The insurance industry is entering a soft market, but unlike earlier soft markets, carriers have not cut prices to gain market share. Numerous life, property/casualty, and reinsurance executives say that underwriting profits remain their first priority.
And though industry watchers hope the pricing discipline will continue, they are realistic. Eventually, temptation and economic fundamentals could lead to price cuts.
“The image I have [of pricing discipline] is someone with their finger in a huge dam, waiting for it to burst,” said William Wilt, vice president and analyst with Morgan Stanley in New York.
Insurance industry professionals discussed the soft market at Standard & Poor’s Insurance Industry conference in New York.
There have been numerous reasons for the onset of a soft market, such as large carrier surpluses, but each line has its specific reasons.
For P/C carriers, margins remain solid. Underwriting results were strong in 2004, with an average combined ratio of 94.5 percent and carriers continued to build capital, according to S&P. And while prices began to soften in the first half of 2005–a 9.4 percent average decline across all P/C lines–they are not making the precipitous drop of previous soft markets.
“In the primary standard line for casualty, you have seen positive price momentum in 2004, and in 2005 there [have been] low single-digit increases,” said John Amore, CEO of global general insurance for Zurich Financial Services. “On the property side, the second quarter saw a pretty significant moderation in prices.”
P/C carriers will reduce prices, but unlike in prior soft markets, insurers will pull back once lower prices affect fundamentals, said Thomas Walsh, a senior vice president at Lehman Brothers.
“While there is a deterioration in rates, we think the industry can have an impact on combined ratios for another 2 to 5 percent,” he said. “You are not going to get the combined ratios of earlier periods in the late 80s and 90s.”
Premium growth fell to a record low of 1.8 percent in 1998, and the combined ratio for the P/C industry skyrocketed to 107.8 percent, according to the Insurance Services Office.
Numerous external pressures have kept P/C prices from falling precipitously, Walsh said. “This industry’s ability to maintain discipline is being driven by rating agencies, client concerns about stability, and other third-party factors,” he added.
Rating agencies will move quickly to downgrade carriers if fundamentals become frayed, Walsh said; once ratings dip below a certain point, many large corporations will be prohibited from using those insurers.
In the life industry, product offerings in a continued low-interest environment illustrates life insurers’ price discipline. According to S&P, life insurers’ portfolio yields will remain flat and in line with 10-year Treasuries, which hovered around 4 percent as of May 31.The yield inhibits insurers’ ability to underwrite annuities, especially products with a guaranteed benefit.
Life insurers’ capital to fund annuity products is often invested in government bonds. The yields on these bonds usually rise and fall in a predictable fashion. But the current Treasury market has suffered unusually low yields.
“The industry has done a good job of improving their capitalization, and their financial stability is back on track,” said David Havens, executive director and analyst for UBS. “But nobody expected to see a four percent yield on a 10-year note now.”
Newer life products, such as guaranteed minimum-accumulation benefits and universal life policies with no-lapse guarantees, could come back to bite companies that did not hedge their exposure effectively. “Product design is like distant thunder for life insurers; you can hear it coming and you are not so sure it can hurt you,” Haven said.
The life industry is managing its book of business effectively at the moment, but lower yields could be problematic, said John Barrett, CEO of Western & Southern Financial Group. “[Interest] rates are touching the edge of minimum guarantees, but the industry is in pretty good shape,” he said. “But another 50 basis-point drop [in yields] could be problematic.”
On a different note, the reinsurance marketplace is unlike prior years in that new firms aren’t entering the mix to shake up pricing, said John Lummis, CFO of RenaissanceRe Holdings Ltd.
“There is an absence of a very aggressive market player at the moment,” he said. “I don’t see anyone out there who has a new business plan that says they need to score big in the [catastrophe] market now.”
New reinsurers have often entered the market following large catastrophes, such as Hurricane Andrew and the Sept. 11 terrorist attacks. Most of those reinsurers have become established players.
In addition, reinsurers do not have high distribution costs, giving them the ability to wait out soft markets, said Joseph Taranto, CEO of Everest Reinsurance. “Insurers have huge infrastructure costs, but reinsurers can say ‘I can’t get my price, so I won’t write the business,’” he said.
Article reprinted with permission from KPMG’s Insurance Insider. Copyright 2005 KPMG LLP. All rights reserved. Disclaimer from KPMG: All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.