global insurance industry quarterly spotlight report third quarter 2014 november 2014

Global Insurance IndustryQuarterly Spotlight Report

Third Quarter 2014November 2014

Global Insurance Industry: Quarterly Spotlight Report

Agenda

• 3Q Global Insurance Highlights 03

• Key Trends Spotlight

Non-Life Premium Rates 08

Global Catastrophe Losses 09

UK Non-Life Personal Lines 10

US Life Insurance Investment Returns 11

China Life Insurance Sector Cash-flow 12

Global Reinsurance 13

Alternative Capital 14

Global Insurance Regulation 15

Global Insurance M&A 16


3Q14 Global Insurance Highlights


Global insurance stocks largely benefited from rising equity markets across all major markets, with life stocks outpacing non-life

Sep-1

3

Oct-13

Nov-1

3

Nov-1

3

Dec-1

3

Dec-1

3

Jan-

14

Jan-

14

Feb-

14

Feb-

14

Mar

-14

Mar

-14

Apr-1

4

Apr-1

4

May

-14

May

-14

Jun-

14

Jun-

14

Jul-1

4

Jul-1

4

Aug-1

4

Sep-1

4

Sep-1

4

85

90

95

100

105

110

115

120

Global Insurance Stock Price PerformanceDaily Closing Prices (Indexed, 09/30/13 = 100)

Americas 1200 Europe 800 Asia 1200 S&P Global 1200

DJ Stoxx Insurance Index All Sectors

Segment Stock Price PerformanceAnnual Percent Change, September 30

China

UK

US

13.8%

16.0%

12.6%

Lif

e

UK

US

7.8%

7.5%

No

n-L

ife

Source: Company filings; Dow Jones; ThompsonOne; Moody’s; A.M. Best Company; EY Research, 2014

3Q14

During 3Q14, global insurance share prices across the major regions converged on the boarder market index driven by improvements in Asia, a moderating economy across Europe and increased sensitivity to equities among carriers in all countries− Asian insurance stocks benefited from a recovery from seasonal, weather-related losses in Korea, increased life insurance sales in China and an upturn in

investment income from foreign sources among Japanese carriers due to Yen depreciation− Insurers across all markets have increased their investments in equities, real estate and infrastructure projects, resulting in a tighter correlation to equity markets

Life insurance stocks increased at a faster rate than non-life during 3Q, with the UK life sector growing by 16%− Insurers are experiencing improved profitability through a shift to higher-margin protection products− Variable/unit-linked policies profited by stock market gains and continued de-risking activities across the industry

Non-life stocks experienced more modest growth as the industry struggles to maintain profitability in the current market cycle− Limited investment gains, price competition, and reduced reserve releases have suppressed earnings− Efficiency gains, due to ongoing cost cutting activities and investments in process and technology improvements have helped mitigate the pressure on profits

12.4%

10.8%

5.6%

10.0%


Coming off a favorable third quarter, global insurers face considerable headwinds for the remainder of 2014

8% 8%

5%

3Q Estimated

3Q Actual

Global Insurance – All LinesAverage Analysts’ Consensus Forecast*

Third Quarter Annual Growth – 2013-14

4Q Estimated

Gross Written Premiums (% Change)

Net Income(% Change)

14%15%

3%

3Q Estimated

3Q Actual

4Q Estimated

7%

Growth rate excluding reinsurers

*Growth rates based on average analyst consensus forecasts across 25 global insurers. Excludes UK based insurers due to absence of 3Q forecast data

Source: Company filings; Dow Jones; ThompsonOne; Moody’s; A.M. Best Company; EY Research, 2014

A moderation in the growth of the global economy will pressure industry fundamentals for 4Q and into early 2015

− Contracting growth in the U.S. as GDP, which grew 3.2% in 3Q, is forecasted to grow 1.9% in 4Q

− Weakening of the European economic recovery, credit challenges in China and fiscal tightening in Japan

− Concerns regarding the sustainability of the current 5+ year bull market

An increase in interest rates, which is expected in early 2015 in the U.S. and U.K. and possibly other countries later in the year, should have a positive impact on investment income

