Worsening Economy and Investment Income Strain P&C Industry

Generally speaking, the economy is more resilient than most pundits presume but nevertheless will continue to face prolonged stagnation in the next couple of years. The downtrend in economic indicators, along with shrinking investment income projections are chief conditions guiding the latest edition of Conning's “Property-Casualty Forecast & Analysis” report.

In the forecast, which projects P&C industry growth and performance from 2011-2013, the Hartford, Conn.-based firm offers a decidedly “gloomy” view for insurers. An overriding concern is that after the compression of revenues in recent years, many anticipated a rebound in both the economy and in interest rates, neither of which occurred.

“Not only has economy faltered, but concern about the economy has increased,” explained Clint Harris, analyst at Conning Research & Consulting. “The government has been trying to recharge the U.S. economy by keeping interest rates low enough to encourage investment. The consequence of all of this is that bond yields have gone lower, and that is a significant driver in revenue for insurers.”

“Therefore, Conning's 2011 premium growth forecast has decreased with the sliding economy to only 2 percent to 3 percent,” Harris continued. “The industry forecast combined ratio, north of 106 percent, includes additional deterioration in the underwriting results and adjustments for the record catastrophe activity of the second quarter. Of course we are closely watching second-half tropical storm results.”

Conning issues such analyses on a quarterly basis, with the focus of each typically varying, depending on market conditions and stressors. For this latest iteration, the firm's analysts targeted premium loss and investment returns for the entire year for 2011, 2012, and 2013.

Harris said that findings from the second quarter were worrisome when compared to the previous analysis at the end of the first quarter. Economic concerns in the U.S. and abroad deepened, in no small part because of the record-breaking number and expense of catastrophe loss on the global scale. As of June 30, 2011 was already considered to be the highest loss year on record globally. The I.I.I. estimated $260 billion in economic losses during the first six months of the year, exceeding the previous record of $220 billion in 2005.

Earlier this month, Steven Weisbart, P.h.D., CLU, senior vice president and chief economist at the Insurance Information Institute (I.I.I.), presented an overview of the economy and P&C insurance industry both globally and in Canada. Weisbart discussed the effects of the 2011 disasters, inflation transmitted globally, and increased political risks in his special report, citing the most costly world insured losses in the past three decades (see figure below).

It should come as no surprise that insurers' concerns deepened as well. So how does premium erosion (and the resultant decrease of underwriting margins) bode for the P&C industry?

“There is some better news here,” Harris said. “All of these things can lead to insurers becoming more conservative. More insurers are starting to talk about areas where they see premium rate firming. This is a condition that normally comes ahead of a true turnaround of underwriting cycles.”

“When insurers become stressed in terms of underwriting margins decreasing and, in this case, also investment margin decreasing, there has to be some proactivity,” Harris added. “One short-term solution is managing operating expenses more aggressively, and carriers have embraced this. Although that can result in increased workloads and maybe fewer hires, mass layoffs are very unlikely. In some cases, a portion of the decisions are based upon this is temporary condition. Othewise, the industry will be looking at a more long-term solution.”

Like Harris, Weisbart accentuated the longer-term issues plaguing the industry in the coming years, including:

• Persistently low interest rates and lower investment income. These put added emphasis on underwriting profit.
• Currency market instability
• Sovereign bond market concerns – Greece, Spain, Ireland, and so on.

“The expected forecast drivers for 2012 and 2013 are stronger economic growth than in 2011 and expanding rate-firming in commercial lines, with negative offsets on investment income,” added Stephan Christiansen, director of research at Conning. “We forecast an increase in both exposure and premium rate growth for each year, but rate firming is short of what should be interpreted as a broad turn in the underwriting cycle. Certainly, the faltering economic recovery has worsened exposure growth expectations. However, the decline in expected investment yields for 2011 and for the next couple of years is becoming an even more significant factor driving industry expectations.” 

Conning's full report is available for purchase on the company's web site.