Despite Rising Premiums, Insurers Still Bleeding Surplus

And with prospect of a recovery to the $289.6 billion surplus level recorded at year-end 2001 unlikely for year-end 2002, financial records for the industry dating at least as far back as the early 1970s will show the first three-year surplus decline once the year plays out.

Industry surplus has declined $63 billion from its peak of $336.3 billion in June 1999, according to Robert Hartwig, senior vice president and economist for the Insurance Information Institute in New York. The 18.7 percent drop in three-plus years "implies a loss in underwriting capacity equal to nearly $100 billion in net written premiums," Mr. Hartwig wrote in a commentary released with the ISO/NAII results.

Before and after the Jersey City, N.J.-based ISO and NAII in Des Plaines, Ill., published the nine-month figures, analysts gave continuous reminders that the combined ratio–which at 104.9 is already down near the best full-year level recorded during the hard market of the mid-1980s–still isnt good enough to generate adequate rates of return on capital. Thats because low interest rates are pushing down net investment income and shrinking bottom line returns, even as levels of invested assets grow.

Even a lower forecast combined ratio of 103.3 in 2003 "doesnt come close to generating the 10-to-15 percent return-on-equity investors expect," Mr. Hartwig wrote in a separate analysis commenting on the results of an annual survey of a dozen Wall Street stock analysts.

While the analysts, on average, predict a combined ratio of 106.3 for the full year 2002, and a ratio 3.0 points lower in 2003, "in the current investment environment, combined ratios must fall below 95 before the industrys financial performance approaches consistency with the risks it assumes," Mr. Hartwig said.

The forecasts of 12 individual 2003 Wall Street analysts published in the Institutes "Early Bird" survey ranged from 99.9 to 105.2, with only one analyst projecting a combined ratio under 100.0 for the year ahead.

At 104.9 for 2002 through nine months, the industrys annualized ROE was just 4.4 percent, according to Don Griffin, NAIIs assistant vice president for business and personal lines.

In the third quarter, as they had for the four quarters before that, industry analysts and executives continued to tell two stories–one of elation and optimism, the other of disappointment and skepticism. The greatest source of optimism was top-line growth, while the most somber messages were about additions to loss reserves.

According to ISO, premiums soared 13.6 percent for the first nine months of 2002, giving the industry the largest percentage jump in premiums through nine months since 1986, when the increase was 23 percent.

The fact that the dramatic 20-percent plus premium jumps of the two prior cycle turns remained a distant memory had no one concerned. As analysts have explained in the past, such sharp rises occurred during economic periods of high inflation and are unlikely to recur. (See, for example, the 1996 report entitled, "The Property-Casualty Underwriting Cycle: Lifting the Veil of Abnormal Losses," by Hartford-based Conning & Company.)

Even at growth rates in the low-teens for the industry overall, the 103.3 combined ratio being forecast for 2003 is better than any combined ratio recorded in the 1980s. And for 2002 through nine months, premium growth exceeded the growth in losses by a wider margin than in the prior hard market.

While premiums grew nearly 14 percent in 2002, losses grew less than 1 percent over a nine-month 2001 loss figure that includes Sept. 11, 2001 losses, ISO reported. Excluding the impact of $9 billion in Sept. 11 losses recorded by insurers in third-quarter 2001, nine-month 2002 losses grew by roughly 5 percent over losses for the first nine months of 2001. In 1985 and 1986, by contrast, when premiums grew 22 percent, losses rose 16 percent.

Still, analysts believe that for many insurers, 2002 results should have been markedly better than 2001 figures because of the absence of any catastrophe the size of the Sept. 11 tragedy. But additions to loss reserves–which many analysts said would be over and done with in 2001s "kitchen-sink" fourth quarter–had many companies reporting disappointing income figures or bottom-line losses for 2002.

For The Chubb Corp., a third-quarter 2002 after-tax addition of $625 million in reserves for asbestos claims rivaled the amount that the Warren, N.J.-based insurer had to put up for Sept. 11 losses in third-quarter 2001. With the asbestos reserve boost falling just $20 million shy of the $645 million after-tax provision posted last year for 9/11, Chubb reported bottom-line net losses of roughly $240 million for both nine-month periods and combined ratios over 130 for both third-quarter 2001 and third-quarter 2002.

