2015 J.P. Morgan Taylor Fry General Insurance Barometer

Transcription

1 2015 J.P. Morgan Taylor Fry General Insurance Barometer Direct Underwriters, Reinsurers and Brokers Insurance Siddharth Parameswaran AC (61-2) Alvin Liu (61-2) J.P. Morgan Securities Australia Limited Taylor Fry Kevin Gomes (61-2) Sharanjit Paddam (61-2) Joshua Jaroudy (61-2) This is the result of a joint research effort between J.P. Morgan and Taylor Fry. See page 26 for analyst certification and important disclosures, including non-us analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Table of Contents Survey Description...3 Executive Summary...4 Macro backdrop for Australian insurers...6 When and why will the cycle turn?...19 Climate change and insurance...21 Survey Participants

3 Survey Description This is the fourth edition of The Barometer, a joint effort between J.P. Morgan and Taylor Fry. The publication continues from 19 editions of the J.P. Morgan Deloitte General Insurance Survey, the last of which was published in 2012, for the year to 2011, with the first edition of the Barometer published the following year. The 2015 J.P. Morgan Taylor Fry General Insurance Barometer provides a detailed overview of the current state of the Australian general insurance industry and the industry s expectations. The report conveys analyses on the key elements of the industry from the perspective of direct underwriters, reinsurers and brokers, including: detailed product information for the current period and industry expectations for the next two years, covering issues such as premium rate trends, capacity changes, claims trends, loss and expense ratios perceptions of product profitability distribution trends practitioner views on key issues affecting the industry and particular classes brokers perceptions of underwriters. As has been our longstanding custom, we have also provided editorial comments from J.P. Morgan and Taylor Fry on key industry issues which serve as a commentary on industry developments to complement the survey results and respondent feedback. Sources of Information All information in this report is sourced from a survey of the major underwriters, reinsurers and brokers in the Australian general insurance industry, along with certain APRA data. A complete list of participating companies is contained at the end of this report. The survey is the 23 nd consecutive data collection and accordingly there is now a substantial body of trend data available, and many of the comments and observations in the report have been drawn from this information. Acknowledgments This report has been produced with the support of the Australian insurance industry. The insurance industry s support has been generous and is greatly appreciated. The J.P. Morgan and Taylor Fry teams hope you find this a valuable reference. 3

4 Executive Summary The key themes to emerge from the 2015 survey and our analysis are outlined below combined ratios hit by catastrophe events...commercial outlook tough The 2015 year saw a significant deterioration of combined ratios for the insurance industry, primarily due to the catastrophe events in 2015 and the impact of excess capital and strong competition affecting premium rates. Survey respondents reported overall combined ratios (including classes not covered in our survey) of 94% in 2015 up from 87% in This was matched by a Direct Insurer APRA RoE of 11%, down from 18% in For the domestic lines that we cover in the survey, the combined ratio worsened to 91% from 86% in This was driven by domestic motor and householders impacted by catastrophe events, but offset by some strong releases in NSW and QLD CTP. In commercial, the combined ratio was 107%, a significant deterioration from 91% in 2014 primarily driven by catastrophe and reserve strengthening in WA workers compensation. The COR trends in 2015 and the outlook for 2016 in our latest survey were worse than the industry expected in the 2014 survey. Survey suggests mixed rates outlook uptick in personal, tough in commercial Participants said that domestic rates stalled to 0% (nominal), below claims inflation of 5%. Motor led trends down with rate reductions of 2%. Domestic class rates are expected to pick up in 2016 across the board, mainly led by CTP. In commercial lines, rate trends were even weaker (-6% reduction overall on weighted average, largely inflation adjusted basis), slightly lower than the -4% expected in the 2014 survey. Fire/ISR continue to show the greatest pressure in commercial lines for both underwriters and brokers, averaging -10%. Most of the pressures here were in large commercial risks. The industry is expecting rate pressures to continue downwards in commercial in 2016 with rate reductions of 3%. Claims inflation in personal lines has ticked up; frequency trends to worsen For the commercial lines, inflation in 2015 was at the same levels to 2014 (4%), whereas domestic lines increased to 5%, from 3%. In particular, the householders class experienced 7% inflation this year above the 4% predicted in the 2014 survey. The inflation outlook for NSW and QLD CTP is high and expected to average 5% in 2016 and 6% in Frequency trends in most classes were unfavourable in 2015 (1.3% in domestic lines, 0.4% in commercial lines). NSW CTP experienced a 9.5% increase in underlying frequency and is predicted to hold these high levels in As mentioned earlier, catastrophe costs were above average in 2015, hurting reported profit trends. Top concerns for the insurance industry The top 2 concerns have not changed from last year. 56% of underwriters in the survey identified competition /rates / capacity as a key concern (it was also the key concern last year). This was followed by 44% identifying technology as a key concern. 86% of insurance brokers are worried about an excessively competitive rates environment, up from 75% last year. 57% indicated concerns regarding pricing and profitability. Reinsurers flagged an abundance of capacity and competition as their key concern, followed by regulatory issues and the investment environment similar to last year. 4

