John Charman, chief executive of Bermuda-based Axis Capital says insurers are caught between softening policy rates and volatile investment markets, a situation he expects to hurt returns.
“You could make the case that this is the perfect storm — where you have minimal prices in the insurance industry, and at the same time extraordinary volatility in your investment portfolio,” Charman told Reuters in an interview from Axis’ Bermuda headquarters.
Historically insurers count on investment income to make up a shortfall in profit when underwriting returns fall.
“I think the industry’s reliance on investment earnings during the soft part of the market cycle to prop up diminished underwriting earnings is going to be a very interesting play-out” said Charman.
“I just don’t think people are really connecting the dots,” he added. “This is structurally a very different situation than in the late 90s,” he said.
Insurers were faced with softening rates and turbulent investment markets in the late 1990s, but the situation appears worse this time around, said Charman.
Back then, market turmoil was largely tied to an overvaluation of technology stocks, in contrast to the pervasive credit crisis now gripping financial markets.
“The industry’s returns are likely to reduce from what they have been,” Charman added.
Investors have been skittish about the sector since the credit crisis took root. Axis shares have fallen by about 25 percent over the last year compared with a 33 percent decline in the S&P Insurance Index over the same period.
Axis, which does not disclose its forecast on returns, posted a 20 percent return on equity in the first quarter, and Charman said it has averaged 18 percent over the company’s nearly seven-year history.
On an annual basis, the company underwrites about $3.5 billion in insurance and reinsurance coverage, mostly for large, commercial customers, although it last year it began expanding into some specialized, smaller premium business.
Reinsurers provide insurance to other insurers spreading the risk of losses between several carriers.
Charman said Axis had been “defensive” in both its insurance and reinsurance underwriting over the last two years, with insurance being the area where underwriting conditions have deteriorated most.
“There is extreme competition, a lot of it irrational … which has to eventually emerge in the financials of the companies that are stupid enough to follow the market down,” he said.
Axis’ investment approach, which is normally conservative, has become increasingly so over the same period, he added. “We recognize risk and we take risk through our underwriting portfolio. That is what we are good at,” said Charman. “We do not want to double our risk through having a lot of risk in our investment portfolio.”
Charman, 55, founded Axis in 2001 after about three decades working at Lloyd’s of London, where he made a name for himself providing hard-to-find coverage during the first Gulf War.
Some insurers have argued that there are now investment opportunities emerging from distressed parts of the market.
Apart from small allocations to some hedge funds moving into distressed parts of the market, Axis is steering clear, said Charman.
“I am still not sure that the volatility justifies the risk/reward,” said Charman. “We may miss a bit of yield, and we can be criticized for that if things go well, but the risk is too great at the moment.
PLANTING SMALLER SEEDS
While market conditions have created a thorny business environment, Charman said Axis plans to expand its business both by product line and geographically.
Axis bought a small unit of insurance brokerage Aon Corp . The unit specializes in providing both coverage to the media industry and so-called errors & omissions coverage, which protects policyholders in the event of negligent acts and omissions that may harm clients.
“You do need efficient technology to be able to process that business,” said Charman, adding that Axis has spent time and money to automate this business as much as possible, cutting down the need for a large workforce.
“We do not want to overwhelm ourselves by having thousands and thousands of people administering small premiums,” he said.
Geographically, Axis has been expanding into Canada and Europe. It recently opened a branch in Singapore for “highly specialized” business, said Charman.
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