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Critical Issue Report Nothing is certain The move away from traditional cycles gives way to line-by-line fluctuations By Phil Zinkewicz In the 1960s and 1970s, property and casualty insurers felt a sense of safeness and security operating within insurance industry cycles. Traditionally, there were three years of soft market conditions, where competition kept prices down and terms and conditions flexible—within reason. There followed three years of a hard market, where prices increased, terms and conditions became restricted and hard-to-place risks moved into the surplus lines arena—again, all within reason. And so went the roller coaster ride. Investment income, while important to the bottom line, was less of a consideration in the underwriting process than it is today. Then came the early 1980s, with soaring interest rates—10%, 12%, 15%—when the promise of huge investment earnings caused underwriters to throw caution to the wind, and cash flow underwriting became the banner under which avaricious corporate CEOs marched. It was a soft insurance market like never before seen, beyond all reason. Then, when interest rates dropped, there followed a hard market like never before seen, again beyond all reason. Traditional insurance industry underwriting cycles were never to be the old three-year-on, three-year-off predictable roller coaster rides again. Today, insurance industry analysts are hard put to make predictions about the performance of the business of insurance. Part of the reason for this is that insurers no longer are operating within their own comfortable cocoons, with only state regulatory oversight to deal with. The federal government has taken on a strong role in the regulation of insurance—Sarbanes-Oxley being only one example. And, state attorneys general have cast a jaundiced eye on insurance industry traditional patterns of behavior, such as contingent commissions. Insurance company transparency is now the order of the day. And, if that’s not enough to throw the insurance industry into a state of uncertainty, the increasingly volatile catastrophes that have hit it in the past few years have left open the question of how to measure industry performance under such dire circumstances. Consequently, traditional insurance industry cycles may no longer be dependable forecasts of insurance industry performance, according to Robert P. Hartwig, senior vice president and general economist for the Insurance Information Institute (I.I.I). “In the 1990s, there was what was generally perceived as a soft market, but not necessarily in commercial lines,” says Hartwig. “Today, the commercial lines arena appears softer than the personal lines market. And, in the Gulf area, the market appears hard all around. What may be happening is that, in part, insurers are becoming more responsible in their underwriting and in their reserving postures, so that cycles are beginning to blur. Overall, we may have to begin looking at cycles on a line-by-line basis.” And, that’s exactly what The Tillinghast business of Towers Perrin did in its recent “outlook” on the various lines of the P-C market for 2006. Jeanne Hollister of Tillinghast told Rough Notes that insurance companies and agents are always looking for external benchmarks with which to measure insurance industry performance and which drive company behavior. “We have made an assumption that it is beneficial to measure industry performance on a by-line basis,” she says. “Overall, we have seen improving profits across many of the lines of the P-C business. Agents can look at our by-line outlook and compare their carriers’ performance with the general industry’s performance.” Overall, Tillinghast expects “modest” growth in U.S. property and casualty insurance premiums for 2006, coupled with a combined ratio below 100%. But here’s how Tillinghast sees the growth patterns line-by-line: Personal auto For personal auto liability coverage we project that premiums will remain essentially flat in 2006, reflecting a 1% growth in the number of cars insured, offset by price decreases in the range of 1% to 2%. During the past few years, we have observed a gradual price flattening for this line of coverage. P-C insurers are increasingly using pricing tiers, and we do not necessarily believe that companies are achieving a revenue-neutral premium impact from their pricing. The competitive environment within this line is such that higher-rated insureds are able to move their business to other companies and find more favorable prices. For the physical damage line, we project that net written premiums will continue to decline slightly, reflecting modest exposure growth (0.7%) offset by price decreases (2.7%) as a result of tier growth. For liability and physical damage, we expect insured losses to grow more quickly than they have in recent years, reflecting a gradual reversal of the decrease in claim frequency observed during the past decade. Commercial auto We expect level premiums for commercial auto liability relative to 2005. Commercial auto physical damage premiums are projected to increase by 3% in 2006 as a result of flat price levels combined with “symbol drive,” which is the phenomenon of newer, more expensive vehicles forcing up the average price of insurance. Homeowners For homeowners coverage, we predict a continuation of the downward trend in underlying calendar year net loss ratios (excluding catastrophe-related losses) that has occurred since 2001. Our loss ratio projection for 2006 is roughly 65%, compared to our estimate of 68% (including Hurricane Katrina) in 2005. Weather-related catastrophe losses vary widely from year to year. During the past 15 years, the impact of catastrophe losses on the industry’s homeowners combined ratio has ranged from 7% to 73%. Our projected combined ratio of 94% for 2006 assumes an “average” catastrophe year and is subject to wide variation. Workers compensation We project a 5% increase in net written premiums in 2006, reflecting moderate wage and inflationary increases. We anticipate a pickup in loss dollar growth in 2006 (6.8%), with increases in claim severity trends (8%) more than offsetting continued declines in claim frequency (3.5%). These anticipated severity and frequency trends are consistent with the patterns that we have observed during each of the past two years. Our projection for workers compensation coverage assumes that reserve inadequacy increased slightly in 2005 and will stay flat in 2006. In total, we project a deterioration in the combined ratio from 107.2 in 2005 to 109.1 in 2006. The Tillinghast report also provides projections for commercial multiple peril coverage, other liability exposures, such as E&O and D&O, product liability coverages, fire and allied lines and reinsurance. (The entire report can be found at: http://www.towersperrin.com/tillinghast/publications/publications/till_update_us/Groundhog_Forecast/update_groundhog.pdf.) * |
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