AM Best is maintaining its negative outlook for the Spanish non-life insurance segment. The company has released a report that highlights the factors that support this negative outlook, written by Jose Berenguer and Mathilde Jakobsen.
The report finds that, in 2022, Spain’s GDP grew by 5.2%, indicating resilient economic activity despite the threats posed by the fallout of Russia’s invasion of Ukraine. Non-life gross written premium (GWP) grew by 5.2%, although this is nominal growth and so not adjusted for inflation. The growth prospects of the country are challenged by economic uncertainty, reports the rating agency.
GWP growth for motor, the largest class of business followed by health, was lower than overall non-life GWP growth. Health insurance GWP grew by 7%, continuing its rapid expansion. According to current projections by the International Monetary Fund (IMF), Spain’s economic activity is expected to slow, with 1.1% growth in GDP projected for 2023. This reflects the effects of high energy and food prices, tighter financial conditions, and weaker external demand.
According to the European Commission, inflation in Spain averaged 8.3% during 2022, standing at 5.8% in December 2022. In an effort to counteract the effects of inflation, the European Central Bank (ECB) began tightening its monetary policy in July 2022, increasing interest rates for the first time since 2016. Since then, the ECB has raised interest rates by 300 basis points, from 0% to 3%, the highest level since 2009. Further interest rate hikes are expected for 2023.
Another factor stated in the report is that increasingly volatile weather conditions have posed a challenge to the segment’s profitability. The Spanish natural catastrophe scheme, Consorcio de Compensación de Seguros (Consorcio), plays an important role in underpinning these results. The compulsory government natural catastrophe scheme covers physical damage caused by natural catastrophe events within Spain and has proven effective in protecting insurers from the downside risks of natural catastrophes.
In 2021, winter storm Filomena caused severe snowfall in the country, leading to business interruption and property losses estimated at around €1.2 billion, well above previous years. Damage caused by Filomena was only partially covered by the Consorcio, increasing the segment’s extraordinary losses by €400 million. While 2022 and 2023 to date have been more benign in terms of weather-related losses in Spain, evolving climate risk is likely to worsen the frequency and severity of weather-related events in the years to come, warns AM Best.
Due to the lack of clarity on how to model increases in climate risk, the segment has so far implemented only limited underwriting and pricing actions. To complement the coverage of the Consorcio, Spanish insurers buy reinsurance protection from the commercial market in order to reduce their retention and cover risks that are outside the remit of the Consorcio.
As our readers will be aware, the reinsurance market hardened further in 2023, ultimately leading to less available capacity and to significant increases in premium rates. As a result, AM Best expects higher reinsurance costs to also weigh on technical results in 2023. In addition to facing higher prices, some have been unable to buy the desired level of protection, leading to the potential for increased volatility in results.
Rising inflation rates and supply chain disruption have posed challenges for Spain’s non-life insurers by pushing up prices for repairs and replacements, affecting motor physical damage as well as other lines of business. Increased traffic patterns post-pandemic have also led to a deterioration in loss trends, following the unusually low frequency experienced during the lockdowns that dominated 2020 and 2021. As a result, several of the country’s motor insurers reported a deterioration in combined ratios for motor in 2022, compared with both 2019 and 2021.
The Spanish non-life insurers have conservative investment portfolios, dominated by fixed-income investments, but with gradual increases towards equity and real estate. There is a concentration in all classes towards Spanish assets, which exposes insurers to local economic volatility. The ultra-low interest rate environment came to an end in 2022, and insurers are adapting to the new shift. In the short term, the sharp uptick in interest rates has translated into significant investment losses for insurers, although these are mainly unrealised.
However, in the longer term, this uptick in interest rates is expected to translate into improved non-technical profitability for insurers. Economic uncertainty is expected to persist in 2023, stemming from the persistence of inflation and the measures taken to combat it. This uncertainty could lead to high levels of volatility in financial markets. If the ECB’s sharp interest rate rises continue, Spanish insurance companies could suffer further significant levels of unrealised losses in their fixed-income investment portfolios. In this challenging market, losses could also be driven by potential volatility in equity markets and real estate valuations.
