Low interest rate biggest shock to insurance industry that must adapt

The reality of lower interest rates has yet to be reflected in casualty business in particular, said Brian Gray, Chief Underwriting Officer for Swiss Re, at the Monte Carlo Rendez-vous. “Here we believe a bubble is forming, which inevitably must pop,” he said at the company’s press and analyst briefing this week.

But the reinsurer predicts that natural catastrophe-led price increases will filter through to the broader market over the next 15 months.

“It is low interest rates not natural catastrophes that have been the biggest shock of the last three years,” said Mr Gray. It is far more significant than the 2010 and 2011 natural catastrophes, added the reinsurer.

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Swiss Re said they expect the low rating environment to stay for a ‘sustained period’ and reinsurers need to increase their combined ratio, and thus underwriting, performance, as a result.

Based on a fall in return on equity in the eight major P&C reinsurance markets to 3.5% in 2010, from 5.9% in 2000, combined ratios need to adjust by 8%, according to Swiss Re figures. “This simply has not happened. This adjustment process just is not complete,” said Mr Gray.

To achieve such a reduction of combined ratio in these markets would take more than an eight percentage point price increase, assuming a combined ratio of slightly below 100, said the reinsurer.

“We don’t think the market yet has really priced in the level of interest rates that currently exists. If these rates are sustained it means a combined ratio change, or a price change, that still has to be baked into the industry,” continued Mr Gray.

Every interest rate rise of 100 basis points, or 1%, is worth around three to four combined ratio points to the risk transfer industry, according to Swiss Re.

US GAAP accounting rules have also led to an overestimation of the reinsurance industry’s capitalisation as they have amplified bond values at a time of low interest rates, the company added.

Which, along with the low interest rates putting pressure on technical results, soft market pricing since 2008, unsustainable reserve releases and natural catastrophe events, are also adding pressure for a market turn, the reinsurer argued.

Some lines are already on the turn, it added. Nat cat prices rose in April and July, driven by claims events and changes to risk models. European motor has seen some upward trend and large corporate business has moved from falling to broadly flat.

But casualty has not adjusted, warned Swiss Re.

“Players continue to release reserves, and there has been sufficient capacity in the market to keep prices flat. However, the reality of low interest rates will be felt,” said Mr Gray.

“Our baseline expectation is that the bottoming out and the sporadic nat cat-led increases that we have seen so far through the spring and summer will transform themselves into a modest but also a much broader upswing in market conditions over the next fifteen months, or next two January renewals,” he added.