5 Part 1: Editorial Comments 5

6 Macro backdrop for Australian insurers Siddharth Parameswaran, Alvin Liu, J.P. Morgan The J.P. Morgan economist s base case for Australia is for below trend growth but still positive for the 25th year in a row. The economy still is in the midst of a multi-year adjustment after an unprecedented boom in commodity prices and resource sector investment. The twin booms created distortions of the type Australia s economy has not handled well in the past (soaring AUD and productivity slump)aud and a productivity slump.) Growth is slowly gravitating to non mining sources. The economic environment since the global financial crisis (GFC) of 2008/2009 proved to be one of low global growth prospects, but without the extreme downside economic outcomes feared. Australia had been a relative outperformer when compared against other developed economies although the prospects going forward may be different with the US and UK rebounding and Australia facing the prospects of falling commodity prices, and considerably reduced business investment. From a global perspective, 2015 saw modest rates of economic growth in developed economies such as the US and UK but weaker although recovering growth in Europe. Europe growth has steadily recovered over the past 2 years from -1.1% real GDP growth in the Mar-13 quarter to 1.6% in the Sep-15 quarter. There could be further boost to growth with potentially another round of stimulus expected to be announced by the ECB in CY2016 following from the 500m sovereign QE program announced in early CY2015. Unemployment rate for Europe remains high at 9.3% (Oct-2015), although has improved from its peak of ~11% at Apr The U.S. appears to be recovering, showing real GDP growth of 2.4% for CY15, which is relatively in line with their long term average and unemployment has improved significantly from ~10% in Dec-09 to ~5% in Sep-15. Similar positive trends have also been observed for UK. Figure 20 - Figure 21. There are expectations in the bond markets of increases in interest rates in the US and UK. Australia during 2015 arguably saw sub par levels of growth, although they were still positive. The J.P. Morgan Economist and Strategists suggest there may similar pressures for Australia in 2016 with sub-par growth and unlikely movement in the jobless rate 1. This suggests a sluggish outlook for the Australian economy, and ultimately for demand in the insurance sector, although demand pull inflation may be kept under check. We focus in this section of the report on the macro drivers affecting the outlook for the general insurance industry. Economic indicators in Australia The outlook based on recent research by the J.P. Morgan Economist is that Australia could grow close to trend in CY2016 at 2.6%, which is above the 2.3% expected for He does warn that the composition of the growth will be driven largely by a rebound in the net exports contribution and a slight acceleration in consumer spending, rather than investment led growth. The unemployment rate in Australia was 6.23% in September 2015 according to statistics from the ABS and has been rising steadily from 6.17% a year earlier. This is above the generally accepted target for NAIRU (non-accelerating inflation rate of unemployment) of 5%; however, we note in recent times the NAIRU may be considered to have increased slightly above this level 2. The J.P. Morgan 1 We reference research by J.P. Morgan Economist on 6 January 2016 Australia: 2016 another underwhelming year. 2 We reference research by J.P. Morgan Economist on 19 November 2010 Australia: lack of slack to change inflation tack & on 20 January 2012 Does the RBA care about the distribution of growth? to form our view on the NAIRU. 6

