By Treanor, Christopher M.
Risk Management , Vol. 55, No. 7
There is good news for corporate risk managers and insurance buyers in 2008.
The soft market that began in 2004 shows no signs of abating in the near term. Short of a catastrophe or economic event that broadly impacts the entire property and casualty industry, current market conditions should last well into 2010 and perhaps beyond. At the same time, the cycle has clearly passed its peak and we are now on the beginning of the downside. All measures point to a slight weakening in the underlying fundamentals of the industry marking the beginning of the march towards the bottom of the cycle. But while the good times last, it is time for buyers to take advantage of the favorable market conditions.
Analyzing Market Trends
In terms of financial performance, 2006 was a banner year for the insurance industry. The P/C industry's combined ratio of 92.4% was the best since 1948. Between 2002 and 2006, the industry added over $200 billion in surplus, rebuilding the capital lost during the last soft market, the events of September 11, 2001, the "Enron Era" of corporate scandals and the back-to-back record Atlantic storm seasons of 2004 and 2005. The $32 billion profit generated by the industry in 2006 was the best on record by far.
While 2007 was certainly another good year, there are clear signs that profits are starting to slip in 2008. According to A.M. Best, the U.S. P/C industry reported its second consecutive underwriting profit-the first time it has done that since 1977-78. The profit of $22.1 billion was 30% lower than the previous year's record $32 billion but nonetheless was robust enough to contribute to a policyholder surplus increase of $34.7 billion. This 7% increase puts U.S. P/C policyholder surplus at a record $527.5 billion or 3.71% of U.S. GDP, according to Advisen. This is approximately the same level it was in 1998 when it began its decline towards the market bottom in 2001. A closer examination of the data reveals some important trends:
Net written premium is down. For the first time since 1949, net written premium in the U.S. Ñ/C industry declined year over year. This decline of $3.8 billion or 0.9% compares to an increase of 14.9% in 2002 and 4.3% in 2006. This reduction can be attributed to both a rapidly declining rate environment and the slowdown of the U.S. economy. As the economy weakens, buyers tend to purchase less insurance as a way of moderating up-front expenses. In addition, the underlying exposures that drive premium (property values, payrolls, revenue and fleet counts) usually decline or grow at a slower pace than during stronger points of the economic cycle. This premium drop manifested itself in the latter part of the year as price decreases accelerated and the economy weakened. The majority of the reduction came from the U.S. reinsurance market, which faced an 11.9% decline, but even the commercial segment registered a 0.4% decline in net written premium. There is no reason to believe that this phenomenon will reverse itself in 2008.
Combined ratios are deteriorating. While still highly favorable, the combined ratio in the commercial segment deteriorated from 91.3% in 2006 to 93.7% in 2007. As previously noted, the industry has not seen back-to-back profitable underwriting years since the late 1970s. This strong performance is a result of a benign storm season, favorable development of prior-year losses and a rate environment that is still far from the bottom of the cycle. A.M. Best forecasts that the industry will have at least one more year of profitability in the commercial segment, with the commercial P/C combined ratio further deteriorating to 97.5% in 2008.
Prior year reserve development is down. According to A.M. Best, 77% of insurers reported positive prior year reserve development totaling $6.8 billion in the aggregate. Best is concerned that some of this reserve released is premature. If that is the case, insurers will need to bolster reserves later, which would increase combined ratios. …