UK protection products should benefit from a continuation of strong UK housing growth – September 2014 prices increased 12.1%, the highest rate since 2007

UK annuity sales will be challenged by the elimination of compulsory annuities for certain defined contribution withdrawals – UK insurers have already reported an impact

Continued geopolitical risks including Russia-Ukraine conflict, Middle East terrorism and territorial disputes in Asia will further challenge the current macro-economy

Global reinsurers face significant challenges from a combination of suppressed investment earnings, significant rate cuts and increased competition from alternative capital sources (see Reinsurance Spotlight)


Source: EY analysis, 2014

Factors Affecting the Primary Insurance Industry

Impact

Current Quarter Comments1Q14 2Q14 3Q14

1Equity market performance

While the insurance sector finished up versus 3Q2013, stock indices ended flat for the quarter due to concerns over the sustainability of current equity market performance, the continuation of low interest rates, declining bond yields and a softening P&C cycle

2 Interest ratesThe decline in bond yields experienced during 9M14 is likely to put pressure on demand for saving products, while further constraining investment income, resulting in a stagnation of top line growth

3 Natural catastropheDespite higher losses due to severe winter weather during 1Q14 and floods in 2Q14, the insured losses from catastrophe events remain below average due benign US hurricane season during 3Q14

4 Pricing trendThe deceleration of premium growth, including a decline in the UK, continued into the third quarter, as a result of persistent rate softening in several markets, including the US, Germany, and France

5 Regulatory environmentThe industry continues to face numerous regulatory reforms as most markets introduced reforms for ensuring higher levels of capital adequacy and removing inefficiencies from the industry

6Reinsurance industry capacity

As the reinsurance industry continues to grapple with excess capacity, primary insurers continue to benefit from softening reinsurance rates as well as terms and conditions

7Alternative risk transfer instruments

Despite a relatively quiet 3Q14, the sector is set to be a record-breaking year for CAT bond issuance providing a cheaper source of risk transfer

8Reinsurance rating environment

Reinsurers witnessed rates softening in most regions and business lines during the January, April and July renewal seasons, a trend favourable for primary insurers

Equity market performance, interest rates and non-life pricing trends continue to be key concerns for the industry


Key Trends Spotlight


* 1H figures denote figures for 1st five months of the year

Source: Insurance Information Institute; A.M. Best; FFSA - Fédération Française des Sociétés d'Assurances; Association of British Insurers (ABI); EY Research, 2014

Non-Life rate declines continue to put pressure on premium growth across most major markets

2010 2011 2012 2013 1H13 1H14

0.7%

3.7%

4.3%4.5%

4.2%4.0%

US Non-Life: Net Premiums Written Growth (%)

2010 2011 2012 2013 1H13 1H14

2.2%

4.1%

3.1%

1.8%2.0%

1.5%

France* Non-Life: Net Premiums Written Growth (%)

The non-life industry continues to experience persistent rate declines across most regions

− In the US rate softening was experienced primarily in property lines driven by continued strong capacity and below average catastrophe losses

− Although rates are still rising in certain casualty lines in the US on an aggregate basis, the pace of increase has dropped to low single digits

− Softening rates have dampened premium growth across several markets, including Germany and France, while growth in the UK has turned negative

Despite the rate declines, premiums have benefited from the growth in exposures fuelled by a positive economic growth outlook for the remainder of the year

− Growth in key areas of the economy, such as car sales, new residential construction, and a drop in unemployment, continue to benefit the non-life insurance industry

Insurers will focus on innovation and improved service to combat the pressure of declining rates

− Implementation of new technology across the value chain will reduce costs and improve service

− Insurers will also seek to improve business and customer insights through better data analytics and risk modeling


Source: Munich Re; Aon Benfield; AM Best; Barclays Equity Research; Morgan Stanley; EY Research, 2014

Largest Natural Catastrophes Worldwide, 9M14

US P&C Industry’s Catastrophe (CAT) Losses during 3Q, (US$ Bn)