7 Australia Economist predicts an increase in the unemployment rate to peak at 6.4% in 1Q16 as a result of continued forecasted sub-trend GDP growth. 3 RBA currently has a record low cash rate of 2% which gives RBA very little room for further monetary policy expansion should it be needed (having already used this tool see Figure 7). According to the J.P. Morgan Australia Economist, RBA may continue to preference a low AUD over a low cash rate and our economist forecasts that there will not be an easing of rates in Housing sales volumes and prices were strong in 2015 and the J.P. Morgan Australian economist expects this to continue to be the case in 2016 although at a slower pace than in Our economist expects that national house price inflation is close to its peak and will most likely decelerate through The Australian dollar has sat around US$0.70 this month, with market sentiment suggesting that these rates will continue to depreciate, which can pose some cost push inflation risk for insurers. 3 We reference research by J.P. Morgan Economist on 6 January 2016 Australia: 2016 another underwhelming year. 4 We reference research by J.P. Morgan Economist on 6 January 2016 Australia: 2016 another underwhelming year. 5 We reference research by J.P. Morgan Economist on 6 January 2016 Australia: 2016 another underwhelming year. 7

8 Figure 1: Unemployment rate Australia Figure 2: Real GDP growth in Australia Source: Bloomberg (12/11/2015) Figure 3: Government fiscal rectification a drag to GDP growth Figure 4: Investments as % of GDP mining /non-mining Source: JPM Figure 5: Price in US$ of commodities falling (Iron ore, Oil) Figure 6: A big risk is a highly leveraged consumer Source: Bloomberg 8

9 Figure 7: Inflation rate indices vs. bond yields Australia Figure 8: A$ weakened but arguably still too strong for RBA s liking Source: Bloomberg Source: Bloomberg Claims: some inflation risks worsened by any economic deterioration Consumer price inflation metrics are below the RBA s long-term target range of 2-3%, with the inflation rate for the year to September 2015 being 1.5%. The generally soft economic environment (affects demand pull inflation), and falls in petrol prices may offset some of the cost-push inflation that may be expected from a depreciating exchange rate. Average Weekly Earnings rose 2% in the year to May 2015 (ABS), which is at the lower end of recent historical levels. This is unsurprising given the softening economic climate. This may be a slight negative for some classes such as workers compensation, whose premiums are levied as a % of wage roll (whereas certain claim costs such as medical and legal may move independently of wage inflation). However, for other classes, it will likely have a positive effect to the extent that the wage components of repair costs could increase at a slower rate in short tail lines, and costs of compensation in court awards (where the award takes into account salary levels) could be subdued in long tail lines. Another key area highlighted in terms of claims inflation is the legal environment, with respondents referring to a slow and effective erosion of tort reforms over time. This particularly affects the liability and CTP classes. Most concern in our view centres around the NSW CTP scheme where so far little effort has been made by the government / regulator in our view to turn around trends in a rise in represented claims. 9

10 Catastrophe costs globally have been benign in 2015 globally but were high in Australia, Catastrophe experience 2015 catastrophe losses were below-trend for the global insurance industry according to our estimates. A worse CAT environment was observed in Australia, where catastrophe claims were above the 10-year trailing average. Figure 9: Australian 2015 catastrophe trends above 10 year trailing average, with an increasing trend over the past few years Figure 10: US industry long term trends ($bn) benign CY14, but above avg. 1H15 Source: J.P. Morgan estimates, ICA. Note: Numbers pre 2013 are normalised figures as at and 2015 numbers are current figures based on latest information (7/12/2015) number includes the most recent SA bushfire Figure 11: Lloyds CAT claims ( m) in 1H15 extremely benign Source: J.P. Morgan estimates, Insurance Institute Information, Figures up to 2013 as at Numbers thereafter are as at reported in that year. 1H15 is a half yearly number Figure 12: Globally, CY2014 and 1H15 had relatively benign experience Source: J.P. Morgan estimates, Lloyds. Note: All figures Indexed for inflation to 2014, except 1H2015, which is indexed to Jun 15. Claims in foreign currency translated at the exchange rates prevailing at the date of loss. Source: Swiss Re, Munich Re. Chart in USD. Numbers up to 2013 are normalised to Numbers post 2013 are as at reported. 10

