Insurance News

Economist predicts rapidly hardening market in 2010

Posted on: May 22, 2009

Insurance prices are not likely to begin rising until early 2010, but federal government actions before then could mean abrupt price spikes rather than gradual shifts, an economist suggested yesterday.

Steven Weisbart, chief economist for the Insurance Information Institute, speaking on a webinar hosted by Advisen, a New York-based research firm, likened the potential impact for the insurance market from proposed reforms in financial services regulation to the steep hard-market price push following rating agencies’ changes adopted after Hurricane Katrina.

“Following Katrina, most of the rating agencies changed their models to require that companies hold more capital than had previously been thought to be needed,” he said. “I wouldn’t be surprised if essentially that same kind of thinking in spades sets in later this year,” he added, referring to capital that might be needed if the system of U.S. insurance regulation is overhauled.

Mr. Weisbart made his remarks after Advisen co-founder David Bradford presented an analysis of market dynamics, predicting a gradual uptick in prices starting in 2010.

Mr. Bradford noted that insurance prices rise when industry capital shrinks faster than the demand for insurance, explaining that industry capital or policyholders’ surplus is a proxy for supply in the supply-demand economics of insurance, while using changes in U.S. gross domestic product as a measure of demand.

“The whole question of what is adequate capital is certainly up for grabs,” Mr. Weisbart said, noting that U.S. Treasury Secretary Timothy Geithner has called for stricter capital standards for insurers that are “systemically important” or in a “position to affect the U.S. financial system” under a two-tiered regulatory structure.

“What I take from that is when the regulatory overhaul is implemented, we may wind up concluding that the insurance industry is not only not overcapitalized anymore “at least those companies that are systemically important “but may be close to needing more capital depending on what the [new] standards are.”

Mr. Bradford, summarizing an assessment by his firm published earlier this week in a special report titled “The Insurance Market in 2009: A Market Poised for Change,” predicted a continuation of the “steady surplus erosion” that began in 2008, noting that in the absence of a sudden shock “like catastrophe losses that would deplete capital quickly “premium hikes will be gradual when they emerge.

He contrasted the likely scenario for early 2010 with the hard market that followed the 9/11 attacks in 2001. Then “we saw a ricochet effect, a boomerang effect where rates shot up suddenly,” Mr. Bradford said, explaining that significant industry losses and sudden capital depletion produced that effect.

“We don’t see that happening [now.] We see rates gliding into the bottom of the cycle later in 2009 and just rattling around for a while,” he said.

Presenting a purely mathematical analysis to support the view that prices are indeed poised to rise in early 2010, Mr. Bradford looked at ratios of U.S. industry policyholders surplus to gross domestic product over past cycles, finding that when the ratio reaches a level of 3.2 percent “as it did at year-end 2008 “the market historically shifted to the next phase (hard or soft) within 12 months.

Mr. Weisbart agreed with Mr. Bradford’s timing of the market turn based on his own analysis of the demand side of the economic equation. “Next year, not this year,” he said.

“The principal question is…how long will recession drag on,” the economist said, noting that insurance lines impacted by commercial activity “increased payrolls, factory restarts and replacements of depleted inventories “are somewhat dependent on the federal government stimulus package.

A lot of the stimulus money is not going out until the end of this year or beginning of next year, he said, citing an example from a report by the General Accounting Office indicating that $450 million in stimulus funds are earmarked for highway repair in Massachusetts, but only $60 million is on its way to the Bay State right now.

“We’re talking about a real drop in the bucket right away,” he said. “So in terms of economic activity [and] in terms of top-line insurance premiums, I think that means 2010 at the earliest,” he said.

Giving a broker’s perspective, Eric Andersen, chief executive of Aon’s U.S. retail business, dismissed the description of the current market as an “invisible hard market” that was first presented early this year by Brian Duperreault, CEO of Marsh & McLennan Companies.

Mr. Duperreault, in a much-quoted speech, described a situation where premiums don’t rise along with insurance prices because the exposure bases used for commercial insurance pricing (sales and payrolls) are still falling.

“I’d actually use the term still a soft market,” Mr. Andersen said, indicating that prices aren’t even rising yet “especially in the small commercial market, the largest segment of the business.

The Aon executive noted that because of the economic recession, insurers can’t dig into empty customer pockets to charge higher rates. Customers “are in absolutely no condition to pay more money for insurance. There have been many, many meetings [with clients] that have opened up with that statement,” he reported.

Customers who are suffering economically are willing to move to insurers offering lower prices “an option they might not have considered in the past” and they are looking at higher deductibles and other ways to retain risk and lower premium costs.

Another aspect of the coming hard market discussed by webinar participants is the likely duration of the period of price increases ahead. Generally, webinar panelists agreed with Mr. Bradford that tight credit markets will hold back the flow of new capital coming into the insurance business to start up new companies “a situation distinguishing the coming hard market from prior ones and potentially causing the next one to last longer.

Depending on the event that precipitated a need for capital, however, Mr. Weisbart said he could foresee one significant alternative source of capital “the federal government.

“Particularly if we’re talking about a large hurricane or a big earthquake, one would guess that, politically, the Obama administration would be very eager to show a much more effective record than the Bush administration [had] in 2005,” he said.

© Copyright 2009 National Underwriter Property & Casualty. A Summit Business Media publication. All Rights Reserved.

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