Economy Forcing Changes in Carrier Investments

May 19, 2009

The current economic environment has produced several influences that in combination are negatively affecting, or at least stressing, property casualty insurance carriers in unique ways, according to one experienced industry analyst.

Investments in financial services providers, such as banks, Fannie Mae preferreds, Fannie Mae issues and debt obligations, have long been thought of as excellent instruments in an insurance company’s investment portfolio, explained Joe Petrelli, CEO of Columbus, Ohio-based actuarial consulting and financial analysis firm, Demotech, during a podcast with Wells Publishing’s CEO Mitch Dunford and Editorial Vice President Andrew Simpson.

Interview with Demotech’s Petrelli

Now, uncertain conditions in the financial services sector are causing many carriers to rethink that viewpoint to the extent that they no longer know how to value the quality of investments in their portfolios, Petrelli said.

He explained that insurance carriers traditionally would maintain a high quality portfolio that provided an investment income stream to augment premiums. With the economic meltdown that investment income stream is not as reliable as it has been in the past.

Additionally, Petrelli said, “even though we are in an environment where there is relatively low inflation, what is happening to the insurance industry is that relatively low inflation is impacting their ability to increase premiums, but at the same time losses are increasing markedly.”

Still, the property casualty insurance industry in general remains strong.

“The thing that is interesting to me is that from a count perspective, if we look at approximately 3,000 companies in the property and casualty insurance industry, from the perspective of sheer count of companies, the overwhelming majority – probably north of 85 percent of the companies – are absolutely fine, and this meltdown in the equity markets, it really isn’t hurting them,” Petrelli said.

Larger, more visible companies have felt the adverse impact of the meltdown most severely, while smaller, regional and specialty companies never invested in exotic investments or got involved in derivatives or any of the types of investments that landed larger firms in trouble, he said. “They stayed with very vanilla portfolios consisting of cash, CDs, government obligations, including federal and state. They just never went there.”

Smaller, regional companies have been able to avoid the financial pitfalls that have beleaguered larger insurers for a number of reasons.

“Number one – the overwhelming majority of the smaller companies are not publicly traded, or beyond that they are mutual companies instead of stock companies. So, there was no investor focus whatsoever,” he said. “They didn’t have to worry about what their quarterly earnings were going to be. … They just focused on delivering insurance to their stakeholders and their insureds, and servicing their business.”

Petrelli acknowledges that many well run publicly traded companies have weathered the current economic storm and are doing fine. As for the smaller companies, they remained committed to fundamental insurance concepts, maintained the quality of their investment portfolio, watched liquidity and the adequacy of loss reserves, focused on the quality of reinsurance and kept their eyes on their business models.

In the current investment environment, with companies struggling to get a decent cash flow, expectations are that insurers will need to raise premiums to make up for investment losses. However, if consumers are unable or unwilling to pay more, carriers may not yet be in the position to raise prices significantly.

Petrelli doesn’t think premium prices are going to rise substantially any time soon. He said it may be the third quarter of 2010 before any significant pricing changes occur. “And it’ll probably be 2011 before things really turn the way the industry would like,” he said.

He said he hopes one outcome of the crisis in financial services will be a change in the way ratings agencies do their jobs.

“One of the dilemmas we have with the downturn in the financial services industry is the sub-prime debt that had been rated triple ‘A’ by many of the rating agencies,” Petrelli said. “We’re now finding that certainly was not triple ‘A’ debt, and there were perhaps some flaws or at least optimistic assumptions in their algorithms and in their financial models. So, I would hope that the rating agencies will recalibrate the way they view debt.”

He would also like to see international insurance rating agencies focus more on fundamentals.

“We want insurance fundamentals first,” Petrelli said. “We want good liquidity in the balance sheet. We want high quality, verifiable assets. We want loss reserves to be adequate, not just reasonable. We’d like to see high quality reinsurance, and we’d like to see companies sticking to what they know, rather than trying to expand just to make a rating agency happy.”

This story was based on an installment in the podcast series, Agency Management Done Right, hosted by Wells Publishing CEO Mitch Dunford, www.insurancejournal.tv/videos/2437/. Wells Publishing is the publisher of Insurance Journal, Claims Journal and MyNewMarkets.com.

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