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At its Insurance 2002 conference in New York recently, Standard and Poor’s offered little consolation to insurance agents and brokers who are looking for quick relief from the pressures of the current hard market.
The consensus emerging from the discussion forecasts that higher prices and more restrictive underwriting will continue at least through the end of this year and into next year. The panelists predicted that the cycle would turn earlier on the commercial side of the market than for personal lines. In commercial lines S&P analysts are looking for aggressive price increases through 2002 before competitive pressure begins to moderate rate levels in 2003. The rating agency expects profit growth in the personal lines through 2003, building to a peak in 2004.
The poor underwriting performance of the recent past, declining investment returns and a shrinking capital base are the drivers behind the change in the market. Underwriting losses, led in 2001 by events at the World Trade Center, and slippage in investment returns have not been the only sources of pressure on the capital base of the insurance industry. Steven Dreyer, managing director in Standard & Poor’s Corporate & Government Ratings Group, pointed out that investors have been seeking to rationalize capital, putting pressure on insurance companies to put their money to good use or return it to their shareholders. Some insurers have achieved this goal, he reported, through stock buy-backs funded by insurer dividends to their parent companies. The mutual insurer that can accumulate capital indefinitely, Dreyer added, is a thing of the past.
Dreyer expressed a little doubt, however, that the capital problems facing the industry in 2002 are as new as everybody seems to believe, speculating that investors and analysts have overestimated the adequacy of the insurance industry’s capital. “Maybe the capital base was never really as strong as we thought it was in the past,” he commented.
An infusion of new money into the industry has moderated the pressure on its capital base, but has not been enough to spare producers and policyholders the pain of higher prices and more restrictive underwriting. Frederic Sklow, a director with Standard & Poor’s, estimated that the property and casualty insurance industry has raised $20 billion in new capital recently, and that $7 billion of this has flowed directly to the primary market.
Despite the influx of additional capital resources, Sklow predicts that the commercial lines market will continue firming through 2002, experiencing an overall 15 percent growth in premium. At the same time, capacity will continue to decline and underwriting will become more restrictive. He forecasts that the capacity shrinkage may moderate in 2003.
Panelists, however, did not expect an expanding capital base to bring immediate relief from the market contraction. Expressing a view that runs counter to conventional wisdom, Brian Dupearreault, chairman & CEO of ACE Limited, contended that the introduction of new capital, principally in the Bermuda market, will not tend to relax market discipline. During the prolonged soft market that began to close in 2000, he argued, it was the old capital that lacked discipline. Bermuda capital, he continued, has been “fairly disciplined” for the duration of the soft market.
An imbalance between supply and demand, Duperreault pointed out, has brought rates back to the levels that prevailed five years ago. He described pricing as “just getting back to a reasonable level,” adding that current interest rate levels require insurers to attain a combined ratio no higher than 100. The insurance business, he added, will continue to remain cyclical, and prices may begin to fluctuate when the industry’s return on equity reaches the acceptable range or goes beyond it. Rolf Huppi, retired chairman and CEO of Zurich Financial Services Group, expressed a similar opinion, predicting that rate firming will continue through 2003 and hopefully leave stability at an appropriate rate level.
Sklow, a commercial lines specialist at SP’s, estimated that prices will continue to rise through the end of this year and that capacity will continue to contract. He predicted that this will be most noticeable in single line capacity. He presented the combination of rising prices and declining capacity as good financial news for insurance companies. “S&P believes that this should contribute to improved operating performance,” he commented.
The current market constriction, Sklow asserted, offers new challenges to the insurance industry. Because the soft market has been so prolonged, he pointed out, many underwriters have never experienced a hard market and will have to learn a new discipline. He wondered now long that discipline will remain in place and how long the hard market will continue.
The personal lines side of the industry, offered Charles Titterton, a director with Standard & Poor’s, bottomed out in the middle of 2001. It is now doing better, and Titterton said that he expects that to continue for several years. The combined ratio for personal auto, he reported, was 108 in 2001, somewhat above the break-even point of 105. He described homeowners results in 2001 as abysmal, arguing that rates were not adequate to produce an economic profit without catastrophes in a year when the insurance industry experienced the third highest catastrophe loss total in its history.
Coupled with declining investment returns, Titterton said, underwriting losses have exerted downward pressure on capital adequacy. Although overall capital adequacy, he reported, remains slightly above S&P’s benchmark for a AAA- rating and some companies continue to maintain strong capital levels, weaker insurers are feeling the pinch. He described capital as adequate, but much less so than in the past. This situation, Titterton believes, has instilled in insurance company management a mindset that the time is right for continued price increases.