11 Figure 13: Normal season for parts of eastern Australia - Forecast for 3 months to February 2015 In Australia, weather changes can be a significant driver of catastrophe costs. Adverse trends can impact loss ratios in short tail classes (fire/isr & householders in particular). The current 2015/16 summer is an El Nino event, with Southern Oscillation Index (which seems to be a major driver of catastrophe costs) falling to approximately -20, which is well below the Bureau of Meteorology s -8 threshold for El Nino. The charts below show a forecast for the cyclone season in 2015/16 and rain season for the 3 months to February Figure 14: Average to below-average cyclone season most likely for Australia Source: Bureau of Meteorology Source: Bureau of Meteorology The shift to El Nino conditions as highlighted by the Bureau of Meteorology, would normally be expected to benefit insurers in terms of catastrophe costs. On average since 1967, El Nino years have had an average catastrophe cost (excluding earthquakes) of $725m, which is significantly below the $3,043m during La Nina years. Compared to the overall average annual catastrophe cost of $1,098m since 1967, an El Nino year would represent on average a ~$380m benefit to the general insurance industry. Nevertheless it appears that trends in 2016 FY so far have not been benign. 11

12 Figure 15: Catastrophe losses, excluding earthquake (A$m in 2011 normalised costs) against the Southern Oscillation Index (indicator of El Nino, neutral and La Nina Years ) Figure 16: Average catastrophe losses (excl. earthquake) for El Nino, neutral and La Nina years using ICA data for catastrophes (excluding earthquake losses) from Source: ICA, BOM, J.P. Morgan estimates. Source: BOM, ICA, J.P. Morgan estimates. Yields on fixed income assets appear to continue to fall, albeit at a slower rate than previously observed between This is a concern for long tail lines in particular. The extent of reductions is large enough to even affect short tail RoEs. Investment markets low investment yields hurting outlook for all classes. Yields on fixed interest investments (typically held by insurance companies in Australia to back their liabilities), have remained low as the RBA continues to work to boost the economy through monetary stimulus in light of global and domestic weakness. Falling yields have been further exacerbated by credit spreads contracting in line with a hunt for yield by investors. As seen below, current yields on fixed income assets of 3-year duration in Australia (of all credit grades) are even lower than the levels seen during the GFC. We note that yields post the as at date for the survey had not moved substantially. Figure 17: Yields on fixed income assets of 3 year duration in Australia Source: Bloomberg Equity markets were volatile in 2015, with the ASX200 Accumulation index ultimately finishing down 2.6% YTD (10/12/2015) 12

13 Figure 18: ASX 200 Accumulation Index Figure 19: ZCB bonds rates has flattened considerably signalling uncertainty and weak outlook for the economy Source: Bloomberg Source: Bloomberg 13

14 Growth in UK in particular has improved over the past 2 years but latest trends for Europe continue weak, having initially shown positive trends in FY14. Figure 20: Real GDP Growth Selected Developed Markets Macro factors overseas impacting global insurance markets Macro trends in the U.S. and U.K. improving but still uncertain for Europe The charts below show that in the US and UK, economic growth data is now at levels matching Australia. In Europe also, growth has recovered to similar levels as its western counterparts, although unemployment levels there still remain challenging. Our global economics team 6 is forecasting a strong divergence in the emerging market and developed market growth in 2016, with a key thematic being the possible risk to international financial stability from this divergence, as well as the pressures of recent drops in oil prices. Historically there has often been a correlation between weak economic activity and a rise in claims although we note that this did not manifest itself during the Financial Crisis (2009 onwards). Figure 21: Unemployment Levels U.S. and U.K. Source: Bloomberg (15/12/2014) Claims trends are potentially a concern with inflation remaining and low yields as seen in previous years Source: Bloomberg (15/12/2014) Inflation continues to remain while real yields remain weak The threat of high inflation in conjunction with near-zero real yields is a very detrimental combination for insurers. Yields in the US fixed income markets have been improving although are still at historically low levels. As a result the continuing low yielding environment continues to be a threat to the insurance industry any inflation will be hard to cover from investment earnings. Premium rates have not been moving to offset the impacts of falling yields. Figure 22: Implied inflation and real yields in U.S. bond market 6 Global Data Watch: August in January, Bruce Kasman 14

