With 2010 in the rearview mirror, it is now time to focus on2011.

The year just ended, like the two tumultuous years before it,proved to be an important one for the future of the property andcasualty insurance industry. The tsunami of major economic,political and regulatory events of 2010 will not only fundamentallyreshape the industry but also alter its growth and profitabilitytrajectories for years to come.

On the economic front, 2010 was a year with one foot stillfirmly planted in the recessionary gloom and economic turmoilresulting from the global financial crisis. Premium growthlanguished for much of the year as demand for most types ofproperty and liability coverage remained slack and insurance buyersin personal and commercial lines alike continued to pinchpennies.

But 2010 was also a bridge—a transition year—to the post-crisisworld. The era of mass exposure destruction was, at long last,over. By year's end, with the economy clearly on the mend,consistent private sector job creation and a strong stock marketperformance, the p&c insurance industry could only benefit.Indeed, one of the earliest signs of recovery is the fact that thep&c industry recorded positive premium growth in 2010 for thefirst time in four years.

Yet were it only so simple that a recovering economy andpositive premium growth would cure all that ails the insuranceindustry. There are many other powerful economic, political anddemographic forces that will shape the p&c insurance industryin 2011 and beyond, including diminished investment earnings, a newregulatory structure and the continued deterioration of the tortenvironment.

THE ECONOMIC OUTLOOK FOR 2011: A REBUILDING YEAR

Foremost on the minds of insurers, agents and brokers is whatthe recovering economy will mean for them on both the top and thebottom lines.

Looking at the top line—and putting aside the issue of rates forthe moment—the recovering economy is unambiguously good news forinsurers and producers alike. Consider the following exposuredrivers:

• Employment and Payrolls

While unemployment remained stubbornly high throughout 2010,hovering just below 10 percent, more than 1.2 million privatesector jobs were created during the year. When jobs are created,payrolls expand. Indeed, the payrolls of private employers—theexposure base for workers' compensation insurers—expanded by anestimated $175 billion in 2010.

Job growth is expected to accelerate in 2011, which will likelyswell payrolls by an additional $200 billion (or more) in 2011.

• New Car/Light Truck Sales

After falling to 10.3 million vehicles in 2009, down 39 percentfrom a peak of 16.9 million vehicles in 2005, new car/truck salesrose to an estimated 11.5 million units in 2010.

A further increase to 12.8 million vehicles is expected in 2011,much to auto insurers' delight. 

 • Industrial Production and CapacityUtilization

Industrial production is expected to expand by approximately 4.5percent in 2011 following an estimated gain of 6 percent in2010.

Industrial production had plunged by as much as 17.6 percent inthe midst of the financial crisis during the first quarter of 2009.Capacity utilization at the nation's factories and utilities—at75.2 percent in November 2010—was well above its recession low of68.2 percent recorded in June 2009 but remains well below thelong-run 80.9 percent average from 1972 to 2008).

Renewed strength in both of these metrics indicates increaseddemand for commercial property and liability insurance needed inthe production process as well as on the finished goods produced.Additional demand is generated as increased transportation of goodsdrives commercial auto, inland marine and marine coverage.

At the same time, the number of businessbankruptcy filings is beginning to fall, helping to preserveexisting demand for insurance products and services and theirassociated revenue streams.

• New Housing Starts

Construction of new homes bottomed out at 560,000 units in 2009,down an astounding 72 percent amid the housing crash from 2.07million units in 2007. The plunge affected home insurers as well asinsurers with books of business tied to the construction,contracting and home supply industries.

The forecast is for a very gradual and tepid recovery, to590,000 units in 2010 and 690,000 in 2011. For home insurers thismeans extremely slow exposure growth, especially as new homes beingbuilt today are generally smaller and less expensive to insure thanhomes in the pre-crash era.

Many commercial insurers will continue to find it difficult togrow their construction book of business as investment inresidential and nonresidential real estate remains moribund andcash-strapped state and local governments continue to lack theresources to invest in infrastructure.

Of course, demand for insurance (exposure) is not the onlyfactor driving the industry's top line. Rate is equally if not moreimportant and on this front the message remains decidedlymixed.

Personal lines, which accounts for approximately 50 percent ofall premiums written, entered 2011 with realized rate gains in boththe private passenger auto and homeowners lines.

