NU Online News Service, Feb. 3, 3:09 p.m. EST
While many observers have pointed out that the property and casualty industry is overcapitalized, Advisen has put a ballpark number on how much excess capital must be drained before a market turn: $74 billion.
"Before a sustainable hard market can happen, either demand must skyrocket, which is unlikely, or roughly $74 billion of excess capital must be drained from the U.S. property and casualty market," Advisen said in a recent "QuickNote."
Advisen said the capital could be drained through one or more large catastrophes, "but the more likely scenario is slow, painful hemorrhaging of capital as deeply eroded rate levels take their toll."
Explaining how it arrived at $74 billion, Advisen said growth in supply—in the form of policyholders' surplus—has exceeded growth in demand for insurance. Advisen explained that, with respect to demand, most U.S. companies are already fully insured, so the need to buy insurance is directly tied to growth, which can be measured by the change in gross domestic product (GDP).
U.S. policyholders' surplus equal to about 3.2 percent of GDP represents the approximate point at which supply and demand are in balance, Advisen said. The ratio dropped below 3.2 percent at the end of 2008 after stock markets crashed, but surged above 3.2 percent in the second half of 2009 and has stayed there ever since.
Advisen said, "Assuming no imminent and material change to the demand side of the equation, policyholders' surplus needs to be reduced by roughly 0.5 percent of GDP, or $74 billion, to bring supply and demand into equilibrium.
Advisen predicted that insurers will not be able to offset underwriting losses going forward with reserve releases. However, if new capital enters the market during the soft market phase in anticipation of higher rates, the onset of the hard market could be delayed, "while capital rushing in to take advantage of rising rates in a hardening market could smother the rally," Advisen said.
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