15 Commercial rates trends have continued to slow - trending negative in the US. Source: Bloomberg (11/12/2015) Figure 23: Premium rate movements in U.S. commercial markets Premium rates increases tending to zero but capital levels are strengthening The outlook on global premium rates has weakened since the peak in 1Q13 and there has been negative premium rate growth observed since 1Q15 across the small, middle and large corporate market. Capital levels however are still quite strong in the U.S. and appear to be holding after strong positive movement since 1Q12 (see Figure 24). Figure 24: U.S. surplus capital - from amalgamated accounts Source: CIAB Source: Insurance Information Institute. Note: Q data includes $22.5bn of paid-in capital from a holding company parent for one insurer s investment in a non- insurance business Reserve releases are expected to decline going forward in the U.S. (see Figure 26, based on information from the Insurance Information Institute) although there still appears to be the ability to support reported profits to some extent through reserve releases. Inflation data overall remains relatively subdued. Figure 25: U.S. P/C surpluses JPM estimate of surpluses in the market reducing (JPM Australia estimate of the US market). Source: J.P. Morgan analysis on reserve surplus position of the US market at Dec

16 Figure 26: U.S. P/C surpluses Surpluses diminishing Source: Insurance Information Institute, A.M. Best. Barclays research for estimates Figure 27: U.S. Towers Watson inflation indices Figure 28: U.S. Towers Watson inflation indices (superimposed) Source: Towers Watson are preliminary figures. Source: Towers Watson are preliminary figures Towers Watsons index on US inflation indices suggest insurance inflation trends are overall still very benign. Global reinsurance rates have been trending downwards as expected, as a result of a benign global CAT environment as well as the excess capital in the market. In the US, there has also been a significant growth in collateralised reinsurance over the past 4 years. 16

17 Figure 29: Global rate-on-line index by region, Figure 30: US Reinsurance Trends sharp rise in collateralised reinsurance over the past 3 year Source Guy Carpenter Source: Aon Benfield Analytics; Insurance Information Institute data is as of June 30 June Alternative capital accounted for 12% of global reinsurance capital as at 30 Sep Global capital levels are not falling In a report on 6 January 2016, Guy Carpenter reported that capital levels in the reinsurance industry were Stable during 2015 at US$400bn but included a 2-3% decline in capital in rated markets" offset by 13% increases in convergence capital (including catastrophe bonds) taking them to US$68bn. Some of that reinsurance capital is being deployed in direct corporate markets or returned to shareholders. Mergers and Acquisitions 2015 saw some large Mergers and Acquisitions announced and completed in the P&C space. We included some of the more notable ones in the table below (including the Zurich RSA acquisition that did not proceed). We think pressures on RoEs are increasing the likelihood more deals. Some of the drivers of M&A in our view include: (a) Pressure on RoEs from soft markets - forcing insurers to seek cost synergies (b) a quest for growth in some form in markets where revenues are weak / negative (c) the desire for efficiency in capital levels through increasing diversity in operations - which is very useful in a Solvency II world (d) the desire for some insurers e.g. in Japan and China to diversify out of their home market for the purposes of growth and / diversification of risk, particularly in an environment where their monetary systems were flushed with liquidity seeking sources of returns. Table 1: Notable Mergers and Acquisitions in 2015CY Announced Deal Date completed Metrics Dec-14 Fosun / Meadowbrook 28/04/2015 US$433mn 9/01/2015 XL / Catlin 1/05/2015 US$4.1bn 4/05/2015 Fosun / Ironshore 23/11/2015 US$1.84bn 10/06/2015 Tokio Marine / HCC 7.5bn US$ 22/06/2015 Fosun / Delek US$462m 1-Jul-15 Ace / Chubb US$ 28.3bn 2/08/2015 EXOR / Partner Re 19/11/2015 US $6.9bn 8/09/2015 Mitsui Sumitomo / Amlin 3.4bn pounds = 2.4x NTA Zurich / RSA - attempted but withdrawn Source: JP Morgan In Australia we have seen insurers continue to seek growth through acquisition where possible. We note that the South Australian CTP which is being privatized had access to customer relationships sold for A$300mn on A$450mn of GWP. Factoring in required capital injections of 100% of GWP, this suggests an average price to NTA of 1.67x. 17

