Insurance Economist Predicts Profitable 2006, Sees Premium Growth Grinding to a Halt

The last 24 months have been traumatic for the insurance industry, but the profit picture for 2006 is quite good overall, according to Robert P. Hartwig, Insurance Information Institute senior vice president and chief economist.

Premium growth, however, is a current concern.

“Recapping last year vs. 2004, if there is one downside to what has happened recently it is that we have entered a period in which premium growth is basically grinding almost to a halt,” Hartwig told more than 700 workers’ compensation executives attending the National Council on Compensation Insurance Annual Issues Symposium in Orlando, Fla. “Industry-wide premium growth in 2005 slowed to about one-half of 1 percent, very slow, the slowest we have seen since the 1990s.

Hartwig advised that industry may also have to watch its underwriting results.

“We have seen losses creep up a little higher, so we are going to expect to see some deterioration in underwriting industry-wide in the year ahead,” he said. “Nevertheless, we started from a relatively strong starting point, outside catastrophe-prone lines. The industry experienced a small underwriting loss last year, after 2004’s first underwriting gain since 1978. Investment income is up considerably, while net income is up about 12 percent, that is a very large leap. Considering we had record catastrophe losses and surpluses rose to $427 billion, a 9 percent increase, and the combined ratio was 101, 100.”

Hartwig said he was sure the audience must be wondering, “How is it that these results ended up being so good, despite record catastrophe losses?”

Resiliency a key strength

“The industry has proved itself to be very resilient—this isn’t your grandmother’s insurance company,” Hartwig explained. “This is not 1992, the year of Hurricane Andrew, in which the insurance industry was laid flat on its back by that huge event. The industry has proven itself to be very resilient in the wake of major catastrophic events.”

Looking at the profit picture, Hartwig quoted statistics indicating the industry generated about $43 billion in profits last year.

“That may sound like a lot, it may sound like a record—it is a record in nominal profit terms,” Hartwig said. “However it is not a record when it comes to ROE which was 10.5 percent.

“In fact, we weren’t even remotely close to profitability levels the industry experienced at peak points of the cycles in the 1970s and 1980s, which were close to 20 percent,” he said, pointing out that 2001 with the September 11 terrorist attacks was the worst year ever in the history of the industry.

Weak premium picture

He said the strength of current profit and of the premium picture is weak with strong cycles nowhere near the strength of the 1970s and 1980s, in the 2000s.

“What we are looking at right now is a period where we are going to rebound from very sluggish premium growth in 2005 to something in the 3 to 4 percent range in aggregate in 2006, and then reduced growth will be encountered after that.

“On an inflation-adjusted basis, premium growth in 2006 is going to be effectively zero, or even slightly negative for the next several years,” Hartwig predicted.

Hartwig said the current period is very much like what happened after 1992, when the industry saw a boost in premium income which then fell off. He predicted the industry will be looking at something similar for the next several years.

Can underwriting margins be maintained?

“The question is, ‘Can the industry maintain its underwriting margins in this era of sluggish premium growth outside of property coverages?'” Hartwig asked.

He said over the past several years storms have had a dramatic impact on industry profitability.

“You might say, ‘What is there to complain about? You hit a record profit in nominal dollar terms, you had a 10.5 percent return last year, that doesn’t sound too bad.’

“The point is, 10.5 percent just does not cut it across the industry,” Hartwig explained. “When you look at the sorts of risks insurers are being asked to assume, it is a tremendous risk, considering you can get more than 5 percent today on a risk-free investment, is 10.5 percent the kind of return you should expect when you are assuming catastrophic hurricane risk, terrorism risk or any other sort of catastrophic risk?

“The answer is, probably not!”

Hartwig said the storms over the past few years knocked 4 to 5 points off the industry’s returns over the past two years.

“It’s very, very fortunate that the industry entered the 2004 and 2005 hurricane seasons in a position of extraordinary financial strength,” Hartwig explained.

He said that picture is quite different from 9/11, when the industry was suffering from a number of problems and issues that occurred during the years and months before the terrorist attacks.

“It’s easy to see the impact that the attacks had on the industry in 2001, when there was a very dramatic effect on profitability, but the industry had already taken a nose-dive before that time, 2000 to 2002 were terrible.

“We have a different trend right now, in which stock markets are going up, at least modestly, and now interest rates are also trending up and will help future investment returns,” Hartwig predicted.

He pointed out that there is a closure or narrowing of returns between stocks and mutual fund companies in the business, and of course many of the big players in the stock insurance arena are mutuals, so what we see is that while mutuals trail stock companies, the gap is now only about three points in terms of profitability relative to a much wider margin in the past — 5 to 6 points in recent years. In other words, mutual companies appear to be becoming more profitable, while stock companies seem to be pretty much holding their own and that applies to Fortune 500 companies overall.

According to Hartwig, property casualty insurance companies are still falling far short of the Fortune 500 rate of return that many investors would like to see.

In terms of all the major coverages we have out there, over the past decade the average return for all property-casualty lines is 7.7 percent, and for workers’ compensation it is 7.9 percent.