Aon Study Looks At Insurance Volatility

With the exception of auto coverage, insurance is a riskier bet than most stocks, according to an insurance brokerage study.

The findings were contained in the Insurance Risk Study released today by Aon Re Global, a unit of Chicago-based Aon Corp.

Aon found that only personal auto has exhibited less underwriting volatility than the one-year S&P 500 volatility for five years running.

“Looking over a long period of time, insurance companies produce higher volatility and lower returns on equity to shareholders,” said Stephen Mildenhall, executive vice president and chief actuary, Aon Re Services.

Mr. Mildenhall said in a statement he issued with the report that “insurance, if not managed appropriately, can bring higher risk and lower return than other major industries. Knowing how to price risk adequately and carry appropriate amounts of risk on the books is at the crux of sound decision-making for insurance companies.”

He advised that for the top-level management of companies and their risk managers, “the risk-vs.-return tradeoff is in an ever-moving cycle requiring constant rebalancing.”

“Knowing when to retain risk, to transfer risk or to make investments in, for example, the S&P 500, can make the difference between creating high shareholder value vs. facing insolvent circumstances.”

According to the brokerage, the study presents an “independent and theoretically sound assessment of underwriting risk parameters.”

It noted that this year the report was extended to include quantifications from select European and Asia-Pacific countries, including France, Germany, Greece, the United Kingdom, Australia and Japan.

The study also provides information on specific personal and commercial lines. It found that the most volatile major line in the 15-year period of 1992 to 2006 was homeowners, which was significantly impacted by the 2004 and 2005 Atlantic hurricane seasons.

Aon said the homeowners line, even excluding these catastrophe loss years, has a risk comparable to commercial auto insurance. Other high-volatility lines include general liability, medical malpractice, professional liability, and directors and officers liability insurance.

The study also contains a price-to-book regression analysis to figure how companies can create shareholder value through enterprise risk management (ERM).

Aon said the findings show that a consistent stream of earnings is strongly correlated with a higher price-to-book ratio and insurance companies can use the results as a valuation tool in future calculations and as a measure of the cost of capital.

Aon Re Global's Insurance Risk Study examines risk from nondiversifiable risk sources, including changing market rate adequacy, unexpected frequency and severity trends, weather-related losses, legal reforms and court decisions, the level of economic activity, and other macroeconomic factors, offering insight on risk from reserve development.

Reserve development in long-tailed liability lines, according to the study, has produced upward revisions in estimated volatility since 2001, as they are booked closer to ultimate each year. For example, the estimate of volatility for other liability claims-made increased from 27 percent to 41 percent between 2001 and 2006.

Aon researchers found that volatility for most lines is substantially increased by the pricing cycle. Market-cycle driven loss ratio correlation between lines increases risk by up to 50 percent and reduces the normal benefits of underwriting diversification.

The study's underwriting volatility benchmarks can be used by insurers to provide better risk disclosure, enterprise risk management, economic capital assessment and capital allocation figures, according to Aon.

The brokerage said the study applies risk theory techniques to six years of National Association of Insurance Commissioners' Annual Statement data for 1,984 individual U.S. groups and companies.