Underwriting Profits Facing Headwinds

On April 12 the Insurance Services Office released the consolidated US Property Casualty Industry financial results based upon carrier statutory year-end financial filings due by March 1 each year. This financial data reveals the extent of commercial risk competition that has been evidence it price reductions for over a year. While property catastrophe risks both in commercial and personal lines have not seen rate reductions, nearly every other line of business has had at least 2 renewal reductions. This is clearly evident in the reduction of written premium for the year and the 63.6% drop in underwriting profits. Reliance on investment returns to help support the profit outlook is not very encouraging given the current economic environment.

INSURANCE UNDERWRITING INCOME

The Net Underwriting Gain of $31.2 Billion in 2006 was a record reversing the loss from the prior catastrophe year of 2005. But renewed price competition in 2007 coupled with a 4.9% increase in Incurred Claims, saw that underwriting profit fall to $19 Billion. These same factors were particularly noticeable in the 4^th Quarter with Underwriting Profits of $9 Billion in 2006 declining to less than $900 Million in 2007. A fragmented market will continue to bring competitive pressures and lower market rates with improved terms almost across all lines of coverage for the rest of 2008 and likely well into 2009. (click here for chart)

INVESTMENT OPERATIONS

Investment Income (interest and dividends) in 2007 showed only modest gains in the 4^th Quarter at 2.1% and for the year at 4.3%. Interest rates remain low and as premium growth turned negative cash flows will further inhibit investment returns. Investment trading was up during the early part of 2007 with favorable market conditions but these subsided late in the year. Realized Capital Gains growth of 60.7% in 2007 came early as they declined relative to 2006 in the 4^th Quarter from $2Billion to only $768 Million. The investment outlook does not appear favorable based on first quarter 2008 conditions so it will not stabilize overall income as underwriting profits disappear this year. (click here for chart)

NET WORTH

The market’s underlying capital base in statutory financial reporting is called Policyholders Surplus and in 2007 increased by $31.6 Billion to $517 Billion or 6.1% over the prior year. In the 3 years since 2004, it has gained $96 Billion a growth record. Surplus increases in 2007 were derived primarily from net income ($61.9 Billion) and New Funds ($3.2 Billion) against deductions for Unrealized Capital Losses ($0.5 Billion) and Shareholder Dividends ($32 Billion). Surplus gains have benefited in recent years from enormous new funds following the back to back catastrophe years of 2004 and 2005. See Chart on next page for composite view of surplus growth.

With natural catastrophe losses at very modest levels insurers can’t take all the credit for these current financial returns. Taken as a whole, the market is showing signs of having excess capital, which is usually the signal, that putting this capital to work means cutting prices and relaxing underwriting standards. That process is already underway but the question is how long and how deep will it go? (click here for chart)

CONCLUSION

It seems certain that slower premium growth will be the market condition for 2008-209 as prices come down and competition for business heats up. Coupled with existing disruptions in the economic and financial markets it could place industry profits in an accelerated decline during 2008. This will not slow the decline in market prices or competition levels. Even the housing market crises has limited fallout in various liability risks now faced by financial institutions, mortgage bankers, property appraisers and potentially real estate agents. Absent extraordinary catastrophe event(s), the competitive commercial risk market environment could last well into the 2010-2012 period. That is based on the typical cyclical swings in hard market pricing (i.e. from peak-to-peak) and soft market prices (i.e. trough-to-trough) that seems to have a 9-10 year cycle swing.

In any event, the market for policyholders should remain favorable across virtually all lines and business segments. It is however, a good time for risk managers and buyers of insurance to think about what actions they might consider if events take place suggesting that these current conditions could to be in jeopardy. This should not be a matter of urgency considering it hasn’t been all that long that favorable market price have been available. Enjoy…..but keep posted to our newsletter for our reading on expected market conditions ahead…quarter by quarter!