Small P/C Insurers’ Underwriting Success Trumped by Lagging Investment Results

December 17, 2002

The competitive advantage that small property-casualty insurers achieved in underwriting at the end of the last decade was nearly offset by lower investment returns, according to a new study from Conning Research & Consulting Inc.

“Small Insurers—Trumped by Investments,” the second study from Conning Research in its series on small insurers, reports that the returns earned by its small-insurer universe of 679 companies lagged those of the 46-company large-insurer benchmark group during the period from 1996 to 2000.

“During that five-year span, large P/C insurers earned an average net return on investment of 8.25 percent—almost 1.4 percentage points higher than the 6.87 percent return earned by the small insurer universe,” said Jack Gohsler, Conning’s senior vice president and one of the study authors. “The large-insurer benchmark group’s comparative success is the combined result of a more aggressive asset mix and higher returns in every major asset class.”

In the first study, Conning reported that its small-insurer universe had substantially higher direct premium growth than the benchmark group of the largest P/C insurers-24.7 percent versus 12.8 percent, between 1996 and 2000. The small-insurer universe also achieved significantly better underwriting results, with a 5-year average combined ratio of 104.3 percent versus 106.0 percent for the large-insurer benchmark group.

A closer examination of the data provides three insights relating to investment performance. First, large P/C insurers were expected to leverage their size and scale to achieve significantly lower investment expense ratios. Surprisingly, the opposite occurred, according to Gohsler. The small insurer universe had an average investment expense ratio of 0.46 percent during the 1996-2000 period, versus 0.57 percent for large insurers. Many small insurers appear to have taken what Conning terms the “minimalist” approach to investment management.

Second, the large-insurer benchmark group aggressively rode the bull market of the late 1990s more successfully than their small insurer counterparts. As a group, they allocated more assets to common stocks and also earned a higher average return on common stocks.

Finally, there was a great deal of variation in the results of companies comprising the small-insurer P-C universe in terms of investment returns, expense ratios, and asset mix. Conning’s segmentation analyses found, for example, that the higher net returns of the largest companies in the small insurer universe were mainly the result of lower investment expenses and not higher gross returns. Also, mutual insurers and stock insurers achieved nearly identical five-year average net investment returns using somewhat different investment approaches.

Conning conferred upon 35 companies in the small-insurer universe its “Top Earners” designation-recognizing them for consistently earning high investment returns. Remarkably, these 35 companies earned an average five-year gross return of 10.24 percent, versus 7.32 percent for the entire small-insurer universe and 8.85 percent for the large-insurer benchmark group. Their five-year average investment expense ratio was a low 0.32 percent, resulting in an average five-year net return of 9.92 percent. Despite the lower overall investment returns earned by the small-insurer universe, there were some stars among small P/C insurers.

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