Assessing Property/Casualty Insolvency Exposure-2001 to 2002

There will be no more than 65 property/casualty insurance company insolvencies over the period Jan. 1, 2001, through Dec. 31, 2002, according to Demotech Inc.

Demotech Inc., a Columbus, Ohio-based financial analysis and actuarial services firm, arrived at this prediction by analyzing its distribution of 2001 Preliminary Financial Stability Ratings®.

Demotech used its Financial Stability Analysis Model to analyze 2,053 property/casualty insurance companies that reported complete year-end 2000 information to the National Association of Insurance Commissioners. The resultant 2001 Preliminary Financial Stability Ratings® were assigned to individual companies (See Figure 1).

With regard to a longer term time horizon, Demotech believes that over the next decade, the p/c insurance industry will experience three major trends: 1) voluntary withdrawals, consolidations and mergers; 2) re-emergence of regional insurers; and 3) the stock market’s realization that some national stock companies are less than national.

Voluntary withdrawals, consolidations and mergers
The competitive pricing wars of the 1980s through the late 1990s were punctuated by predictions that the pricing wars would soon be over. From the late 1990s to date, the new logic is that competitive pricing is the new paradigm and the p/c insurance industry had better get used to it.

Successful carriers will institute modest, targeted rate increases. In those jurisdictions, situations, or lines of business where rate increases cannot be as large as they need to be, availability will become the issue. That is, Demotech believes that carriers that do not or cannot raise rates will elect not to compete for chronically under-priced business. Carriers will selectively withdraw from lines, niches or states where they believe that a reasonable rate of return cannot be achieved. For marginal carriers, this will lead to an orderly process of voluntary withdrawals, consolidations and mergers.

Re-emergence of regional insurers
Concurrent with selective voluntary withdrawals, Demotech envisions the next decade as a period of opportunity and growth for well-positioned regional insurers. Demotech views regional insurance companies as the original niche marketers of the insurance industry. Hundreds of regional insurers have dates of incorporation in the late 1800s. They were niching before niche became a catch phrase.

Further, Demotech believes that regional insurers have mastered the art of survival through a combination of niching, conservative balance sheets and intensive use of reinsurance. Over the past few years, they have further honed their skills by re-focusing on their competitive advantage.

Regional companies never wanted to be everything to everybody. Those that have embraced technology, maintained a conservative balance sheet and have below-average financial leverage are well positioned to expand their market share in those states and lines of business that they know best.

These carriers tend to have above-average expense ratios. Generally, these expense ratios can be attributed to above-average commission levels and heavy reliance on reinsurance. It is Demotech’s belief that the Achilles heel of most regional insurers falls into one of two categories—management succession or revitalization of their agency plant.

Nationals that are less than national
Several insurance companies have positioned themselves as national or even international insurance companies. That is, they are widely licensed and offer a variety of product lines in a significant number of jurisdictions.

From Demotech’s perspective, the definition of a national or international insurance company should include more than expansive licensing and a diversified product line. National and international insurance companies should be able to influence the markets that they are serving. To claim the title national or international, they should be more than a player—they need to be a leader in at least one specific geographic area or at least one specific line of business.

Looking at it from a different perspective, there can only be a few national or international insurance companies. If they are not leaders, they are niche players. Although the overall scale of activities is different, the challenges that non-leaders face in the national or international marketplace are comparable to the challenges that regionals face in the national marketplace.

Summary
Despite lower interest rates and the concurrent decline in investment income; regardless of an uncertain stock market and exposure to unrealized and realized capital losses; even with a competitive pricing environment that discourages across the board rate increases; Demotech expects fewer than 65 p/c insurance insolvencies among active p/c insurance companies during the period Jan. 1, 2001, and Dec. 31, 2002.

Furthermore, over the next decade, the p/c industry should anticipate voluntary withdrawals, consolidations and mergers due to the fact that some insurers are not positioned to raise rate levels, reduce expense ratios, improve investment income or otherwise improve their return on equity.

Conversely, over the next decade, regional insurers with strong balance sheets, revitalized distribution systems and below average financial leverage will be uniquely positioned to sustain focused growth in their niche markets.

As for national and international insurers, the next ten years will represent a struggle for leadership. There can only be so many leaders despite the size of the marketplace.

Joseph L. Petrelli is president of Demotech Inc. of Columbus, Ohio. Petrelli is an actuary and has earned an MBA from The Ohio State University. Demotech Inc., www.demotech.com, is a financial analysis and actuarial assistance company.