P/C Pricing Growth Fastest Since 1986, New York Analysts Told

The property and casualty industry is well into a rebound from the terrorist attacks of Sept. 11, 2001, with premiums increasing aggressively for more than a year, a trend that will certainly continue throughout 2003 and into 2004, according to Chicago-based Raymond James Financial.

Greg Peters, senior vice president for equity research at the financial service brokerage, told the seventh annual Insurance Conference of the New York Society of Security Analysts recently that the year 2002 saw the fastest rate of growth in property casualty pricing since 1986. U.S. non-life premiums, according to Raymond James, rose 15 percent in 2002. Going forward, Peters said, that rate will remain positive for the industry, though it will decelerate, to 11 percent in 2003 and to 6 percent in 2004.

NYSSA’s own big-picture assessment of the insurance industry’s current climate, set out in program notes prepared for the two-day conference, ran like this:

“Many insurers,” said the Society, “are rationing their coverage by offering customers lower coverage limits, higher deductibles, more restrictive terms [and] conditions or prices they know are likely to be unacceptable.

“As a result, the U.S. property casualty insurance industry earned $4.6 billion in the first half of 2002, up 66.4 percent from the $2.8 billion in 2001.”

The Society took note that there were relatively few natural catastrophe losses in the U.S. in the third quarter and that the industry concurrently lobbied for limits to its total liability for damages from any future terrorist attack. [The latter effort recently met with modest success when Congress allowed for some federal backup for private terrorism protection].

Despite this, NYSSA said the industry is beset with these challenges:

Investment gains fell by 28.3 percent during the first half of 2002. Some predictions see a decline in bond yields for the third quarter of 2002 that will depress 2003 earnings by 2.2 percent.

Net asbestos and environmental liability losses, according to A.M. Best, could exceed $65 billion, with property/casualty insurers under-reserved as much as 50 percent for such liabilities.

In the wake of the Enron, Global Crossing, and Tyco episodes, directors and officers liability insurance lines took an enormous hit, with federal securities fraud class action lawsuits jumping 126 percent in 2002.

The medical malpractice insurance market is at risk, as the median jury award increased 43 percent to $1 million in 2000, a year when plaintiff victories rose to 38 percent from 29 percent in 1996.

Peters presented an over-view from Raymond James of the recent performance, outlook and financial issues currently facing the non-life market in the United States.

For 2002, he reported, James anticipates a combined ratio of around 105.3. “This, of course, compares with some disastrous results in recent years,” he said, pointing to the 116 the industry posted in 2001 and the 110 of 2000. With rate increases already in place, and with everything else equal, Raymond James anticipates that the combined will continue to improve. They’re looking for 104.4 in 2003 and 103.5 in 2004.

As for the rate hikes themselves, he pointed to the dramatic change since the first quarter of 2000, when increases were a “meager” 1 percent, compared with last year’s third-quarter peak of 9.3 percent. In commercial lines, in the first quarter of 2000 only 27 percent of small, medium and large accounts reported rate increases of more than 10 percent, a number that swelled after 9/11 to a peak in last year’s second quarter of 85 percent. The latter number eased off “a little” by the fourth quarter to 66 percent.

“The bottom line,” Peters said, “[is that] the rate increases have a delayed impact on the income statement given the nature of how insurance accounting works. The fact that the industry has been able to achieve these rate increases over the past year, in my opinion, foretells that the coming years should be pretty good from a margins standpoint as these rate increases make their way through the income statement.

“Another very important component in the current property and casualty business climate has been favorable changes to terms and conditions,” Peters said. “That is not a quantifiable number, but the simple fact is in many instances insurance companies are offering reduced limits for the same amount or even higher premium dollars, which does not necessarily show up on the top-line statistics you follow for the industry,” he told the analysts. “But they can be as important, if not more important, to the industry’s profitability.” This is, he said, “another sign that the results going forward are going to be significantly improved certainly for 2003.”

And there are other indicators, he said, especially when one looks at the personal lines auto picture, that this is a market more sensitive to earnings and as the earnings of many companies rose substantially in the 1997-98 period, it attracted many investors. It’s important to note, he continued, that the rate has started to deteriorate for personal lines. State Farm, for example, the largest insurer of cars and homes (one out of every five) in the U.S. reported a combined ratio of 125 last year. Year to date, it’s ratio is more than 110 percent. “The bottom line here,” Peters said, “is that the industry’s premium rate increases for auto will start to decelerate and the eight-hundred pound gorilla, State Farm, is still hemorrhaging and cannot survive with losses like these. In our opinion, this is going to provide yet further support to extend the pricing cycle for the insurance industry.”

Medical malpractice, though a minute component of total industry premium, provides yet another reason why the pricing cycle for the U.S. insurance market is going to continue past 2003. In 1991 the American malpractice industry had a peak-combined ratio of 127 percent. That improved to its best percentage of 96 in 1994. “However, more recently results have been downright horrific,” he said. “In 2001 it was 153, and here we’re talking only underwriting results.”

Equally important, in the last three-to-five years, the insurance industry’s investment returns have been negative, this from a business that historically reports combined ratios in excess of 100, which means it needs investment income to achieve overall operating profitability. Looking to 2002, Raymond James expects another decline of almost 5 percent on the investment side, despite the very strong cash flow reported by most in the industry. The need for profitability on the underwriting side, then, is still another reason why pricing stabilization will extend beyond 2002 and 2003.

Then there is the industry’s chronic history of under-reserving deficiencies, reflected in recent years, and dramatically apparent in asbestos and environmental liability reserves which some observers believe are short by as much as $25 billion. “Everything else equal, you take $25 billion out of industry surplus and you have another reason why we continue to believe the pricing cycle will extend beyond 2003,” Peters said.

Reinsurance recoverables, he said, especially post 9/11 is “an issue for some, not an issue for most.”