Remarkable. Historic. That’s how industry analysts have now begun to describe the current soft property-casualty market, which doesn’t show any signs of letting up.

At least the economy seems to be on an upswing. That’s the only good news for independent insurance agents as the 2011 policy renewal season shapes up and ships out.

A veritable horde of factors has conspired to cause, and maintain, the market’s softness. Barring a series of extraordinary losses, no one is predicting a turnaround any time soon. At most, A.M. Best sees some minor tightening in personal lines through the year, but not enough to put significantly more commission dollars in agents’ pockets.

In the old days, the p-c industry grooved to a cycle, whereby markets fast and furiously turned hard or soft. The industry’s sophistication in leveraging technology to assess, model, quantify and segment risks, particularly in automobile and property lines, has made such cyclical upheaval less likely going forward. Markets will turn slowly, unless a black swan—a highly improbable but consequential event that strikes out of the blue and causes unfathomable loss—swoops in.
Small Setbacks Still Equal Soft Market

The record snowstorms in the Eastern United States took a bite out of the industry’s capital, as did higher-than-expected windstorm frequency losses across the rest of the country; but added up they were hummingbird size—not the black swan needed to turn the market. “There is just no catalyst to bring a broad, sustained hard market,” sighs Robert Hartwig, president and chief economist of the New York-based Insurance Information Institute. “There’s nothing right now. Not a thing.”

Hartwig isn’t alone in this assessment. Industry watchers at Ernst & Young, Conning, A.M. Best and Deloitte share his view. “For the market to sustainably harden requires not only some shock to the existing system but a recognition that what just happened has a reasonable chance of happening again, and therefore insurers must respond with higher prices,” says Stephan Christiansen, managing director of insurance research at Conning.

What about another Hurricane Katrina? “The industry could handle it, without it influencing the broad picture much,” he says. “There might be a short-term response but nothing sustainable unless something new emerges, something that puts fear into the market that things will be much different over the next few years.”

Capacious Capacity
So what’s causing the p-c insurance market to have the consistency of whipped cream? In a word: capacity. The industry is awash in capital and surplus, despite generally meager investment income. One needs to go back to the mid-1980s to get an historical sense of how the industry got to where it is today. Then cash flow was king, guiding many insurers to underwrite business at giveaway prices in return for the sizable investment income the premiums would reap. Then came the backlash. “When losses came in, the investment income didn’t pick up the slack, forcing many insurers to become more conservative from an underwriting standpoint,” explains Chris McShea, a partner in the insurance practice at Ernst & Young.

At the same time insurers beefed up their underwriting, a surprising thing occurred—loss trends in the non-catastrophe lines started declining. Automobile, homeowners, general liability and commercial automobile insurance markets have stabilized over the past 15 years, despite an off-year here and there when losses ticked up a bit. The capital tucked away for anticipated losses gradually built up, as did retained earnings, fostering excess capacity conditions. As the loss trends declined and organic growth in the industry to absorb the excess capacity petered out, a mountain of cash gradually materialized.

Then, another phenomenon occurred—loss reserves held by insurers were released over the last several years and added to capital. “We have been calling for the reserve releases to end for the last couple years, but the decline in claims frequency continues to support it,” says Christiansen. “The overall build-up in capital had made the industry’s surplus close to an all-time high—if not the all-time high. Meanwhile, the premium-to-surplus ratio is pretty much at the all-time low, meaning we have sluggish premium growth against a continual build-up in surplus.”

Christiansen calculates the premium-to-surplus ratio is lower in commercial lines, given that market’s “extreme amount of surplus” (largely income off the loss reserves), although the ratio in personal lines is just a whisker away.

Piling On
Another factor affecting the market is the industry’s use of predictive loss models for underwriting. McShea says much of this activity is driven by concerns over losing customers to a competitor. “It’s laser surgery to find and keep the best risks by quickly giving them rate reductions,” he explains. “Since everyone is doing the same thing, it shrinks the pie (for new business). You make money one deal at a time in this industry.”

What else is contributing to the soft market? Reinsurance, a factor in previous hard markets, is a negligible issue, given the paucity of truly significant catastrophes, lower liability claims frequency and higher self-insured retentions taken by primary carriers, meaning the trigger for reinsurance becomes harder to pull. Consequently, reinsurance remains a buyer’s market.
Investment income is another factor, one that may prolong the soft market if inflation sets in and drives up long-term yields. Christiansen mulls the idea of runaway inflation possibly even stimulating a return to cash flow underwriting. “If inflationary forces build up, and we’re already seeing this in oil prices and food prices, it may contribute further to the soft market,” he says.

All in all, the picture is not bright. “At least the market saw growth for the first time last year since 2006,” says Hartwig. “That said, it was meager—a little more than half a percent in total premiums written.”

