Recession takes its toll on insurance industry – KPMG Survey

The deterioration of the South African economy during 2008 had an adverse effect on the financial performance of the insurance industry. Declining disposable household income coupled with lower employment statistics reduced the consumer’s ability to fund their insurance spend. This is a key finding of the 2008 KPMG Insurance Industry Survey released today. The survey was compiled from the 2008 annual financial statements of South African insurers.

Short-term insurance

The insurers that participated in the survey, which is representative of the industry as a whole, collectively reported gross written premiums of R51.0billion for 2008 which compares to the R46.7 billion reported in 2007. This represents a 9.2% increase. “When the premium growth is compared with consumer price inflation of 11.5% and a gross domestic product of 3.1% during the same period, it is clear that the short-term insurance market has shrunk in real terms during 2008,” says Gerdus Dixon, National Insurance Industry Leader at KPMG. “This is a worrisome statistic.”

The participants reported aggregated underwriting profit of R1.1 billion for 2008, which is down by 35.3% on the R1.7 billion reported in 2007. Other than the challenging economic environment and the muted investment results, the lower profitability was influenced by an unusually high number of industrial property claims and a motor risk class that remains under pressure.

Dixon says that the poor loss experience on industrial property risks stems in part from a situation where during 2005 and 2007, when the economy was growing, corporates and insurers were focused on marketing products and services to generate revenue and less so on risk management. The neglected risk management has manifested itself in large losses during 2008 and 2009. The losses, in terms of severity and frequency, are significantly higher than what have been experienced by the industry in the past decade.

Dixon says that insurance companies will undoubtedly address the poor loss experience on industrial claims. The obvious step is for insurers to increase their premium rates. However, this can only be done to a certain level. Insurers also need to work with the insurers to better identify and mitigate risks to reduce loss incidents.

Further, the motor books of many insurers are currently running at a loss which is attributed to a combination of factors. South African road conditions are not satisfactory, especially with the current construction on the road networks. Other exacerbating factors include inexperienced drivers and expensive motor parts. However, the survey also shows that motor risks can be underwritten profitably by insurers that are able to charge appropriate risk rates and apply selection, most notably direct personal lines and niche insurers.

The participants reported a 20% increase in management and administrative expenses rising from R6.4 billion in 2007 to R7.7 billion in 2008. Other than an increase in staff and information technology costs, the expenses of some insurers included non-recurring items from strategic initiatives.

Long-term insurance

The deterioration in economic conditions did not bode well for the persistency of long-term insurance policies. Persistency refers to the portion of insurance policies that stay in force and do not lapse. This statistic varies amongst insurers and per type book. Dixon says that some insurers reported increases in their lapse experience of more than 20% when compared to the previous year. The poorer persistency required insurers to strengthen the lapse assumptions in their policyholder liabilities with a resulting strain on the income statement.

The participating insurers reported realised and unrealised investment losses of R72.4 billion compared to profits of R87.9 billion in 2007. These losses were partially offset by higher dividend, rental and interest income, but overall the participants reported net losses arising from investments of R10.8 billion. Although most of these losses are allocated to policyholders through linked and participating policies, those insurers with substantial investment guarantees embedded in their policies were also significantly impacted. Dixon says these insurers increased the investment guarantee component of their policyholder liabilities. A further consequence of a depressed investment market is that it limits insurers’ ability to generate revenue i.e. the lower the value of assets managed by the industry the lower the administration fees that can be earned.

The cash flow statements of life insurers also tell a story. The cash flows from operations for the five largest insurers represents an outflow of R28.1 billion (2007 – outflow of R7.4 billion). For an industry with ambitious growth targets, negative cash flows is not good news.

The 2008 financial year was full of thorny issues for the insurance industry and the trading conditions are unlikely to improve significantly in 2009. KPMG sees the issue of persistency as a key business risk for both short- and long-term insurers. Undoubtedly the industry will shift some of its focus from new business to existing policyholders to limit churn and lapses. Dixon says “The insurance industry is innovative and has a strong record of trading through the cycles. There is no doubt that the industry will do so again and be stronger for it”.