Hurricane Risk Reduces Prospective Profit of Homeowners Insurance

Increases in homeowners insurance rates have not been sufficient thus far to provide an adequate return on equity on homeowners insurance, making further increases necessary, according to an analysis by Aon Re, the world’s largest reinsurance broker.

With capital requirements and the cost of catastrophe reinsurance up year over year, especially in states most at risk for hurricanes, Aon Re’s analysis of prospective return on equity for the homeowners insurance line is 5.7 percent. A similar analysis in 2005 revealed a 9.3 percent return on equity in 2005. Many insurers seek a return of 14 percent or more.

Aon Re’s findings are highlighted in its 2006 Homeowners Return on Equity Outlook.

“Homeowners insurers are in a challenging position. Rating agencies are taking an even-closer look at catastrophe risk as they assess insurers’ capital adequacy, meteorologists and risk modeling firms expect more and stronger hurricanes at least in the near term, and the increases in homeowners insurance rates that we’ve seen thus far aren’t enough to provide insurers the opportunity to earn back their cost of capital,” said Bryon G. Ehrhart, president and chief executive officer of Aon Re Services, Inc. “Homeowners insurers must keep more capital on hand to meet industry standards than was necessary only a year ago. As a result, we at Aon Re are helping our clients to understand the new capital requirements and needed rate actions.”

Aon Re’s prospective return on equity is 3.5 percent for hurricane- affected states viewed as a group, 8.1 percent for the non-hurricane-affected states. To reach a prospective return on equity of 14 percent, an estimated average rate increase of 43.3 percent would be required for the hurricane-affected states, 11.1 percent for the non-hurricane-affected states.

“The needed rate increase for hurricane states is likely to be large, not only because of the changing views of expected losses due to hurricanes, but also because of the amount of capital that is necessary to operate in those states, which is linked to their risk of catastrophic loss,” said Randall E. Brubaker, senior vice president of Aon Re Services, Inc.

Prospective returns on equity at current rates and rate increases for 14 percent return on equity are based on analysis of actuarial support for rate filings of the five leading companies in states making up 80 percent of the U.S. population, where this information is publicly available. Estimates reflect rate increases filed by these largest insurers through July 2006. Smaller states were estimated using combined ROE of reviewed states, credibility adjusted based on state loss-ratio data reported in annual statements.

Estimates are based on an Aon Re analysis updated in 2006 of capital requirements and cost of reinsurance by state for a company with an A.M. Best “A” rating. Prospective profit and needed rate increases for actual companies will vary and should be based on individual company analysis

Source: Aon Corp.