September 8th, 2012

Slower Economic Growth and Financial Crisis: Overcoming the Risks

Posted at 11:00 PM ET

flandro_davidDavid Flandro, Global Head of Business Intelligence

Over the last five years, robust economic growth has been replaced by financial crisis, economic stagnation and fears of a Eurozone split. Although the insurance sector has remained solid and functioned admirably in the face of such difficulty, the operating environment is as challenging as ever.

Events in Europe pose particular headwinds for (re)insurers. Fears of a Greek exit from the Eurozone still loom as does concern about contagion to larger economies. The central issue in the European market is lack of overall growth and recessionary pressures facing many countries.

For insurers, slower economic expansion pressurizes top line growth. As global gross domestic product rises and falls, insurance premiums tend to do the same. In this environment, greater corporate expense control and tighter corporate budgets make it more difficult for commercial insurers to achieve rate increases. These conditions often tempt some carriers to engage in “cash flow” underwriting to gain market share and to also set less conservative loss estimates. With history as a guide, we know such temptations must be avoided.

The other challenge posed by the current environment is, of course, on the investment side. As yield spreads have risen on government bonds deemed risky, carriers have adjusted their bond portfolios in favor of lower yielding, defensive positions. This has created a “flight to quality” towards shorter term, higher-grade investments such as Swiss, U.S., Japanese, German and British government bonds. Reinsurers are now more conservatively invested than at any time in at least the last 20 years. But with reduced risk comes lower reward. Falling investment yields are squeezing earnings, reinforcing the importance of profitable underwriting. As if this weren’t enough, the sector is now particularly sensitive to unexpected interest rate movements.

Finally, sector reserves are almost certainly less redundant than they were one year ago, mitigating yet another potential source of earnings. Studies by Guy Carpenter indicate that reserve releases will slow soon. In addition, the sector may begin to see deteriorating reserves in 2014 or beyond. Both of which will significantly impact profitability.

How, then, can carriers achieve profitable growth in this challenging environment? It is eminently clear that underwriting excellence is paramount. Strong enterprise risk management and risk transfer solutions are also imperative. Many carriers are therefore relying more on analytical tools and approaches to help them better assess, underwrite and manage the risks they take on. Predictive analytics, effective enterprise risk management and both traditional and innovative reinsurance solutions are just some of the ways in which insurers can help improve their franchise and position themselves for profitable growth. Insurers with access to deep knowledge of their markets and those that can effectively apply best practice techniques and tools will be best positioned to take on challenges and achieve success in any environment. Guy Carpenter has dedicated extensive resources to understanding these risks and it is our objective to assist clients in overcoming the current challenges by deploying best-in-class risk management tools, reinsurance placement and strategic advisory services.

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