Insurance News

P&C Industry Braces For Difficult Decade

Posted on: January 7, 2010

We made it! This exceedingly volatile, outrageously expensive and mercilessly cruel first decade of the new millennium careened to a chaotic close and somehow, incredibly, the property and casualty insurance industry crossed the finish line more or less intact.

The odds were certainly against us. The decade witnessed two recessions, a pair of wars, terrorist attacks, record catastrophe losses, global warming, record oil prices, the biggest corporate bankruptcies and swindles in global history, a collapse of the banking sector, record federal deficits, a hostile Congress and an angry, anxious public.

To think that we began the decade consumed by fear over Y2K?we were so naïve back then, weren?t we?

We?ve now been freshly delivered onto the doorstep of a new decade and there is every reason to be fearful about what lies beyond the threshold.

Yes, the p&c insurance industry has a track record of successfully managing through difficult times, but the ?00s? may have been little more than the opening act for the ?10s.?

The rhyme of history–observed as the underwriting cycle in the insurance industry–provides some assurance that the future will not come completely untethered from the past. Beyond this there are no guarantees.

Nevertheless, there are many powerful economic, political and demographic forces that will reshape the p&c insurance industry in the decade ahead, including diminished investment earnings, a shifting regulatory structure, the prospect of higher catastrophe losses, as well as the virtual certainty of a deteriorating tort environment.

The following are some observations about what the p&c insurance industry should expect in the decade to come:

? Underwriting performance will need to improve in the 2010s!

One baby step into the new decade reveals an industry at a tipping point. With a combined ratio of approximately 100 in 2009, insurers find themselves at the razor?s edge of underwriting profit and loss.

But there is little doubt where we are headed. The momentum of markets and the reality of the annual statement tilt us toward higher industry combined ratios in the years to come, forcing insurers to grapple with rising underwriting losses at a time of low investment returns.

A breakeven underwriting performance in 2009 was possible only because catastrophe losses were abnormally low and because prior year reserve releases knocked about four points off the combined ratio.

Catastrophe losses will surge sooner rather than later, and the pool of excess reserves available for release after six years of declining commercial insurance prices is becoming quite shallow.

Managing for an underwriting profit is critical. Data shows that p&c insurer impairment rates over the past 40 years are highly correlated with underwriting performance.

? The new investment paradigm for the 2010s: Back to the Future!

Managing for an underwriting profit in the 2010s is unquestionably more important than at any time since the early 1970s. Indeed, the p&c insurance industry produced underwriting profits in 40 of the 60 years from 1920 through 1979, but only three in the 30 years since then.

High underwriting losses are sustainable only when investment earnings are available to offset those losses. Given the experience of the past two years, the current yield curve and structure of the industry?s investment portfolio, it?s quite obvious that those earnings are not only not available, but they?re nowhere in sight.

For insurers to be successful in the 2010s, they?d do well to study the 1940s and 1950s. During that period of time government policies kept interest rates low (sound familiar?) and insurers themselves–chastened by the experience of The Great Depression–minimized their exposure to the stock market, just as they?ve done today.

A ?Back to the Future? strategy consisting of strong underwriting margins and modest investment earnings looks increasingly like a winner because it?s the only way to sustain risk-appropriate rates of return.

Consider that through the first nine months of 2009 (the latest figures available), the annualized rate of return on average surplus in the p&c insurance industry was just 4.5 percent based on a combined ratio of 100.7. In 2005, the identical combined ratio yielded a 9.6 percent rate of return.

Virtually all of the difference is attributable to higher interest rates and a strong stock market that year.

As a final note on this topic, regulators and policyholders need to be educated on the fact that lower investment earnings–all else being equal–implies a greater insurance premium rate need.

? Expect a quantum shift in regulation!

The recent near-death experience of the U.S. financial system guarantees that the 2010s will witness the most sweeping regulatory changes this side of the Great Depression.

Congress is still debating the exact structure of the new regulatory framework, but judging by their record lobbying expenditures, financial firms are clearly concerned about the outcome.

Although heavily criticized for these expenditures, the financial industry is keenly aware that the rules and regulations passed in 2010 will define the regulatory operating environment not for the next decade, but quite possibly for most of the remainder of the 21st century.

One cornerstone of whatever plan President Barack Obama ultimately signs will involve the strengthening of prudential supervision and the creation of a systemic risk regulator.

Property and casualty insurers are working hard to educate Congress that they were not part of the problem that sparked the financial crisis, and therefore should not be subject to such regulation (currently the jurisdiction of states).

Property and casualty insurers also want to ensure that they are not subject to pre- or post-event assessments to fund losses (or recovery of government aid) associated with the systemic failures of financial institutions.

