The commercial insurance premium market cycle is near bottom and general commercial insurance prices will start to rise by the fourth quarter of 2009 or the first quarter of 2010, Advisen Ltd., predicted earlier this week.

Advisen estimated the property-casualty insurance industry was roughly $100 billion overcapitalized as of the end of 2007. It said policyholders' surplus–statutory accounting terminology for the capital supporting underwriting operation–needed to be reduced by about $100 billion through losses, dividends, share buy-backs or other means to bring insurance supply in line with demand.

Advisen said that U.S. policyholders' surplus declined $36.8 billion, or 7 percent, for the 12 months ended Sept. 30, 2008, according to A.M. Best. Consultancy Towers Perrin forecasted as much as an $80 billion decrease in surplus by the end of 2008. Advisen added that while $80 billion represents a significant sum of the $100 billion in excess capacity–moving the market much closer to the bottom of the soft market cycle–the demand side of the equation also has changed since the end of 2007.

According to the International Monetary Fund, Advisen said, the global economy is now in a recession, with growth projected at 2.2 percent for 2009, down from 3.7 percent projected for 2008. The IMF projected that advanced economies as a group will contract 0.3 percent, with the U.S. contracting 0.7 percent.

“In years past, insurance companies recouped underwriting losses with investment income, but in 2008 the combination of underwriting losses and material investment losses means a five-year soft market is coming to an end,” David K. Bradford, Advisen executive vice president and chief knowledge officer said in a statement. “The global recession may delay the return of hard market conditions by keeping demand for insurance down, but once the hard market sets in, it is likely to last longer than was the case in recent cycles.”

The report explained that the commercial insurance pricing cycle is a function of the law of supply-and-demand. When the supply of insurance–as measured by the capital held by insurers to support underwriting–grows faster than the growth in demand for insurance, rates fall. Between the fourth quarter of 2003 and the second quarter of 2008, capital to support underwriting grew rapidly, driven by underwriting profits and strong investment returns. The rapid accumulation of risk capital fueled competition, driving down rate levels.

Advisen said that in mature economies, such as the U.S., Canada and Western Europe, the demand for insurance grows about the same pace as the overall economy. Until the collapse of the U.S. subprime mortgage market threw the global economy into a recession, economic growth was robust–although the increase in insurance supply far outstripped the growth in insurance demand.

The economic crisis impacts both the supply of and the demand for commercial p-c insurance, Advisen said. On the supply side, plummeting stock markets, frozen credit markets and in some cases, investments in “toxic” mortgage-backed assets caused many insurers to post investment losses in the third quarter.

These investment losses are on top of underwriting losses driven by five years of price cutting, higher than average catastrophe losses ($24.9 billion, higher than the full year totals for both 2006 and 2007), and reserves for directors and officers liability and errors and omissions liability claims resulting from the subprime mortgage meltdown and the subsequent credit crisis ($9.6 billion in ultimate losses over accident years 2007, 2008 and 2009, according to Advisen forecasts).

Through nine months of 2008, the U.S. p-c industry's net income after taxes fell 85 percent to $7.3 billion according to A.M. Best. After-tax return on equity (return on surplus), was only 1.4 percent for the nine month period; down from 9.5 percent for the same period of 2007. Best projects the first full-year underwriting loss since 2005, Advisen said.

According to Advisen, as companies downsize, the demand for insurance not only decreases, it decreases at a pace faster than the contraction of the overall economy.

While going without insurance is not an option for most companies, many will look for ways to slash their insurance bills. An obvious option is to raise retentions–which will increase the use of captives and other alternative risk financing mechanisms.

Advisen said that more companies will also gravitate to low-cost providers, even if it is necessary to loosen financial security criteria. Although these are typical responses to hard market conditions, it is likely that companies will resort to them even before the market turns as they are squeezed by a deteriorating economy. All these factors will help prolong the current soft market, Advisen said.

One thing that could keep market conditions competitive in some sectors is a weakened AIG battling for renewals, Advisen said. Because AIG is perceived by its competitors as vulnerable, competition for its clients will remain intense. This heightened level of competition could keep price levels in some segments of the commercial lines market depressed after economic factors indicate the market should be hardening.

Advisen added that one or more very large catastrophe losses could trigger a sudden and sharp increase in insurance prices. If catastrophe losses are mild-to-moderate in 2009, average commercial insurance prices will begin to creep higher in the fourth quarter of 2009 or the first quarter of 2010.

Not every line of business will increase at the same pace, Advisen said. Premiums already have increased for financial institution D&O and E&O, where claims are up sharply because of the meltdown of the subprime mortgage market and the ensuing credit crisis.

The reinsurance market will firm up sooner than the overall primary insurance market, placing upward pressure on heavily reinsured lines such as excess liability, Advisen observed.

Special Reports /

Advisen Predicts Market Hardening In Late 2009

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