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Despite Record Catastrophe Losses, a Hard Market Remains Elusive

Posted on Nov 04, 2011

Sustained large underwriting losses, a material decline in surplus and capacity, a tight reinsurance market, and renewed pricing discipline will harden the insurance market. But all of those have yet to occur with enough severity and at the same time.

While 2011 is on track to be one of the highest catastrophic loss years on record, the return to a hard insurance market in the near future may still prove elusive.

So said Robert P. Hartwig, economist and president of the Insurance Information Institute, who this week outlined how global events will affect the profitability of the property/casualty insurance industry.

"There is economic fear, concerns over the political system, and people are worried about whether they will still have jobs," Hartwig told the Professional Liability Underwriting Society's annual conference here in San Diego.

The list of key events includes: the European sovereign debt, bank and currency crises; the U.S. debt and budget crisis, including the Standard & Poor's downgrade and possible austerity measures; the U.S. housing crisis; persistently high unemployment; the threat of inflation and deflation; political upheaval; overregulation; computer network attacks and terrorism.

Then there has been the avalanche of catastrophic losses: the earthquakes in Japan, New Zealand, Turkey, Haiti and Chile; the U.S. tornadoes, floods, wildfires, hurricanes and winter storms; and the effects of the man-made disasters such as the Deepwater Horizon spill.

"But are there 'Black Swans' everywhere ¿ things never occurring before ¿ or does it just seem that way?" Hartwig said. "The answer is no, all of these things have happened in some way before. But this malaise, this is the environment in which we in the insurance industry are going have to operate."

For the property/casualty insurance industry, the recovery of profits will be set back by high catastrophe losses, low interest rates and diminishing reserve releases, he said. The industry's profits in the first half of the year were down 71.6 percent from a year ago, to $4.8 billion, due to catastrophe losses and as noncatastrophic underwriting results deteriorated.

For the first half of 2011, the industry posted a 109.4 combined ratio and a return on equity of 2.3 percent

"We're headed toward a trough in ROE, but as the effects of greater pricing power from the market emerges, history suggests that the next ROE peak will be in 2016 or 2017," Hartwig said.

At the midpoint of the year, 2011 was the highest loss year on record globally for insurers. But will this turn the market and will prices harden? Hartwig said that four criteria must be met to harden the soft market.

"We need a sustained period of large underwriting losses, and we're not there yet; we're in the early stages," Hartwig said.

Apart from the second quarter of 2011, overall property/casualty underwriting losses remain modest. Combined ratios, excluding the second quarter, are still in the low 100s, versus 110-plus at the onset of the last hard market. Prior-year reserve releases continue to reduce underwriting losses and boost return on equity.

"There needs to be a material decline in surplus and capacity," he said. "We entered 2011 with surplus at a record high, but that has since fallen."

Surplus hit a record $565 billion as of March 31, but fell by 1 percent in the second quarter. Little excess capacity remains in the reinsurance markets and weak growth in demand for insurance is insufficient to absorb much excess capacity.

"We need a tight reinsurance market and that is somewhat in place," he said. "Much of the global excess capacity was eroded by catastrophes, and there are higher prices in Asia Pacific, but modestly-higher pricing for U.S. risks."

There also needs to be renewed underwriting and pricing discipline. Commercial lines pricing trends are turning from negative to flat, or are up in some lines such as property and workers' comp. Competition remains intense as many carriers seek to maintain market share.

Insurers can no longer depend on investment returns to boost profitability, as the "new investment reality" is one of diminished returns, Hartwig said. As a result, there's a greater onus on pricing.

For every 1 percent drop in investment returns, underwriting pricing has got to improve an average of 3.5 percent, "but that is not happening," Hartwig said.

"As we look forward, where is the industry going to grow? The answer is in emerging markets ¿ China, the Middle East, and parts of South America," Hartwig said. "But that's also the places where there is the most political risk. So incremental growth is going to be achieved with greater risk; that's the unfortunate nexus."

November 8, 2011

KATIE KUEHNER-HEBERT

http://www.riskandinsurance.com/story.jsp?storyId=533343067