18 These trends may help put a stop to the downward trend in the insurance cycle. Implications for the outlook for Australian Insurers The 2016 outlook for the Australian economy appears relatively weak with similar sub-par growth trends to those observed in 2015 likely. For Australian insurers this should mean muted growth prospects, and no economy led pressure valves on premium rates. Globally, economic trends are strengthening in the US and UK and Europe, which should boost premium volumes in those markets. Internationally capital may incrementally be allocated to those markets (but we think this impact will be small, and it will be profitability dependent) Low investment yields continue to be a concern. For long tail lines in particular, this can make a substantial difference to returns in the absence of adequate premium rate increases. Australian insurance companies in this environment are likely to receive no favours from the economic cycle for the growth or profit prospects. A ray of light is that there is an increased appetite for mergers and acquisitions which could provide a circuit breaker to limit price declines. 18

19 Figure 31: Australian Premium Rate Index - rebased to 100 in 1993 When and why will the cycle turn? Siddharth Parameswaran, Alvin Liu, J.P. Morgan In this section we show the history of premium rate movements in commercial and personal lines classes and outline industry participant views on what it may take to turn the current pricing trends. The survey suggests 2017 maybe when commercial markets stabilize, whilst personal lines classes are forecast to increase in We show in the chart below indices for premium rate movements in commercial insurance and personal insurance. We have adjusted the personal lines movements for CPI, in order to arrive at a proxy for a "real" rate index. We note that commercial class rate movements are largely expressed as a % of turnover so are arguably already inflation adjusted. Rates in the industry were negative in 2014 and 2015 on an inflation adjusted basis for both commercial and personal lines. The industry numerical responses suggested further downside in 2016 in commercial, followed by a stabilization from Personal lines rates are expected to more than match CPI from 2016 onwards. JPM Comment: We think this is a reasonable central case for personal lines, particularly given some pressures on one large industry player in certain personal lines classes. Source: JP Morgan Taylor Fry General Insurance Barometer The following charts show that profitability has been elevated in the personal lines market for some time, although as mentioned earlier in the survey, 2015 was helped significantly by large reserve releases in CTP classes. Commercial insurance RoEs however collapsed in to be even worse than the trends seen in 2011, when there were significant losses from the Brisbane floods, Cyclone Yasi etc. Commercial property RoEs have only been at these low levels in 1991 and

20 Figure 32: Notional RoEs for personal lines (financial years) Figure 33: Notional RoEs for commercial lines (financial years) Source: APRA, JPM Estimates from APRA combined ratios assuming capital allocation for motor of 25% of NEP for motor, 40% for householders, 100% for CTP and liability, 50% for property and 60% for liability. Source: APRA, JPM Estimates from APRA combined ratios assuming capital allocation for motor of 25% of NEP for motor, 40% for householders, 100% for CTP and liability, 50% for property and 60% for liability In the sections Issues Confronting the Underwriters and Issues Confronting the Brokers we show responses to questions we asked the industry on when the cycle would turn, and why. We note the following: In response to a question to underwriters about when the cycle would turn, one response suggested the cycle was already turning, another suggested the end of Calendar Year 2016, whilst 3 said there was no near term end in sight. Broker responses to the question did not suggest any timelines for a change but some commented that competition between brokers was still continuing at very strong levels right now. JPM Comment: This suggests on balance that particularly in commercial classes - there is no immediate catalyst for a turn despite the losses. Capacity is still plentiful, and competition between brokers is stifling a unified response upward on rates. In response to asking what would cause a turn in the cycle, underwriter responses included: reserve releases drying up, lawyers becoming more active (which they suggested was happening in the form of low cost represented models in CTP), increased pressures from a weak economic cycle, and continuing losses from events. Broker suggested that a lot of pressure in the cycle had been caused by new capacity from Lloyds syndicates setting up offices in Australia. Whilst the comments from the industry for commercial lines appear very bearish, we believe that the risks of a stabilization and eventual turn are increasing. We note that: There have been significant management changes in the industry (at 4 of the 5 largest general insurers in Australia). This could be a catalyst for change, bearing in mind that reserve releases are likely to be a much lower contributor to their expected profits over time than for their predecessors. There have been recent acquisitions globally - and 5 respondents in our survey suggested that this would increase over Any acquirers are likely to be focused on increasing profitability of their operations to justify their purchase prices. APRA and line management should have a much better view of underlying profitability than occurred in previous cycles and it is likely they would view current rates on Commercial property being unreasonably low (at least that is our view of current rates). 20

