Underwriting margins bite short-term insurance profits

Whether you're looking at interest rates, property prices or short-term underwriting margins, one fact holds true. Major economic trends move in boom-and-bust cycles. The proverbial seven good years are inevitably followed by seven years of pain.

A quick look at the shareholder communications of some of South Africa's listed short-term insurers confirms we're moving into a downturn where underwriting margins are concerned.

Mutual and Federal is the latest insurance company to confirm the trend. A SENS announcement included a warning on 2006 earnings. "The company therefore expects both the headline and basic earnings per share for the year ended 31 December 2006 to be 40% to 50% lower than those of the prior corresponding period."

From boom to bust

Analysts are quick to point out that underwriting margins were high during 2003, 2004 and parts of 2005. Chris Steward of Investec comments that "by 2005, underwriting margins were as high as 9 to 11 percent of premium income, compared with historic levels of 2 percent."

Peter Wille, an analyst at BoE Private Clients points out "the underwriting margin has been moving down the whole year [2006] so most of the market was expecting the underwriting profits to come down to current levels."

A quick look at Santam's last investor communiqu reveals similar concerns.

On 22 November 2006 the company issued the following statement by way of a SENS announcement: "This serves as a general communication to Santam shareholders with regards to the business environment to date. As mentioned with the announcement of our 2006 interim financial results in August, pricing and underwriting margins in the South African short-term insurance market remain under pressure."

Given this information, Mutual and Federal's warning should not have taken investors by surprise.

Insurance premiums might be on the rise

One of the major pressures on the short-term insurance industry is the rising number of claims submitted. Total claims slowed in 2005; but increased again in 2006 due to increasing cases of theft and motor vehicle accidents.

Motor vehicle insurance is a particular area of concern due to the soaring costs of motor vehicle repairs and car rentals. Accidents are on the rise due to huge increases in the number of vehicles on the roads and an ageing transport network.

Underwriting costs are also on the rise. Insurers find it more difficult to record the relevant risk profiles required to complete premium calculations. One of the major concerns here is the accurate assessment of driver experience.

With underwriting margins coming under increasing pressure the short-term insurance industry will probably look to the consumer to boost flagging profits. There is a strong case for premiums to be hiked in the coming year.

Editor's thoughts:
The consumer is also at the mercy of business cycles. We only hope insurance premiums will adjust to reflect the next boom cycle too.