To understand where the insurance industry is today, it is important to look back about nine years, when nearly $6.2 billion was lost. In 2001, the insurance industry suffered its worst year in recorded history, and it was the only year to date in which the industry actually lost money.
The combined ratio was north of 115 percent, which was close to an all-time high. In other words, for every dollar of premium the industry wrote, it spent $1.15. This caused surplus to drop, and several insurance companies folded. The insurance industry needed to change—and quickly.
The combined ratio between 2001 and 2006 shows dramatic improvement from 115.6 percent to 92.3 percent. (The one aberration was 2005, which was impacted by Hurricane Katrina.) During that same time frame, policyholder surplus expanded from $295.3 billion to $488.8 billion—more than 65 percent. The industry earned $85 billion. The profits continued to drive policyholders’ surplus, and it grew in 2007 to $517.9 billion.
But, the increased surplus created increased competition. Rates, which had started to decrease in 2005, dropped on average 15 percent in 2007. Compounded with decreases of 5 percent and 8 percent in 2005 and 2006, cumulative rates dropped more than 25 percent during that time frame.
The drop in rates affected underwriting profit, and the combined ratio inched up to 95.5 percent in 2007. This was no cause for concern as the industry still earned more than $62 billion, which generated a return on equity of about 12.4 percent.
However, 2008 was a different story. Rates continued to drop, falling about 33 percent from 2005. This drove the combined ratio up from 95.5 percent to 105.1 percent. At the same time, investment income dropped 7 percent. This dramatic underwriting loss and decrease in investment returns dropped the industry’s return on equity to 0.5 percent, making 2008 the second worse year in history. At the same time, net written premiums also dropped—something that almost never happens.
Finally, policyholders’ surplus dropped for the first time in years.
Based on the first half of 2009, it appears the carnage will continue. Net income was down almost 60 percent from 2008 (14.1 percent to 5.8 percent), and return on equity dropped from 5.5 percent to 2.5 percent. Results could continue to deteriorate.
Although some newcomers may try to compete on price, the industry appears to be on the front end of a hard market. In other words, rates may increase, coverage may become harder to find, and terms could become more restrictive. However, the news is not all bad.
The Market in General
Insurers are in an awkward position. Despite their drop in surplus in 2008, their capacity is still adequate, so they can afford to remain competitive to retain their market share. This will change at some point, but no one knows exactly when.
The preferred market for property, liability, auto and umbrella coverages will be flat to plus-5 percent in 2010. The only segment of this market that will not be particularly competitive is accounts with 20 percent or more of their total insured values exposed to coastal windstorms.
Similar things can be said about the professional liability marketplace. Architects, engineers, accountants, attorneys and other professionals with decent loss histories and risk profiles should do fairly well in 2010. Although there will not be dramatic rate reductions, pricing should remain relatively constant.
Workers’ Compensation
The workers’ compensation market nation-wide is relatively stable and has not changed significantly in the last year. The combined ratio in 2008 was 101 percent, the same ratio as in 2007. There are some concerns, however. Medical claims costs continue to rise, and low investment returns make it difficult for insurers to overcome their underwriting losses.
Surety
The surety industry had an exceptionally good year in 2008. Although written premiums dropped in 2009 and the frequency of contractor defaults trended up, 2009 is expected to be a profitable year as well.
But with many contractors burning off their backlogs and residential and commercial work evaporating, sureties are getting the jitters. Public works projects are just about the only work available to bid on today. The municipal sector is fiercely competitive and has very thin margins, if any at all. While several years ago five contractors would bid a project, today there may be 20 or more bidders.
Many contractors have been trying to break into the federal market. Federal work is plentiful, but it has become increasingly restrictive to selective types of programs, such as small businesses and minority- and women-owned businesses.
Contractor defaults will increase in 2010. Despite these concerns, no major changes have occurred in rate or capacity. However, surety companies are starting to underwrite more conservatively, keeping a focus on liquidity, interest-bearing debt, availability of credit and overall risk management.
Employee Benefits
In general, health insurance rates are going up for both HMOs and PPOs, with the primary drivers being the aging workforce, increased costs of pharmaceutical drugs, new medical technology and the renegotiation of provider contracts (doctors, hospitals, laboratories and other medical facilities).
Health savings account (HSA) plans entered the market in 2003 with a flurry of interest from those looking to lower premiums and save pre-tax money.
HSA plans have seen higher than expected utilization, which has caused rate increases higher than those in PPO plans. HSA rates are expected to rise by 20 percent in 2010. Actuaries believe by the end of the year or in early 2011, future increases will be comparable to PPO plans.
Overall Cost of Risk
Although firms can prepare in the short term for survival in a hard market, their “cost of risk” really needs to be looked at long term. In fact, insurance is just one of the elements in the overall cost of risk; for many companies, it is less than half the total. Other costs include time spent analyzing and managing risk; money spent on uncovered losses or deductibles; and time spent dealing with losses.
Well-run companies always look for ways to effectively manage their risk. Risk management is not a cyclical exercise; it needs to be a vital part of every company. Only lowering the frequency and severity of losses lowers premiums in the long run.