Surplus for the ALIRT Property & Casualty (P&C)Composite rose 5.1% in 2014 on strong operating earnings of $25.2billion and net capital gains of $15.7 billion, partially offset byshareholder dividends and other miscellaneous charges, according tothe “Year End 2014 P&C Industry Review” report, released March19 by ALIRT InsuranceResearch LLC, Windsor, Conn. The Composite is composed of 50large U.S. P&C insurers (excluding professional reinsurers),representing approximately 53% of total industry net writtenpremium.

The report also notes that underwriting and operating resultswere weaker than in the same period in the prior year, but they didremain above historical averages by most measures, supported bycontinued positive pricing and moderate catastrophe andweather-related losses. Accident year underwriting results nearlybroke even, and prior year reserve releases, while lower, continuedto contribute to underwriting gains. Direct and net premiumswritten increased, the report says, though at lower rates than inthe prior two years, attributable to firmer pricing and slowlyimproved economic conditions.

From 1997 to 2001 the industry found itself in a “significantsoft market” in which pricing on broad commercial coverage droppedas insurers hoped to make up for underwriting losses withinvestment income. The industry saw significant price hikes from2002 to 2004, which improved cash flow until the financial crisisof 2008.

Net operating cash flows bottomed out in 2011, according to thereport, at which point pricing again became positive and P&Ccash flow again improved. Soft pricing reversed in 2012 beforedoing “real damage” to most insurer’s balance sheets, the reportsays. Prices rose for two years, then began to ease again, althoughthey remain positive.

Next page: 5 reasons why this underwriting cycle isan anomaly

(Source: ALIRT Insurance Research)

Is this current cycle an anomaly or could the commercial linesrate cycle become shallower in the future? ALIRT hypothesizes thatthe cycle is different this time, for the following fivereasons.

1. Data analytics and data mining

The industry has a great ability to gather, order and deriveactionable information from massive amounts of data, and “thescience of data analytics/data mining will only continue toexpand,” the report says, suggesting that this factor has“revolutionary implications” for the insurance industry,particularly the P&C market, which depends on analyzingmultivariate datasets to properly price risk.

The ability to have a more accurate sense of the ultimate costof risk will allow insurers to price with greater discrimination,which should encourage company management to rein in underwritingrisks before losses get out of control, leading to what the reportcalls “shallow underwriting cycles.”

2. Specialty focus

Many insurers are moving to either fully concentrate on or roundout their standard lines of business with specialty offerings.Specialty P&C business offers insurers “a means to insulatethemselves somewhat from the broad sway of pricing cycles” byproviding greater value in terms of underwriting insight to meettargeted needs. The report notes that strong specialty underwritershave a product that few can replicate, thus benefiting them from asupply and demand perspective. Good specialists tend to have abetter sense of the ultimate cost of the risk they’re underwritingand should know where and when to pull back when pricing gets outof line.

(Source: ALIRT Insurance Research)

3. Professional management—market leaders

ALIRT finds that the U.S. P&C market continues to witnessgrowth in the professionalism of its leaders. This is perhaps dueto a greater involvement in the business by alternative sources ofcapital, especially given that the P&C industry’s returns areviewed as non-correlated to many other investment classes. It mayalso reflect greater expectations on the part of professional andinstitutional investors as the competition for profitableinvestments becomes more globalized.

4. Consolidation—scale

The combination of excess capacity in the U.S. P&C market,the perceived need for scale and diversification, inexpensivesources of capital, and aggressive private investors has led to arecent increase in the number of mergers and acquisitions. ALIRTexpects that the creation of larger insurers should result in moreorganizations investing in the human capital and technology neededto better understand and price risk. “A smaller number of insurersmeans fewer ‘cats to herd’ when trying to gain an unofficialconsensus on price adequacy,” the report says.

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5. Investment environment

The report notes that the U.S. has been operating in anextremely low interest rate environment since the financial crisisof 2008. ALIRT states that the pressure on investment income haskept management more focused on underwriting results over the pastseven years. The report speculates that although strongerinvestment returns in the future may lead some insurers to revertto “cash flow underwriting,” the discipline of having to dependmore on underwriting gains to drive returns may become a habit withinsurers.

For more information or to obtain a copy of the report, send ane-mail to [email protected].