P&C Insurance Industry Will Be Smaller at End of Financial Crisis

While property and casualty insurance companies remain somewhat insulated from what happens in the general economy, the industry is projected to be smaller, in dollar terms, once the current financial crisis is corrected, according to a leading industry economist. Once the recession finally ends, the industry will be about 3 percent smaller, perhaps even 7 percent smaller accounting for inflation, said Dr. Robert Hartwig, president of the Insurance Information Institute.

There will not be a sudden end to the current financial downturn, Hartwig told an audience of independent insurance agents at the recent conference and trade show of the Independent Insurance Agents of Texas.

“We will not wake up one morning and say thank goodness this crisis is over. It will be slow. It will be uneven. It will be two steps forward and one step back. That’s how recoveries are. And it will be a different experience in every state,” Hartwig said.

The monetary reduction in the P/C insurance industry won’t result solely from the weak economy. “It’s also because this economic downturn happened to be coincident with the soft market,” Hartwig said. “Especially in commercial lines — that’s what’s holding down growth in the industry.”

Hartwig noted that workers’ compensation is “probably the softest of all commercial lines today.” And because it is the largest commercial line of insurance, it has a significant affect on overall industry growth numbers. He added that falling prices, weak exposure growth, increased government intervention in private reinsurance and insurance markets, large retentions and alternative forms of risk transfer have all combined to siphon premium from the private P/C insurance market.

While acknowledging the potential for a “mini-consolidation wave” among insurers as a result of the soft economy/soft insurance market, Hartwig expects the industry to “emerge with its risk management model more intact than most of the financial services sector. The P&C insurers have truly distinguished themselves in a positive way from the banks and the investment banks — and to a significant extent many life insurers.”

Hartwig said investment earnings will continue to suffer for “an extended period of time.” As a result, “insurers are going to have to return to their basics, return to their roots as underwriters. This period of low investments is putting the greatest pressure to generate underwriting profits that we’ve seen in more than 40 years,” he said. “The only way, really, to earn a risk appropriate rate of return given the current investment environment is to generate an underwriting profit.”

He predicted the industry, which was profitable before the crisis and has remained so throughout, will continue that profitability. However, profits may be harder to come by.

Still, the P/C insurance industry has the ability to sustain itself for some time through a period of “profitable stagnation,” Hartwig said. “In other words, where there is very low growth, but where it remains profitable. That can be done through very, very disciplined underwriting.”

A Key Challenge

Hartwig said the erosion of capital — about 12 percent of the industry’s capital was lost in 2008 — is likely one of the most significant challenges the industry will be facing over the next few years.

“It will take years for the industry to recover from these losses,” Hartwig said. “The reality is the industry went into financial crisis extremely well capitalized. Almost a record, essentially, and remains well capitalized by historical standards. This issue of being able to reload capital after a major event, imagine an event striking Texas, causing $40 billion [in damage] like Hurricane Katrina did — where’s the money going to come from that the industry needs to raise?”

While the long term reduction in investment earnings is a challenge, Hartwig noted that at least the capitol markets are beginning to open up again. Recently, he said, 19 banks that had been forced to undergo Treasury Department strength tests had collectively raised $85 billion in 30 days.

“If a bunch of troubled banks can do it, a bunch of insurance and reinsurance companies who are not troubled, who remain financially strong can do that as well,” he asserted.

Still, he reiterated that the industry has to be prepared to “operate in an environment where earnings account for a smaller fraction of profit.” Such a scenario implies a degree of underwriting discipline that the industry has not seen in more than 30 years.

“Prior to the mid 1970s the industry usually ran at an underwriting profit,” Hartwig said. “It is a lesson that needs to be re-learned.”