According to federal statistics, private passenger autoinsurance prices were up about 5 percent, although shopping andother consumer behaviors (e.g., moving to a higher deductible)reduce the net gain to insurers to roughly 3 percent. The increaseis notable given that private passenger auto insurance is thelargest of all p&c lines, accounting for more than one-third ofall industry premiums.

The cost of homeowners insurance is up approximately 2 to 3percent.

In commercial lines, however, renewals heading into early 2011were still slightly negative, according to most price indexes.

FAVORED REGIONS, FAVORED INDUSTRIES

The Great Recession is generally viewed as having wroughtindiscriminant destruction across the entire American economiclandscape. The reality of the Great Recession's destructive forceis something quite different, with the experience of individualstates, regions and industries varying widely.

Unemployment rates, for example, during the recession rangedfrom more than 15 percent in the hardest hit states, such asMichigan, to as little as 4 to 5 percent in others, such as NorthDakota.

In terms of economic growth (and exposure creation), theeconomies of a surprising number of states continued to growthroughout the recession while others languished. In 2009, real(inflation-adjusted) economic growth in Oklahoma led the nation at6.6 percent, while Nevada's economy contracted by 6.4 percent.

The enormous divergence in fortunes among the states—and theirsubsequent ability to recover—has important implications forinsurers. Some p&c insurers may find themselves well situatedto seize on the early opportunities that the uneven recoveryaffords, while others remain too tightly tethered to a regionalfootprint or industry mix beset with continuing economicproblems.

If there was a "sweet spot" for insurers during the GreatRecession it was clearly the swath of states stretching from Texasnorthward through the Plains and Mountain states. Most of thesestates were not major participants in the housing bubble andtherefore avoided the harshest effects of the ensuing collapse. Inaddition, most of these states are pro-business and have highexposure to favored industries as discussed below.

Regional differences in the pace of recoveryare the norm in the wake of every recession. Likewise, growth incertain industries will outpace others. Industries likely to leadthe way in the recovery from the Great Recession include healthcare (irrespective of Republican efforts to reshape legislationpassed in 2010), agriculture, energy (traditional and alternative),natural resources, technology, transportation and export-orientedsectors.

Insurers with high exposure to these industries are wellpositioned to realize early stage growth.

As the recovery matures, retailing, recreation and hospitality,travel, and possibly even manufacturing will show more dynamicgrowth.

Construction, unfortunately, remains a laggard due to a glut inresidential and nonresidential real estate, lingering credit marketwoes and strained public sector budgets.

 IT'S NOT JUST THE ECONOMY, STUPID!

The economy will be a major influence on the p&c insuranceindustry's top line in 2010, but the bottom line is somethingaltogether different—and underwriting performance, not the economy,in the long run is the most important driver of bottom lineresults.

Indeed, with a combined ratio of approximately 100 in 2010(excluding mortgage and financial guaranty insurers), insurers findthemselves for the second year in a row at the razor's edge ofunderwriting profit and loss. Last year's breakeven underwritingperformance, as in 2009, was possible only because catastrophelosses were no more than average and because prior year reservereleases knocked three to four points off the combined ratio.

Catastrophe losses in the future are more likely to surge thanshrivel, and the pool of excess reserves available for releaseafter seven years of declining commercial insurance prices isbecoming quite shallow.

Managing for an underwriting profit is critical.

Other critical factors include managing for the new investmentparadigm—one in which the rate of return on fixed income securities(which account for two-thirds of industry investments) issuppressed by Federal Reserve monetary policy. The effect is thatinvestment income is slumping and providing less of an offset forfuture underwriting losses.

Landmark legislation in the form of last year's Dodd-Frank WallStreet Reform and Consumer Protection Act represents yet anotherhurdle for insurers to clear in 2011. While the industry waslargely successful in avoiding the imposition of inappropriatebank-style regulation, the current implementation and rulemakingphase of the Act poses a number of risks.

First, insurers are legitimately concerned that the newlycreated Federal Insurance Office, while in principle a source ofinformation and expertise within the Treasury Department, couldsuffer from mission creep, with the FIO being laden down withresponsibilities that duplicate those already performed by thestates or worse, adopting an activist agenda, which could provecostly and confusing to insurers and consumers alike.

The dawn of each new year poses a unique set of challenges, and2011 is no exception.

The long-awaited strengthening economy, on the other hand,brings with it many opportunities for growth—the first in severalyears.

The ages-old test for insurers will be to manage thoseopportunities in a way that paves the road for sustainedprofitability in the years ahead.