E&Y Sees Troubling Signs In P-C Segment

Mr. Oakley is one of the authors of the "State of the Financial Services Industry" report released this week by Ernst & Young LLP in New York, which noted distressing signs in the U.S. property-casualty insurance segment including increased competition from Bermuda.

Commenting on the current hard market, Mr. Oakley observed that premiums have increased rapidly since 9-11 with the implementation of double-digit rate hikes in many lines.

"I believe p-c insurers will do everything they can to continue to increase their rates. However, that will only hold up as long as the majority of major players continue to follow that course," Mr. Oakley told National Underwriter.

He added that it is "simplistic to think that since rates have risen, things must be getting better. There are reasons to believe that isn't the case. While p-c insurance has recently benefited from rate increases, it is unlikely that these alone will drive good performance for the segment," he argued.

Commercial average premium rates have increased most recently at a rate of about 20 percent, while rate hikes in personal lines reached a 10-percent level, according to the E&Y report.

In personal lines, auto carriers have finally stopped playing market share games, and homeowners insurers now need to compensate for the recent large increase in losses–for both sectors, the current rate increases are the largest since the 1985-to-1986 hard market, the study found.

But E&Y said these increases are not enough to provide adequate returns to p-c insurers. "Even at current levels, prices are still low compared to what the adequate return on equity should be. Combined ratios are settling around 107 percent, which is not profitable at the current interest rates," Mr. Oakley said.

It is clear that additional rate hikes are necessary if the p-c segment is to attain reasonable levels of profitability–the commercial segment would need a 90 percent combined ratio to realize an adequate return on equity of, say, 15 percent, he noted. "And if you look around the industry right now, no one has that kind of combined ratio," he said.

Reserve adequacy is another troubling issue for the p-c industry, the E&Y report stated. It noted that Morgan Stanley in New York has estimated a $120 billion reserve shortfall for the sector.

Mr. Oakley said his firm saw the American International Group announcement this week, that it would take a $1.8 billion charge after taxes to boost reserves, as "one more example of reserve shortfall in the industry."

Even the continuing rate increases could bring bad news for carriers' bottom line, since commercial policyholders who are the best risks are withdrawing from the third-party insurance market and self-insuring, according to E&Y.

"They are self-insuring through captives, they are taking higher retention, and they are utilizing the capital market mechanism for covering their risks," Mr. Oakley noted. "Some of the best customers are opting out and this complicates insurers' effort to drive the combined ratio down."

Another major trend affecting the commercial sector is the growing clout of the Bermuda market, the E&Y study said. This market is eclipsing the London market in terms of capital growth.

Premiums in this market are increasing because Bermuda provides a favorable regulatory environment, tax efficiency, and ease to enter and exit the market, the study noted. Premiums written by Bermuda-based companies have grown by 42 percent since 1998, compared with 5 percent for the U.S. p-c industry as a whole.

Additionally, more than half of the $20 billion in new capital raised since the Sept. 11 terror attacks has gone into the Bermuda marketplace, the study explained, far surpassing the $1.7 billion that flowed into the U.K. market during the same period, as well as the $4.3 billion and $3.7 billion of new capital that flowed into North America and Europe, respectively.