Amid signs that the property/casualty insurance market is improving, insurers’ prospects for greater profitability may actually be diminishing in today’s rapidly slowing economy, an industry leader warned.
At present growth rates, the industry’s combined ratio is on track to be 114.9 – 4.5 points worse than 2000 – and could hit an all-time record poor combined ratio of 139.6 five years from now, according to Frank J. Coyne, president and chief executive officer of Insurance Services Office Inc. The combined ratio is the percentage of each premium dollar an insurance company has to spend on claims and expenses. When a combined ratio is more than 100 percent, the insurer has an underwriting loss.
Combined with poor underwriting performance, lower investment gains in today’s declining equities markets could spell disaster for many insurers, Coyne told insurance company executives at the Pacific Insurance & Surety Conference. Insurers’ net income continues to decline, said Coyne, noting that in 2000 the industry posted net income of $19 billion, down more than 13 percent from 1999 and down nearly 50 percent from a peak in 1997.
Last year’s premium grew 5 percent – more than twice the growth of 1999 – but failed to keep pace with economic growth, based on the national gross domestic product, which rose 7.1 percent, Coyne said.
“The up-tick in premium growth thus far may signal only that rates have stopped declining for the moment,” he said. Moreover, at an estimated $240 billion in 2000, loss and loss-adjustment expenses were up in 2000 nearly 8 percent from 1999 and could easily have increased 10 percent – twice as fast as premiums – but for a sharp decline in 2000 catastrophe losses, noted Coyne.
“As long as growth in losses outpaces growth in premiums, underwriting results will continue to deteriorate – no matter how good anecdotal reports of price firming may sound,” he said.
Coyne also warned insurers not to be lulled by last year’s low catastrophe losses, which at $4 billion were half the 1999 figure. With the population in the country’s most earthquake- and hurricane-prone areas continually growing, catastrophe losses will continue to worsen.
Citing a decade of sub-par underwriting performance, Coyne said the industry had developed an “unhealthy” tolerance for low premium growth because “investment gains in an unprecedented bull market would always pull insurers through – or so it seemed.”
Coyne noted that ever are now being threatened by declining stock markets. Insurers’ total investment gains, consisting -increasing investment gains that insurers need to counterbalance ever-escalating underwriting losses of investment income and capital gains, have been on a sharp downward trend.
In just three years, the excess of investment gains over underwriting losses dwindled nearly 95 percent – from $75.5 billion in 1997 to just $4.1 billion. “If stock prices continue falling at the rates they have been, investment gains could easily fall short of underwriting losses. Year to date, the Dow Jones is down 7.54 percent, the S&P 500 is down 11.63 percent and the NASDAQ is down 20.18 percent.
Coyne cited other “warning lights flashing on the industry’s economic dashboard.” He noted the industry’s surplus, projected to be $320 billion, fell more than 4 percent at year-end 2000. “Last year’s decline in surplus is the first since 1984, when surplus fell more than 3 percent at the bottom of the worst underwriting cycle in the industry’s history.”
But even with a smaller surplus, the industry’s 2000 GAAP rate of return at 5.6 percent remained below the average yield on risk-free U.S. Treasury notes. “Unless returns on capital improve, you might expect pressure on company management to return capital to its owners so they can re-deploy it more advantageously,” warned Coyne.
Another warning light is the 26-percent cut in dividends to shareholders in 2000 – the first such drop since 1994, when dividends were cut 13 percent following the Northridge, Calif., earthquake.
Increasing insurer insolvencies are another key concern, said Coyne. In 2000, 31 property/casualty insurers were declared insolvent, up from just seven in 1999. “Company failures could surge still higher,” if stock prices continue falling or if the industry is hit by a megacatastrophe, according to Coyne.
Other concerns include the sharp, downward trend of insurer cash flows, continuing exposure to asbestos and environmental liability, and an estimated $3.5-billion decline in the industry’s reserves for losses and loss-adjustment expenses.
“Astute leaders will recognize the underlying dangers amid signs of market improvement and will not be distracted or deterred from executing fundamentals of solid underwriting,” Coyne said.
Referring to ISO’s extrapolations of perilously high combined ratios, Coyne reminded listeners that last year he “raised a few eyebrows when I told you that based on then-current conditions, the industry’s combined ratio could hit 111.7 in 2000 and was on track to reach 136.2 by 2005.” The combined ratio for 2000 would have been exactly 111.7 had catastrophe losses not dropped to unusually low levels, he noted.
Coyne said ISO’s extrapolations of perilously high combined ratios are a warning. But “what could be is not what has to be,” he said. “Recognize that risk-based pricing and sound risk assessment, along with efficient and effective risk evaluation, adjudication and settlement are still the single most important determinants of success.”
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