Stalled Premium, Investment Gains Dim Industry's Profit Picture

Falling interest rates and stalled premium growth mean the best returns on equity the property-casualty insurance industry can hope for in coming years will be in the high-single-digits, according to the president of the Insurance Information Institute, Robert P. Hartwig.

"Interest rates are lower than they were a decade ago. They're falling, and they're going to fall again," Mr. Hartwig said, noting that volatile stock market returns add to a bleak investment picture that has so far kept insurers focused on maintaining good underwriting results.

Addressing the Casualty Actuaries of Greater New York, Mr. Hartwig said the industry is expected to earn roughly $60 billion from its investment portfolio in 2007--including interest on bonds, stock dividends as well as realized and unrealized capital gains. This figure is no better than it was a decade ago, he noted, even though invested assets have grown in the intervening years.

Interest rates are much lower and stock market returns are much less generous, he explained.

That means "there's no way that poor underwriting and pricing decisions [can] be papered over" with investment earnings, he told the actuaries, noting that the phenomenal underwriting results of recent past years reflect, in part, the fact that insurers haven't been able to rely on Wall Street gains as they did in past cycles.

Still, profitability has begun its "inexorable cyclical decline," he said.

Displaying a historical graph of insurer returns over several decades, Mr. Hartwig noted that industry profit peaks have occurred "almost like clockwork in the teens for nine-to-10-year intervals, followed by scary roller coaster rides for the next four-to-six years that take [results down] to the trough."

He added that "if historical norms were to hold, then that would suggest that in 2011 we'd have a 1- or 2 percent return on equity."

The hope, however, is that this cycle will be shallower than in the past, he said, noting that factors such as underwriting discipline, increased vigilance by industry watchdogs (citing rating agencies and regulators) and healthier loss reserve positions could bring the cycle trough up from low-single-digit ROE levels to high-single-digits.

At the low-point of the last cycle, the industry ROE was actually negative, coming in at minus-1.2 percent in 2001, he recalled.

For 2007, Mr. Hartwig said that overall ROE is expected to come in at about 13 percent, and that net income--in dollars--is expected to be about $63 billion, which is roughly equivalent to 2006.

The ROE high point of this cycle of 14 percent occurred in 2006--four years past the peak in premium growth in 2002.

In the meantime, although underwriting results have started to decline, property-casualty insurers will still make about $28 billion in underwriting profits this year, Mr. Hartwig reported. That would represent an 11.7 percent drop from $31.7 billion in 2006, he noted.

Underwriting results are deteriorating, he said, "but don't go away with the idea that they're bad," noting that the combined ratio for 2007 is expected to come in at about 93.5, and that the industry will likely still make an underwriting profit in 2008.

The consensus view of analysts being polled by the Insurance Information Institute for its annual "Early Bird" survey is likely to be about 97.0 for next year, he said, adding that the results are still being tallied.

This is "extraordinary" given the companion prediction that there will be "zero premium growth" in 2007 and 2008, Mr. Hartwig added.

"We have the first sustained underwriting profit in this industry in half a century," he said, referring to the fact that combined ratios will have remained below 100 for three full years if the 97.0 prediction for 2008 holds.

"Nobody in this room was working in this industry the last time that happened" in the late 1940s, he said, noting that those prior periods of sustained profit also occurred in years when there were low interest rates.

Underwriting profits in the past few years benefited from loss reserve takedowns of $5.3 billion and $7 billion in 2006 and 2007, respectively, he said--at one point referring to the task of estimating reserves as being "at the heart of what actuaries do."

While the predicted underwriting profit for 2008 anticipates a similar level of reserve redundancy next year, the reserve well will soon be tapped out, he warned. The question is when the fat in reserves will be depleted, said Mr. Hartwig.

"You can have infinite reserve inadequacy, but you're not going to have infinite reserve redundancy," he added.

Discussing the deteriorating underwriting results line-by-line for some major p-c insurance segments, Mr. Hartwig said while private passenger auto combined ratios improved from 108 in 2001 to 95.5 in 2006, "something in the underlying frequency and severity trends is not dropping as much as it once did," adding that prices are falling as well.

A long favorable drop in frequency is coming to an end, and severity is still rising for auto bodily damage claims, he said.

Mr. Hartwig also shared historical figures for homeowners, noting that the line was a "complete disaster" even without any natural catastrophes back in 2001, with a 122 combined ratio.

By 2004 and 2005, even with the major hurricane losses that occurred in those years, the industry combined ratios were down to 94.4 and 100.3, respectively, he said, adding that these better results reflect the fact that a lot more of the business has been reinsured in recent years.

For 2007, the homeowners line is expected to come in at a 91 or 92 combined ratio, up from the 90.4 level reported in 2006, he said.

"This line has been nursed back to health because of the way insurers protect against large-scale losses," he said, noting insurers' utilization of reinsurance purchases as well as re-underwriting initiatives and the absence of major catastrophes in the last two years.

Mr. Hartwig also noted that while workers' compensation continues to be profitable, there are some danger signs on the horizon. (See page 18 for details.)