Month Region EventLoss

Estimates

Feb-14 Japan Winter damage >$2.5 bn

May-14 Eastern Europe Floods >$2.5 bn

Jun-14 Western Europe Severe storm, hailstorm <$2.5 bn

Jan-14 US Winter damage $1.7 bn

May-14 US Severe storm $1.6 bn

Sept-14 Mexico Hurricane Odile $1.0 bn

3Q14 China Earthquake $1.0 bn

If current trends persist for the remainder of the year, 2014 will be the quietest year, in terms of CAT losses, for insurers since 2008

− The 3Q14 hurricane season was the quietest for the US P&C industry in more than a decade

− The $27 billion of CAT losses incurred globally during 9M14 was 56% below the 10 year average losses

While the severity of insured catastrophe losses across Asia has declined in recent quarters, the frequency of events has increased

− During 9M14, the Asia-Pacific region experienced over 100 CAT-events, particularly floods, severe storms and earthquakes

− The impact on insured losses in the Asia-Pacific region has been minimized due to the current low level of insurance penetration across the region

The subdued insured losses have not only boosted earnings and capital positions but have also masked the impact of the declining premium rates

However, the rising frequency of CAT-events remains a concern as one major event can quickly lead to a spike in losses for the industry

19.1

0.73.7

23.7

48.4

1.3 1.3

16.1

2.6 2

8.4

1.8 1.9 1.2

9.4

Natural catastrophe losses through the first nine months of 2014 are well below average, providing a positive impact on industry earnings and capital positions


1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14

-20%

-15%

-10%

-5%

0%

5%

10%

Motor Pricing Property Pricing

*LASPO Act: refers to Legal Aid, Sentencing and Punishment of Offenders Act of 2012

Source: Barclays Equity Research; AA British Insurance Premium Index; AM Best; Timetric; EY P&C Actuarial, Annual UK Motor Insurance Forecast; EY Research, 2014

Following the industry’s first underwriting profit in 20 years, at the end of 2013, the motor insurance sector is likely to return to underwriting losses in 2014, with a combined ratio of 109.3%

YTD 2014, UK motor insurers have witnessed y-o-y declines in premium, despite rising claims costs and expenses

− Insurers continue to lower rates in anticipation of claims cost savings from the LASPO Act*, as well as to compete effectively through price comparison websites

− The forecast for claims inflation is 1.3% in 2014 with an increase to 2.6% in 2015

Several motor insurers may look to expand their property book of business, which has structurally higher underwriting margins, less cyclicality and less regulatory risk

Underwriting results for the property insurance segment also appear to be deteriorating

− Property insurance premium rates declined y-o-y by 7.2% during 3Q14 mainly due to intensifying competition

− During 1H14, floods led to £451 million worth of claims while storms resulted in £640 million of losses

To protect margins in the current soft cycle, insurers will need to adopt and implement more effective cycle management practices

UK Non-Life: Personal Lines Pricing Change (%)

2009 2010 2011 2012 2013 2014F

70%

80%

90%

100%

110%

120%

130%

Motor Property

UK Non-Life: Personal Lines Combined Ratio (%)

Underwriting fundamentals for the UK personal lines segment deteriorated during the first nine months of 2014, eroding margins


2007 2008 2009 2010 2011 2012 2013 1H13 1H14

7.9%

0.6%

-8.1%

0.8%

7.2%

4.3%

-5.6% -6.0%

3.8%

5.8%5.4%

5.1%

5.2%

5.1%

4.9% 4.9% 4.8% 4.8%

Direct Premium & Annuity Consideration Net Yield on Invested Assets

The US life insurance industry ROE to decline slightly to10.8% in 2014 and 10.3% in 2015 as the 10-year Treasury yield continues to drop and interest rates remain low

The low rate environment will continued to pressure investment yields in for the remainder of 2014 and further pressure margins on spread-based products

Top-line growth in 2H14 and 2015 is likely to remain modest as individual life and group benefit sales are expected to remain flat while variable annuity business will continue to decline

In an operating environment that doesn’t support organic growth, life insurers need to look for other strategic options to deploy their continuously building excess capital

Several large insurers like MetLife, Prudential and Principal Financial are deploying capital for acquisitions and share buybacks to improve returns

