Aon Re: Homeowner business hasn’t covered capital costs

Although they’ve improved steadily in the past four years, returns in the homeowners insurance business still aren’t adequate to cover the cost of capital, according to a new report prepared by Aon Re.Sharp increases in homeowners’ rates after the 2004 and 2005 storms have failed to provide insurers the opportunity to earn back their cost of capital, the report says.A.M. Best reports Bryon Ehrhart, president of Aon Re Services, as saying that about a third of the reduction in the prospective return on equity projected to drop from 9.3% to 5.7% this year comes from increased costs for reinsurance and modeled risks. The other two-thirds of the shortfall is a result of greater capital required by rating agencies, Aon Re says.As A.M. Best notes, rating agencies are taking an even closer look at catastrophe risk as they assess insurers’ capital adequacy, while meteorologists and risk modeling firms expect more and stronger hurricanes in the near term. Reinsurance costs have risen as a result of the increased frequency and vulnerability estimates.”If you look at the cost of capital for homeowners insurers, it’s probably on the order of 10 to 12%,” A.M. Best quotes Ehrhart as saying. “With the business currently forecast to return 5.7%, there’s a significant amount of work that’s necessary for insurers to actually get a return that’s at least recovering its cost of capital and then rewarding shareholders and mutual policyholders for the risk they’re taking.”Aon Re’s report projects a return on equity of 3.5% for hurricane-affected states (viewed as a group) and 8.1% for non-hurricane-prone states. The company said many insurers seek a return of 14% or more. To a 14% ROE, an estimated average rate increase of 43.3% would be required for hurricane-affected states and 11.1% for the non-hurricane-affected states, the Aon Re report states.Clearly hurricanes drive a lot of capital, Greg Heerde, a senior vice president at Aon Re, told A.M. Best. “The wind PML (probable maximum loss) dominates the industry,” he said. “The 1-in-100 hurricane PML is larger than the 1-250-quake PML.”Heerde noted that one component of the capital charge is reinstatement premiums. “If you’re paying more for your catastrophe cover, and a catastrophe happens and you have to pay to reinstate that layer, the capital charge actually goes up because of the increased reinsurance costs,” Heerde said.