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U.S. Economic Problems Should Have Muted Impact On P&C Insurers

BOSTON, Ma.—The weakening economy and credit crunch will have a muted impact on property/casualty (P&C) insurers, Dr. Robert P. Hartwig, president of the Insurance Information Institute (III), told attendees of the CAS Ratemaking Seminar on March 18. In a general session, Dr. Hartwig noted that despite the slowdown in the U.S. economy, the P&C industry will be somewhat cushioned from its effects.

“Insurers are in a better position than banks and many other segments of the economy. The vast majority of P&C insurance business (98 to 99 percent) is related to renewals and is going to be renewed,” he said.

Hartwig also observed that the impact on insurers in terms of exposure growth would be marginal, because many types of insurance, such as workers compensation and auto liability, are compulsory.   

While insurers are sensitive to interest rates, Hartwig said the silver lining is that historically the industry’s best underwriting results over the last 100 years have been turned in during or following periods when interest rates were low.

“This decade is no exception. That focuses management on underwriting and turns their attention to understanding that you’re not going to be able to pay for poor underwriting and pricing decisions with what you’ve earned on the investment side of the equation,” he said.

Even though the P&C industry produced strong financial results in 2006 and 2007, the slow cyclical and economic growth environment ahead does represent a challenge for insurers. Hartwig noted that in 2006/2007 the P&C industry’s overall profitability reached its highest level since 1988, with estimated returns on equity (ROEs) of 13 to 14 percent. But the industry is now past its peak, he said.

“Profits in dollar terms peaked at about $64 billion in 2006. They are headed down now, not surprisingly, as we move further into the soft market and the pricing situation produces a deterioration in the underwriting results,” explained Hartwig.

The reality is that, on average, the P&C insurance industry does not exceed the Fortune 500 group profitability benchmark, even in peak years of profitability, he noted. Industry ROEs across personal, commercial, and reinsurance lines are all now declining.

“If history is any guide, the industry has peaks of profitability and troughs of profitability that are about 9-10 years apart from one another. If this cycle is like the past three or four cycles, it would mean in 2010 we would generate a low single-digit ROE,” Hartwig said.   

“That is literally the $64 billion question. Is this cycle going to be different from the past?” he added.

Hartwig went on to outline some of the key factors that will influence the length and depth of the underwriting cycle, such as capacity.   

He noted that the industry has had rapid surplus growth in recent years that has left insurers with as much as $85 billion to $100 billion in additional capital, according to analysts. At the same time, management is working to return capital to shareholders through share buyback programs, the value of which reached an all-time record high in 2007.

“Rising capital can lead to greater price competition. That’s what happened in the 1990s. Ultimately if it goes far enough, it takes you into the area of large-scale underwriting losses and maybe reserve deficiencies,” he said.

However, unlike a decade ago, right now reserve adequacy is in the best shape in years, which could extend the depth and length of the cycle, he observed.

Turning to investment gains, Hartwig noted that with sharp declines in stock prices and falling interest rates, portfolio yields are certain to fall, contributing to greater market discipline. Rating agencies are also quicker to downgrade companies, resulting in greater focus on cycle management.   

Meanwhile, managements today are able to make faster adjustments to price, underwriting and changing market conditions than in previous soft markets because they have better tools in terms of information systems, he added.

Hartwig concluded that after an extremely strong 2006 and 2007, insurers will have to rely on momentum and discipline to see them through 2008 and beyond.

“You as an insurer are facing the same expected losses in 2008 as you did last year, but if the investment side of the equation is going to contribute less to the bottom line, then the rest of the income has to come from the underwriting side.” “Many people outside the industry don’t understand that,” he said.   

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