European Operations business review
“European Operations had a successful year, delivering a combined operating ratio of 93.8% and implementing several key strategic initiatives. We continue to exercise strong underwriting discipline in a very competitive market and remain focused on enhancing our value proposition to both clients and brokers.”Richard Pryce
Chief Executive Officer • European Operations
Outlook for 2015
We do not anticipate any change in market conditions and therefore all sectors of the market will remain competitive. Nonetheless, we are very well positioned to retain our core portfolio and grow our business with selective quality opportunities in 2015. Retention in particular will be a key priority for the European Operations team.
We are starting to see benefits from the enhanced focus and investment in our client value proposition. In conjunction with our strong distribution capability we anticipate seeing and converting more quality new business in 2015.
In addition, we will see the increasing benefits from our ongoing expense reduction program and this will include nearly a full year of benefit from offshoring.
2014 has been a year of change and challenge for everyone at European Operations. The decisive action that we have taken means we are better positioned to grow the business profitably. I would like to thank all my colleagues for their skill, dedication and support during a challenging but ultimately successful year.
“During 2014 we have made significant positive progress across the business and delivered on the key priorities we identified at the beginning of the year. Whilst we are in no way complacent we believe that we are well positioned for 2015.”
All areas of our business are currently being impacted by challenging market conditions and, in some sectors, competition intensified as the year progressed. Premium rates on renewed business declined by 1.3% on average in 2014 compared with a reduction of 0.6% in the first half. Our Retail portfolio experienced renewal premium rate increases of around 1.0%; however, International Markets and Reinsurance experienced premium rate reductions averaging 3.9% and 3.3% respectively.
Whilst the economic environment has stabilised or is modestly improving in most of our key geographies, we are not yet seeing any meaningful increase in business activity.
In those sectors where competition is more challenged we have been prepared to sacrifice premium income to maintain our financial performance and to protect capital. The reduction in gross written premium reflects our commitment to disciplined and technical underwriting.
The depth, breadth and quality of our products and services, combined with an extended distribution footprint, create a market-leading value proposition for both brokers and clients. We are very well positioned to effectively navigate the competitive environment by retaining our quality core portfolio and converting profitable new business opportunities.
After a difficult start to the year following the UK storm claims and a significant reduction in gross written premium during the first quarter, European Operations’ underwriting performance improved steadily across the remainder of 2014. Our combined operating ratio of 93.8% is especially pleasing as lower risk free rates adversely impacted the underwriting result by $217 million or 6.1%.
Large individual risk and catastrophe claims increased to 13.8% of net earned premium from 11.2% in the previous year, largely due to the aforementioned UK storm claims.
Despite some strengthening of long tail disease claims in the UK, favourable prior accident year claims development contributed $158 million or 4.4% to the underwriting result.
The reinsurance transaction to dispose of €253 million of undiscounted Italian and Spanish medical malpractice liabilities reduced net claims incurred and net earned premium by $362 million. Although broadly profit neutral, the transaction improved European Operations’ full year combined operating ratio by 0.5% (with a 4.0% positive impact on the net claims ratio offset by a 3.5% adverse impact on the combined commission and expense ratio as highlighted in the table below) and has reduced the level of uncertainty in the residual net discounted central estimate of outstanding claims liabilities.
The impact of the medical malpractice reinsurance transaction on European Operations’ reported underwriting ratios is highlighted in the table below.
In spite of the rating environment, both QBE Re and our International Markets divisions produced excellent underwriting results. The Retail division performed better as the year progressed and I am particularly pleased with our Continental European business which reported a record underwriting result. The Financial and Speciality business again delivered a strong result.
Our ongoing focus on expense management resulted in a reduction in operating expenses. Nonetheless, our expense ratio increased year‑on‑year reflecting the material decline in net earned premium and the one-off impact of the medical malpractice reinsurance transaction.
Gross written premium fell by 14% to $4,526 million from $5,236 million in the previous year.
On a constant currency basis, gross written premium declined 17% to £2,751 million from £3,332 million in the previous year, below the £2,900 million target set 12 months ago but above our revised estimate of £2,700 million established with the release of the interim 2014 result.
This top-line reduction was principally the result of two factors.
Firstly, the portfolio and geographic remediation and disposal activities we had identified to improve long term underwriting performance led to a reduction in gross written premium of $543 million (£330 million) as expected. All of these actions were successfully completed during the year.
Secondly, the more competitive market conditions led to a reduction in overall income, particularly within the International Markets and Reinsurance business units. QBE Re’s gross written premium in particular was also adversely impacted by a change in buying habits as customers restructured reinsurance programs and retained more risk in-house.
