Investors Warm Up To P&C Insurers, Challenges Remain

Large national insurers such as Travelers and Chubb grew their comp books in the double digits during first-quarter 2011 (or, just under 10 percent in the case of Chubb). Meanwhile, specialists such as SeaBright and regional insurers including Selective reported declining premiums on combined ratios both rising and long past "breaking the buck" (that is, increasingly above underwriting break-even). Moreover, a casual review of year-end statutory filings suggests that workers' comp reserve adequacy is the most questionable across virtually all lines of insurance, particularly for accident year 2008 and subsequent.

What lies ahead? There is a one-word answer—change. Prices appear to be moving higher, but add to that mix  economic, technological and medical changes ranging from health-care reform (and concerns over cost-shifting), to regulatory pressures (will regulators allow rate increases to blunt the nascent business recovery?) and one has the ingredients for a volatile line of insurance in 2011 and beyond. Interestingly, it appears that the workers' comp industry has consolidated more than any other major commercial-insurance line over the past five years. What can that mean for specialists or regional carriers writing comp on an accommodation basis?

(2) Super-regionals?

 While definitions can be vague and the sample sizes are small, it is reasonable to observe that regional and super-regional insurers face substantial competitive challenges relative to many of their national and international competitors. Combined ratios over 100 and operating returns-on-equity in the mid-single digits seem sure to lag the low double-digit returns of larger competitors. Expense-ratio disadvantages account for some relative drag on financial performance, but there are other factors at play.

Technology and social attitudes toward personal interactions may be eroding the local, face-to-face underwriting advantages (with independent agents) normally touted by regional insurers. In addition, national insurers may have passed a tipping point where technology, scale and massive internal datasets can be fully exploited at the expense of smaller competitors.

 (3) Mathematical challenges

Financial executives can probably empathize with Scotty, the engineer in the "Star Trek" series who was always trying to squeeze as much as he could from the sometimes creaky engine of the starship Enterprise. Like Scotty, insurance executives face challenges at every turn.

• Investment leverage (invested assets to equity) is under pressure from a prolonged soft market and struggling economy.

• Federal Reserve policies seem likely to keep new investment yields below expiring yields for the near term, at least.

• Rating agency and regulatory pressures constrain premium leverage.

All are hoping for lift from the one variable ostensibly under their control—pricing—but this quickly takes us to the debate on whether insurers are all price takers, or whether some can effectively deploy a differentiated pricing strategy.

Most executives look to engineer better returns on equity through active capital management (e.g., debt or share buybacks), while increasingly innovative managers consider alternative strategies such as growing fee income or building capital-light business models.

Scotty would be proud, but investors probably shouldn't expect warp-speed ROEs out of any insurer soon.

(4) Retention rates on the rise

Most primary insurers commented positively on their stable-to-rising retention rates. This statistic seems to suggest that deep discounts on new commercial business weren't as available this quarter, in turn supporting the view that the market is experiencing a bottoming or early turn.