21 Climate change and insurance Sharanjit Paddam, Taylor Fry On 29 September 2015, Mark Carney, Governor of the Bank of England and Chairman of the Financial Stability Board stood in front of the historic Lutine Bell at Lloyd s of London the spiritual home of the insurance industry and announced to the gathered senior members of the industry that the risks of climate change to their industry were real. He noted three broad channels through which climate change can affect financial stability: Physical risks the impacts today on insurance liabilities and the value of financial assets that arise from climate and weather related events, such as floods and storms that damage property or disrupt trade; Liability risks the impacts that could arise tomorrow if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible. Such claims could come decades in the future, but have the potential to hit carbon extractors and emitters and, if they have liability cover, their insurers the hardest; and Transition risks the financial risks which could result from the process of adjustment towards a lower-carbon economy. Changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent. Carney s views came from an extended period of consultation with the insurance industry in the UK, which were summarised in a Bank of England Prudential Regulation Authority report: The impact of climate change on the UK insurance sector, prepared for the UK Department for Environment, Food & Rural Affairs. Physical risks Notable conclusions of the report include: There is growing evidence that the insurance losses arising from global natural catastrophes are increasing Whilst increasing exposure is the primary factor driving these increases, there are indications that climate change is also having an impact. For example, Lloyd s of London estimates that the 20cm of sea-level rise since the 1950s increased Superstorm Sandy s surge losses by 30% in New York alone. Climate change is likely to drive reassessments of prudential capital requirements for insurers The increasing globalisation of the supply chain, increase the systemic risk. For example, the 2011 Thai floods resulted in US$12b of insurance payments including claims arising from the interruption of the supply chain for global manufacturing firms. While many of these conclusions arise from the analysis of international insurance placed in the UK, Australia is not immune. Indeed Australia ranks as the most exposed developed nation to natural perils, and so is highly exposed to physical risks. The recent increase in premium rates for property insurance in Northern Australia reflects the growing realisation of the industry that the risk can no longer be cross subsidised across Australia in the presence of a competitive market. 21

22 Liability risks The Bank of England, cognisant of the impact of historical latent liabilities such as asbestos and pollution losses, sees the potential for increased claims in general liability classes of business, such as public liability, directors and officers and professional indemnity, due to a failure to mitigate, a failure to adapt or a failure to disclose. Whilst litigation has generally been unsuccessful to date, the Bank notes that there is a risk that a successful action will open the way for other actions. Of note is the recent investigation by the New York State attorney general into whether or not Exxon Mobil mislead the public about the risks of climate change, or mislead investors about how such risks might hurt the oil business. Transition risks Not only does Australia have the largest exposure to natural perils of any developed nation, its economy is more reliant on coal than any other developed nation. At the recent COP21 meeting in Paris, nations around the world reaffirmed their commitment to reduce greenhouse gas emissions. Such actions in the longer term are likely to lead to a reduction in demand for fossil fuels, and there are risks of a sudden revaluation of such assets. Where insurers are exposed, directly or indirectly, to the fossil fuel industry, this leaves an exposure to the risk of a sudden reduction in asset values. More broadly, the transition to a low-carbon economy will see a fundamental shift in areas of production, leading industries, infrastructure demands and population centres in Australia. These will have a long term impact on the demand for different types of insurance, and associated risk management, underwriting, and claims expertise. How can Australian insurers respond? While insurers, who generally underwrite on an annual basis, have the option to walk away when physical risks increase, this is by no means a long term solution. Firstly, insurers need to grow their business, and the more risks become uninsurable, or premiums unaffordable, the smaller the potential market for insurers to operate in. From this perspective, the long term reduction in premium income is the greatest threat. Secondly, unaffordable premiums increase the risk of adverse publicity and the risk of government interventions in the market, which are generally not in the interests of insurers. Lastly, the potential increase in capital requirements to support larger variability in losses, will act to reduce returns on equity, or increase the affordability problem. Insurers need to engage governments and policy makers into adapting for climate change e.g. through better protections from flood, stronger building standards to reduce cyclone losses, and better planning controls to reduce development in high risk areas. Without these changes, insurers will see a loss of revenue and an increased exposure to losses. Insurers must also take steps to identify and measure their exposure to transition risks through existing investments in carbon-intensive assets, as well as to liability risks from historical policies. Where material exposure are identified, insurers need to adopt a plan of action to reduce such exposures, not only on existing assets and liabilities, but also on underwriting standards for future business, as well as investment policy for future asset acquisitions. The transition to a low carbon economy also offers insurers substantial new opportunities for business. Swiss Re released a report in 2015 Profiling the risks in 22

