Insurers find that central banks are all too predictable

Marc Sidwell
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HUNDREDS of homes being evacuated due to flooding in Scotland and northern England wasn’t the ideal backdrop for Lloyd’s of London to announce its upbeat interim results, boosted by a “favourable claims climate”. Then again, even as the number of flood alerts rises, it needn’t sink the Lloyd’s insurance market’s optimism, partly because of its limited exposure, but mainly because such events are a drop in the ocean next to the catastrophes of 2011 – the New Zealand earthquake and Japanese tsunami among them. Lloyd’s saw claims on the half year down almost a third against the same period in 2011, to £4.6bn from £6.7bn.

But while the insurance market in general can breathe a sigh of relief at a six-month period without such horrific disasters, that’s not to say the rest of the year can be counted on to remain calm. Earthquakes aren’t becoming any more common but they are no easier to predict, and an earthquake of the politico-economic kind, notably the possible collapse of the Eurozone, remains a distinct possibility, as current events in Spain and Greece are busy reminding us. Luke Savage, the Lloyd’s finance director, said yesterday that the Lloyd’s market has minimised its investment exposure to such an outcome but acknowledged that a spike in professional liability claims could follow a single currency meltdown.

Speaking of investment, the euro isn’t the only man-made catastrophe looming in the insurance sector’s path. The other is the low interest rates imposed by central banks in the hope of economic stimulus – earlier this month, alongside his announcement of unlimited QE, chairman of the Federal Reserve Ben Bernanke vowed to keep US short-term interest rates at rock bottom into the middle of 2015. But in June the European Insurance and Occupational Pensions Authority (EIOPA) warned that the continuing impact of low interest rates was making insurers more vulnerable – as previous commitments run into unexpectedly poor returns on investment portfolios.

Ernst and Young estimated in October 2011 that, if low interest rates persisted, “over the next three years, book yields in the industry could decline by approximately 50 basis points (bps) for life insurers and 30 basis points for property/casualty companies, putting pressure on companies’ earnings, premium rates and product designs.” PwC has also observed that 2011 was notable, not just for its natural catastrophes, but as the year “insurers started to feel meaningful effects from the low interest rate environment.”

Despite the improved climate for claims in the last six months, then, the long-term forecast on interest rates doesn’t look good for the sector. Ironically enough, the quest for yield this situation creates has produced one bright spot – catastrophe bonds have also had a stellar first half, with twice as much issuance compared to the same period last year – $3.6bn (£2.2bn). Alas, the predictability of central bankers means they have a much more reliable prospect than most insurers of doing just as well in the next six months.