How commercial insurers and their customers can partner in turbulent times – A Chief Financial Officer’s perspective

We're living through times of high macroeconomic uncertainty and every organisation, be they a commercial insurer (such as Swiss Re Corporate Solutions) or a corporate client, is facing similar challenges - inflation, slowing economic growth, rising interest rates and challenging labour markets.

Those challenges are difficult for any single enterprise to manage on their own, so a strong partnership with our customers is essential if we're to avoid the worst of what is thrown at us. Any strong partnership is built upon transparency, and we see it as our responsibility to explain our views on the cost of insurance to our clients.  

At what level do we consider insurance prices as adequate and when do we believe they're unsustainable? In this blog I'll reflect on the issue in the broader macroeconomic context and share my views on the parameters we, as commercial insurers, depend upon.

In particular, let me proactively address why we've seen aggregate price levels increase in recent years, and, more importantly, why we believe as per now those price levels on aggregate will need to stay there or increase further to ensure long-term partnerships between commercial insurers and their customers.

Before we dive into the detail, let’s take a look at the basics. For corporates, commercial insurance is an efficient substitute of capital, which is used to keep the Total Cost of Risk within levels tolerated by their investors. It allows them to be protected against risks, for which otherwise their capital would be tied up. Depending on the price level of insurance, corporates will decide on how much of risk they would like to retain, as outlined in the graph below.

In turn, as insurers, we must set our premium prices based on the expected frequency and severity of insured events, including our actual claims experience, and at levels that allow us to generate returns for our investors, specifically, returns above the cost of equity. Underperformance on this metric, across the industry, drives capacity and price fluctuations as insurance markets adjust to create a new equilibrium.

Let's now look at some of the concrete facts within this framework which help explain why insurance price levels have increased substantially over the last few years.

The insurance industry has been impacted by increasing claims levels and costs since 2017. For example, while insured losses from large loss events averaged USD 48bn per year from 2013-2016, the average during 2017-2021 has already hit USD 117bn. This has been driven by severe and more frequent natural catastrophes such as wildfires, winter storms and floods, Covid, as well as man-made events and social inflation in casualty claims.

Above average claims frequency, preceded by a prolonged soft pricing cycle, has contributed to insurers not earning their cost of equity in the last few years. With full transparency, a bare 5% return on equity was generated on average by commercial insurers in 2017-2022 year-to-date, while the cost of equity was around 9%. Not surprisingly, average share price performance of commercial insurers was at the very bottom with increases of only 5%, while many other industries were seeing their share prices go up by 50% and more in the same period.

While the rate increases that insurers have applied in the last few years had started to absorb the increased claims costs, high inflation, which started in 2021, has hindered this positive progress. Consumer price inflation levels in many parts of the world have reached levels not seen for decades, e.g. above 8% levels in the US and Europe in August 2022. If inflation is to be addressed sustainably, we believe that risk-adequate pricing will continue to be key.

In simple terms, inflation increases the cost of the claims that insurers pay out every year. But by how much is the key question. The more explicit cost factors such as consumer price index, construction costs and wages, are typically re-evaluated with exposure assessments.

However, this adjustment alone does not account for the full picture. 'Inflation lags' (representing the time delay with which exposures are evaluated) are particularly pronounced in times of high inflation. It drives the number of claims above a given attachment point or deductible, contributing to increased claims frequency. It is accompanied by multiplying effects on social inflation, driving claims severity. And lastly, there's a compounded inflation impact on claims being paid further into the future for the longer-tailed business.

As a partial offset, insurer investment portfolios will start to benefit from increasing interest rates, but the relief will lag the immediate impact on claims costs. There are two reasons for this – on the one hand, interest rate increases by central banks typically come with a delay vs actual inflation. On the other hand, insurer asset portfolios show a relatively slow turnover (which benefitted insurers' customers the other way round in the times of zero and negative interest rates). And lastly, as in other industries, the cost of equity in insurance is going up, as investors adjust their required absolute return expectations, given debt products regain higher attractiveness as an alternative.

The way forward? It's all about conversation! We’re in the same boat as our customers and must tackle the challenges of these uncertain times together. Let's jointly determine the right level of risk transfer for your corporate and the insurance products best suited to facilitate this risk transfer.

As a specialised risk partner for corporates, Swiss Re Corporate Solutions has the right toolbox to find the optimal custom-made solutions for you, be it via innovative risk transfer products or by advising our customers on self-retention solutions such as captives. Most importantly, we’d like to keep the dialogue going and I’m committed to joining these discussions personally, if you’d like, to find the best way forward together.