The reduction in gross written premium across European Operations was far less severe in the second half of 2014, with most of the aforementioned remediation and disposal activities impacting first half written premiums.
Gross earned premium declined only 7% reflecting the earning of premium written in prior periods. Net earned premium fell 14% year-on-year and in line with the reduction in gross written premium, largely due to the medical malpractice reinsurance transaction. Excluding the medical malpractice reinsurance transaction, net earned premium fell by only 6%.
All other things being equal, net earned premium will increase by $362 million in 2015 due to the non-recurrence of the medical malpractice reinsurance transaction.
The aforementioned medical malpractice reinsurance transaction distorts European Operations’ 2014 net claims ratio as highlighted in the preceding table. The claims commentary following refers to the 2014 claims ratio (and components therein) excluding the impact of the medical malpractice reinsurance.
The 2014 net claims ratio increased slightly to 60.1% from 59.7% in the prior year, although the claims line was impacted by a number of significant and largely offsetting items.
On the back of the aforementioned portfolio and geographic remediation and disposal activities and the maintenance of strict underwriting discipline, the attritional ratio improved to 46.7% from 47.3% in the prior year.
Following a high incidence of large individual risk and catastrophe claims during the first half of 2014, including UK and European storms, claims activity in the second half of the year was relatively benign. As such, the underlying cost of large individual risk and catastrophe claims was only marginally higher than 2013 at 12.5% of net earned premium compared with 11.2% in the previous year.
The net claims ratio was adversely impacted by $217 million or 5.5% due to the very material reduction in risk-free rates during the year (principally GBP, USD, Euro, CAD and AUD) and especially during the second half.
Partially offsetting the adverse discount rate movement, net claims costs benefited from favourable prior accident year claims development totalling $158 million, largely within our marine & energy portfolios and QIEL property portfolio. Claims reserves pertaining to long tail disease claims in the UK were strengthened, consistent with industry trends.
The net claims ratio also benefited from a $140 million release of risk margins reflecting the significant reduction in the level of uncertainty in the consolidated net discounted central estimate of claims. This was principally due to the medical malpractice reinsurance transaction that eliminated $362 million of long-tail liabilities (with associated uncertainty that has been challenging to accurately model) coupled with a reduction in the net central estimate driven by the aforementioned favourable prior accident year claims development. On a management basis, the mean term of European Operations’ net discounted claims liabilities reduced from 3.9 to 3.7 years, again primarily as a result of the medical malpractice reinsurance.
Commission and expenses
The aforementioned medical malpractice reinsurance transaction distorts European Operations’ 2014 commission and expense ratios as highlighted in the preceding table. The commission and expense commentary below refers to the 2014 commission and expense ratios excluding the impact of the medical malpractice reinsurance.
The net commission ratio improved to 18.3% from 18.5% in the prior year. Whilst there remains upward pressure on gross commission rates reflective of the competitive nature of the markets, the net commission ratio improved as a result of a reduction in reinstatement premium payable in 2014 as well as a change in business mix, principally the increase in the relative premium contribution of the lower commission paying Retail division.
Notwithstanding an absolute reduction in expenses, European Operations’ FY14 expense ratio increased to 15.9% from 15.5% in the prior year, impacted by the year-on-year decline in net earned premium. Underwriting expenses fell by $20 million during the year as a result of lower Lloyd’s premium charges and our local operational improvement program that has delivered significant reductions in headcount and related costs. Moreover, our Quantum program is on track to deliver claims procurement and indirect expense savings that will be realised in 2015.
The successful delivery of the key initiatives we identified for 2014, most notably the sale of aviation and bloodstock renewal portfolios, medical malpractice reinsurance and disposal of Central & Eastern Europe assets, means we can spend more time focused on the pursuit of profitable growth.
During our strategic planning exercise undertaken earlier in the year, we identified several opportunities for additional profitable growth over the next few years. It is pleasing to see some of the opportunities already coming to fruition, namely the opening of a QBE Re branch in Bermuda, the build out of expanded financial lines capabilities in Continental Europe and expanded energy capabilities.
Our client value proposition is central to our future success and our progress across the organisation during 2014 is very encouraging. Finally we continue to recruit high quality specialists throughout the division to help us deliver exceptional value and service to all our stakeholders.
As reported at the half year, we completed a refresh of European Operations’ executive team with the appointment of David Hall as Managing Director, Retail. During the second half of 2014, we have continued to strengthen and enhance our specialist underwriting and leadership teams with a combination of internal promotions and external hires. Our global leadership program has been extremely successful and fundamental to identifying and developing many of our talented colleagues and preparing them for exciting career opportunities across the Group.