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Most insurance industry analysts predict slower P/C premium growth for 2007, according to an Insurance Information Institute’s annual survey of Wall Street stock analysts and industry professionals released each year on Feb. 2, Groundhog Day. This year’s survey results indicate that the respite in catastrophe losses in 2006, combined with a strong performance in virtually all other major lines of property/casualty (P/C) insurance, will, in all likelihood, propel the industry to its best underwriting performance since 1936.
Analysts further expect the industry’s profitability to continue in 2007, albeit with an underwriting performance that generates a much smaller underwriting profit; the trend of decreasing underwriting profits is expected to continue in 2008.
The I.I.I.’s poll also shows that analysts uniformly expect premium growth to become even more sluggish in 2007 and 2008. This apparent paradox — a peak in industry profits, but stalling premium growth — is a clear reminder of the cyclical nature of the property/casualty business.
Premium growth stuck in neutral
The average forecast calls for an increase in net written premiums of just 1.8 percent in 2007, a substantial slowdown from the 3.3 percent estimated for 2006. The 1.8 percent increase in premium growth that analysts forecast for 2007 would be the third slowest rate of growth for P/C insurers since 1998, during the depths of the last soft market. It represents a near halving of the estimated figure for 2006.
The deceleration in premium growth in 2007 is a direct result of an across-the-board softening in the personal and commercial lines pricing environment. The exception to this general trend is hurricane-exposed coastal property insurance coverages. For 2008, the average forecast calls for an equally modest increase in net written premiums at just 1.9 percent.
Premium growth peaked during the most recent cycle at 14.6 percent in 2002, before dropping to 9.8 percent in 2003. It is also worth noting that premium growth in 2006 will come in well below the average analysts’ expectations from a year ago. In last year’s Groundhog survey, the consensus estimate was for net written premium growth of 3.8 percent.
Buyers of insurance are, of course, the clear winners when it comes to reaping the benefits of slowing premium growth. For example, countrywide auto insurance expenditures are expected to fall 0.5 percent in 2007 — the first drop since 1999. Businesses will see declines of 5 percent or more in 2007, across their entire insurance program.
Overall, the share of P/C insurance premiums relative to the overall economy will shrink by about 2.5 and 3.1 percent in 2006 and 2007, respectively.
For insurers, the current premium growth pattern is eerily reminiscent of the soft market of the late 1990s, when the industry recorded growth of 2.9 percent in 1997 and 1.8 percent in 1998. Those years presaged some of the worst years in the insurance industry’s history, with combined ratios rising from 102 in 1997 to nearly 116 in 2001. Fortunately, with an expected combined ratio of 96.6 in 2007 and 98.6 in 2008, the comparison — at least so far — appears to be superficial, or at least premature.
Combined ratio: best result in decades
The combined ratio — the ratio of losses and expenses to premiums — for 2007 is projected to be 96.6, a deterioration from an estimated 93.2 in 2006. The 93.2 estimate for 2006, if accurate, would represent the industry’s best underwriting performance since the 93.3 combined ratio recorded 70 years earlier in 1936. If, as predicted, the combined ratio in 2007 comes in under 100, it would produce just the third underwriting profit in the property/casualty insurance industry since 1978.
While the survey results indicate fundamentally sound underwriting performances in 2006 and 2007, the anticipated 3.4 point deterioration in the combined ratio for 2007 begs questions about 2008 and beyond. This year’s Groundhog survey includes, for the first time, combined ratio projections for 2008 — the combined ratio for that year is forecasted to be 98.6, a very respectable number, but one that nonetheless represents an additional 2.0 point deterioration from 2007 and a 5.4 point deterioration relative to 2006.
2007 looks favorable; challenges remain
What are the biggest potential downside risks for 2007? Still high on the list is exposure to catastrophic loss, which superseded loss of pricing and underwriting discipline as the chief concern in 2005 — by far the worst year for catastrophe losses, with $61.2 billion in insured losses.
Analysts’ forecasts for net written premium growth in 2007 — which range from 0.1 percent on the low end to just 3.1 percent on the high side — reflect the fact that pricing and underwriting discipline remain a key issue.
Increased interest by traditional commercial insurance buyers in alternative forms of risk transfer, especially captives, self-insurance arrangements and large deductibles, is causing significant leakage of premiums from the system. Also, insurer pullbacks from coastal areas are resulting in the ceding of significant premium to state-run residual market mechanisms.
High on the list of external threats are adverse court decisions in Mississippi and Louisiana that have injected significant additional uncertainty into what are already very difficult operating environments.
Terrorism and more
Among other major external risks, terrorism remains a key concern as the two-year extension of the Terrorism Risk Insurance Act is set to expire on Dec. 31, 2007. While the shift to Democratic control in Congress leads many industry pundits to believe that passage of some form of backstop is likely, there is concern as to exactly what the program will look like and how it will operate.
Fortunately for insurers, at least some of the momentum built in 2006 will be carried into 2007 and 2008. That being said, insurers will need to come to grips with challenges unrelated to catastrophe losses, including increasing price pressure and the slow growth environment in the year ahead.