IF YOU want to know where the insurance market is headed, Frank J. Coyne, chairman, president and CEO of Insurance Services Office has some familiar advice for you: Follow the money. In this case, the money in question is insurers' surplus, or net worth. At the American Association of Managing General Agents' annual convention, which was held in May in Maui, in the Hawaiian Islands, Coyne made the case that a drop in surplus in the third quarter of 1999 set off a hard market and that its recovery in the last few years has led to today's steadily softening rates. (The exception, of course, is for property rates in catastrophe-prone areas.)
"The short explanation for both hard markets and soft markets is supply and demand," said Coyne, who proceeded to focus on the former. "The supply of insurance depends on insurers' capacity to provide financial protection," he said. "Insurers' capacity depends on their surplus."
According to charts Coyne presented, insurer's surplus started falling in mid-1999, from approximately $341 billion, and bottomed out a year after 9/11 at roughly $273 billion. Since then, however, it's risen steadily. "With industry (surplus) having risen to a record high $427 billion at year-end 2005, no one should be surprised that insurance markets are softening," Coyne said.
The first factor that has fueled the rise in surplus has been a big improvement in carriers' underwriting results, Coyne said. The industry's combined ratio--the measure of insurers' loss costs relative to earned premium and other expenses relative to written premium--peaked at roughly 116 following 9/11, Coyne observed. Then it fell steadily to 98.3 at the end of 2004. "Instead of losing almost 16 cents on every dollar of premium, insurers made almost two cents," he said. "Even with last year's record-setting catastrophe losses, the combined ratio (for 2005) rose to just 100.9. Adjusted for what I hope is abnormal catastrophe losses, the combined ratio for 2005 was a profitable 95.1"
It indeed seems remarkable that insurers were able to cope so well with the storms of 2005. That, said Coyne, "is a testament to the efficiency and scale of global risk-sharing mechanisms." While cat losses hit a record $58 billion in 2005, Coyne said ISO estimates that U.S. insurers ultimately will be on the hook for $31 billion to $36 billion, after reinsurance recoverables.
To the degree that primary insurers sidestepped last year's hurricanes, reinsurers were hammered. "Numerous sources report that property reinsurance rates are now rising substantially for U.S. risks in cat-prone areas, increasing primary insurers' costs," Coyne said. (He was silent, however, on the implications for carrier surplus.)
With underwriting result at a break-even or better level over the past couple of years, insurers' investment results, the other major contributor to surplus, have become gravy. While annual investment income fell some $3.5 billion, to $37.2 billion, between 2000 and 2002, there's been a turnaround since. Between 2004 and 2005, investment income rose to $49.5 billion from $40 billion, a 23.7% increase. "There was a $3.2 billion one-time special dividend received by one of the Berkshire Hathaway portfolio companies," Coyne said. "Even excluding that, we had a healthy 15.8% increase in investment income last year."
When you put it all together, Coyne said, you get an industry that, last year's hurricanes notwithstanding, rebounded from a -2.3% rate of return on surplus in 2001 to a 10.5% return in 2005. "Even excluding the $3.2 billion one-time special dividend, the rate of return in 2005 was 9.8%," Coyne said, "still an impressive number for the property-casualty industry."
With the bottom line doing so well, imagine how deliriously happy the industry would be if the top line were too. Alas, that is not the case. The skunk at this garden party is net written premiums, which rose just 1.8% last year. In fact, since growth in NWP peaked at 14.1% in 2002, it has gone steadily downhill, reflecting lower rates.
That insurers are earning higher profits on less money would seem in part to reflect insurers' underwriting acumen. That, Coyne implied, has been enhanced by carriers' growing use of technology advances like data mining, modeling and scoring. They've enabled carriers to "operate with scalpels instead of meat cleavers when they decide to grab market share or stand back," he said. (While Coyne didn't say so, that presumably includes standing as far back from Southeastern coastal property risks as regulators will allow. Whether insurers are using a meat cleaver or scalpel there has been a topic of lively debate among agents.)
So what lies ahead? More softness--but also more profitability, according to Coyne's figures. He sees 2006 net written premium rising by an anemic .7%. Still, the combined ratio should drop slightly, to 100.3, while net investment income is forecast to jump 16.5%, to $57.6 billion. As a result of these and other factors, Coyne sees a 9.4% rise in surplus, to $467 billion. To go back to where we started this discussion, that should mean the market will get even softer in 2007. For MGAs, Coyne noted, admitted carriers are likely to come after more E&S business. While he didn't address concerns of retail agents and brokers, it's pretty clear that they need to be ready to get by with less commission income--and hope that state attorneys general don't mess with profit-sharing contingencies.
In concluding his comments, Coyne said the industry's current performance does not guarantee that it could withstand another hurricane season like the one of 2005. Then he added, perhaps with carriers primarily in mind, "But so far things are going well for the industry, and you're in a beautiful place, so enjoy it."
