ISO’s Coyne: Survival May Be Greatest Challenge for Many P/C Insurers

With all signs pointing to increasing competition in U.S. property/casualty markets, the most important challenge many insurers face may be survival itself, an industry leader said Tuesday.

In remarks at the 76th Annual Insurance Accounting & Systems Association Conference, ISO Chairman, President and CEO Frank Coyne said competition is intensifying even though the property/casualty industry continues to suffer from lackluster profitability and loss-reserve deficiencies.

With resurgent competition threatening to undermine insurers’ profitability and their balance sheets as they confront other challenges, “the biggest challenge facing many insurers may very well be survival itself,” said Coyne.

As evidence of increasing competition, Coyne cited ISO MarketWatch data showing increases in commercial insurance peaked in mid-2002 but then dwindled to 4.9 percent in December 2003 — only about one-third of what they were at their peak. “More significantly, first-quarter 2004 data from the Council of Agents and Brokers indicate rates are now declining,” said Coyne.

Coyne also pointed to signs of increasing competition in personal lines insurance markets, noting increases in the Consumer Price Index for personal auto insurance slowed to just 3.6 percent in first-quarter 2004 from an average of 8.8 percent in 2002.

With property/casualty insurers still suffering from lackluster profitability and loss-reserve deficiencies, intensifying competition threatens to bring about further reductions in the number of insurers serving U.S. property/casualty markets, according to Coyne.

ISO’s chief executive noted that in 1990, almost 1,300 private insurance groups served U.S. property/casualty markets. By 2002, the number had dwindled to just over 900. “In little more than a decade, the number of private property/casualty insurers serving the U.S. fell 26 percent,” noted Coyne. Many of those insurers driven from the marketplace went insolvent, he added.

Though the 20 insolvencies last year were only about one-third of the record set in 1991, Coyne pointed to a “disturbing” long-term trend in the number of property/casualty insolvencies. The number of insolvencies rose from an average 13 per year in the 1970s to about 30 per year in the 1980s and 1990s. And so far this decade, despite the benefit of several years of firming in insurance markets, the property/casualty industry has suffered an average of 36 insolvencies per year — nearly three times as many as in the 1970s.

Mergers and acquisitions have also taken a toll on the number of property/casualty insurers, said Coyne. He noted M&A activity is on the rise, with the number of deals increasing from 36 in 2002 to 51 in 2003, according to Conning & Company. The reported value of property/casualty mergers and acquisitions rose from $500 million in 2002 to more than $20 billion last year.

“Successful mergers among strong carriers enable them to ratchet up the pressure on their competition — ultimately driving more weak insurers into insolvency or the arms of stronger partners,” continued Coyne.

Commenting on the property/casualty industry’s profitability, Coyne observed that the industry’s rate of return improved eight-fold last year. But starting from a base of just 1.1 percent in 2002, even an eight-fold increase in profitability left the industry with a lackluster 9.4 percent rate of return — well below the 13.4 percent rate of return for the Fortune 500, and not a lot of profit for taking all the risk inherent in the insurance business.

Coyne also observed that, despite the vagaries of insurance cycles, competition has been ratcheting upward over time, driving down insurers’ profitability.

Only once in the past 20 years were insurers able to achieve a healthy 15 percent rate of return on surplus. That was in 1986. Coyne noted, “The industry’s 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 the first four years of this decade, the industry’s rate of return dipped further to 3.6 percent.”

The need to bolster deficient loss reserves also threatens insurer profitability. Preliminary ISO estimates indicate that property/casualty industry loss and loss-adjustment expense reserves may have been deficient by $89 billion to $107 billion at year-end 2003.

Seeking to explain why competition is intensifying even though insurers continue to suffer from sub-par profitability and weak balance sheets, Coyne noted that insurance markets are governed by the law of supply and demand. “Surplus determines capacity, and capacity determines supply.” (In the insurance business, surplus, like equity, is the amount by which assets exceed liabilities.) “Changes in capacity explain both the hard market that’s coming to a close and the soft market that’s just beginning,” said Coyne.

Surplus dropped $18 billion or 5 percent in second-quarter 1999, and commercial insurance rates started heading up in July 1999. “And it is no coincidence,” said Coyne, “that rate increases gained momentum through much of 2002 as insurer surplus trended downward. Surplus declined more than 19 percent from its peak in the second quarter of 1999 to the third quarter of 2002, severely constraining capacity.

“Finally, with industry surplus having risen to $347 billion at year-end 2003, it is no coincidence that competition is intensifying.”

Faced with increases in competitive pressures, property/casualty insurers must overcome a host of other challenges, including asbestos claims, terrorism exposure, natural catastrophes and the quality of reinsurance, said Coyne.

To survive in the face of these challenges, property/casualty insurers will need the best available data and high-end analytics. Data and analytics are essential tools in the quest to achieve solid underwriting, cost-based pricing and strong loss adjudication — the three immutable fundamentals of the property/casualty business, said Coyne.

“But insurers will need more than data and analytics. They will need the fortitude to adhere to decisions based on data and analytics — the fortitude to execute against core fundamentals as competition heats up in the weeks and months ahead,” added Coyne.