A look behind the very good property/casualty results for 2006

February 25, 2007

News Currents

The numbers, or estimates, for the property/ casualty insurance industry for 2006 are in. Dr. Robert Hartwig, president and chief economist of the Insurance Information Institute, sat down with Insurance Journal’s Andrew Simpson at III’s Joint Property Casualty Insurance Conference in New York and discussed what could make 2006 the best year in terms of underwriting performance in 50-plus years.

To view the complete video interview of Hartwig, visit www. insurancejournal.com/broadcasts.

What do the overall results
of 2006 look like for property /casualty insurers?

Hartwig: The results for the industry were quite good in 2006, and there are numerous ways to measure that. In terms of dollars, yes, the industry did generate [a] record in terms of dollars of profit in 2006. In terms of returns on equity, there are a couple of ways to look at that. The industry had its best return on equity at about 14 percent. That is the best it has seen since 1988.

While that is very good for P/C insurers, in fact, that is just about the norm for the Fortune 500 group. Really the industry just joined the pack after having trailed it for many years. It is still quite possible that the industry will fall behind the Fortune 500 group when all the final numbers are in. That will be the 19th consecutive year that the industry underperformed the Fortune 500.

All in all, it was a very good year for insurers in terms of underwriting performance. This is the most remarkable statistic of all. We estimate the combined ratio to be about 94 for the year. That would be the best result since 1955. In fact, there is a possibility it could be in the 92 range when all the numbers are in. That would be the best number since 1948.

What effect did the mild
hurricane season have on those results?

Hartwig: The mild hurricane season had significant impact in pushing down and making the underwriting results better than they would have otherwise been. But I think too much credit has been given to the absence of hurricanes. Even if we had a normal hurricane year in 2006, we would have still seen a very good year for insurers; probably a combined ratio in the 97 to 98 range.

[To] put that in perspective, that would only be the second underwriting profit the industry has had since 1978. Even with a normal level of catastrophe loss activity, it would have been a good year. That means that the results were robust. Basically every type of coverage, all across the country, was contributing to the industry’s bottom line. Along with, of course, robust investment results.

So lines that would not have been affected necessarily by the mild hurricane season have also looked good?

Hartwig: That is right. Lines such as workers’ compensation and auto insurance, which aren’t really catastrophe-prone lines, contributed tremendously to the industry’s bottom line. [They] helped the industry stay above water in years like 2004 and 2005.

What have insurers done with the profits?

Hartwig: What insurers have done is largely reinvest their profits. They have also reinvested their unrealized capital gains. So what that means is insurers are going to post their second-largest ever increase in policyholder surplus, the best measure of claims paying capacity. We estimate by Dec. 31, 2006, that number reached $481.5 billion, which is a new record. But it is important to keep in mind that this is not one sum, one pool of money that is available to pay any mega-type claim that arises. It is in thousands of little pots. Each one of those pots represents an individual insurance company. There are even pots within that, that basically represent the individual lines of insurance each of those insurers writes. It is not some almost $500 billion that is available to pay some single terrorism loss, some single major hurricane or earthquake.

The Consumer Federation of America has suggested that there is too much surplus?

Hartwig: There is too much surplus in the industry when there is no concern about not being able to meet the claims. We live in an era that is very dangerous. In fact, we are looking at potential claims, from a single event, from an earthquake or hurricane, that could easily exceed $100 billion. That would consume more than 20 percent of the industry’s total claims paying capacity. Again, that whole 20 percent is not available to pay on that single event. It would be a very difficult event at that level, and of course, some terrorist attack scenarios are even worse.

It is also the case, we are a cyclical business. There are times when the industry increases its surplus, there are times when it decreases. For instance, part of the reason for the increase is the buoyant equity markets that we saw in 2006. Had stock markets gone down or investments turned south as was the case during the 2000-2002 period, we would have seen a surplus decline, as we did during that period. It is very prudent for insurers to take this time to rebuild their claims paying resources.

The good underwriting results seem to suggest there is more discipline in pricing.

Hartwig: Right. Typically, what we saw at the end of previous hard markets in the ’70s or ’80s is basically pricing would fall off a cliff. Now, pricing has moderated, but there is no information that suggests that we are at the beginning of or about to enter a slippery slope in which insurers are price cutting to gain market share and don’t pay any attention to underwriting performance.

The price cuts that we are seeing today, generally speaking, are justified by good, underlying fundamental results. In other words, what insurers are seeing in workers’ comp is fewer claims and often times lower claim costs. [It’s the] same thing in auto insurance. The savings are being passed along to consumers. Insurers can lower rates and maintain profit margins.

Are the results of 2006 sustainable through the new year?

Hartwig: It is unlikely that the results of 2006 are sustainable, in the sense that we had abnormally low catastrophe losses during a period of time when catastrophe losses are expected to be abnormally high. In and of itself, we would expect some deterioration in underwriting performance. Even if you normalize catastrophe losses and you assume the industry is becoming more competitive, there is more pressure on pricing. We still expect momentum into 2007. I am expecting a combined ratio of 97 or 98 in 2007. That would be a very good result, [and] would generate a healthy ROE for the industry for the second year in a row.

Topics Catastrophe Carriers Profit Loss Excess Surplus Underwriting Property Hurricane Property Casualty Casualty

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