Underwriting cycles - fact or fiction?

- Herman Schoeman, MD of Guardrisk

South Africa's short-term insurance industry has - in recent years, and even decades - become used to extremely volatile underwriting cycles, with insurers' underwriting results varying considerably from one cycle to another. The volatile nature of the market is particularly perplexing when one considers that the local market has not really suffered any large catastrophes for a number of years.

One can only wonder whether shareholders and investors would be satisfied with such volatility in their return on investment in any other industry. Undoubtedly, shareholders and investors - and the entire short-term insurance industry - would welcome a definitive explanation of the market's volatility but it would seem that this question fits into the same category as "how long is a piece of string?".

Some may say that volatility is indicative of a mature industry, while others will certainly contend that it is perhaps immaturity (from a business point of view) that drives insurers to continue "buying" new business on the back of healthy underwriting results.

South Africa's highly regulated financial services environment may be blamed for not leaving enough room for diversification of the business. Diversification strategies are inevitably aimed at increasing the sustainability of income streams to shareholders and all other industries are generally "allowed" to expand into areas that they consider to be lucrative, whether these are related to their core business or not. Notwithstanding the fact that the trend towards diversification seems to have turned and many businesses are choosing to rather get back to their core strategies; the point remains that it is very difficult - if not impossible - for our industry to diversify.

Another contributor to volatility could be decreasing client loyalty as a result of fierce competition, strong branding and consumers? access to technology. Insurers embarking on a price strategy to "buy" client loyalty will find little sympathy among increasingly savvy consumers, bent on flexing their growing consumer awareness muscles. In the corporate arena, large corporate and semi-government (parastatals) accounts - seeking to display the transparency so fiercely advocated by corporate governance guidelines ? are increasingly going out to tender with a general tendency to opt for the "cheaper" service provider, in a price driven market.

The flexibility of the insurance industry's reserves may also add to volatility. Many reserves and technical provisions are calculated and estimated according to statutory requirements rather than the actual reserves needed - and one may well ask to what extent this has resulted in the reflection of profit figures to "go with the flow".

The new breed of leadership coming through the entire industry - both insurers and intermediaries - may have a positive effect on stemming, or at least stabilizing, underwriting cycles. These individuals definitely have new ideas about sustainability and consistency of returns; which are reinforced by shareholders' demands, and increased requirements in terms of disclosure, transparency and sound corporate governance.

Brokers are generally recognising the negative long-term impact of a volatile - primarily price driven - underwriting environment on their clients; and acknowledging that a stable insurance market together with other insurance vehicles and risk financing solutions, available to corporate customers in the local and international markets, have an important role to play.

Going forward more and more stakeholders will become involved and interested in the business and its results. And, undoubtedly, the mobility and focus on the cost of capital (in other words, the efficient allocation of capital) will have a major impact on the way that management goes about underwriting practices and underwriting results in future.

Another stabilizing factor may be the new trend towards remuneration packages linked to performance management - moving away from guaranteed large salaries and incentive structures based on revenue growth, to bigger incentives based on bottom-line results over periods longer than one year.

New accounting standards for insurers and the move towards risk based capital (as opposed to a one size fits all calculation of solvency levels) will also bring stability to results. As will the fact that financial reporting is now widely seen as a risk area and not merely as a reflection of historical numbers. Shareholders want proof that significant risks are adequately managed and they will not tolerate huge volatility in returns for unknown or difficult-to-quantify reasons.

Black Economic Empowerment (BEE) investment in the industry could also become a strategic driver of future stable results as management take on the added "social" responsibility to deliver and ensure success in BEE wealth creation.

So - while the jury inevitability will remain out on the exact cause of volatile underwriting cycles - there may well be calmer waters ahead for the local short-term insurance industry.

For further information please contact:

Herman Schoeman, MD of Guardrisk

Telephone: +27 11 669-1001

Issued by:

Melanie Davis, PR@Work

Telephone: +27 11 615-3309 / +27 83 225 7450