The ongoing pressures of diminishing investment returns, dwindling loss reserves and intense competition are beginning to erode industry fundamentals, cautioned A.M. Best in a special report titled “Insurers Hunt for Diminishing Opportunities in a Market Laden with Challenges.”

“There is no doubt that the re/insurance industry is entering a highly challenging period in its history. It is a time when margins are coming under increasing pressure at all levels of the industry and return on equities are now in high single digits,” said Mahesh Mistry, director, analytics, and co-author of the report. “If tested by a major event or series of events, and with diminishing reserve releases to fall back on, industry fundamentals could begin to deteriorate.”

On a positive note, the report said: “lessons have been learned from the past, with insurers and reinsurers adopting more robust risk practices to ensure balance sheets are better equipped to absorb the challenges that potentially lie ahead.”

“Devising new solutions and products to help close the protection gap, making better use of data and exposure management tools, and pursuing growth with control and discipline are some of the areas in which insurers and reinsurers can create competitive advantage and prosper in an otherwise difficult operating environment,” said Catherine Thomas, senior director, analytics and co-author of the report.

A.M. Best discussed some of the looming threats that re/insurers must consider going forward:

• Adverse reserve development.“Over the past five years, insurers and reinsurers in the United States, European and London markets have become increasingly dependent on bolstering results with sizable reserve releases. To a large extent this has masked the industry’s deteriorating fundamentals,” the report said.

There are opportunities for companies that emerge “unscathed from a period where the industry is reporting materially deficient reserves as they will be in a stronger position to take advantage of subsequent rate increases,” said A.M. Best. “Companies least likely to be affected by reserve deficiencies are those that have strong data management and analytical capabilities, with robust feedback loops to ensure rapid action is taken in respect of reserving, pricing and wordings in response to emerging claims trends.”

• Accumulation risk.Globalization and technological advances are creating a world where there is greater interconnectivity and interdependencies, which is increasing “the potential for significant accumulation of risk.” “At the same time, increased complexity is making the detection and management of accumulations within portfolios more challenging, particularly for casualty books of business,” the report said.

One potential accumulation risk relates to casualty clash events, which “involve a significant loss to multiple policies or insureds from a single event, while casualty catastrophes can impact multiple companies, geographies and lines of business. They are events, activities or products that result in a number of lawsuits from multiple plaintiffs alleging damages that impact multiple insureds, coverages and/or time periods.”

• Energy prices.The energy insurance sector has seen capacity increase three-fold over the past 10 years while both upstream and downstream energy classes have seen a continuous reduction in premium rates, the report said.

“With the increased level of competition in the energy sector, underwriting margins have consistently been squeezed, and the fall in the price of oil has further intensified the situation. Many projects have become uneconomical and been cancelled, while investments in new projects have been limited,” the report went on to say. A.M. Best noted that this is likely is further reduce premium volumes and place greater pressure on managing costs.

Pandemic, Low Interest Rates

Other threats discussed by A.M. Best in its report are pandemic and low interest rates.

The report asked: are insurers equipped to withstand a severe global pandemic? A global pandemic would affect numerous classes of both life and non-life insurance and could threaten the financial strength of insurers and reinsurers, the report noted. “Under such a scenario, insurers would be faced with both underwriting and investment losses as well as operational challenges, such as workforce absenteeism.”

The risk of pandemics is also an opportunity for the industry, the report affirmed. “Improved modeling capabilities and confidence in medical advances may offer the market the tools it needs to develop new products to help close the significant gap that exists between economic and insurance costs arising from major pandemics.”

In a discussion of low interest rates, the report said that some view the low interest rate environment as the “new normal,” which ultimately “would have significant implications for the profitability, solvency and business models of insurers.”

But an interest rate spike also is a concern for insurers, the report cautioned. “Fixed income securities tend to dominate insurers’ investment portfolios, and as yield spreads and bond prices move in opposite directions, a sharp rate rise would mean that unrealized gains accumulated during the years of a low-rate environment would suddenly become unrealized losses,” A.M. Best said.

“Companies adjusting their business models in response to the extended period of low interest rates could be disproportionately disadvantaged if rates suddenly move upwards,” the report warned.

The full report can be obtained via the A.M. Best website.