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State of the P-C market
How are insurers doing it? Smoke and mirrors?
By Michael J. Moody, MBA, ARM
For many years, the insurance industry has been characterized by a seven-year pricing cycle. And while this has varied somewhat from cycle to cycle, it has been pretty close regarding the timing. However, in recent years, it has become less and less predictable. Today, the “seven-year cycle” may well have gone the way of Beta recording devices. For the most part, worldwide events have gotten bigger and bigger and more frequent, but the results can’t be felt for many years thereafter.
However, the biggest issue concerning rates has to do with the insurance industry’s ability to attract capital. For a variety of reasons, the industry offers investors an approach that few other investments can offer. Among the most favorable ones are better-than-average rates of returns, diversified portfolios and zero beta investments that do not move in concert with the stock markets. Thus, while the rest of the financial services industry is in shambles, the insurance industry continues to maintain a positive position. It’s this positive position and the ability to attract capital that accounts for much of the current cutthroat competition that continues to control the industry.
Despite this, many insurance industry observers have difficulty understanding how this competitive environment can continue. What’s behind this long-running soft market?
Surprising 2009 results
After the general commercial property/casualty rates had been steadily falling for at least five years, many industry watchers had predicted some hardening in 2009 rates. Several years ago, it was widely believed that between adverse losses in underwriting and poor investment activities, it was only a matter of time before the industry’s excess capacity would be destroyed, thus signaling that the bottom of the soft market cycle had been reached.
However, few could have successfully predicted the actual financial results. Much of the following information has been provided in releases from ISO and/or the Property Casualty Insurers Association of America. It tells a story that few could have guessed, given the turmoil in the rest of the world’s financial markets. Stated below are a few of the key statistics regarding the commercial insurance industriy’s 2009 financial results:
• Policyholders’ surplus increased by $54.2 billion to $511.5 billion or about 11.8% during 2009. This figure was an increase from $457.3 billion the prior year. And as the Insurance Information Institute (I.I.I.) notes, “This reversal is notable and important because the industry’s surplus had plunged to $437.1 billion in the later part of 2007.”
• Advisen, one of the premier business information and market data services that specifically deals with the commercial insurance industry, states that with several notable exceptions, “property and casualty insurers were largely unscathed by investment losses directly attributable to the meltdown of the subprime mortgage market in 2007.”
• The net income (after taxes) in 2009 reached a total of $28.3 billion or nearly 10 times the $3 billion earned in 2008. It is interesting to note that the increase was incurred entirely during the final three quarters of 2009.
Bottom line, despite the global recession and declining premium volume, the insurance industry fared quite well in 2009 and set the stage for a very interesting beginning to 2010.
Early 2010 results
At the time this article was written, the results from the first quarter of 2010 had just been made public. For the most part, the results continued to astonish many within the industry. Again, several key factors summarize the overall financial results regarding the first quarter of 2010:
• Against a time period that was full of surprises, one of the biggest was the fact that the property/casualty industry returned to profitability during the first quarter of 2010, despite continued erosion in both written and earned premium. According to several reporting bodies, private U.S. P-C insurers’ net income (after taxes) swung to a positive $8.9 billion in the first quarter of 2010 compared to a negative $1.3 billion for the first quarter of the prior year. These results came despite a decline in net written premiums of $1.4 billion or about 3% from the first quarter of 2009.
• Another unexpected stat was that insurers’ net investment gains (i.e., the sum of net investment income and realized capital gains or losses on investment) more than tripled over the prior year’s first period. According to Advisen, insurers’ investment income rose $8.8 billion to a total of $12.6 billion, as compared to a gain of $3.7 billion in the first quarter of 2009.
• ISO’s Property Claims Service Unit states that catastrophic losses striking the United States in the first quarter of 2010 caused $2.6 billion in direct insured losses. They also point out, “This figure was $0.7 billion less when compared to the $3.3 billion in the first quarter of 2009.”
• Underwriting results also improved significantly during the first quarter of 2010, in spite of continued declining premiums. As a result, the combined ratio improved from 102.2% in the first quarter of 2009 to 101.1% in the first quarter of 2010.
• The Risk & Insurance Management Society’s (RIMS) “Benchmarking Survey” reported, “Average premium in every line tracked fell in the first quarter.” They go on to note that, “Abundant capacity coupled with diminished demand kept downward pressure on rates.”
For the most part, the above noted results from the past couple of years are really quite remarkable, particularly since the industry has experienced a chronic soft market over the past six or seven years. Many people within the insurance industry, as well as those outside of it, have questioned how results like these could possibly occur. To summarize how this can happen, it all comes down to one issue: “over capacity.” The industry is flush with cash and, as a result, insurers are willing to do just about anything to get more premium. And despite a crumbling world economy, the soft pricing of the past half dozen years only deepens.
Crystal ball
As noted above, there appears to be little that will change the current pricing policy of major insurers. The fact is that there continues to be too much capital in the insurance industry and, at this point, the industry is only adding to the total. There are, however, several situations that could change this scenario. Obviously, one of these situations could be a significant environmental related loss event (e.g., hurricane, earthquake, etc.) or a man-made event such as 9/11. Either of these situations would have an adverse effect on insurer surplus and would result in increasing premiums. However, Conning Research & Consulting stated in their recent “Property-Casualty Forecast & Analysis” that, based on their proprietary software, they are “projecting insured catastrophic losses for 2010, 2011 and 2012 of around $20 billion per year.”
One other issue that could cause an increase in rates is a rapidly expanding economy. If, for example, employment or sales of new homes were to increase significantly—anything that would move the economy away from the current recessionary landscape—demand for insurance would follow shortly thereafter. However, given the sluggish economic results thus far, this does not appear to be in the cards anytime soon. From statistics provided by many governmental agencies, economic growth will occur gradually over an extended period of time, rather than making a large movement upward.
One additional way that insurers’ surplus could be altered is finding additional places to deploy their capital. For the most part, premium growth from mature markets such as North America and Western Europe is quite limited. However, emerging markets do offer insurers opportunities for more productive ways to deploy their capital. That is one of the key reasons that most insurers/reinsurers are so interested in writing coverage in places like China or India, for example. SwissRe has stated, “The total premium income in China grew 31% in 2008 as compared to an average overall global decline of 2%. Many feel that the emerging markets offer significant opportunities for insurers/reinsurers to better utilize and deploy their capital, thereby reflecting the increasing demand in their rating structures.”
Any of the above situations would allow a more profitable allocation of capital and would ultimately result in creating more pricing pressure at home. Failing any of the above noted situations, one would expect that, overall, the trend of downward pressure on the premiums will result in modest reductions or possibly flat premium renewals for most commercial insurance buyers for the next couple of years.
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