P/C Industry Must Strengthen Underwriting to Counter Weak Investments

The most recent reports of property/casualty insurers indicate a return to profits, thanks in large measure to a quiet hurricane season. But behind the rosy reports is a thorny problem — lower investment income.

According to Dr. Robert Hartwig, president and economist at the Insurance Information Institute, insurers’ investment income fell 50 percent in 2008 and has been down again in 2009, so it’s something insurers have got to get used to.

“It’s dropping again in 2009 and those numbers aren’t going to rebound tremendously over the next several years. The reason for that is because interest rates are so much lower. The Federal Reserve is committed to keeping interest rates low. And insurers are going to invest in the lowest risk assets. So they’re just not going to generate that much in the way of investment return for years to come,” he told Insurance Journal in a recent interview.

There’s also another reason investments will be down.

“They’ve also de-risked their portfolios to a significant extent. So they’re not riding the stock market recovery as much as, perhaps, they rode it on the way down. So this is all going to temper investment earnings. Not just last year, not just in 2009, not just in 2010, but beyond.”

This investment outlook puts the pressure on insurers to appropriately price and underwrite their products.

“[T]hey have just two sources of revenue. They have premium and they have investment earnings,” he said. “The expected losses remain the same, whether we’re talking about a hurricane or an auto claim or a medical malpractice claim. The earnings on investments are going to be impacted by the current investment environment, but the losses are not.”

So the question becomes whether insurers are incorporating the new investment reality into their pricing.

“We’ve not seen that happen yet. Ultimately that reality, will have to be reflected,” answered Hartwig.

He added that it’s important that regulators, who monitor and in many cases approve rates, understand this changed investment environment as well. They have grown accustomed to insurers keeping premiums lower by offsetting losses with investment returns.

“Today, the industry is earning less in investment earnings than it was 20 years ago. And so that premium to meet the expected losses has to come from someplace,” Harwtig said.

Capital Availability

While the outlook for investment income is a concern, Hartwig has a more positive assessment of the availability of capital in the industry these days, an availability that could become important should a major catastrophe drain insurers’ coffers. He said capital markets have thawed from just a year ago.

“[A]s we approach the end of 2009 and move into 2010, the capital markets have shown once again that they do have an appetite for risk and I do believe that if the industry needed to raise the sums that it raised in the wake of Katrina, or the wake of September 11^th— where the industry raised on the order of $25 to $30 billion plus after each one of those events within a short span of time– it would be able to do it today. Maybe at somewhat higher costs, and maybe not quite as quickly, but it would be able to do it.”

That, he says, is a big change from a year ago, in the fourth quarter of 2008 or even in the first quarter of 2009, where credit markets and capital markets were effectively frozen and it would have been very difficult for the industry to raise much capital on short notice at reasonable terms.

“So, we did dodge a bullet,” he said.

Uneven Recovery

As nation’s economic recovery unfolds, it is likely to be uneven across the country and within markets, presenting both challenges and opportunities for the property/casualty insurance industry, according to the insurance industry economist.

Hartwig believes the recovery is real. There are encouraging signs including slight growth in the gross domestic product (GDP) and a slowdown in unemployment claims. The economy still needs more time to recover from what has been a very deep recession.

Hartwig noted that the recovery has taken hold first on Wall Street more than anywhere else.

“We’ve seen the stock market up more than 50 percent since it’s March lows. We’re starting to see banks and insurance companies report profits whereas a year ago they were reporting significant losses,” Hartwig said.

Yet there is a disconnect between Wall Street and Main Street.

“We’re seeing a lot of bankruptcies of small and medium sized businesses. We’re seeing difficulty for small businesses that want to expand or hire new workers to obtain credit from banks,” he said.

According to Hartwig, employment typically lags behind Wall Street and other indicators for a quarter or two before it begins to improve.

“So if the recession officially ended at the end of June or the end of July, we could expect the unemployment rate to continue to rise through the first quarter of next year and potentially into the early part of the second quarter, ” he said.

Regional Recovery

What’s happening on Wall Street versus Main Street is not the only gap. Just as some parts of the country were harder hit by the recession, some regions will be slower to recover than others, according to the III leader.

“It’s going to be a very uneven recovery across the country. Some parts of the country were hit much harder by this economic downturn than others, particularly those parts of the country that benefited from the economic boom, specifically in housing,” he said. “So states like California, Florida, Nevada, Arizona, are going to be slower to recover because they went so deeply into the recession; they suffered the worse of the collapse. For as home price are stabilizing or even increasing in some parts of the country now, places that benefited the most from the housing boom are still seeing their prices fall. So states like California may not see a recovery begin until two years after the official end of the recession in the summer of 2009. ”

Some states are doing quite well already.

“Many of the resource intensive, and natural resource intensive, energy intensive states, basically in a swath from Texas up through the agricultural heartland, through the Mountain states, up to the Canadian border, these states are doing rather well. Most did not participate in the boom, but they’re also a natural resource intensive and with the high price of natural resources throughout most of this economic downturn, they’ve done quite well, ” he said.

Future Economy

While a recession destroys many businesses, new businesses and even industries can grow out of a downturn, too. Hartwig suggests there are several industries that are growing and will need insurance solutions in the years ahead.

One promising sector is energy.

“Ten years ago, nobody was insuring windmills, hardly, and today they are. No one was insuring arrays of solar panels in the desert, and today they do. The solutions are there and insurers are willing to participate,” he said.

The growth won’t just be in new or green energy. “Traditional energy as well. We’re going to continue to have increase in demand for energy. No matter what you hear about the green revolution, the majority of energy demands in the future are going to be met through fossil fuels, particularly through natural gas,” Hartwig told Insurance Journal.

According to the III chief, insurers and brokers with a construction focus stand to gain from government funding on infrastructure projects.

“We’re going to have to continue to develop the infrastructure. We’re talking about big demand. But we’re also talking about a lot of funds being funneled through government and we’re talking about infrastructure projects.”

Finally, Hartwig is also high on export-oriented risks, including those in manufacturing, agriculture and natural resources that benefit from the low dollar. “[T]he low dollar, while it might be a bit of a record low against the euro right now, and it may come off of that low, the reality is that the low dollar’s here to stay for quite some period of time. That’s going to benefit export-oriented businesses,” he said.

Resource Box

Watch excerpts from the video interview with Dr. Hartwig or listen to the entire interview in audio on Insurance Journal TV at www.insurancejournal.tv