Source: SNL Financial; AM Best; J.P. Morgan; Morgan Stanley; EY Research, 2014

US Life: Premiums Growth and Yield on Invested Assets (%)

US Life: Pre-Tax Operating Income (US$ Bn)

2007 2008 2009 2010 2011 2012 2013 1H13 1H14

44.6

-1.4

61.0

53.1

28.0

59.663.8

32.6

26.4

US Life: Return on Average Equity (%)

2007 2008 2009 2010 2011 2012 2013 2014F 2015F

13.8%

-0.4%

9.3%10.1% 10.2% 10.3%

10.9% 10.8%10.3%

US life insurance returns are likely to stagnate while organic growth weakens in the face of continued low interest rates


87.6%

China Life New China Life CPIC Life China Taiping Ping An Life

32.2

13.3 9.73.0 3.7

55.6

18.7 16.37.6 5.1

-5.3% -5.9%

-21.3%

-55.9%

24.0%

1H13 1H14 Change in Operating Cash Flow (%)

Chinese life insurers are likely to experience significant cash flow pressure during 4Q14

− Net cash flow has been hampered by both slowing premium growth, leading to moderating inflows, and rising surrender payments pushing up outflows

− To compete with higher return and shorter duration wealth management products, insurers in late 2013 increased their focus on sales of high cash value products with a 1 year duration. As a result, increased surrender activity is expected beginning next quarter.

− Regular maturity payments for 5-years bancassurance products sold in 2009 represent another source of significant concern

Chinese life insurers will need to rebalance their product strategy to address ongoing cash outflow concerns, which could include a focus on products with high premium flow at the expense of margins

Source: China Insurance Regulatory Commission (CIRC); Morgan Stanley ; Deutsche Bank; CIMB; EY Research, 2014

China Life: Surrender Payment (Rmb Bn) and Change in Cash Flow

Total Cash Outflow Forecast on Surrenders & Maturity (Rnb Bn); 4Q14-1H15

China Life New China Life CPIC Life China Taiping Ping An Life

0

25

50

75

100

125

150

175

0%

10%

20%

30%

40%

50%

Maturity Payment Surrender Payment % of Premiums*

China Life: Gross Written Premium YoY Growth (%)

Premium growth decline to single digits since April:

• Change in requirement that a minimum 20% (previously 10%) of bancassuance sales must qualify as protection products

• Competition from wealth management products continues to hurt bancassurance product sales

* Annualized 1H14 premiumJan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14

87.6%

24.3%

10.4%

-4.6%

5.7%

-11.2%

7.3%

-3.0%

Chinese life insurers face potential significant cash outflows due to a combination of high surrender activity and maturity payments on high cash value products


2007 2008 2009 2010 2011 2012 2013 1H14

388321

378446 427

466 490 511

22

19

22

24 2839

5059

410

340

400

470 455

505540

570

Traditional Alternative

Source: Aon Benfield; AM Best; Willis; Munich Re; EY Research, 2014

Insurers are witnessing the lowest cost of reinsurance in 10 years, driven by persistent declines in reinsurance rates in almost all lines, across most regions

− Relatively benign weather related-loss events during 9M14

− Global reinsurance sector ‘s capital position is at a record high level while demand is largely stagnant

− Intensifying competitive pressures combined with the continuous influx of new capital from alternative sources

The low cost of hedging catastrophe risk through reinsurance programs and alternative risk transfer instruments is aiding many insurers to seek growth opportunities in CAT-prone, high margin coastal regions

With declining reinsurance rates and loosening terms and conditions, margins are getting thinner and earnings volatility is gradually increasing

− Benign catastrophe related losses have masked the weakening of earnings in recent quarters

− A softening rate cycle is slowly starting to undermine earnings and erode returns for reinsurers

Reinsurers with diverse business portfolios and distribution have an edge in the current environment

Global Reinsurance Market Capital (US$ Bn)

2009 2010 2011 2012 2013 1H14 5yr-Avg

53.9%63.8%

76.1%60.7% 56.5% 58.4% 63.2%

30.6%

31.6%

31.3%

31.3%32.2% 31.0%

31.4%

84.5%

95.4%

107.4%

92.0% 88.7% 89.4%94.6%

14.7%10.6%

2.5%12.1% 13.1% 11.9% 10.8%

Loss Ratio Expense Ratio Return on Equity (RoE)

