Industry At ‘Point Of Inflection,’ Says Standard & Poor’s

The insurance industry, now teeter-tottering between a hard and a soft market, “has reached a point of inflection,” said Robert Partridge, Standard & Poor’s managing director, at S&P’s 20th annual insurance conference in New York City.

At such a point, he asked in effect, will the industry maintain its hard-won pricing discipline of the past few years, when it went through a severe market correction on the heels of a 15-year soft market, or will it once again descend into price wars and the scourge of cash flow underwriting?

His comments came during a discussion of Standard & Poor’s recent revision of its outlook on the U.S. commercial lines property/casualty sector to stable from negative and the decision to maintain its stable outlook on the U.S. personal lines sector.

“All companies have to balance multiple constituents, including policyholders, economies of scale, shareholders and capital markets,” Partridge said. “Maintaining that balance will help determine whether the outlook will remain stable.”

In commercial lines, he said, embedded profitability remains on insurer balance sheets after several quarters of significant rate increases. Although rates are now declining, underlying profitability is still very strong in the current accident year. There was a 10.7 percent gain in premiums in 2003, as measured by the Insurance Services Office, which adds to stability into 2005 for most commercial lines insurers, he said. Reserve actions have offset this profitability in the past because of legacy issues such as asbestos exposure and underpricing. From 1998 to 2001, Partridge explained, there was rampant underpricing, though in the last few years, insurers have made up for this.

The question now is, how long will the good times last? What happens next depends on pricing discipline. “There is a balance that needs to be maintained here, if it’s to remain stable,” Partridge said.

One reason why insurers might increase their rates is because many still struggle with legacy issues, such as liability exposure to asbestos or medical malpractice. They need to reinforce their balance sheets by increasing their profitability, Partridge noted. Some commercial lines instability could come from the rate decreases, however. Resisting the temptation to lower rates will extend stability in the industry, Partridge emphasized.

During the same discussion, Evan G. Greenberg, president and CEO of ACE Ltd. warned, “U.S. property/casualty insurers that give in to competitive pressure to lower rates do so at their own peril.

“I would caution that rates are adequate now, but there is not a lot of room for a further decrease in rates,” Greenberg said. “A substantial rate decrease in the future would simply be unprofitable,” he said. “Underwriting discipline is going to become the distinction between those companies that are professional and look for permanence and those that are not.”

Rates have decreased over the past six months from double digits to single digits. As important, he added, terms and conditions are holding, though it’s difficult “to put your finger on that” as easily as you can with rates.

“In the main,” he said, “it’s a good underwriting climate” though pressure for competition will mount, more so on the reinsurance side than on the primary side.

Cash flow will be strong through 2004 and 2005 and these will be “relatively good years” for operating income as well, he said.

Greenberg cautioned that rates are adequate now but there’s not a lot of room for substantial increases going forward. “The underwriting culture will dictate that,” he said.

Will the industry learn at last the lessons of the past and mend its ways going forward? “If history is any marker for the future, it’s not encouraging,” Greenberg said, noting that the potential to return to the industry’s errant ways is always there.

He further noted that Bermuda, where his own company is based, has not been a “destroyer of capital.”

“There’s lots of private capital behind Bermuda and this tends to maintain discipline,” he said.

Reserve adequacy too is an important factor in assessing the health of the property/casualty market, but lingering doubts about certain lines—including workers’ compensation, professional liability, and asbestos—blur any definitive views.

“If you look at the price earnings ratios of some of the commercial property/casualty companies that have had significant reserve issues, they tend to be considerably lower than companies that don’t have these problems,” said David Havens, executive director and insurance analyst at UBS. “If you look at the present book ratios of companies that are viewed as problematic, there are a handful of companies that are trading at significantly less than 100 percent,” he said. In general, Havens said analysts don’t get a clear picture of reserving deficiencies. “It’s as murky as SCUBA diving in the Hudson River,” he said.

On the subject of pricing and competition, Havens said, “It’s like the first day of summer,” meaning it will never be better than it is now. Insurance remains a cyclical business, he added, though the next cycle is unlikely to be like the last, where “the level of pain was so severe.” The next cycle, he said, “will be more disciplined.”

“The companies are walking the walk and talking the talk right now,” he said, but it remains to be seen what happens in the future.

On consolidation, Greenberg noted that he expected it to continue in the commercial lines sector in the near future. “There will be more mergers and acquisitions,” he said. The “drive to grow” will continue well into the future and “we’ll see it in all shapes.”

Partridge noted that the fear of inheriting legacy liability exposures would increase the number of book sales, which carry less liability risk for the purchaser.

S&P is maintaining its stable outlook on personal lines primarily because the sector has the flexibility to accurately assess, diversify and price risk, S&P’s Partridge said, though market share wars in the industry threaten that stability. For example, State Farm General Insurance Co. and USAA Casualty Insurance Co. have both announced rate decreases.

Topics USA Market Property Casualty Casualty