NU Online News Service, July 21, 2:00 p.m. EDT

As reserve releases slow, accident-year losses rise, and investment yields weaken, property and casualty insurers may need to reconsider cost reductions in the form of cutting salaries and advertising budgets to improve profitability, according to a Keefe, Bruyette & Woods industry update.

While the industry is not yet talking about cost cutting, KBW says, the lack of growth may force the issue. “Many companies already went through a round of layoffs and cost cuts in 2008-09—always a painful effort and not one which management teams want to go through again,” the firm notes.

But KBW adds, “As hopes for a meaningful improvement in the economy fade and the end of the soft-market pricing appears to be more of an easing rather than a traditional hardening, we believe that a lift to premiums may yet be distant. Cost cuts, in addition to capital management, may be the easiest tool available to improve profitability.”

KBW says its review of industry expenses for companies under its coverage show “significant growth” in recent years in salaries, head counts and advertising spending. “All of these increases occurred despite a slowdown in growth and worsening margins,” says KBW.

The industry’s expense ratio, the firm says, has grown steadily from 24.6 percent in 2003 to 28.3 percent in 2010. Actual expense growth has declined since 2006, KBW notes, but that has not kept pace with the decline in premium growth, leading to the rising expense ratio for the industry over that time.

Analyzing where the industry’s expenditures are coming from, KBW says salaries have increased 16 percent since 2005, to $27.3 billion. KBW notes that Allstate and Liberty Mutual have managed to decrease salaries paid from 2006 to 2010, while Geico increased salaries by almost 22 percent.

Advertising for the industry increased 72 percent from 2005 to 2010 to over $5 billion. “The $2.1 billion increase in advertising…is eye-catching and brings to mind the barrage of insurance commercials we all frequently skip over as we use our DVRs,” KBW says.

From 2006 to 2010, State Farm has increased its advertising by almost 105 percent and Progressive increased advertising by nearly 87 percent. Geico’s advertising budget, though, is nearly 50 percent higher than the next-largest competitor, KBW notes.