Global Reinsurance Underwriting Ratios and Return on Equity

Global reinsurers remain concerned over rising capital levels, stagnating top-line growth, weakening margins, and intensifying competitive pressures


37%

44%

12%

7%

2007 2008 2009 2010 2011 2012 2013 2014

1.0 0.7 0.7 0.31.0 1.5

0.71.4

3.5

1.80.8

2.4 0.7

2.1 3.3

4.5

1.4

0.3

0.4

0.20.9

0.8

1.6

0.3

2.0

0.0 1.6

2.42.0

1.9

1.9

7.9

2.83.5

5.3

4.6

6.3

7.5

6.2 Total

4Q

3Q

2Q

Catastrophe Bond (CAT Bond) Issuance (US$ Bn)

Alternative capital continues to flow into the reinsurance sector through catastrophe bonds, sidecars and hedge fund reinsurance companies

− During 1H14, alternative capital increased over 34% versus 1H13 and nearly 20% since year-end 2013

− Given a persistently gloomy investment environment, CAT bonds are offering attractive returns to investors, especially given relatively low losses in recent quarters

CAT-bonds have overtaken collateralized reinsurance as the largest contributor to alternative capital

− CAT-bond issuance reached $4.5 billion for 2Q14, setting a new record for issuance in any single quarter

− Total issuance of $5.9 billion in 1H14 is the highest for any year reflecting the continued strong demand for CAT-bonds from both sponsors and investors

While 3Q14 saw just one transaction, adding $250 million to CAT bond issuance, total issuance is still likely to reach $8-$9 billion for 2014, a new record for any single year

− CAT-bond issuance reached $6.2 billion for 9M14, which is higher than the record $6.0 billion reached during 9M07

Despite the growth in alternative capital, expectations are that funds will be diverted to government and corporate bonds once sovereign bond yields rise to long-term levels

45%

41%

9%

5%

Collateralized Reinsurance CAT Bonds Sidecars Collateralized ILW

Alternative Capital Split by Product (%), 1H13 vs 1H14

1H13Total Alternative

CapitalUSD44 billion

1H14Total Alternative

CapitalUSD59 billion

Source: Aon Benfield; AM Best; Willis; Munich Re; EY Research, 2014

The sector is set to hit a record breaking year for Catastrophe (CAT) bond issuance


EIOPA publishes paper to support Solvency II calculation

EIOPA published the underlying assumptions in the standard formula for the Solvency II Capital Requirement(SCR) calculation.

The paper aims to support the application of Solvency II Preparatory Guidelines on forward looking assessment of own risks

UK aims to reduce claims-based legal disputes

Britain's Treasury announced reforms to modernise commercial insurance laws, aimed at reducing the number of claims-based legal disputes

The new laws focusses on removing loopholes in previous framework by forcing businesses to better disclose risk information before buying a policy, making insurers more flexible about breaches of warranty

EMEA

Revised capital requirements for P&C insurers in Canada

Canadian financial regulator made changes to the Minimum Capital Test (MCT) guidelines for P&C insurers resulting in higher capital requirements

The new framework will come into effect on 1 January 2015, and is likely to produce an average 2.8ppt decline in capital ratios across the industry

US Senate passes Terrorism Risk Insurance Act

TRIA provides insurers with the long-term financial assurances needed to provide terrorism risk cover

It also increased insurers' co-pay to 20% from 15% and raised the mandatory recoupment threshold to $37.5 billion from $27.5 billion

Brazil to amend insurance advisors regulations

Susep has agreed to amend regulations passed in October 2013 regarding the agent's role as an insurance advisor

Americas

China issues draft guidelines for insurance groups

China Insurance Regulatory Commission (CIRC) has published draft guidelines for consolidated supervision of insurance groups.

The new rules enable domestic insurers and China-based units of foreign insurers to buy a stake in more than one insurer in the same market segment

China preparing for 2nd generation solvency reforms

CIRC started the technical tests to quantify the risk-based minimum capital for life insurers under its second-generation solvency reform.

