A look behind the very good P/C results for 2006

The numbers, or estimates, for the property casualty insurance industry for 2006 are in. Dr Robert Hartwig, president and chief economist of the Insurance Information Institute, discussed them with Insurance Journal’s Andrew Simpson at III’s Joint Property Casualty Insurance Conference in New York. The complete video interview may be viewed at www.insurancejournal.com/broadcast.

What do the overall results of 2006 look like for property casualty insurers?
Hartwig: The results for the industry were quite good in 2006 and there are numerous ways to measure that. In terms of dollars, yes, the industry did generate record in terms of dollars of profit in 2006. In terms of ROEs there are a couple of ways to look at that. The industry had its best return on equity at about 14 percent. That is the best it has seen since 1988.

While that is very good for property casualty insurers, in fact, that is just about the norm for the Fortune 500 group. Really the industry is just joined the pack after having trailed it for many many years. It is still quite possible actually that the industry will fall behind the Fortune 500 group when all the final numbers are in. That will be the nineteenth consecutive year actually that the industry underperformed the Fortune 500 group.

All in all it was a very good year for insurers in terms of underwriting performance. This is the most remarkable statistic of all. The combined ratio we estimate to be about 94 for the year. That would be the best result since 1955. In fact, there is a possibility it could be down in the 92 range when all the numbers in. That would be the best number since 1948.

What effect did the mild hurricane season have on those results?
Hartwig: The mild hurricane season did have a significant impact in pushing down and making the underwriting results better than they would have otherwise been. But I think too much credit has been given to the absence of hurricanes. Even if we had a normal hurricane year in 2006 we would have still seen a very good year for insurers. Probably a combined ratio perhaps in the 97-98 range.

Now, put that in perspective, that would only be the second underwriting profit the industry has had since 1978. Even with a normal level of catastrophe loss activity, it would have been a good year. That means that the results were robust. That basically every type of coverage, all across the country, was contributing to the industry’s bottom line. Along with, of course, robust investment results in 2006.

So lines that would not have been affected necessarily by the mild hurricane season have also looked good?
Hartwig: That is right. Lines such as workers compensation and auto insurance, which aren’t really catastrophe prone lines, contributed tremendously to the industry’s bottom line in 2006. And helped the industry stay above water in years like 2004 and 2005.

What have insurers done with the profits?
Hartwig: Well what insurers have done is largely reinvest their profits that they earned in 2006. They have also reinvested their unrealized capital gains. So what that means is insurers are going to post their second largest ever increase in policy holder surplus, the best measure of claims paying capacity. We estimate by 12/31/06 that number reached $481.5 billion, which is a new record, but it is important to keep in mind that this is not one sum, one pool of money that is available to pay any mega type claim that arises. It is in thousands of little pots. Each one of those pots represents an individual insurance company. There are even pots within that, that basically represent the individual lines of insurance each of those insurers write. It is not some almost $500 billion that is available to pay some single terrorism loss, some single major hurricane or earthquake.

The Consumer Federation of America has suggested that there is too much surplus?
Hartwig: There is too much surplus in the industry when there is no concern about not being able to meet the claims. We live in an era that is very dangerous. In fact, we are looking at potential claims, from a single event, from an earthquake or hurricane that could easily exceed $100 billion. That would consume more than 20 percent of the industry’s total claims paying capacity. Again, that whole 20 percent is not available to pay on that single event. It would be a very difficult event at that level, and of course some terrorist attack scenarios are even worse.

It is also the case, we are a cyclical business. There are times when the industry increases its surplus, there are times when it decreases. For instance, part of the reason for the increase is the buoyant equity markets that we saw in 2006. Well, had it been the case that the stock markets went down or that investments turned south generally as was the case during the 2000-2002 period, we would have seen a surplus decline as we did during that period of time. It is very prudent for insurers to take this time to rebuild their claims paying resources.

The good underwriting results seem to suggest there is more discipline in the pricing these days than years ago.
Hartwig: Right, Typically what we saw at the end of previous hard markets in the 70’s or 80’s is basically pricing would fall off a cliff. Now pricing has moderated, but there is not right now any information that suggests that we are at the beginning of or about to enter a slippery slope where insurers are simply price cutting to gain market share and don’t pay any attention to underwriting performance.

Basically, the price cuts that we are seeing today, generally speaking, are justified by good underlying fundamental results. In other words, what insurers are seeing in workers comp is fewer claims and lower claim costs often times. Same thing in auto insurance. These savings are being passed along to consumers. Insurers can lower rates and at the same time maintain profit margins.

Looking ahead, are the results of 2006 sustainable through the new year?
Hartwig: It is unlikely that the results of 2006 are sustainable. In the sense that we had abnormally low catastrophe losses during a period of time where catastrophe losses are expected to be abnormally high. In and of itself we would expect for some deterioration in underwriting performance. Even if you normalize catastrophe losses and you assume the industry is becoming more competitive, there is more pressure on pricing, we still expect momentum into 2007. I am expecting a combined ratio of 97 or 98 in 2007. That would be a very good result, would generate a healthy ROE for the industry for the second year in a row.