Homeowners line faces challenging times

Economy, catastrophe potential portend negative outlook

By Phil Zinkewicz

The period between 2003 and 2007 was very favorable for the homeowners line of insurance. Return on surplus for the line averaged an estimated 11% for the five-year period. However, analysts are predicting more challenging times for writers of homeowners insurance as well as for the agents who represent those carriers.

Consider a recent study by Conning Research and Consulting. “Conditions in the housing market will suppress exposure growth as long as housing starts remain at low levels and as values decline,” says Alan Dobbins, an analyst at Conning.

“Insurance-to-value also will be adversely affected, and explaining the need to maintain or increase policy limits in the face of dropping market values will be a challenge for agents and insurers,” he explains. “Another challenge to the domestic economy is the threat of inflation—increasing the cost of the average homeowners claim and pressuring margins in the wake of declining premiums.”

Dobbins says that the profitability of the homeowners line also will be shaped by catastrophe activity. “The light catastrophe years of 2006 and 2007 were a significant factor in the remarkable turnaround of the homeowners line,” Dobbins writes in his report.

“Companies should not expect such favorable catastrophe results going forward, and we can expect a return to a more normal level of catastrophe loss activity, which likely will turn the fortunes of this line,” he continues. “Along with a greater frequency of loss activity, a worsening severity picture is also in store, as the value at risk, particularly in wind-exposed locations, is increasing. Population growth continues in coastal locations, along with an increase in property values, creating the ideal conditions for a mega catastrophe.”

The Conning analyst says that the market has adjusted the way in which catastrophe losses affect the homeowners line. “Retentions have been lowered for traditional insurers and a great deal of catastrophe exposure has been shifted to residual markets. Florida’s Citizens Property Insurance Corporation is the most widely watched and discussed, but other windstorm pools and beach plans also have seen explosive growth in policy count following the hurricanes of 2004 and 2005.”

Dobbins points out, however, that the last few years have also witnessed the emergence of a “new breed” of insurers, the small “take-out” specialists that remove risks from the residual markets. “These new, smaller companies, with limited capital and concentrated exposures, are untested in their ability to remain viable in the face of severe catastrophe events,” he says.

A “very real concern” for the industry, Dobbins notes, is the coupling of regulators’ incentive to appease consumers with the economic downturn. “The temptation of regulators—particularly those elected to their positions—to provide relief to constituents in the form of regulation that impedes the functioning of competitive markets may create a difficult environment for homeowners insurers,” he comments.

“Rather than being a positive influence on the homeowners line—as anticipated a few years ago—it now appears more likely that regulatory influences will be a constraint to profitable growth for the next several years,” Dobbins observes. “The rise of activist regulators in states such as Florida and California is dimming the attractiveness of those markets for insurers.

“Additionally, the uncertainty of state or federal regulation and the ongoing threat of court-enforced, post-contractual coverage extensions make this a difficult operating environment for insurers. There is a great risk to insurers, and to the economic system, in the failure of the courts to apply the terms of the agreements entered into by the parties to a contract.”

More gloomy news

Fitch Ratings, in a special report titled “Homeowners Insurance Market: Challenges Ahead, Best Years in the Past,” also sees significant changes coming for the homeowners insurance market in the next few years. Fitch analysts Douglas M. Pawlowski and Gregory W. Dickerson say that insurers had better gird their loins and prepare for these changes.

“Homeowners insurance has shifted from its traditional role as a loss leader, sold in concert with personal auto business, to a line that has produced steadier stand-alone underwriting profits over the past six years,” the analysts say in their report.

“This change in results was driven by rate increases as well as improved underwriting discipline highlighted by more sophisticated pricing techniques. These positive steps have combined to more than offset a steady increase in claims severity, culminating in the best underwriting results in recent memory.”

The Fitch report continues: “The composition of the 10 largest homeowners insurance writers has remained virtually unchanged over the past decade, and members of the group continue to generate lower than industry average underwriting ratios for the homeowners line. However, the two largest writers, State Farm and Allstate, underperformed the industry over the latest five-year time horizon.”

Pawlowski and Dickerson say that the ailing economy does not necessarily hamstring the homeowners insurance line given its reliance on renewal premium rather than new business. “However,” they add, “inflationary pressures increase loss severity as the cost of building materials rises and times of economic stress also create an environment where fraud is more prevalent.”

Looking forward, the Fitch analysts expect underwriting results and overall profitability to deteriorate from current levels to a modest underwriting loss in 2008 as rates decline due to excess capacity, readily available reinsurance protection, and regulatory and political pressures.

Top-line growth, if any, should be modest, which will place underwriters with higher expense structures at a disadvantage, the analysts say. “Underwriting performance in homeowners is likely to further deteriorate into a larger underwriting loss through 2009 as there are no indicators that market competitiveness in the broader insurance industry is abating. The key factor looking further ahead is whether insurers will revert to the past loss leader approach to homeowners as competition and growth challenges mount in their other personal lines business.”