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11 January 2005 Angelo Coppola

"The underwriting performance of the short-term insurance sector was the best it's been in more than a decade", says Bruce Campbell, MD of Mutual & Federal. That is until the tsunami disaster.

Underwriting profits as a percentage of net premium income for the sector as at June 2004 is 10,5% - a stunning reversal of the -2,3% recorded in 1999.

9/11 was the event that triggered the reversal in fortune. Prior to that the world market was awash with insurance capacity which had the effect of driving down rates. 9/11 soaked up much of the excess capacity and allowed rates to appreciate to more realistic levels.

"For much of the 1990s, South African insurers relied on their investment performance to carry them through several years of weak or negative underwriting results. When the financial market bubble started to burst in 2000, insurers were forced to focus more intently on their underwriting disciplines", says Campbell.

Insurers derive income from two sources: underwriting - that which is left of premiums once all claims and administration costs are deducted - and investment returns from accumulated underwriting surpluses.

Apart from the post 9/11 firming in insurance rates, several other factors account for the turnaround in underwriting performance:

- a steady decline in car theft: Mutual & Federal's experience in this regard shows a drop of about 6% in vehicle theft claims since September 2002;

- an even more dramatic drop in car hijackings: in Mutual & Federal's case, hijackings are down from a peak of 326 for the September 2002 quarter to 252 for the June 2004 quarter;

- the stronger Rand reduced the cost of imported audio visual and computer commodities and stabilized the costs of motor vehicle parts, which make up a part of insurers' costs;

- benign weather conditions, which reduced the number and scale of weather-related claims;

- the relative absence of large fires claims;

- a focus on claims procurement which includes preferential rate agreements with approved suppliers;

Given the dramatic improvement in underwriting performance over the last five years, the question inevitably arises: how long can it last?

"Obviously, an underwriting ratio (underwriting result expressed as a percentage of net premium income) of 10,5% is unsustainable and we might be approaching the upper end of the underwriting cycle.

In the medium term we expect the industry's underwriting ratio to settle at about 4%", says Campbell.

What tends to happen at the peak of the underwriting cycle is rate cutting, particularly for large, corporate business.

Insurance volumes are highly sensitive to rates, so one way for insurers and brokers to grow their business is to drop rates, and for the incumbent insurers to renew policies at lower rates.

We are already seeing this happening in the local market. Those companies that are more profit-focused tend to avoid lower quality business and so risk losing market share.

There is also evidence of a softening in the reinsurance market after three years of significant rate increases. Post-9/11, re-insurers withdrew from or hiked rates for riskier lines of business.

Since then, reinsurance capacity - and hence, competition - has returned to this market, and rates are once again under extreme pressure, in some cases returning to 2001 levels.

The reduction in car theft and hijackings is undoubtedly a credit to more robust law enforcement, anti-theft devices and satellite tracking systems, though we should not discount the role played by a more security-conscious driving public.

Contributing further to this reduction is an ongoing drive for the improvement of risk selection and underwriting standards.

Insurers would obviously like to see a continuation in the downward trends in all crime.

But there is little doubt that the relative absence of fire and weather-related claims is a temporary phenomenon. Just recently we saw extensive flooding in the Cape and the impact of this flood will only be determined at a later stage.

Similarly, any weakness in the Rand will increase the cost of imported vehicle parts and other claims commodities, with a knock-on effect on insurers' underwriting performance.

"Given these uncertainties, insurers will have to manage their administration and acquisition costs with great care over the coming years.

Most are expecting rather modest returns from their investment portfolios, and will continue to rely on positive underwriting returns to carry the day.

Though we expect underwriting performance to weaken from here, the market cannot afford a return to the debilitating underwriting losses of the late 1990s", says Campbell.

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