The Australian insurance sector will remain resilient as operating challenges ease in the next few years. Premium rate increases have more than countered earnings pressure from claims inflation in all sectors excepting mortgage insurance. The earnings lift from higher premium rates will continue to offset reinsurance rate pressures, and higher spending on technology, cyber defense, and regulation. Ongoing strong investment returns will also likely underpin the profitability of Australian insurers over the next 12-18 months.

S&P Global Ratings expects underlying profitability will stabilize at the current solid level over the next two years. In our view, the creditworthiness of Australian insurers will remain stable over 2024 and 2025.

Affordability Should Improve As Inflation Normalizes

As key inflationary pressures ease, insurers will likely respond by moderating premium rate hikes over the course of 2024 and 2025. Lower inflation should be a positive for the sector. Over the past couple of years, P/C insurers, in particular, have meaningfully upped their premium rates to offset claims inflation and rising reinsurance prices. This resulted in premium rates rising much quicker than broader inflation and wage growth. The response came with a downside, however. It magnified affordability constraints for customers. Adjustments to sums insured and excesses have been levers utilized to soften premium rate rises for consumers.

In our opinion, Australia continues to provide a supportive and broadly stable economic environment for insurers. The country's effective public policymaking has supported the economy's resilience to external shocks and mitigates the impact of external imbalances, while supporting sustained profitable growth for insurers. Regulation and oversight of insurers is viewed as high quality and broad-based--capturing a wide variety of company and industry challenges. This can, however, place strain on the operating expenses and resources of insurers.

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Property/Casualty Insurance Sector: Premium Growth To Slow

We expect the Australian P/C insurance sector to moderate further rises in premium rates leading to lower premium growth through to 2025. Yet profitability should remain strong over that period. We forecast the underlying return on equity (i.e., removing unrealized investment gains or losses) to stabilize at about 12%, roughly in line with 2023.

Lower natural hazard losses, easing claims inflation, and slowing reinsurance price increases should assist profitability across 2024. Underlying returns will also benefit from enhanced risk-based pricing, continued efficiency initiatives across operations and claims management, well-structured reinsurance arrangements, and higher running yields on investment portfolios.

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Uncertainty on future claims will remain, however, in our view. Based on data from the Insurance Council of Australia, in the 10 years to Dec. 31, 2023, Australia had about 40 declared catastrophes, with initial losses totaling about A$28 billion. These losses were about twice the size of that experienced in the decade to 2013, with 54 declared catastrophes. Although the increase in frequency of events appears to have moderated, the severity of these events has significantly increased.

Insurers will combat rising reinsurance costs

The resulting claims and future uncertainty has fed into a significant rise in reinsurance costs. In the past seven years Australian P/C reinsurance costs have grown by about 44%, consuming most of the growth in gross earned premiums, which were 64% higher. Insurer's earnings have also been impacted as reinsurance recoveries only increased by 18% over that period.

In response, Australia's P/C insurers have been managing their exposure by increasingly applying risk-based pricing, adjusting appetite for particular insurance risks, and increasingly sharing risk retention with the policyholders. We believe sound risk management coupled with supportive reinsurance programs will help to moderate the impact of large losses on insurers over the short to medium term.

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Capital buffers to remain stable

Capital adequacy remains a key strength. We expect P/C insurers will maintain sufficient capital buffers above regulatory requirements to absorb any earnings volatility. We also think the sector can cover losses from different risks in extreme stress scenarios. Based on S&P Global Ratings' risk-based insurance capital model, most rated Australian P/C insurers have very strong capital adequacy.

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Life Insurance Sector: Breathing Room For Product And Model Upgrades

For life insurance, we expect to see modest premium growth of about 3% in each of 2024 and 2025, slightly ahead of growth in recent years. The Australian life sector benefits from solid demand for life-risk and income protection products to cover globally high levels of personal indebtedness. Premium flows are also supported by Australia's high per capita income and some tax efficiency benefits, although regular stepped premium increases (age and inflation-based) for most risk products can reduce demand with age.

The industry does face some hurdles including complex and outdated product design, a lack of product innovation, and access to affordable advice channels which could lead to dwindling new business sales. Life insurers will continue to address these industry challenges with underwriting and product reforms and through preventive health and wellness offerings--although these initiatives can take time to flow through to performance. While the industry is biased to risk products, momentum is building to expand retirement drawdown products, such as annuities for the aging population.

Life insurer profitability exposed to rising claims frequency in 2024

Bottom-line profitability for the sector looks set to progressively improve over 2024 and 2025 benefiting from some post-COVID reserve releases, as well as from higher investment yields and the unwinding of unrealized bond losses. Underwriting constraints won't disappear, however.

A number of factors could continue to drag on profitability after a sluggish five years. Distribution problems are impeding potential for new sales and retention. Claims frequency may stay higher after an increase led largely by the individual disability income (income protection) line. This could continue, generated by mental health issues or from industries with difficult workplace conditions. Ongoing pricing and product reforms returned the disability income line to profit in 2021 and 2022, but the turnaround was short lived with deterioration in 2023 and likely into 2024.

