Homeowners insurers not earning cost of capital despite modest rate increases

November 4, 2007

The countrywide prospective return on equity for the homeowners line of insurance for 2007 is 7.0 percent, up from 5.4 percent in 2006, according to an analysis by Aon Re Global, a unit of Aon Corp. The year-over-year improvement in prospective ROE is due to marginally more adequate homeowners insurance rates than in 2006 and an expected lower cost of reinsurance, the analysis found.

The update for 2007 — the sixth year Aon Re has undertaken this study — is based on a review of the rate filings of the top five companies in states making up more than 80 percent of the U.S. population. The study looks at prospective return on equity by state.

As in 2006, a significant difference in prospective ROE is found between “hurricane states” and “non-hurricane states” — at 5.4 percent versus 8.7 percent respectively.

“Our assignment of capital by state is based on retained risk by state,” said Randall E. Brubaker, senior vice president and actuary at Aon Re Services. “We continue to find that approved rates in hurricane states in general do not adequately reflect the level of risk and capital requirements derived from operating in these states.”

The continuing reductions of policies in force by insurance companies in the hurricane states and the growth of state-sponsored residual markets is driven in part by the lower prospective ROE in these states.

“We see the market share of public entities growing in the hurricane states,” said Kenneth Selzer, executive vice president at Aon Re Global. “Aon Re is working to serve both private insurers and the public entities to make efficient use of capital in this changing operating environment.”

Aon Re’s Homeowners ROE analysis is based on capital requirements and cost of reinsurance for an assumed company that operates countrywide with combined equity capital and reinsurance sufficient for an expected “A” rating by A.M. Best. The results of the study are indicative of industry trends, but do not reflect the actual capital structure, reinsurance, geographic distribution or specific rate needs of an individual company. Aon Re Services assists its clients by applying the methodologies in the study to the particular unique situation and needs of any client.

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