limited by Adfero
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11 Dec 2006