Those new to property and casualty insurance are reportedly first struck by the cyclical nature of the industry.
Generally, extended periods of soft pricing are followed by much shorter periods of hard pricing. After three solid years of price firming, segments of both the reinsurance and commercial lines markets exhibited signs of turning in late 2004 and in the first half of 2005, according to Review/Preview 2006–Property/Casualty Edition, issued by A.M. Best Co.
According to the report, growth in premiums written leveled off considerably. What was once a tight knot on terms and conditions was starting to unravel. Most saw the return to another soft market. In the hard-to-soft market game of who will blink first, many eyelids were fluttering. Clearly, a soft market was imminent and predicted for the commercial and reinsurance segments.
The market softening was interrupted by the one-two-three punch of hurricanes Katrina, Rita and Wilma, which slowed the turning market. Any thought of a softening personal lines market was immediately squashed by these storms. These events, particularly Katrina, had ramifications on the insurance industry that went beyond the current estimate of up to $60 billion of insured losses.
Two months after more than $50 billion left the market, approximately $20 billion was put in as investors translated current losses into future opportunities. Of this amount, nearly $12 billion was raised by existing reinsurers reloading. Start-up companies, primarily writing reinsurance, rallied capital, quickly organized management teams and made the trek to visit A.M. Best’s analysts. The rush was on to take advantage of the higher pricing anticipated at the Jan. 1 renewals.
Beyond the ramifications of hurricanes Katrina, Rita and Wilma, the industry had to cope with the far-reaching fallout from the investigations of New York state Attorney General Eliot Spitzer. Then consideration must be given to the “standard run of the mill” operating issues: Sarbanes-Oxley compliance issues and costs, the status of the renewal of the Terrorism Risk Insurance Act, concerns for the viability of asbestos and environmental liability funding and debate over a national catastrophe risk plan.
Growth in written premiums is expected to remain in the low single digits in 2006 as the softening market continues and price decrements and weakening terms and conditions become more commonplace. Yet the industry’s results will remain strong as underwriting discipline remains at the forefront of decision making and catastrophe losses are expected to return to a more normalized level.
However, given the projections for continued above-average hurricane activity, A.M. Best has increased the estimated catastrophe load for 2006 to 4 points from the historical 3-point estimate. Underwriting profits are likely to be complemented by increased net investment income as cash flows remain positive, long-term interest rates inch upward and cash reserves are invested in higher-yielding investment instruments, forcing surplus still higher.
Although these trends have fortified the financial health of the U.S. property/casualty insurance industry and allowed it to absorb the worst catastrophe season on record, a number of thinly capitalized, poorly positioned and undisciplined players will face downgrades as they fall prey to accelerating competition.
While the effects of the record catastrophe losses have added several points to the loss ratios of many carriers, the overall impact of these losses is not expected to create widespread solvency issues. Rather, a few insurers that will be faced with the inability to recapitalize their balance sheets to the level that supports their ratings, or whose risk-management capabilities will be called into question, will suffer downgrades to their financial strength and credit ratings.
With success comes challenges, and insurers will be confronted with more aggressive competition both in pricing and in terms and conditions in 2006. With policyholder surplus at record levels, pressure likely will mount on carriers to generate adequate returns on capital.
Accordingly, it will become increasingly difficult for companies to hold the line on the underwriting culture that has been synonymous with market conditions since the end of 2001.
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