Combined Ratio Declines, But Red Flags Keep Insurers On Edge

Part of the problem was that investment income dropped 3.5 percent to $24.5 billion, while another factor was the fact that the industry incurred $12.3 billion in federal income taxes in first-half 2006–20.3 percent more than the year before.

However, while knocking any wood within sight, analysts are almost ready to breathe a sigh of relief about the reprieve Mother Nature has granted insurers thus far.

Bear Stearns analyst David Small said he was updating full-year income forecasts on the positive side for all the carriers with catastrophe exposure.

"With a surprisingly light hurricane season so far, and no hurricanes making landfall in the U.S., Q3 '06 natural catastrophes may be among the lightest of the new century, likely somewhere between the low of $315 million in Q3 '00 and the $3.7 billion of Q3 '03," Mr. Small wrote.

Nonetheless, the dangers of seeming prosperity could be seen even in the improving investment climate of the past several weeks, which should boost net investment income figures for the full year, warned Morgan Stanley property-casualty analyst William Wilt.

"Competition seems likely to rise due to increasing capacity and confidence in the strength of underwriting," Mr. Wilt wrote. So in the midst of all these favorable numbers, the analyst lowered his overall rating of the industry from "attractive" to "in-line" as a result of the "backdrop of diminishing operating prospects."

Michael Murray, ISO assistant vice president, also noted that signs abound of increased competition in non-catastrophe-exposed areas.

"While stories about price increases and insurance availability problems in coastal states hammered by Hurricanes Katrina, Wilma and Rita continue to appear almost daily, the countrywide [Consumer Price Index] for tenants' and household insurance dropped 1.5 percent in second-quarter 2006 compared to its level a year earlier, and the CPI for motor vehicle insurance rose a scant 0.3 percent–far less than the 4 percent increase in consumer prices overall," he said.

Mr. Hartwig agreed that despite an impressive underwriting performance in the first half of 2006, the industry faces a number of other red flags, including slow premium growth in the first six months of the year and new capital accumulation risks.

Mr. Hartwig said the "sluggish" 2.9 percent gain in premiums over the first six months reflected a virtual across-the-board softening of the personal and commercial lines pricing environment–outside of catastrophe-prone areas and lines.

In addition, regulators have contributed to shrinking growth by "refusing to allow insurers to charge risk-based rates," Mr. Hartwig asserted.

"Some insurers may also be paying more for reinsurance, which causes them to report lower net written premium growth figures if they cannot fully recoup those costs at the retail level," he said.

Meanwhile, alternatives to traditional insurance–including captives, self-insurance arrangements and large deductibles–have helped slow the growth rate in premiums written by carriers, he added.

In addition, "insurer pullbacks from coastal areas are resulting in the ceding of significant premium to state-run residual market mechanisms, often in states that otherwise offer significant growth opportunities," he noted.

Mr. Hartwig said that an unhealthy, rapid accumulation of capital also threatens the industry, making it less attractive to investors, as well as possibly spurring price competition. "The primary consequence of rapid capital accumulation is to produce lower returns on equity–a problem that is exacerbated in an economic environment with limited opportunities for organic or merger-driven growth," he said.

Moreover, the record catastrophe losses of 2004-05 have not only driven rating agencies to require insurers to hold more capital for the risks they've taken, but have also made insurers themselves more risk averse, thus limiting their opportunities.