The property/casualty industry’s frequently volatile underwriting cycle is back with a vengeance and will have no mercy this time around, Robert Hartwig, senior vice president and chief economist for the Insurance Information Institute (I.I.I.), told the Casualty Actuarial Society Ratemaking Seminar recently.
Examining the P/C industry’s financial outlook and whether the cycle will be different this time around, Hartwig pointed out that 2004 final financial results are likely to show the industry produced its first underwriting profit since 1978.
He said the highlights of the P/C financial results for the first nine months of 2004 compared to the same period in 2003 show that while the growth rate in net written premiums was less than half of what it was a year earlier, there was record surplus and a very rare underwriting profit – a combined ratio of under 100.
“So where we are in the cycle has changed dramatically over the past 24 months,” he explained.
Hartwig’s presentation showed that real net written premium growth in the 2001 to 2004 hard market was an estimated 6.8 percent – nowhere near as much as in the previous two hard market periods in the 1970’s and ’80’s, even when adjusted for inflation. And the industry has also fallen short in the profitability category in the current cycle, as well, he said.
Hartwig predicted that by the end of 2005, inflation-adjusted premium growth will be zero, but added that change in loss costs will not be zero.
“In 2001 – the peak in the soft side of the cycle – just about every major line of P/C insurance was a disaster, including private passenger auto, workers compensation and homeowners, not to mention the commercial lines impacted by 9/11,” he emphasized.
The financial results of both commercial and personal lines improved over the past 10 years, but the compression between the lines’ combined ratios occurred because the impact and influence of investment income has been greatly diminished. “You simply can’t count on that investment income component, so you’ve got to run a better combined ratio going forward,” Hartwig stated.
“One way to dampen the cycle is to focus on underwriting – we have to become an industry focused on underwriting because any focus on investment income is going to lead us very quickly astray,” he warned, adding that another very important area is keeping a lid on the expense ratio.
And while company CEOs are going to be talking about keeping this in line, they are not going to be able do so to the extent they would like if the rating environment deteriorates substantially over the next 24 months, he noted.
While the P/C insurance industry has under-performed the other Fortune 500 industries every year since 1987 in return on equity, there was a dramatic turnaround last year because profitability was restored. In fact, were it not for the four hurricanes that struck the United States in 2004, insurers would likely have surpassed the Fortune 500 profitability benchmark, Hartwig said.
The industry economist contrasted “yes” and “no” arguments about whether the cycle will really be different in the future. He noted that things that might make the answer “yes” include new management with the benefit of 20/20 hindsight, investments in management information systems, regulators who are finally “waking up,” and the pro-business domination of the Republican-controlled Congress and White House.
And among the arguments that might make the answer “no,” he said, are that company managements never learn, the P/C industry will always be an “impossible business,” investor fatigue, a return to cash-flow underwriting, and regulators who are still “asleep at the wheel.”
“The cycle is a natural born killer – it kills insurance companies, dozens at a time,” said Hartwig. The number one killer of insurance companies isn’t catastrophic losses like last year’s Florida hurricanes, but deficient loss reserves and this is where actuaries come into the picture, he pointed out.
Hartwig outlined for the actuaries three pricing strategies in which he labeled private passenger auto as a success story and workers’ compensation as a “slow motion train wreck,” while stating that the jury’s still out on homeowners insurance.
Private passenger auto profitability deteriorated throughout the 1990s, but improved dramatically in recent years; rising medical costs and severity resulted in more than half of all workers’ comp accounts renewing up at least 20 percent in 2002, though 55 percent of these accounts renewed negative in the last quarter of 2004; and catastrophic losses in states like Florida, Texas, and California leaving a lot of uncertainty in homeowners insurance.
While there are many competing hypotheses for the underwriting cycle, Hartwig concluded, some solutions include shifting the basis of competition to emphasize underwriting, maintaining underwriting and pricing discipline, removing regulatory barriers, and shortening the information lag by investing in management information systems.
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