Floods a ‘tipping point’ for insurers, Morningstar warns

Rising reinsurance costs due to natural disasters will force a rethink on insurers’ profit outlook, according to Morningstar.

A house near the flooded Hawkesbury River in Richmond. Morningstar has warned on the profit outlook for the nation’s insurers as reinsurance costs are set to rise. Picture: NCA NewsWire/Damian Shaw

Flooding devastating the east coast could be a tipping point for the nation’s general insurers, with a big question mark over the profit outlook as they grapple with spiralling reinsurance costs, which they will struggle to fully pass on to customers, Morningstar has warned.

Australia’s largest general insurer, IAG, on Wednesday cautioned on its annual profit guidance as claims across its brands from the floods and storms in NSW and Queensland hit 24,000.

The insurance giant said it had received about 3500 claims from widespread flooding across Sydney over the last three days and told shareholders to expect a margin at the lower end of its 10-12 per cent guidance.

The bigger issue is the impact of the floods on reinsurance costs across the industry, which insurers may not be able to fully pass on to customers, Morningstar banking and insurance analyst Nathan Zaia said.

“We think it could have a permanent impact on what sort of profit insurers can make. It’s something the whole industry will need to address,” Mr Zaia said.

“With higher reinsurance costs you see rising claim inflation, but you can only do that for so long before people either stop getting insurance altogether or opt for lower insurance cover.”

Mr Zaia expects the margin pressures to be a key feature of insurers’ performances in 2023 but does see an improvement in time if the cash rate moves higher, giving a boost to insurers’ investments.

“We assume a 10 per cent increase in reinsurance costs in fiscal 2023, which represents around 40 per cent of gross written premiums, up from 38 per cent in fiscal 2021,” Mr Zaia said in a research note this week.

The alternative, he said, would be for IAG to reduce its cover to avoid paying more.

“We don’t think management will want to increase risk given events of recent years, he predicted.

“As cost headwinds mount, it is difficult to imagine insurers will be able to put up rates enough to recoup all the margin pressure without it having a meaningful impact on policy numbers.

“Repair costs are rising given inflationary pressures (which will get worse as demand rises following large weather events). Large hazard events have become more costly and frequent, and investment income is weak given the low cash rate environment.”

Insurers will likely have to accept lower margins until returns on investment portfolios improve, he predicted.

UBS analysts have taken a similar view on the 2023 outlook, warning that consensus expectations are too high in light of the looming reinsurance challenges. IAG’s reinsurance cover rolls over on July 1.

“We think market focus turns to fiscal 2023, where consensus expects a sharp increase in margin (to 14.7 per cent). This looks increasingly challenged by reinsurance constraints and a likely associated increase in catastrophe budget,” UBS analysts told clients in a note.

UBS is tipping that IAG’s aggregate cover renewal on July 1 “will become more restrictive, on price, terms and/or coverage”. Suncorp is in a similar position, the analysts warned.

In a separate note to clients earlier this month, the investment bank warned on the unfavourable outlook for reinsurance in light of the recent natural disasters.

“We note commentary from global reinsurers Swiss, Munich and Scor relating to controlling cat risk and restructuring aggregate covers.

“We expect the domestic insurers to face increased reinsurance rates in FY23 and likely higher retentions and higher cat budgets.”

Analysts at Citi, meanwhile, have taken a different view, seeing the insurance sector as “attractive” despite the rising costs

“There are likely to be some future adverse impacts including further upward pressure on the fiscal 2023 perils allowance, the potential for an increased maximum event retention moving forward and increased reinsurance costs,” Citi analysts said in a research note.

They expect the renewal of IAG’s aggregate cover at 1 July 2022 to present an even greater challenge.

“However, with strong premium rate rises both continuing and yet to fully earn through and the potential for rising interest rates, we still view the story as attractive and make no changes to our underlying margin forecasts.”