Pricing by Line by Line
It’s been a tough time for the carriers, too. When the insurance pie keeps shrinking and there is scant cause like high losses to justify premium hikes, the sheer number of insurance companies competing in the p-c market makes it difficult to risk higher pricing. “Insurers are fighting for every shred of market share; they cannot afford to increase pricing and lose a key customer,” says Howard Mills, chief adviser to the insurance practice at Deloitte.

Instead, the intense competition continues to drive rates down, especially in commercial lines. “Commercial lines is experiencing rate decreases across the board,” says Ed Keane, senior financial analyst at A.M. Best.
Personal lines offers hope of a turnaround, however. “We’re seeing some positive premium movement in the homeowners line because companies are concerned about their catastrophic exposures,” Christiansen says. “There’s also some natural growth from replacement cost coverage increases. But homeowners insurance has been hurt by the housing crisis, especially the slowdown in new housing starts. Whereas we saw a natural upgrade in insurance values from the refinancing boom, that now is gone.”

Personal automobile also experienced some marginal growth in the last year and is now in positive territory, meaning rates no longer are trending south. Christiansen chalks this up to the complex pricing and rating structures that exist in this market, making comparison shopping by consumers difficult. But, even this silver lining has a bit of tarnish. “Consumers are still pinching pennies, reducing coverages, increasing deductibles and in some cases, eliminating damage coverage,” he explains.

Others agree that personal lines is beginning to show some firming, with emphasis on the word “beginning.” Joe Burtone, an assistant vice president at A.M. Best, says carriers “are getting small, moderate single-digit-type rate increases, especially in the homeowners line. They’ve gotten much better at properly measuring the risk, doing things like geographic coding of exposures down to the zip code and even the street level in some cases. This has assisted them to exclude certain coverages in their terms and conditions like roofs older than 20 years of age. Down the line I imagine we’ll see a single digit increase here and there.”

Personal auto, he adds, is experiencing very moderate rate increases, due to continuing concern over medical care costs. At the same time, the economy is causing policyholders to take higher deductibles. Burtone says only 3% of insureds today have a $500 deductible; the remainder have at least a $1,000 deductible.

More of the Same?
So what’s the prognosis? Expect more of the same. Hartwig anticipates that total premiums written will grow in the 2% range this year, driven mostly by personal lines. “We may see commercial lines break even in 2011, for the first time in many years,” he adds. “As payrolls increase, and we saw 1.4 million new net private sector jobs created last year, that should help workers’ compensation. Had premiums not been going down in the line last year, it would’ve helped earlier. We’ve witnessed a quarter of all workers’ comp premiums written literally disappear in the past five years, so there is some opportunity ahead to rebuild this.”

The longtime economist also projects a gradual upturn in commercial automobile, as businesses that deferred spending money to replace older fleet vehicles because of the dour economy eventually begin to fund these purchases.

Regarding the rest of the market, Christiansen says that “at some point, and right now we’re predicting in 2012, the industry’s results will hit bottom. To produce income, insurers will need to get it on the underwriting side. Some carriers are beginning to predict rate increases in the bigger lines, which indicates the bottom might be around the corner.”

Hartwig concurs: “As underwriting performance deteriorates, the well will someday run dry for insurers. But that
will take several years.”

As for the industry’s formerly notorious cycle, most observers just don’t see a knee-jerk cyclical reaction to a hard market. “A lot has changed since the days of dramatic reversals in the cycle,” Mills says. “Insurers now have analytic models at their disposal, greatly improving their understanding of risk and exposure concentrations. I’m betting on a gradual market shift. But, I’m not betting a lot.”

Banham (russ@russbanham.com) is an IA senior contributing writer.
 

It Just Keeps Going…and Going
“We’ve seen a perfect storm of bad factors coming together to create one of the most persistent soft markets we’ve ever seen, one that will likely continue for some time,” says Howard Mills, chief adviser to the insurance practice at Deloitte.
Mills notes that each year, agents expect the market to turn and it doesn’t—and it doesn’t help that the National Weather Service predicts higher-than-active hurricane seasons only to get it all wrong. “There just isn’t enough loss activity to drive a hard market. And the recession certainly hasn’t helped,” he says. “Businesses and people continue to search for ways to cut costs. This affects their decision-making when it comes to buying insurance. It’s been a tough time, indeed, for agents.”
—R.B.

Regulators Put the Brakes on Rates
Regulation is another issue standing in the way of significant rate increases. Howard Mills, insurance advisor at Deloitte, says regulators will be loath to allow rate increases when their constituents are out of work or otherwise suffering from lingering economic malaise. “In states where homeowners, automobile and workers’ compensation require regulatory approval, regulators are looking at the industry’s surplus and reserves and aren’t seeing much rationale to jack up rates,” he explains.

“If the economy remains sluggish, will regulators allow higher rates in lines like workers’ compensation?” asks Stephen Christiansen, managing director of insurance research at Conning. “We’ve seen some increases in California and Florida, but I’m not sure if this will spread any time soon. Unless we see a mega-catastrophe, things will be gradual.”
—R.B.