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A Hardening Market

Not so soon says insurance research firm

Those who are hoping for a hardening of the property and casualty insurance marketplace may be disappointed, according to David Paul, a principal in ALIRT Insurance Research, an organization that models the financial performance trends of life, health and property/casualty insurers vs. their peers and respective insurance industry sectors. Paul was a speaker at the Target Markets Program Administrators Association’s Mid Year Meeting in April.

“The last hard market began in late 1999/early 2000 when reported combined ratios were in the 108% to 110% range,” says Paul. “We reported a combined ratio of 98.3% for the first quarter of 2009. With insurers still making profits on an underwriting basis, it appears unlikely now that we will see a significant hardening of pricing this year, barring enormous catastrophe losses. We are likely looking into 2010 for signs of hardening, again depending on what happens on the underwriting side.”

The 2008 year-end composite analysis, Paul explains, revealed the impact of almost five years of soft pricing, heavy catastrophe losses in the first quarters of the year, and investment losses from the on-going global financial crisis contributed to weakened underwriting results and a sharp decline in surplus for the P-C industry. “It is unlikely,” according to the analysis, “heading into 2009, that industry pricing has reached a cyclical trough and that rate reductions will moderate, or aggregate rates become flat or even strengthen in 2009.

“The history of past pricing cycles indicates that a near-term pricing turn was probable, even without the surge of investment losses,” the analysis continues. “Extrapolating from composite results, ALIRT estimates total surplus depletion of approximately $63 billion in 2008, or 12% of year-end 2007 surplus. However, the speed and severity of a pricing turn is very much an open question. While the supply of insurance capacity is decidedly lower, given weaker surplus positions and capital constraints facing potential new entrants to the market, demand for insurance is also trending lower, given the impact of deepening recession on insured exposure units. And even if pricing does improve, insureds may seek to rein in costs by increasing deductibles.”

Moreover, the analysis reports, many of the current investment losses are unrealized and could reverse if equity and/or capital markets improve, reintroducing capacity into the market. “Also, the industry’s current reserve position appears to be adequate to slightly redundant, a notable difference from the market environment for the last turn in 2000. “Lastly,” notes the analysis, “even with the sharp loss of surplus, the industry’s net premium leverage is below historical norms, and underwriting results, excluding catastrophes, hover around the 100% break even point—historically decent results.”

Turning to 2009, Paul said that reported underwriting results were aided by $2.9 billion of net prior year reserve releases in the first three months of the year. This comes on top of $5.8 billion of net reserve releases in 2008, with the majority of redundant reserves coming from the 2008 accident year, likely tied to downwards revised catastrophe losses from the Gulf storms, he says.

Based on insurers’ statutory statements, Paul points to the following as highlights of the first quarter of 2009:

• The accident year combined ratio, which excludes the impact of prior year reserve development, was 103.5 for the first three months of the year. The accident year results have now underperformed reported results for 12 consecutive quarters, a reflection of reserve releases into earnings and an on-going indication of a soft market cycle.

• Three-month 2009 pre-tax operating income of $6.5 billion was 14% lower than that for the prior year period, reflecting declining premium flow and weaker net investment income. Pre-tax ROE improved 10 basis points to 10.%, when compared to the full year 2008 ROE of 9.4%.

• In the first three months of 2009, net investment yield fell by 102 basis points to 3.52%, from 4.54% for the full year 2008. Total return fell by 112 basis points to -3.31% vs. -2.18% in 2008, reflecting the lower yield but especially the continued net capital losses, which were driven largely by weaker equity markets in the first quarter.

• Surplus fell 2.9% in the first quarter, continuing a trend witnessed since the first quarter of 2008. This was largely due to net capital losses of $9.9 billion and other one-time charges of $2.2 billion, which drove surplus to $249 billion in the first quarter of 2009, down from $256 billion at year-end 2008.

• Direct and net premiums declined 2.7% and 4.0%, respectively, in the first quarter of 2009 when compared to the prior year period. This is a continuation of declines in both direct and net premiums written in 2009.

• Gross and net underwriting leverage ratios (gross and net premiums to surplus) were largely unchanged when compared with the full year 2008 results. Annualized premium leverage ratios were 1.42 times (gross) and 0.88 times (net) for the first three months of 2009, vs. 1.40 and 0.89, respectively, for the full year 2008.

Paul says that, in terms of individual company results, 20 companies analyzed by ALIRT reported surplus gains in the first three months of 2009, vs. only six in 2008, led by Safeco Insurance Co. of America, along with Progressive Direct Insurance Co. and Progressive Casualty Insurance Co. “Only three companies reported declines of 10% or more, with the largest drops reported at Nationwide Mutual Insurance Co., lead Crum & Forster pool member United States Fire Insurance Co. and Erie Insurance Exchange.”

Of the P-C companies reporting to ALIRT, eight had combined ratios below 90%, including Factory Mutual Insurance Co. (59%), lead AIU Holdings E&S writer Lexington Insurance Co. (86.3%), two Chubb subsidiaries, Federal Insurance Co. (87.2%) and Pacific Indemnity Co. (88.3%), USAA Casualty Insurance Co. (87.6%), Travelers Indemnity Co. (87.8%) and two lead Hartford subsidiaries, Hartford Accident & Indemnity and Hartford Fire (88.6%).

Paul pointed out that 22 companies reported combined ratios that exceeded 100% in the first three months of 2009, with the poorest performances reported by Liberty Mutual subsidiaries Employers Insurance Co. of Wausau and General Insurance Co. of America (115.3% and 107.2%, respectively), regional insurers Erie Insurance Exchange (112.6%) and Sentry Insurance Co. (112.0%), State Farm Fire & Casualty Co. (110%) and New Jersey Manufacturers Insurance Co. (106.9%).

Paul summed up his position on the current soft market cycle this way: “While it is unlikely that we will see a further softening of overall rates going forward, the present economic conditions do not necessarily argue for a rapid firming either. While surplus declined again in the first quarter, after a large surplus decline in 2008, the offsetting factors of dwindling demand, as the economy continues in recession, and continued core underwriting profitability seem to indicate that rates will not migrate rapidly in any direction. What’s more, with a rebound in equity markets in the second quarter, surplus may strengthen as unrealized losses reverse, providing additional capacity.”