Property-casualty underwriting and operating results were weaker in 2014 than in 2013 but remain above historical averages by most measures, according to a new report from ALIRT Insurance Research, LLC.

And despite significant reliance on redundant reserves and excess capital, the industry is well-poised for continued success moving forward—especially because the market cycle may be less prone to extreme highs and lows in the future.

Net premium leverage, or net premiums divided by surplus, remained at a 15-year low of .75 for all lines of business, according to the report. “Traditionally that would indicate that market rates would continue to soften or at least firming prices would start to fall,” says David Paul, principal at ALIRT. “That’s what we’ve expected to see. But interestingly we’re seeing that underwriters are being more disciplined this time, almost regardless of capacity.”

The Only Constant is Change

Why? ALIRT’s “Year End 2014 P&C Industry Review” outlines five different reasons why the underwriting cycle might be dramatically different moving forward:

1) Data analytics and data mining. Sophisticated capabilities in gathering, ordering and deriving actionable information from massive amounts of data has revolutionary implications for p-c insurance. Securing a more accurate sense of the ultimate cost of risk will foster greater risk discrimination among insurance companies, enabling them to “pull back underwriting reins well before losses get out of control,” the report says.

2) Specialty focus. The trend of focusing on specialty p-c offerings gives companies a way to insulate themselves from the broad sway of pricing cycles—giving them what the report calls “greater pricing power.”

3) Professional management. ALIRT reports that market leaders in the p-c market have experienced significant professional growth that reflects greater expectations from institutional investors “as the competition for profitable investments becomes more globalized.”

4) Consolidation and scale. Demand for insurance “is picking up as the economy gets somewhat stronger, but surplus development is outstripping demand,” Paul says. “That’s one of the reasons we see the net premium leverage continuing to fall or be very low.” 

In addition to excess capacity, the necessity of scale and diversification, inexpensive sources of capital and aggressive investors continue to drive mergers and acquisitions in the insurance industry. A smaller of number of insurers will translate into “fewer cats to herd when trying to gain an unofficial consensus on price adequacy,” the report says.

5) Investment environment. “Because of the lower interest rates, we’ve seen a shift of assets toward some of these alternative asset classes,” Paul explains. “It’s not massive. If folks continue to underwrite conservatively, it’s not a problem—they just make up for it with strong underwriting.”

Low interest rates have persisted since the economic recession in 2007—putting pressure on investment income as a source of profit and forcing insurers to depend more on underwriting gains to drive returns.

What It Means For Your Agency

Commercial trends are more volatile than personal lines, which means personal lines-heavy agencies won’t see as much of an impact from a leveling of market cycles. But for “people writing commercial lines insurance, it’s a net positive,” Paul says. “You don’t get sidelined waiting for a hard market so that you can get a pay raise by doing the same thing.”

And because soft markets tend to last longer than hard ones, “having that even out would be a benefit just in terms of smoothing the top line for agencies, and by extension the bottom line,” Paul points out. “If we do go into this environment where the underwriting cycle is less severe, you’ll see stability in pricing—which is a net positive for buyers and enables agents to be much more predictive of what their revenue stream’s going to look like.”

Rates have continued to firm, but the year-over-year rate of increase is declining—another positive for customers, Paul says. “I don’t think we’re going to see any very large increases,” he says. “If anything, we’re likely see a continued softening of prices over the next couple of years.”

Overall, the results point to carrier stability and a strong p-c balance sheet. ALIRT’s composite scores “are still above the long-term average,” Paul points out. “That’s indicative of the financial strength of the industry.” And with help from the predictive capabilities of data analytics and data mining, pricing strategies will only continue to improve. “If you price correctly in this industry, you shouldn’t have a problem—you’ll continue to make profits and your capital will continue to grow,” Paul says.

But in the face of deteriorating investment income, underwriting discipline must remain in place, “and at some point the industry, especially publicly traded companies, will have to address overcapitalization because the returns won’t be adequate for private investors,” Paul says. “As long as underwriting is done well, investment income is just the cherry on top of the sundae.”

Jacquelyn Connelly is IA senior editor.