Insurers Trim Expenses, But Not Commissions

Budgets tightened mostly in home offices & branches; producer payments track premiums

Its expensive to underwrite property-casualty insurance, with 25 cents of every dollar going toward underwriting expenses. And it hasnt gotten a whole lot cheaper in recent years despite discussions of cost-cutting efforts by individual insurers.

Still, the overall net underwriting expense ratio for the property-casualty industry did drop roughly 2.6 points over the past seven years, from a level of 27.6 back in 1998. In 2003 and for the first nine months of 2004, the average industry statutory expense ratio on a net-of-reinsurance basis held at about 25.0.

In NUs second “Data Insights” issue of 2005, we present individual insurer and industrywide information for two large categories of insurer expensesdirect commissions and salariesand overall expense ratios, using figures compiled from the U.S. Insurance product of National Underwriter Data Services.

Most of the charts presented on these pages provide information for the six full years ending with 2003the last full year of data available. Our expense ratio chart (page 16), however, is supplemented with nine-month 2004 data filed on quarterly reports with regulators.

While our expense ratio chart gives some sense of which insurers run the leanest businesses, when full-year 2004 figures are available, they will shed more light on the added costs that some insurers are recording as they tally up bills for Sarbanes-Oxley compliance.

So far, the overall nine-month 2004 expense ratio for the industry, at 24.8, looks impressive by historical standards. According to the Jersey City, N.J.-based Insurance Services Office Inc., the last time the p-c industry expense ratio was near 25.0 was in 1986, when it fell to 25.2. And that broke a record that stood since 1959. (ISO publishes this information annually in its “Insurer Financial Results” publication.)

Close examination of the downward expense ratio trends through the first nine months of 2004 reveals that the declines are not an indication that p-c organizations are being more efficiently run. Instead, underlying movements in expense dollars and premiums show that while insurer costs continued to grow, the far faster growth in hard-market premiums is what brought overall expense ratios down to record-low levels.

After hovering around 28.0 in 1998, 1999 and 2000, the industry expense ratio took its first major dive in 2001. With net premiums finally climbing 7.5 percent after years of soft market pricing, the expense ratio tumbled to 26.5 in 2001 from 28.3 in 2000. The ratio fell another point in 2002 as premium growth doubled, and moved down to 24.9 in the last year of the hard market2003.

According to aggregate industry expense figures, there are only three areas where p-c insurers as a group have actually cut costs since 2000equipment expenditures, travel and printing. Industrywide, insurers slashed $1.6 billion from equipment costs in 2001the largest single-year drop for any expense line item shown on insurance company annual statements.

For the industrys rank-and-file employees, there was more bad news than just feeling chained to the desk by tight travel budgets and struggling with the same old tools. Salary growth has been unimpressive, especially when compared to premium and commission growth figures.

Salaries related to underwriting activities represent the second largest underwriting expense category for insurers, accounting for roughly 20 percent of overall underwriting expenses. These salaries grew just 3.4 percent in 2001, 4.0 percent in 2002, and 7.3 percent in 200315.4 percent in total for the three years. Over the same time period, net written premiums grew more than twice as much34.3 percent.

(Its worth noting that claims personnel did only slightly better than underwriters from a wage growth standpoint, averaging a 20 percent boost over the last three years, compared to 15 percent for underwriters. On page 17, we present individual company salary figures for all company activitiesincluding claims handling and investment activities, not just the underwriting portion that finds its way into the underwriting expense ratios.)

The differential between salary growth and premium growth was a key factor in driving down the overall industry ratio of net underwriting expenses-to-premiums. (See accompanying bar chart.) In 2001, the ratio of underwriters salaries-to-premiums (net of reinsurance) fell to 5.8 from 6.1 in 2000. That was followed by a more significant change a year later, when the salary-to-premium ratio fell even further–to 5.3 in 2002.

Agents and brokers did better in the compensation department, with insurance companies paying commissions that grew almost in line with premiums year-over-year. Since commissions represent the largest underwriting expense items for insurers (nearly 40 percent of their underwriting expenses overall), the fact that commissions did not grow exactly as much as premiums was a second factor driving expense ratios down in recent years.

Unlike the salary ratios, which took two major steps downward in 2001 and 2002, net commission ratios for the industry have tended to glide down gradually since 1998, falling slowly from 11.3 in 1998 to 10.4 in 2003.

That is not the case for individual insurers, however. The accompanying line graph (page 15) displays ratios of direct commission to direct premiums for 10 large commercial insurers, showing that their strategies have varied widely.

(Unlike the net commission rates summarized on the previous bar graph, direct commissions are shown on the graph on page 15, allowing readers to make carrier-to-carrier comparisons of compensation paid to producers without the noise of ceding commissions paid by reinsurers. Direct commissions have grown more than 42 percent over the six years from 1998-2003, falling a bit shy of direct premiums, which grew 49 percent.

The previous bar chart summarizes net commissions, which grew 31 percent from 1998-to-2003. These net-of-reinsurance figures ultimately find their way into insurance company expense and combined ratios, and can be used by insurance company readers to benchmark their overall expense ratio performance.)

While p-c insurer expense ratios were for the most part helped by the impact of the hard market, even insurers couldnt escape some of the negative impacts of higher-priced insurance when they dug into their pockets to buy coverage for their own operations. Insurance expenditures grew 40 percent from 2001 to 2003, while net premium revenues taken in grew only 25 percent over the two-year period. Employee benefit costs packed a bigger wallop, jumping more than 70 percent over the two-year period.

Expense Ratio Champions

The ups and downs of insurance market cycles had almost no impact on the overall expense ratios of a select group of insurance organizations. These expense ratio championsincluding direct writers New Jersey Manufacturers and USAA, as well as broker writer American International Group, seem to have the formula for recording low expense ratios year in and year out.

For others, bringing expenses in line has been a struggle. Notable in this group is CNA (Continental Casualty Group). Once ranked among the insurers with the highest expense ratios on our ranking of 59 large insurers, CNA improved its expense ratio more than any other insurer listed (ignoring ceding commission impacts). CNA shaved 5.0 expense ratio points between 2001 and 2003, in spite of the fact that the Chicago-based insurer was still shedding premiums in 2001.

Our ranking of insurers by expense ratio (on page 17) includes only 59 insurers that wrote more than $1 billion in net premiums in 2003. On our Web site, a larger ranking of 222 insurance organizations writing more than $100 million in premiums in 2003 (and reporting non-negative expense ratios from 1998-2003) puts additional direct writers at the top of the list.

Interestingly, eight of the top 20 shown on our Web site ranking are medical malpractice insurers, whichas a groupwere the least profitable companies in our first Data Insights report (published Jan. 24). In contrast, some of the most profitable companies (those with the lowest combined ratios) show up with the worst expense ratios, mainly as a result of paying out higher commission rates to agents and brokers.

Other chart for this article:
-Expense Ratio Champions
-Salary Increases Lag and Who Pays Them

Reproduced from National Underwriter Edition, February 18, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Insurers Trim Expenses, But Not Commissions

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