The hands that hold the purse strings

Re/insurers have come under fire in recent years for posting some rather disappointing returns. CFOs have worked hard to change this, but will their efforts pay off? Bermuda:Re+ILS asked readers for their opinions.

“CFOs are bullish about the future, with more than three-quarters of respondents predicting that profitability will increase over the next five years.”

Spare a thought for the chief financial officer (CFO), the executive with the ultimate responsibility for ensuring a company has good news to share with investors when quarterly earnings season comes around.

With interest rates at rock bottom and the global economy struggling, it is not the easiest time to generate profits, although the hardening market at least will give CFOs something to cheer about.

Bermuda:Re+ILS wanted to better understand the issues that are keeping CFOs awake at night. Our survey provided some answers.

Figure 1:

Do you expect re/insurers to achieve better profits in the next five years than they have achieved in the last five years?

Looking to the future

CFOs are bullish about the future, with more than three-quarters of respondents predicting that profitability will increase over the next five years compared with the last five (Figure 1). Most hedged their bets, with 55 percent predicting that profits would increase a little, compared with 21 percent predicting significant increases—although the broader sentiment is clear.

“The bar is set pretty low, as profits have been low over the last five years. Re/insurers are being forced to demand higher returns now, partly because of low interest rates, partly because of requirements such as those of Lloyd’s to cut out unprofitable business,” noted one respondent.

The remaining respondents were split evenly, with 6 percent feeling extremely pessimistic and predicting a significant decline in profitability. Meanwhile, 9 percent predicted small declines, with the same number saying that profitability would remain broadly flat.

“Re/insurance covers someone else’s economic decision. If the underlying gross domestic product (GDP) of a specific market/region/country is negative or much lower than before, there are fewer economic events to cover off,” observed one respondent. “Re/insurance does not create anything; it is an adhesive that is attached to a completed business/personal event.”

“While insurable interests may rise with inflation, loss retention will rise a bit faster, and capital inflows are easier than ever in history,” added another.

Figure 2:

What are the biggest hurdles Bermudian re/insurers face to their profitability?

Cause for concern?

Most respondents were confident about the prospects for the industry and its ability to increase profits—especially considering the hardening market conditions and the relatively low bar set by the previous five years. However, few doubt that there are significant headwinds facing the industry and that increasing profits will require a considerable amount of work.

What are these headwinds, and which are causing the greatest concern?

More than a quarter of respondents (27 percent) said the biggest challenge is an actuarial one, with difficulties in accurately modelling risk being the greatest obstacle to profitability (Figure 2). More than one in five respondents (22 percent) saw an urgent need to invest in technology as a challenge, increasing costs and making it harder to generate a healthy profit—although wise technology investment should pay off in the medium or longer term, and increase profitability over time.

Slightly fewer respondents (19 percent) saw market volatility as a key threat to profitability over the next five years—although only 5 percent cited low interest rates as the primary obstacle to industry profitability across that timeframe.

The high number of “other” responses underlines the broad array of issues CFOs currently have to think about—although many said they had chosen “other” because they thought two of the given options were equally important.

One respondent cited “shifts in fundamental risk appetites and general diminution of risk transfer” as a cause for concern. Another thought there was a need to rethink and rebrand core identity. “Right now, for Bermuda, it’s all about survival.”

Figure 3:

When do you expect to see interest rates return to levels more in line with historical norms?

Getting back to normal

While respondents to the previous question clearly did not feel that interest rates were the biggest concern for CFOs right now, they are worth noting. There is no doubt that the super-low interest rate environment makes it harder to make a return from bond investments, which make up the lion’s share of many re/insurer portfolios.

There was a broad spread of opinions on the question of interest rates. Just over one-third (34 percent) of respondents predicted that low rates would persist for at least three more years, while another 18 percent saw no end in sight (Figure 3).

However, there are also optimists who see the beginning of normalisation in the rate environment in the shorter term, with 27 percent predicting that rates would start to rise within three years and 21 percent thinking that rates could pick up even sooner than that.

“The aging population is in drawdown when it comes to savings. The next few generations are not savers. That process has held rates down and will crack, sharply,” noted one respondent

Figure 4:

Do re/insurers need to fundamentally rethink their investment strategies?

New strategies and fine tuning

The question of how investors should allocate their capital is closely related to expectations about the future path of interest rates. Those who believe rates will soon start to rise, or think they will eventually return to something like that long-term historical average, are more likely to have faith in traditional investment strategies that have served them well in the past.

Those who expect rates to remain depressed, or believe the neutral interest rate is now lower than it has been in the past, are less likely to be convinced that traditional investment strategies will work. Those strategies were, after all, developed in a completely different rates environment.

Respondents gravitated to the centre on this question (Figure 4). Only 9 percent suggested that investment strategies need no work at all, while 7 percent took the other extreme view: that investment strategies are completely broken.

Nearly half of the respondents (47 percent) said that investment strategies required mere fine-tuning for optimal performance, while 37 percent felt something a little more substantial was needed.

Figure 5:

Where do you see opportunities to cut costs in the business?*

*Respondents could choose more than one answer

Making savings

Generating returns—either via underwriting or investing—is only one side of the problem for CFOs. Financial performance can also be improved with cost-cutting. Where do readers see opportunities for re/insurers to cut costs?

In a year when there has been almost no travel, and a very considerable amount of working from home, it is unsurprising that 62 percent of respondents saw opportunities to slash travel budgets and 41 percent highlighted opportunities for downsizing offices (Figure 5).

No other response garnered quite the same level of support, although a little over a quarter (27 percent) saw opportunities to cut staff, while slightly fewer (26 percent) saw savings opportunities in entertainment budgets. Technology and remuneration less popular options still, with 13 percent and 12 percent, respectively.

Wherever CFOs look to make savings, there is little in the way of low-hanging fruit. “Expense margins are thinner than they’ve ever been,” commented one respondent.

Figure 6:

How concerned are you about the risk of a global recession and/or a serious systemic shock creating a big rise in market volatility?

Hedging bets

CFOs have some room to manoeuvre when it comes to their own companies, whether they look to slash costs or pursue a riskier investment strategy in a bid to drive up returns.

Sometimes, however, the most influential factors are outside their control. It doesn’t matter how carefully a company has budgeted or how sensible its policies are if a pandemic causes large swathes of the global economy to be shut down simultaneously—or if a major US bank collapses, for example.

Once again, respondents hedged their bets, with nearly two-thirds (64 percent) taking the option of “somewhat concerned”. It is probably telling that double the number of respondents (24 percent) admitted to being very concerned, compared with 12 percent saying they are not concerned at all (Figure 6).

“If you’re not looking ahead a decade, you will certainly hit that iceberg,” warned one respondent, while another pointed out that “it has already happened”—no doubt placing faith in the adage that lightning never strikes twice in the same place.


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November 2020

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