Australia's insurance sector post strong returns despite dampened ROE: analysts

The sector will reach an ROE of 15% this year, lower than last year’s 16%.

Australia’s insurance industry returns will be agile over the next three years but return on equity (ROE) will decline to low double digits over the same period, with the sector reaching a 15% ROE in the year to 30 June 2020, according to an S&P Global Ratings report.

The estimation is slightly lower than the 16% in 2019, mainly attributed to shifting demographics, affordability problems, stricter regulatory oversight, and inflation in medical claims.

There is likely an industry consolidation over the next five years, analysts Craig A. Bennett and Angela Zhou said. Twenty-six out of 37 insurers under supervision by the Australian Prudential Regulation Authority (APRA) operate as mutual organisations that comprise about 38% market share by premium revenue. Mutual health insurers earned about 30% of the industry profit and gained a 7% weighted average ROE for the year ended 30 June 2019, the analysts noted.

In comparison, corporates held a 62% market share, realised about 70% of profits, and generated a 35% weighted average ROE for 2019. “Over the past five years, mutual insurers have achieved marginal market share growth from the corporate entities,” they noted.

“However, margins have compressed for the health insurance industry as a whole, with the ROE declining year-on-year since 2017. While there are three mutual entities that have maintained double-digit ROE over the past three years, we expect consolidation of smaller players amid compressing margins in the current operating environment.”

Set for growth
Regulatory and operational oversights may hinder new health insurance entrants, the report said. The market is also saturated with incumbents that benefit from strong brand loyalty and economies of scale.

There have been no new players or exits to and from the sector since 2017, the analysts said.

There is also minimal product risk due to simplicity of products, short-natured claims and low exposure to pandemic risk, given Australia’s high vaccination rates and government pandemic planning. Insurers also have well-defined waiting or non-claim products for certain risk classes in new policies.

“Health insurers can also benefit from the risk equalisation trust administered by APRA, which redistributes claims experience relative to an insurer's policyholder mix,” the analysts said.

In addition, APRA is moving forward with its three-phase private health insurance roadmap to broadly align the Private Health Insurance prudential standards with other regulated Australian insurers.

Surging medical services and compliance costs remain key risks to sector profitability. Whilst claims expense growth was lower than prior periods at 3% in 2019, claims costs ballooned faster than premium rates.

The analysts also expect compliance costs to grow as APRA floats enhancements to the health insurance prudential standards. Investment in operational systems and fintech are likely to further pressure the industry's profitability that could have a disproportionate effect on smaller mutual insurers, they said.

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