As thousands of risk management professionals, carrier executives, vendors and industry watchers gathered at the Risk and Insurance Management Society’s annual conference in San Diego, last month, there was only one question on the minds of corporate buyers of insurance—”When will prices come down?”
According to some industry groups, commercial insurance prices are already on the decline—at least by a smidge.
The RIMS’s Benchmark Survey for the first quarter of 2004 reported that premium prices for property insurance fell by about 1.5 percent, while general liability premium prices fell by 1.4 percent. This marked the first time in more than four years that prices for two major lines declined in the same quarter. RIMS also noted that the cost of property insurance fell 8.8 percent in the fourth quarter of 2003, “the first decline in premium prices for any major line of commercial insurance since 2000.”
Risk managers and other buyers of insurance may be jumping for joy, but industry experts including AON’s Deputy Chairman Max Taylor remain conservatively cautious when discussing the approach of a softer market.
“The first to heal may be the first to be wounded,” Taylor said to a luncheon crowd at the RIMS conference. He added that while we are seeing some prices fall, any significant amount of increased losses or a severe catastrophic event could revert the market back into harder days. However, an informal survey of both buyers and sellers in AON’s 2004 U.S. Property Report stated that premiums fell an average of 10 percent for buyers of U.S. commercial property insurance in 2003.
Rates are losing steam said Frank Coyne, chairman, president and CEO of Insurance Services Office (ISO), at a conference session. “Rate increases gained momentum through July 2002. Since then, rate increases have been losing steam, dwindling last September to less than half of what they were at their peak.”
But the overall tone of most industry executives at RIMS was clear … hard market prices may be coming to an end, a feat that Coyne claims “is remarkable considering insurers’ rate of return was just 9.4 percent in 2003.” In fact, Coyne noted that only once in the last 20 years, has the industry experienced a “healthy” rate of return on equity; a mire 15 percent in 1986.
Coyne also noted that insurers’ rate of return on average surplus dropped from 13.7 percent in the 1970s to 10.3 percent in the 1980s to 8.7 percent in the 1990s. And for this decade, the average rate of return thus far is only 3.6 percent. He said the declines in the industry’s rate of return made reductions in supply and increases in price inevitable.
Additionally, poor insurer profitability has led to a “dramatic reduction in the number of private insurers service the U.S. marketplace,” from 1,272 in 1990 to just 938 in 2002.
Coyne noted that industry data also shows “insurance markets have been battered by circumstances that cut deeply into supply, starting with abysmal underwriting results.” According to ISO, in the 20 years from 1960 to 1979, the combined ratio averaged 100.4, a loss of about one-half cent on every dollar of written premium. From 1980 to 1999, the combined ratio averaged 108.5, a loss of nearly nine cents on every dollar of premium written. And thus far, for this decade the combined ratio continues to average about 108.3.
The good news … Coyne forecasts the industry’s combined ratio will improve from last year’s 100.1 to 98.8 this year—the best since 1978 when it achieved a combined ratio of 97.4. But with current investment results, tax rates and financial leverage, ISO estimates the industry would need a combined ratio of 94.3 to reach a “healthy” rate of return level of 15 percent.
Breaking the cycle
Another question posed by attendees of the RIMS conference was, what lessons have been learned from another round in the infamous insurance cycle?
As Zurich’s CEO James Schiro put it to a morning crowd at the conference, “In recent years we have been reminded—some of us perhaps painfully—that insurance is a notoriously cyclical business.” So how does the industry break that cycle and refrain from the soft market events where insurers slash prices to battle for market share?
According to Schiro, it is the industry’s obligation to find ways to safely moderate the cycle. “Some of the storms have passed, but some we have to navigate through,” he said, claiming the industry has much-improved its seamanship as it progresses to the next phase in the cycle.
“At Zurich, as at many other insurance companies, our shareholders were taken on a bumpy ride over the last couple of years,” Schiro said. “If we want to continue to rely on their capital, insurers must develop and implement business models designed to generate more stable returns.”
And part of Schiro’s message was imminent throughout many presentations. The necessity to earn underwriting profits throughout the entire insurance cycle … hard or soft. But is a moderate cycle a real possibility, or just wishful thinking?
“I believe it is fair to say that our industry has learned an important lesson from the recent cycle,” Schiro noted. “Top player companies have driven combined ratios of 100 percent,” he said. “I’ll admit that Zurich was not among the top players.”
According to Schiro, the industry has changed. “Seven out of 10 new CEOs do not come from within the industry,” he said. Schiro, the former chief executive officer of PricewaterhouseCoopers, joined Zurich in May 2002 and has been charged with heading up Zurich’s recovery process, which aims to regain its AA financial strength rating this year.
“We are not in the business of taking shareholders’ money, and we will not commit our capital to underwriting losses,” Schiro added. “We have to get better at the way we manage cost structure. The tools for better asset and liability management are being implemented more widely. … I continue to see realistic pricing, and the necessity to earn an underwriting profit is not disputed. The building blocks are in place for a better business model, one that may help us break out of the stark cyclicality of the past.”
How long will that commitment to better and more moderated business models will last remains to be seen? Fierce market share competition is just beginning. According to Coyne, with the industry surplus posted at a record $347 billion at year-end 2003, “is it any coincidence competition is returning?”
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