Although declining industry surplus would normally spur a hard market, last year's 12 percent plunge is a less potent driver of insurance market conditions than a demand falloff resulting from depression-like economic conditions, some experts say.

Last week, a joint announcement released by the Insurance Services Office, the Property Casualty Insurers Association of America and the Insurance Information Institute revealed that private U.S. property-casualty insurers had $455.6 billion in policyholders' surplus (statutory net worth) at year-end 2008, compared to $517.9 billion for year-end 2007.

Separately, a few days earlier, New York-based Advisen described the unique economic conditions that are stalling a hard market even though surplus–analogous to “supply” in the insurance supply-and-demand equation–is falling.

In a report titled “The Impact of the Economic Crisis On the P&C Insurance Industry,” Advisen said that although insurance pricing cycles are typically uncorrelated with broader economic cycles, since there is steady demand during most recessions, this is not an “average recession”–and is actually closer to the Great Depression.

“No recession since World War II has influenced both supply and demand so profoundly,” David Bradford, Advisen's executive vice president and chief knowledge officer, said in a statement.

WHAT'S BEHIND THE PLUNGE?

Fueling the $62.3 billion surplus drop in 2008–and a yet-to-be tabulated additional decline in the first quarter of 2009–were steep investment losses. During 2008, insurers recorded $19.8 billion in realized capital losses from sales of investments, and unrealized capital losses totaled $52.9 billion.

Also adding to p-c insurers' woes in 2008, were underwriting losses of $21.2 billion, translating to an industry combined ratio of 105.1. In contrast, in 2007, the industry recorded an overall underwriting profit of $19.3 billion, or a combined ratio of 95.5.

David Sampson, PCI's president and chief executive officer, noted that a $14.8 billion increase in catastrophe losses from 2007 to $21.8 billion in 2008 explained roughly one-third of the overall deterioration in underwriting results.

I.I.I. President Robert Hartwig noted that “insurers routinely plow back most of their earnings into the business in order to build up capital positions.”

But on the bottom line, last year, the industry only managed to eke out a slim profit of $2.4 billion. The result represented a 96.2 percent decline from 2007's net income figure of $62.5 billion.

Michael R. Murray, ISO's assistant vice president for financial analysis, noted that insurers' net income in 2008 would have been the lowest in more than two decades if not for the net loss the industry suffered in 2001 from the 9/11 attacks.

The 2008 net income figure translates into a rate of return of only 0.5 percent for the year–the second-lowest full-year rate of return since ISO starting collecting annual data in 1959, and 8.7 percentage points below insurers' 9.2 percent average rate of return of the past 50 years, according to Mr. Murray.

On the top line, net written premiums dropped 1.4 percent to $434.6 billion, making 2008 the weakest year for premium growth in ISO's record books. The previous record low for annual premium growth was negative 0.6 percent in 2007, Mr. Murray reported.

As premiums declined, overall net loss and loss adjustment expenses (after reinsurance recoveries) jumped 14.2 percent to $339.2 billion in 2008.

DEMAND DEPRESSED

Industrywide premium declines are “almost unheard of,” Advisen said in its report, noting that the last premium declines occurred during World War II.

While insurance exhibits inelastic demand during most recessions, “this is not your father's recession. It is more akin to grandpa's recession,” the report said, defining grandpa's recession as the Great Depression.

Advisen highlighted dismal gross domestic product and employment figures in the report. With the fourth-quarter 2008 growth at an annualized rate of negative 6.2 percent, and the unemployment rate at 8.1 percent, “this recession has already earned its reputation as comparable only to the 1981-1982 recession as the worst in the post-Depression era,” the report said.

The depths of the 1981-1982 recession saw the unemployment rate reach 10.8 percent, according to the report.

The current economic climate will cause exposure units to shrink, businesses to fail, and force companies to consider budget-cutting measures, such as higher retentions and lower limits, the report said.

As the falloff in demand produces a top- line premium drop across the industry, the economic crisis will also directly impact incurred losses due to fraud, increased professional liability lawsuits and higher workers' compensation payouts.

But in the current depressed economic environment, increased losses will not drive premiums up until policyholders' surplus “becomes more drastically reduced,” Advisen predicted. “Such loss increases will merely serve to strain insurance companies' balance sheets through at least mid-2009.”

NOT THE GREAT DEPRESSION

Mr. Hartwig drew his own analogies to the Great Depression but easily pushed aside direct comparisons by presenting some historical numbers.

Although 2007 and 2008 did indeed mark the first consecutive years of negative premium growth since 1930-1933, he said estimates from I.I.I. indicate that premiums written fell by a staggering 35 percent over a four-year span from their 1929 peak through their 1933 trough.

In addition, during the Great Depression policyholders' surplus fell by an estimated 37 percent, contrasting the 12 percent dip of 2008.

“The bottom line is that the impact of the current financial crisis on p-c insurance, as bad as it is, is not even remotely close to the impacts experienced during the Great Depression,” he said. “Indeed, premiums, surplus and assets will likely return to their pre-crisis levels within a few years, [while] it took 10-to-12 years (i.e., until 1939, 1940 or 1941) for these same financials to recover in the wake of the Depression.”

Likewise, Advisen expects a quicker recovery. When policyholders' surplus as a percentage of GDP is declining, “supply is shrinking relative to demand and a hard premium market usually follows,” the Advisen report said.

While both policyholders' surplus and GDP have been dropping, the level of decline in the GDP is becoming “less dramatic” than policyholders' surplus, “and continual large declines in GDP are unlikely to persist beyond midyear,” the report said.

Special Reports /

U.S. P-C Industry Surplus Dropped 12%

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