Insurers are meeting with some success in these efforts, judging by the language contained in various bills now under consideration by Congress. What is also clear is that the federal government will not overtly attempt to usurp the supervisory authority currently exercised by the states.

That being said, one of the greatest dangers insurers face is a creeping form of federal regulation that will, over time, result in what amounts to a dual regulatory system that is largely hostile to the industry.

Worse still is that much of this regulation will involve outside discussions unrelated to financial industry regulatory reform.

The heated debate over health care reform provides just one such example. In the 1,990-page bill adopted by the House of Representatives, there is language that discourages states from implementing caps on noneconomic damage awards in medical malpractice cases, despite the fact that the Congressional Budget Office said that such caps could save taxpayers $54 billion.

The House health care bill would also roll back the limited antitrust exemption under the McCarran-Ferguson Act for health insurers and medical malpractice carriers, harming the ability of smaller insurers to compete.

In addition, the same bill would provide the Federal Trade Commission with the authority to initiate studies on any line of insurance–not just health and medical malpractice.

Financial industry reform regulation currently under consideration would also create a Federal Insurance Office. While in principle the FIO would be a source of information and expertise within the Treasury Department, the danger of mission creep is real, with the FIO being laden down with responsibilities that duplicate those already performed by the states.

Because ultimately the FIO?s leadership will be staffed by political appointees, the FIO–like other federal agencies–could at times adopt an activist agenda, which could prove costly and confusing to insurers and consumers alike.

Of broader concern is that insurers could be hurt if the independence of the Federal Reserve is weakened, as is proposed in bills put forth by both the House and Senate.

Weakening the U.S. central bank?s authority to implement monetary policy and regulate the banking system could increase the influence of politics in Fed decision-making and easily lead to inflation and loss of confidence in the dollar, as well as greater instability in the U.S. financial system in general.

All of these developments would result in negative outcomes for large institutional investors and inflation-sensitive global industries such as p&c insurance and reinsurance companies.

? Will we see another doubling of catastrophe losses in the 2010s?

There is little doubt that the ?00s? were a decade of disaster. Insured catastrophe losses from 2000 through 2009 totaled approximately $193 billion–more than double the $89 billion recorded during the 1990s. Nine of the 12 most expensive disasters in U.S. history occurred during the most recent decade, even after adjusting for inflation.

The next decade could easily witness an event twice the size of Katrina?s $41 billion in insured losses, and record a single-year catastrophe loss total that would exceed $100 billion for the first time (eclipsing the $62 billion recorded in 2005).

Demographics, a volatile climate, rising material and labor prices and an eventual return to higher property values virtually guarantee that the 2010s will be even more expensive.

That the losses will occur is hardly in doubt. How they will be financed is subject to greater uncertainty. Although traditional insurance and reinsurance will continue to finance the majority of losses, an increasing share will likely be financed through securitization of catastrophe risk.

The biggest wild card is the role of the federal government. The creation of a federal catastrophe reinsurance facility is a possibility, particularly if a major catastrophic event pushes the cost of traditional insurance and reinsurance rapidly upward.

State governments, of course, ramped up their assumption of risk over the past decade–with disastrous consequences. There is little evidence that they have learned any lessons from those experiences.

? Is the tort environment a looming crisis?

The tort environment in the decade ahead will deteriorate–potentially to the point of crisis. The era of tort reform in America ended when Congress went Democratic in 2006. Erosion of the reforms of the previous decade is already underway, and no tort reforms are forthcoming from the current Congress or the Obama administration.

In addition, every piece of legislation signed into law represents a potential bonanza for the trial bar. Health care reform legislation and its gift to medical malpractice attorneys (as mentioned previously) is just one such example. Pending climate-change legislation could present the trial bar with enormous litigation opportunities.

According to a recent Towers Perrin study, tort costs?which were generally flat or down from 2003 through 2007?once again are poised to rise.

Towers-Perrin estimates that between 2006 and 2011, tort costs will increase by 17.1 percent, rising $42.3 billion to $289.2 billion–equivalent to a tort tax consuming 1.9 percent of the nation?s gross domestic product.

Historically, rising tort costs have been costly to businesses and their insurers. Tort crises of the past have had significant roles as catalysts in hard markets in the 1970s, 1980s and early 2000s.


Every new decade poses its challenges, and the 2010s are no exception.

Yet the trauma of the past decade imparts a particularly strong sense of foreboding.

The list of unforeseen challenges over the next 10 years is certainly a long one, but if history is any guide, the property and casualty insurance industry will travel through to 2020, demonstrating its resilience all along the way.

© Copyright 2010 National Underwriter Property & Casualty. A Summit Business Media publication. All Rights Reserved.

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