Hartwig predicts profitable 2006, sees premium growth grinding to a halt

The last 24 months have been traumatic for the insurance industry, but the profit picture for 2006 is quite good in the industry overall, Robert P. Hartwig, Insurance Information Institute senior vice president and chief economist, told attendees at the May 11 National Council on Compensation Insurance Annual Issues Symposium in Orlando, Fla.

“Recapping last year vs. 2004, if there is one downside to what has happened recently, we are in a period right now in which premium growth is basically grinding almost to a halt,” Hartwig told more than 700 workers’ compensation executives attending the symposium. “Industry-wide we had premium growth last year of about one-half of 1 percent, very slow, the slowest we have seen since the 1990s.

“We have seen losses creep up at a little higher rate, so we are going to expect to see deterioration in underwriting industry-wide in the year ahead,” he said. “Nevertheless, we started from a relatively strong point, outside catastrophe-prone lines. We had a small underwriting loss last year, after 2004 we had the first underwriting loss since 1978. Invested income is off considerably, while net income is up about 12 percent, which is a very large leap. Considering we had record capacity losses and surpluses went to $427 billion dollars, a 9 percent increase, and combined ratio was 1,100.”

Hartwig said he was sure the audience must be wondering, “How is it that these results ended up being so good, despite record catastrophe losses?”

Resiliency a key strength
“The industry has been very resilient–this isn’t your grandmother’s insurance company,” Hartwig explained. “This is not 1992, the year of Hurricane Andrew, in which the insurance industry was laid flat on its back by that huge event. The industry has proven to be very resilient in the wake of a major catastrophic event.”

Looking at the profit picture, Hartwig quoted statistics indicating the industry generated about $43 billion in profits last year.

“That may sound like a lot, it may sound like a record–it is a record in nominal profit terms,” Hartwig said. “However it is not a record when it comes to ROE, return on average surplus last year, which was 10.5 percent.

“In fact, we weren’t even remotely close to profitability levels the industry used to see at peak points of the cycle in the 1970s and 1980s, which were close to 20 percent,” he said, pointing out that 9/11 was the worst year ever in the history of the industry.

Weak premium picture
He said the strength of profit of the premium picture is weak with strong cycles in the 1970s and 1980s, but nowhere near that strength in the 2000s.

“We are looking at a period in which we are going to rebound from very sluggish premium growth in 2005 to something in the 3 to 4 percent range in aggregate in 2006, and then reduced growth after that.

“On an inflation-adjusted basis, premium growth in 2006 will be effectively zero, or even slightly negative for the next several years,” Hartwig predicted.

Hartwig said the current period is very much like what happened after 1992, when there was a boost in premium income and then it fell off.

Maintaining underwriting margins
“The question is, ‘Can the industry maintain its underwriting margins in a period with sluggish premium growth outside of property coverages?'” Hartwig asked.

The storms have made a dramatic impact on profitability over the past several years.

“You might say, ‘What is there to complain about? You hit a record profit in nominal dollar terms, you had a 10.5 percent return last year, that doesn’t sound too bad.’

“The point is, 10.5 percent just does not cut it across the industry,” Hartwig explained. “When you look at the risks insurers are being asked to assume, it is a tremendous risk, considering you can get more than 5 percent today on a risk-free investment, is 10.5 percent the kind of return to expect when you are assuming catastrophic hurricane risk, terrorism risk or any other sort of catastrophic risk?

“The answer is, probably not!”

Hartwig said over the past few years storms knocked 4 to 5 points off the industry’s returns.

“It’s fortunate the industry entered the 2004 and 2005 hurricane seasons in extraordinary financial strength,” Hartwig explained.

He said that picture is quite different from 9/11, when the industry suffered from problems and issues that occurred during the years and months before the terrorist attacks.

“IN 2001, it’s easy to see the impact on the industry and a dramatic effect on profitability, but the industry had already taken a nose-dive, 2000 to 2002 were terrible.

“We have a different trend right now, stock markets are going up, at least modestly, and interest rates are also trending up and will help future returns,” Hartwig predicted.

He said returns are narrowing between stocks and mutual fund companies. Many of the big players are mutuals, so while mutuals trail stock companies, the gap is only about three points in terms of profitability relative to a much wider margin, 5 to 6 points in recent years. Mutual companies are becoming more profitable, while stock companies are holding their own, and that applies to Fortune 500 companies overall.

According to Hartwig, property casualty insurance companies are still falling far short of the Fortune 500 rate of return many investors would like to see.

He said that over the past decade, in terms of all the major coverages, the average return for all property-casualty lines is 7.7 percent; while workers’ compensation is 7.9 percent.

Confidence important
According to Hartwig, it is extremely important and crucial that the industry maintain the confidence of Wall Street. He said the industry could need to go to the Street on a moment’s notice to raise potentially tremendous sums of capital.

“In the wake of 9/11, the industry raised between $25 billion and $30 billion,” Hartwig said. “The industry also raised large amounts during the storms of 2005.” He said this also goes for reinsurers.

“What did Wall Street think about the insurance industry last year in August when the property-casualty market cap was at about 4 percent?” Hartwig asked.

He said every time there was a prediction of a hurricane coming ashore, there was a dip in the market.

“You see a runup of property-casualty stock toward the end of the year, finishing up at 9 percent, while the S&P was only up 3 percent,” he said. “That is an amazing feat!”

“How is it possible that, despite record losses, insurance stock prices were driven up?” Hartwig asked. “We see that reinsurers were down throughout the entire year, but finished the year almost even Dec. 31; and brokers, who had been down ever since Elliott Spitzer’s revelations in October, 2004, found their way above the axis as well.”

Hartwig said it is not at all surprising that during the first half of 2006, insurers stock prices are “taking a breather.”

Underwriting profit the key
Hartwig said underwriting drives the industry’s profitability, with quality underwriting making the difference between companies that are going to be profitable and successful. He said the insurance industry needs to generate an underwriting profit to achieve its cost of capital.

“That’s the rate of return we need to hit in order to be able to attract or retain capital in this business. Because of the relatively low results on the investment side, we need that underwriting profit, so on the underwriting side we need tremendous improvement with a 116 combined ratio. Imagine paying out $1.16 for every dollar you take in, in a $350 billion business, right until 1993 when the hurricane struck, and winding up with a rate of 101 last year, and the prediction for 2006 is a 98 combined ratio–of course that assumes no catastrophe results, whatever that means in this day and age,” he added.

Topics Catastrophe Trends Profit Loss Pricing Trends Underwriting Hurricane Property Market Property Casualty