Stalled Momentum..?

The 2004 financial returns of both the Canadian and U.S. property and casualty insurance industries tell a story of “record profitability”. Notably, the earnings gain made by insurers on both sides of the border were primarily driven by robust underwriting profits that resulted not just from higher pricing but almost static growth of claims costs.

The questions now being asked by industry analysts is whether this underwriting momentum can be maintained going forward and if the current picture of the claims landscape reflects a true leveling off of costs or if it is simply an artificial “lull” as insureds regain their confidence after the shocking impact of the hard market. The bad news for insurers is that the analysts believe underwriting will weaken going forward as pricing declines and the rise in claims costs begins to outstrip that of premiums. And, the analysts are not overly optimistic of a more invigorated investment environment coming to the North American insurance industry’s aid over this year and into 2006. Essentially, insurers in Canada and the U.S. likely hit their “earnings peak” in 2004 and now face erosion of the bottom-line as they course through 2005 into next year.

The positive highlights of the financial results of U.S. insurers for 2004 include a 10% year-on-year boost in return on equity (ROE) to 10.5%, largely driven by a US$9.9 billion improvement in underwriting which produced a profit of US$5 billion (versus 2003’s underwriting loss of US$4.9 billion). Insurers’ claims costs for 2004 rose by 3.8% (well below premium growth) and provide an even brighter picture of a mere 2.7% annual growth rate when catastrophic losses are eliminated (insurers incurred US$17.5 billion in catastrophe-related claims mainly resulting from four hurricanes that struck with such rapid succession and intensity that the risk potential thereof is regarded as being almost impossible). And, “…the most recent [industry financial] recovery was accomplished amid some of the most challenging investment conditions since the ‘Great Depression’ – as interest rates plunged to 40-year lows and stock markets tanked in three of the past years”, observes Robert Hartwig, chief economist of the Insurance Information Institute (III). On the downside, insurers saw premium growth for 2004 slump by more than half to 4.7% compared with 2003’s growth rate of 9.8%. “The deceleration is due almost entirely to significant moderation in commercial and personal lines rates,” notes Hartwig.

The bottom-line of the Canadian insurance industry enjoyed an even richer feast over 2004 as net income soared by 60% year-on-year to produce a record 18% ROE. Again, the renewed prosperity of insurers was driven by a five times jump in underwriting profit to reach $2.5 billion. The industry’s direct claims costs for 2004 actually dropped by about 2% while net claims growth slowed to 1%. However, similar to their U.S. cousins, insurers’ growth in premiums for last year of around 8.3% reflects roughly half the annual rate achieved over the two preceding years. Canadian insurers also experienced flat growth in total net investment income (investment income and capital gains) for last year.

Both the Insurance Bureau of Canada’s (IBC) chief economist Jane Voll and Joel Baker, president of MSA Research, expect that 2005 will see a noticeable rise in claims costs while premium growth will continue its decline. Voll says there is only “upside risk” facing insurers on the claims side in moving forward (see MarketWatch of the April 2005 issue for further details). In the latest “MSA/Baron Outlook Report”, Baker says “claims costs are likely to pick up in 2005/6 as perceived availability and price softening increases”. Overall, he expects that 2004’s level of profitability is unlikely to be sustainable this year and into 2006 as commercial lines price softening and auto premium rollbacks begin to eat at the industry’s operating margin.

And, Baker points out that direct premium growth for last year was less than 4%, and that the much higher 8.3% year-on-year rise in net written premiums is due to higher primary company retention levels rather than pricing or new business volume. “…future retained premium growth should slow dramatically [moving forward] as cessions to reinsurers are not likely to drop much further”, he notes.

U.S. analysts are just as pessimistic of the insurance industry’s ability to maintain underwriting momentum. Stephan Christiansen, director of research at Conning Research and Consulting Inc., believes softening market conditions will erode the industry’s performance. “Our analysis suggests that 2006 will be the first year of deterioration,” he says. Industry pricing is weakening more rapidly than anyone expected, observes Hartwig. An III survey of analysts conducted in December 2003 predicted net written premium growth of around 8% for 2004, he says. “Even the lowest estimate among the respondents [to the 2003 survey] – at 5.2% [for 2004] – appears to have been too optimistic and was 0.5% points above the actual result of 4.7%,” he notes. “On a catastrophe-adjusted basis, 2004 is likely to represent the zenith in the current cycle in terms of underwriting and profit performance,” he adds. The industry’s improved profitability over the past year led to growth in capacity which in turn has sparked increased competition, observes John Kollar, vice president of consulting and research at the Insurance Services Office (ISO). This heightened competition threatens to undermine the industry’s underwriting results going forward, he concludes.