Cost-of-living pressures, an uptick in unemployment, and lingering disruptions from the pandemic can also raise claims risk. Propensity to claim is also buoyed by social factors such as media coverage, motivation to take legal action, and societal expectations for compensation.

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Capital support from offshore insurance groups will stay a strength

Capital adequacy continues to be a strength for life insurers, with rated entities having strong capital adequacy according to our risk-based capital model for insurers. Life insurers also have significant buffers above regulatory capital requirements. Further, most Australian life insurers have access to the material capital resources of large offshore insurance parent groups, if needed.

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Health Insurance Sector: Demographics Are A Driver

Participation in health insurance will continue to benefit from taxation incentives as well as pandemic-era health concerns and some trepidation about the public health system, in our view. Aging demographics, steady population growth and consumers' prioritization of health cover—elevated during the pandemic--should also continue driving industry participation after years of slow decline.

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Top-line premium growth will benefit from higher participation and lower lapse rates. Premium rate increases were largely in line with prior years (see chart 7), but affordability concerns could still drag.

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Health insurers' sound profitability should hold steady

Health insurers' profitability should remain sound in 2024, with modest claims growth and improved investment returns, before moderating from 2025. Claims frequency has been lower than expected as the anticipated surge in procedures post-COVID is hampered by a lack of hospital bandwidth and available medical specialists.

Insurers' earnings have also been assisted as customers defer or reduce their usage of non-surgical and extras product benefits--possibly due to affordability and social contact concerns. The medical inflation impact has also been lower than expected--despite increasing labor costs. Some of the drivers are a shift to out-of-hospital and virtual care, and initiatives to promote shorter hospital stays with less invasive procedures.

Large players benefit from scale efficiency and leverage in supplier contract negotiations. Performance for the sector should moderate from fiscal 2025 as usage normalizes, pandemic-era reserve releases dissipate, and medical inflation tracks higher. Investment returns should remain supportive on higher running yields and as unrealized bond losses continue to unwind through to 2025.

Capital should remain a strength for the health sector

Regulatory capital requirements for health insurers are rising after the new private health insurance capital framework became effective on July 1, 2023. Nevertheless, we expect insurers to meet the new requirements without raising additional equity, although they may look to access debt capital markets. The new capital framework consists of charges for different risks to strengthen risk sensitivity and improve comparability across health insurers. Despite the increase in regulatory capital requirements, we expect capital buffers for health insurers to remain sound.

Mortgage Insurance Sector: Profitability To Remain Strong Despite Weakening Demand

We anticipate mortgage insurance premiums will start to grow modestly over the next few years, as mortgage market activity increases. This follows large swings in recent years, with strong premium growth followed by large contractions over the past two years (see chart 8). Lower premiums reflected subdued market conditions, in particular low levels of high loan to value (LTV) ratio lending and the impact of the federal government's Home Guarantee Scheme. Higher interest rates have also affected mortgage eligibility. In our view, demand for mortgage insurance won't increase until interest rates decline across calendar 2025 and 2026.

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Profitability to remain strong, with claims rising modestly from a very low base

The rapid rise in interest rates over the past two years has pressured the ability of borrowers to service their mortgages. However, we expect increases in claims to be moderate over the next year, coming off a very low base. This partly reflects savings buffers held, proactive management of properties by their owners, and continued housing shortages that underpin house prices. We also expect no material risks from the cohort of borrowers who moved from fixed rate to (higher) variable rate mortgages over the past year, with mortgage delinquency rates remaining low.

According to forecasts by S&P Global Economics, unemployment rates will rise only modestly over the next one to two years and this, along with modest house price appreciation, should continue to support serviceability and low levels of claims for mortgage insurers. Profitability will also be assisted by sound investment income benefiting from higher reinvestment rates.

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Structural changes in the mortgage insurance sector should support credit quality

While the recent strong performance of mortgage insurers has been largely due to low levels of unemployment and solid house price appreciation, a number of other factors will support the sector in the long term. These include the stronger underwriting practices of lenders and mortgage insurers over the past five to 10 years following regulatory intervention; a change in industry practices around hardship and financial assistance; and the strengthening of borrowers' liquidity buffers in the form of prepayments, offset accounts, and savings.

Strong capital buffers to persist

We expect capital adequacy to remain a key strength for mortgage insurers. Mortgage insurers have onerous capital requirements reflecting the long-tailed nature of their business, where claims can emerge many years after policy inception. Nevertheless, all mortgage insurers have strong capital adequacy, with large buffers above requirements. We forecast this to remain the case for the next two to three years, at a minimum, with sound earnings and conservative investment portfolios supporting insurers' capital positions.

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Steady As She Goes

We have stable outlooks on 79% of the Australian insurers we rate. Key factors include solid earnings profiles and strong capital adequacy buffers. The Australian insurance sector continues to demonstrate resilience despite challenges wrought by elevated inflation, high interest rates, and cyclically high reinsurance costs. With signs that these pressures are moderating, we expect the creditworthiness of insurers to remain strong for at least the next 12-18 months.

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