These cover risks including interest rates, market, credit and insurance operations risks

India introduces motor insurance reforms

Indian insurance regulator introduced long-term third party motor insurance policy for two-wheelers.

The new rules allow for three years policy instead of current one year policy. These reforms are aimed at increasing persistency and lowering costs

Asia-Pacific

Source: A.M. Best; SNL Insurance daily; Business News Americas; Insurance Newslinks; Reuters News; Press trust of India; EY Research, 2014

FASB introduces new revenue recognition standard and requires more disclosures

The revenue recognition standard is more principle based and will require insurance entities and brokers to exercise more judgment

FASB also issued a standard that will require insurers to make new disclosures about their short-duration insurance contracts.

Insurers need to make annual updates to all assumptions used to measure the liability for future policy benefits for certain long-duration contracts

Regulators in most markets continue to introduce reforms aimed at ensuring higher levels of capital adequacy and removing inefficiencies from the industry


Private equity (PE) interest in the sector remains strong, with 37% of the top 25 deals involving a financial buyer (total value of the top 25 deals between Jan-Sep 2014 was $32.2b, of which $11.8b was from financial buyers)

− YTD M&A data indicates that $1b+ deals are firmly back on the agenda, with private equity firms actively involved in a number of these “mega” deals

− Mega deals include KKR’s acquisition of Sedgwick Claims Management for $2.4b (Jan 2014); CPPIB’s acquisition of Wilton Re for $1.8b (Mar 2014) and TPG Capital’s acquisition of Aon Warranty for $1.5b (Mar 2014)

− Most PE investment cases are based heavily on market disruptive developments, including the potentially transformational impact of technology on all elements of the insurance value chain

Although there is still strong appetite for M&A in rapid growth markets (RGMs), the value of deals remained lower than anticipated

Mature and established markets, including the US (39% of total deal volume) and the UK (12% of total deal volume) have account for the bulk of M&A activity through 3Q14

Looking ahead, the momentum of M&A activity across the global Insurance sector is likely to continue

− Based on current rates of deal activity, 2014 is expected to record the highest volume of M&A deals in the last 5 years

− According to EY’s 11th Capital Confidence Barometer, there is increasing optimism among global insurers, with a corresponding increase in the proportion of companies looking to pursue acquisitions

2010

2011

2012

2013

2014 YTD

224

292

269

246

251

226

224

181

178

166

90

75

72

63

64

23

17

22

16

17

563

608

544

503

498

Americas Europe Asia Pacific Middle East & Africa Series5

Source: ThomsonOne; Mergermarket; EY Research, 2014

Global Insurance M&A Deal Volume (2010 - Q3 YTD)

2010

2011

2012

2013

2014 YTD

$ 32.7

$ 23.2

$ 21.6

$ 16.2

$ 26.1

$ 12.9

$ 16.0

$ 13.6

$ 15.1

$ 12.4

$ 20.2

$ 9.5

$ 12.7

$ 8.3

$ 5.4

$ 1.3

$ 0.4

$ 0.8

$ 0.8

$ 0.3

67

49

49

40

44

Americas Europe Asia Pacific Middle East & Africa Series5 Series6

Global Insurance M&A Deal Value (US$ Bn); 2010 - Q3 YTD

Year to date value of M&A activity for the global insurance sector increased by 35% versus the same period last year, driven in part by strong demand from financial buyers


Published: November 2014

WarningThe information contained in this report may include dated material. Major events may have occurred since original publication that might alter the accuracy of the report.

For further information, please contact the authors:David Sterner, Strategic Analyst - Insurance [email protected] +1 215 841 0213Vikash Kr. Singh, Analyst - Insurance [email protected] +91 124 6192577

Includes copyrighted material.Any use of this material, including reproduction or distribution, must comply with applicable copyright law, as well as EY’s contractual obligations. Reproduction or reuse in excess of “fair use” may result in liability for copyright infringement. Please refer to Ernst & Young Client Confidentiality, Client Privacy and Knowledge-Sharing Policy (SCORE #CA7506) for additional guidance.

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