Economy: Risky Business

Despite record – or near record – underwriting capacity, sustained and broadly based growth in the demand for insurance products means that market conditions will remain firm in 2015-16, and conditions will allow insurers to increase premiums.

The competition among insurers will be very intense, but solid demand growth will allow insurers to maintain, or improve, underwriting discipline, which is essential to profitability given the low rates of return expected on low-risk types of financial assets. Barring major catastrophic events, property and casualty insurers are very likely to earn high levels of underwriting profits on personal lines in 2015-16.

Insurers should not count on large gains in investment income to significantly reinforce their underwriting profits. The returns on investments will be low for an extended period, raising the importance of underwriting discipline for the industry’s profitability going forward. Yields on relatively risk-free types of bonds will begin to increase in the second half of 2015, but yields will still be extremely low from a historical perspective. Yields on maturing bonds of the same duration are generally higher than on new bonds.

Another factor depressing yields is that the average maturity of bonds held by insurers has declined. Although rates on riskier categories of bonds are much higher than on treasuries and the prospects for real estate price appreciation are good, insurers’ profits will not benefit much from such trends because they hold too many risky assets in their investment portfolios.

There will be an increase in households’ demand for property and casualty insurance, with homeowners leading automobile insurance. A huge positive for insurers is the housing upturn will provide a substantial boost to the number of new homeowners’ and title insurance policies written in Georgia. Plus, home prices rose in 2013 and 2014 and are expected to rise moderately in 2015 and 2016, which will lead to increases in insured amounts.

The proportion of households that are unable to make their mortgage payments will diminish in 2015, so claim rates on home insurance policies will decline. Loss performance will improve because there will be a smaller proportion of foreclosed, vacant and uncared for homes. Georgia’s relatively high rate of questionable claims will drop. Insurers therefore should be able to devote fewer financial resources toward detecting insurance fraud and settling claims.

As the labor market expands, household net worth rises and credit market conditions improve, households will spend more for high-priced durable goods, such as automobiles and boats, which will cause demand to grow for property insurance products. The need to increase automobile insurance liability limits also will add to the demand for auto insurance.

Demand for commercial lines of insurance purchased by businesses will increase. The leaders will be workers compensation and liability, and policies related to cyber- and data-security. Policies written to state and local governments will also increase for the first time since the Great Recession. Nonetheless, intense competition among insurers will prevent premiums from rising very much for most commercial lines.

There are some very encouraging trends in the nonresidential property markets that will benefit insurers: The prices paid for commercial properties are on the upswing – albeit from depressed bases. Because Georgia’s transportation, logistics and manufacturing sectors have been outperforming the overall economy, the situation in Georgia’s industrial property market will improve faster than its office or retail markets. Plus, the approval of the Savannah Harbor Expansion Project bodes well for the continued growth of these industries.

A more optimistic attitude toward spending for new equipment and facilities also will boost demand growth for property insurance. Indeed, business spending for equipment will grow almost three times faster than the GDP, reflecting the need to replace equipment, improve productivity and become less labor intensive.

Capacity utilization for goods is above its long-run average. Strong cash flows and easier credit will fuel such spending. Plus, the significant number of economic development projects announced in recent years bodes especially well for such spending in Georgia.

Taken together, the insurance industry looks strong for the year ahead.