General insurance might scream more grudge than glamour purchase. Yet in an ever-evolving world, no can dispute that the sector helps manage change and all the risks associated it.
From the Grenfell fire and recent terrorist attacks to cyber security and the growing number of natural disasters, the insurance sector is behind the scene helping pick up the pieces.
Anyone who has experienced a car crash, where the liabilities could be widespread, or faced a health crisis can tell you that nothing in life is certain. It is this possibility of risk and uncertainty that makes people buy insurance.
A multifaceted sector
As the risks to an individual and a company differ greatly, the sector is split into two areas: personal and commercial lines insurance. Within each is a number of different categories ranging from pecuniary to liability.
These policies can be brought either through an insurance broker or directly from an insurance provider. Direct general insurance lends itself to the new digital arena where consumers want instant quotes at the click of a button.
Traditionally, insurance companies were owned by the policy holders they worked to protect, but over recent years many of these companies have demutualised and been converted into stock companies.
In addition to established policies offered by insurance companies, some businesses and individuals may present with unusual or risky exposures and this is where Lloyd's of London comes into play.
What began as a coffee house in the 1600s, where the shipping industry gathered to trade ocean cargo insurance, is now a marketplace where expert underwriters and brokers who cover more than 200 territories come together to do business.
Amongst the most famous things to be insured at Lloyd’s were the legs of actress Betty Grable for $1m each in the 1940s. They are also the first and only insurers of Richard Branson’s Virgin Galactic private spaceship.
Some risks are so large that insurers may seek cover for some of it from other insurers – a practice known as reinsurance. This allows the insurer additional security for its equity and solvency and more stable results when unusual and major events occur.
What affects the sector’s share prices?
As insurance companies invest most of the premiums from policyholders they are not immune, like so many other sectors, to the fluctuations in interest rates and this affects their generated income.
The UK insurance sector is responsible for investments of £1.9 trillion, equivalent to 25% of the UK’s net total worth.
One of the biggest challenges to the sector is climate risk. This not only affects investment opportunity, but also presents solvency issues. Assets can be directly damaged by floods, droughts and severe storms, but portfolios can also be harmed indirectly, through weaker growth and lower asset returns.
According to a report from ClimateWise, a global network of 29 insurance industry organisations, there is an urgent need to address the growing $100bn annual climate risk 'protection gap.'
It highlighted that since the 1950s, the frequency of weather-related catastrophes, such as windstorms and floods, has increased six-fold with total losses increasing five-fold since the 1980s to around $170bn today.
Research by the Economist Intelligence found that a rise in temperature of 6oC by 2100 could result in losses for global assets of $43 trillion. This is 30% of the world’s entire stock of managed assets.
What can make one company buck the trend?
Any insurance company that has responded positively to the digital revolution will continue to buck the trend according to James Dalton, Director of General Insurance Policy at the ABI.
In a recent speech at the JP Morgan European Insurance Conference, he said that digitisation is rewriting the rulebook for all elements of insurers’ businesses and is delivering huge change from customer relationships to to claims.
He added that insurers need to get prepared for changing consumer demands and expectations.
A survey of 2,005 British adults, conducted on behalf of GMC Software in 2016, found that 85% of consumers with insurance would like their insurer to give them insight into how they could lower their premium, for instance by suggesting changes in behaviour.
A driver behavioural app, for example, can monitor motorists’ driving skills and this data is then turned into an individual score that helps determine the motorist’s premium, with "safer" drivers earning up to 20% off premiums.
What can make a company's share price fall?
There are many factors that affect a company’s share price. A landmark claim is an obvious one. In 2001, Munich Re faced an estimated bill of £31m arising from a rail crash in Selby, UK, in which ten people died after a Land Rover collided with a train.
Dutch‑Belgian group Fortis insured Gary Hart, the driver of the Land Rover whose accident led to the disaster, but Fortis’s reinsurance cover meant that it had to pay only the first £1.5m of the claim.
Changes to Government legislation are another cause. Shares in UK insurance groups Admiral and Direct Line fell sharply this year after news that the Government was increasing the amount that the industry pays for personal injury compensation claims.
The Ministry of Justice announced that it was cutting the Ogden discount rate, used to calculate lump sum pay-outs, to minus 0.75%, from 2.5%. This was a much bigger cut than the industry had expected.
The announcement forced many listed insurers to make unscheduled announcements to the London Stock Exchange, with many having to delay reporting their financial results as they recalculated the impact.
Some motor insurers have called it the biggest claims issue the industry has faced in a generation.
What should I look out for in company accounts?
In addition to financial statements, things to look out for in company accounts are reserve ratios relating to a company’s ability to pay claims and meet ongoing obligations to policyholders.
Exposure to catastrophic and environmental loss and details of the company's operations are always important.
Profitability is also a key factor in the decision to invest. The income from underwriting must also be considered in addition to investment income.
Role of insurance rating organisations
The good news for investors is that the insurance sector receives financial strength ratings from insurance rating organisations that carefully analyse and evaluate a company’s financial performance both past, present and future; the stronger the rating, the less likely the possibility of financial difficulty.
Each organization uses its own formula for determining the financial strength ratings. According to Edem Kuenyehia, Director, Market Development at AM Best, insurance companies get rated because it is a critical requirement (often “A-” minimum) for credit sensitive market segments such as reinsurance and large commercial business.
He added: “A Financial Strength Rating is an independent opinion of an insurer’s financial strength and ability to meet its on-going insurance policy and contract obligations. It is not a warranty of a company’s financial strength and is intended to be prospective.”
What else is there to watch out for?
In 2015, in a letter to Shareholders, Berkshire Hathaway's CEO Warren Buffett outlined the four commandments that an insurance operation must follow. These are disciplines that sound simple on paper, but are probably not so in practice.
Firstly he said, it must understand all exposures that might cause a policy to incur losses and then assess the likelihood of any exposure causing this loss and the probable cost if it does. After that a company must set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered.
Finally and perhaps most importantly, be willing to walk away if the appropriate premium can't be obtained.
All things aside, it is this disciplined risk evaluation and underwriting expertise that will make an insurance company stand out from the rest and enjoy financial longevity.