Hartford Financial Services disclosed the potential for non-product asbestos losses from a particular insured in third-quarter 2002, and analysts anticipated a fourth-quarter reserve announcement from Hartford-based Travelers Property Casualty as well.

At Markel Corp. in Richmond, Va., Vice Chairman Steven Markel announced smaller reserve addition–$44 million, pre-tax, with $30 million relating to asbestos and environmental exposures.

"It does seem sometimes that we take two steps forward and then one back," he said during a late October conference call with investment analysts, noting that $10 million of the reserve boost was attributable to Markels discontinued international operations–a book of business that had also required a $39 million reserve boost in third-quarter 2001.

Like Markel, a host of other companies had more than those decades-old asbestos exposures to worry about.

At Ohio Casualty, Chief Executive Dan Carmichael said: "Its an understatement to say that the most recent quarters results are very disappointing," referring to two substantial non-asbestos charges as "potholes" in need of "repaving" that caused his company to report a $69.9 million net loss for the quarter.

The charges were a $41 million after-tax reserve boost for construction defect claims for residential contractors and developers, and a $35 million after-tax write-down of an intangible asset related to the impaired profitability associated with agent relationships, he reported.

Even Los Angeles-based personal auto insurer Mercury General had reserve problems to report in the third quarter, with $14 million of adverse development for the quarter, and $24 million for the year, relating to higher severity for California bodily injury coverage.

In Overland Park, Kan., GE ERCs various reserve charges–relating to almost any liability line of business you can think of–totaled $2.5 billion pre-tax.

Meanwhile, rating agencies continued to downgrade commercial insurers and reinsurers as they announced what Standard & Poors in New York called "stunning" charges in 2002.

According to Mark Puccia, managing director of insurance ratings for S&P, the rating agency downgraded 38 p-c groups (including 31 commercial lines groups) in 2001 and another 30 p-c groups (24 commercial) in 2002 as of early December. John Iten, senior insurance analyst for commercial lines, added that 40 percent of ratings for commercial lines companies put forth by S&P carry a negative outlook or "CreditWatch" status.

Mr. Puccia, who discussed conclusions contained in S&P reports on the U.S. commercial lines, personal lines and global reinsurance industries during a conference call earlier this month, said that he doesnt expect nearly as many commercial insurer downgrades in 2003.

However, S&P does expect downgrades to be "front-loaded" for commercial lines insurers in the first half of 2003, as additional news on reserve charges comes through during a "fairly bloody fourth quarter."

"Its funny. Were in the midst of the hardest market in recent memory, and yet the prospects for many companies remain uncertain because of the reserving issues," Mr. Puccia said. "This credibility gap is just simply undermining the industry," he added, expressing concern over the lack of disclosure on the subject until "the moment of reserve strengthening."

Noting that an S&P non-asbestos reserve study done in 2001 had shown that "over half of the industry had material reserve deficiencies," he said that according to an October 2002 update of that study, "only half of those [underreserved companies] have actually materially upped their reserves" during the course of 2002. "In other words, over a quarter of the industry still hasnt come clean," he said.

"The hard market needs to endure through 2004 to support existing ratings," Mr. Puccia concluded.

But how long the hard market will actually endure–and what levels of premium increases and price hikes will be achieved in the next two years–remain debatable subjects.

While Mr. Puccia said 15-to-20 percent commercial lines rate hikes are "a done deal" for 2003, Mr. Iten said that low double-digit or high single-digit price increases were more likely in 2004. "Its just not realistic for buyers to be expected to continue paying up" in a weak economy, he said.

Across all lines, analysts participating in the Early Bird forecast were split on the overall growth level of net written premiums for 2003. With forecasts ranging from 9.0 percent to 18.4 percent, six of the 12 analysts polled predicted lower premium growth in 2003 than in 2002.

The average 2003 forecast for the group was 12.3 percent, which would represent the first deceleration–from a 13.6 percent average predicted for 2002–if it comes to pass, Mr. Hartwig said.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, December 30, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.