23 solar and wind, which identified new risk management approaches in the renewable energy sector, including the opportunity to use weather derivatives to manage the variability in revenue from renewable energy sources due to variability in output. They noted that By the end of this decade, a 50% increase in renewable energy investment is likely to produce more than a doubling of insurance spending. As always, insurers that are agile enough to quickly respond to the changing market with products that meet the needs of their customers are likely to thrive in the new reality of climate change. 23

24 Part 2: Survey Participants 24

25 Survey Participants The participants in this year s survey are listed below. Where an international organisation is shown, the response is from its Australian-based subsidiary or branch. Underwriters Allianz Australia Insurance Ltd AXA Chubb Insurance CommInsure Hollard Brokers Arthur J Gallagher Aon Risk Services Australia Fitzpatrick & Co. Insurance Brokers Jardine Lloyd Thompson Reinsurers General Reinsurance Hannover Re Liberty International Underwriters NTI RACQ Suncorp Zurich Macey Insurance Brokers Marsh Philp, Newby & Owen Steadfast SCOR Asia Pacific Swiss Re 25

26 Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or intervention. Important Disclosures Company-Specific Disclosures: Important disclosures, including price charts and credit opinion history tables, are available for compendium reports and all J.P. Morgan covered companies by visiting calling , or ing with your request. J.P. Morgan s Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call or research.disclosure.inquiries@jpmorgan.com. Explanation of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst s (or the analyst s team s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst s (or the analyst s team s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst s (or the analyst s team s) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-australia) and U.K. small- and mid-cap equity research, each stock s expected total return is compared to the expected total return of a benchmark country market index, not to those analysts coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analyst s coverage universe can be found on J.P. Morgan s research website, Coverage Universe: Parameswaran, Siddharth: AMP Limited (AMP.AX), Challenger Limited (CGF.AX), IOOF Holdings Limited (IFL.AX), Insurance Australia Group (IAG.AX), NIB Holdings Limited (NHF.AX), QBE Insurance Group (QBE.AX), Steadfast Group LTD (SDF.AX), Suncorp Group Ltd (SUN.AX) J.P. Morgan Equity Research Ratings Distribution, as of December 31, 2015 Overweight (buy) Neutral (hold) Underweight (sell) J.P. Morgan Global Equity Research Coverage 44% 44% 12% IB clients* 52% 47% 35% JPMS Equity Research Coverage 45% 47% 8% IB clients* 70% 63% 50% *Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category. Please note that stocks with an NR designation are not included in the table above. Equity Valuation and Risks: For valuation methodology and risks associated with covered companies or price targets for covered companies, please see the most recent company-specific research report at contact the primary analyst or your J.P. Morgan representative, or research.disclosure.inquiries@jpmorgan.com. Equity Analysts' Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues. Registration of non-us Analysts: Unless otherwise noted, the non-us analysts listed on the front of this report are employees of non-us affiliates of JPMS, are not registered/qualified as research analysts under NASD/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Other Disclosures 26

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