Economy: A Slow Insurance Recovery

In 2006, insurers posted their best underwriting performance in 57 years, emphasizing premium growth over market share. But the industry was sorely tested over the next two years as insurers flinched and premiums declined.

In 2008-09, capital erosion led to significant reduction of policyholder surplus – a measure of underwriting capacity. Fortunately, insurers were extremely well capitalized going into the financial crisis. Still, in mid-2009, surplus was more than 16 percent below its 2007 peak. The premiums-to-surplus ratio rose from 0.85 in late 2007 to about 1.0 in mid-2009, well below the 50-year average of 1.5. The lower the ratio, the better the industry can cover the risks that it has insured.

In 2010, I expect insurance premiums to increase, so property and casualty insurers will come closer to earning underwriting profits on personal and commercial lines than in 2008 or 2009.

Insurers should not count on gains in investment income to significantly reinforce their gain in pricing power, however. A long-term shift towards lower returns on investments is likely to continue, raising the importance of underwriting discipline for the industry’s profitability going forward.

The Federal Reserve rate cuts significantly reduced yields on relatively risk-free types of long-term bonds, which constitute the vast majority of insurers’ portfolios. Rates on riskier categories of bonds rose, but insurers did not benefit because they hold too many risky assets.

Although the vast majority of insurance business is tied to renewals, there will be a slight decline in households’ demand for property and casualty insurance, which will limit insurers’ profits this year. The housing boom produced outsized and unsustainable gains in insurable property. The prolonged downturn in housing activity eliminated the most powerful force contributing to growth of insurable property in Georgia.

The housing recovery will be too anemic to substantially boost the number of new policies written. The lingering effects of the recession and depreciation of home values will severely limit increases in insured amounts and may lead to further reductions in some local markets. The proportion of households unable to make their mortgage payments will remain quite high.

Consequently, claim rates on home insurance policies will be elevated. Homeowners who are in a financial bind will be less able to maintain their homes. Loss performance will deteriorate on foreclosed, vacant and uncared-for homes. Insurers should be prepared to devote substantially more financial resources towards detecting insurance fraud and settling claims.

My forecast calls for more spending by households for high-priced durable goods, which will increase demand for property insurance products.

The need to increase automobile insurance liability limits will add to the demand for auto insurance.

As the recovery broadens, demand for commercial lines of insurance will increase, although less competition among insurers will cause premiums to harden slightly. In contrast, a softening of the prices paid for commercial properties and significantly less new office, hotel, retail and industrial development are among the factors that will stymie demand growth. More spending for new equipment and facilities will boost demand for property insurance.

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. Many long-term clients will find they are paying more for less coverage, and a growing number of clients will be denied coverage.

In Georgia, job losses have decreased de-mand for life insurance and related products. Policy lapse rose and participation in employee benefit plans declined; policy loans increased. All of these adverse trends will slowly turn for the better in 2010.

The combination of decreased competition and improved fundamentals on the demand side will result in rate increases – the greatest for those with the worst possible risks. Since premium hikes are expected, higher underwriting profits also are expected; but low returns on managed assets will limit gains in overall profitability.