Risky Business

Two years ago, insurers posted their best underwriting performance in 57 years. They did that by emphasizing premium growth over market share. Last year, the industry’s re-focus on fundamental underwriting standards was sorely tested. Insurers flinched and premiums declined, but the industry still managed to generate underwriting profits.

This year, insurers’ resolve will be re-tested. I expect heightened competition among insurers and a less than accommodating macroeconomic environment to further reduce insurers’ pricing power. Premiums will decline for the second straight year for commodity-like insurance products. Nonetheless, barring a major catastrophic loss, property and casualty insurers will earn underwriting profits on both personal and commercial lines in 2008.

The margin of underwriting profit will be thinner than in 2007, but commercial lines again will outperform personal lines. Profits are being reinvested in the industry, which will improve insurers’ ability to pay claims in the event of higher catastrophic losses.

Although most policyholders will see flat or lower premiums, property owners in coastal areas will continue to experience premium increases. Reinsurance prices have surged in areas subject to catastrophe-related losses; these price hikes eventually are passed onto the policyholder.

In 2008, insurers will not be able to offset the loss of pricing power with gains in investment income. The shift toward lower returns on investments began in the second half of 2007. It reflects less favorable performance from equities, slow growth of U.S. businesses’ profits, low short-term interest rates and low rates on relatively risk-free types of long-term bonds. Rates on riskier categories of bonds probably will be much higher in 2008 than they were in the first half of 2007.

Slow growth in households’ demand for property and casualty insurance will limit insurers’ profits. The recent housing boom produced outsized and unsustainable gains in insurable property. From 2002-2006, people literally had much more each year to insure. Georgia’s boom ended abruptly in mid-2006, and the bust deepened in 2007. The downturn eliminated the powerful force that had been contributing to growth in the amount of insurable property in Georgia.

I expect the housing recession to persist through late 2008. It slows growth in the number of new policies written and reduces increases in insured amounts. As long as existing homes do not appreciate in value, there will be little or no pressure on homeowners to raise insured amounts on their current home insurance policies.

As the proportion of households unable to make their mortgage payments rises, claim rates on home insurance policies will increase. Homeowners in a financial bind will be less able to maintain and otherwise secure their homes. Insurers should be prepared to devote substantially more financial resources toward settling claims and detecting insurance fraud.

Demand for commercial lines of insurance purchased by businesses will expand in 2008, but the pace will decelerate. Heightened competition among insurers will cause premiums to soften for most commercial lines. The main factors contributing to demand growth will be continuing sub-par GDP growth, lagged effects of announced expansions and relocations, higher prices paid for commercial properties over the last several years, and new office, hotel, retail and industrial development. The more cautious approach to spending for new equipment and facilities that emerged in the second half of 2007 will limit growth for property insurance, however.

The recent re-pricing of risk in the financial markets suggests that insurers will become even more selective in the coverage they are willing to provide. As insurers revise their risk assessments, many long-term clients will find they are paying more for substantially less coverage. A growing number will be denied coverage altogether.

One serious problem is adequately managing catastrophic losses. The frequency of both natural and man-made catastrophes has been trending upward for the last 20 years; and the severity of claims is increasing. Nationally, hurricanes and tornadoes account for about 65 percent of catastrophic losses, with terrorism and earthquakes accounting for an additional 10 percent each.

Fortunately for Georgia insurers, the total value of insured coastal exposure is only $73 billion – which amounts to just 6 percent of Georgia’s total statewide exposure.