The business outlook for the London insurance market is a familiar one across other global markets: Underwriting profits are under pressure as ongoing soft market prices begin to take a toll.

In separate reports on the London market, both A.M. Best and PwC cautioned about the effects of lower premium rates.

A.M. Best said that while London market insurers performed well in the first half, these good results conceal “fundamental challenges to the market’s competitive position and prospective profitability.”

In its review of pricing conditions in the Lloyd’s market, PwC revealed a similar story: Counterintuitive pricing trends could lead to nasty surprises. PwC indicated that pricing may not be adequate in certain classes of business, such as casualty and cargo, energy and terrorism.

“Our review points to a number of potential problem hot spots and numerous examples of the market assuming a greater level of profitability than what may be supported by recent experience and rate changes,” said Jerome Kirk, London market actuarial leader at PwC.

A.M. Best’s report, titled “London Market Insurers Adapting to an Evolving Operating Environment,” said pressure on underwriting profitability is a challenge for the entire London market.

“Premium rates across the market continue to fall, as traditional and alternative capital compete for business,” according to Catherine Thomas, senior director at A.M. Best and author of the report. “Large property and energy risks, particularly those that are catastrophe-exposed, remain under the most pressure.”

Historically, disciplined London market players have been able “to materially shrink their businesses during difficult underwriting periods, ready to expand rapidly when rates improve,” said the rating agency’s report.

But in today’s operating environment, where diverse and plentiful capital quickly exploits any post-event market upturn, insurers need to adapt their traditional soft-market strategies, A.M. Best noted.

“A more granular segmentation of portfolios, supported by strong data analytics, is increasingly necessary to identify pockets of profitable business,” said Thomas. “In the property sector, a higher proportion of insurers’ catastrophe budgets are being allocated to binder business, where prices are proving more resilient to competition than in the reinsurance and open-market segments.”

The A.M. Best report said there also has been more focus on casualty business because it is “less vulnerable to competition from capital markets.”

“Maintaining access to profitable business is increasingly difficult, and some insurers will need to expand their global footprint in order to remain competitive,” A.M. Best said, noting, however, that the subsequent pressure on expense ratios will “necessitate an increase in scale.”

“For others, superior niche expertise and strong relationships with clients, brokers and MGAs may be sufficient to maintain their competitive positions,” the report went on to say.

In comments accompanying its review of Lloyd’s pricing, PwC’s Kirk encouraged Lloyd’s managing agents to look “carefully and critically at their half-year reserves” while ensuring they have “the right pricing management information, including bridging to reserves to avoid nasty surprises in terms of either financial results or regulator interventions.”

‘Poorly Performing’ Classes at Lloyd’s

In its review, PwC focused on business classes that Lloyd’s has identified as “poorly performing.” Inadequate pricing was identified as the root cause for underwriting pressures in the following classes:

• Casualty and Cargo

PwC said its analysis highlights evidence that experience and rate changes are “not being appropriately reflected in pricing for these classes.”

“In May 2016, we observed often counterintuitive material reductions in the booked, planned and priced loss ratios in the casualty class of business…These reductions are particularly acute when recent rate reductions are considered.”

A similar picture was apparent in the cargo class with market average planned combined ratios of around 100 percent after allowing for reinsurance. This makes the business “wholly reliant on good fortune in claims experience and investment returns to make a profit.”

• Energy

Market average risk adjusted rate reductions exceeded 25 percent last year for offshore property risks exposed to natural catastrophes in the Gulf of Mexico, said PwC, noting that market business plans include, on average, a 30 percent catastrophe loss ratio for this class. While catastrophes have been relatively benign over recent years, “there are increasing concerns over rate adequacy, with the market average initial 2016 planned combined ratio being 100 percent after allowing for reinsurance.”

• Terrorism

Recent terrorism activity in Europe has led to material uncertainty for re/insurers over loss frequency, “with implications for the ongoing appropriateness of current pricing and catastrophe models.” The growth in terrorism premiums over the last four years has been “fueled by more than a doubling of premiums from a variety of delegated underwriting sources, such as broker facilities, binding authorities and where re/insurers chose to follow another lead underwriter.”

However, PwC noted that this growth in terrorism premiums has been “outstripped by the growth in exposures and highlights ongoing rating pressure for this class, with overall market average risk-adjusted rate reductions between 5 and 7 percent per annum since 2013…” Excess of loss reinsurance treaties, which included the reinsurance of national pools, experienced the greatest risk adjusted rate reductions of nearly 10 percent in 2015.

“The market needs to ask whether the reward on offer is worth the (extreme) downside risk and how they can adapt the product to better meet the needs of corporations and society,” said Harjit Saini, London market director, who led PwC’s pricing review.

Source: A.M. Best and PwC