LA QUINTA, Calif., March 17, 2000 – Frank J. Coyne, president and chief operating officer of Insurance Services Office, Inc. (ISO) warned today that if imbalances between growth in premiums, losses and expenses continue at recent rates, property/casualty insurers' underwriting results will be even worse than in record-poor 1984.
An extrapolation of third-quarter 1999 growth rates in premiums, losses and expenses by ISO actuaries shows the industry's combined ratio would increase from last year's 107.5 to 111.7 in the year 2000, and to 136.2 in the year 2005 – almost 20 points worse than the industry's all-time worst combined ratio of 118.0 in 1984, said Coyne.
Coyne emphasized the figures were not forecasts, but are "what-if numbers that illustrate the consequences if recent trends continue."
The combined ratio is a basic measure of insurers' underwriting performance that shows the percentage of each premium dollar that goes to claims and expenses. A combined ratio of 100 or more is an underwriting loss.
Speaking at the Pacific Insurance & Surety Conference here, Coyne indicated that underlying trends are worse than reported financial results show. "Since the mid-1990s, growth in reported losses has been depressed by declines in catastrophe losses, and in environmental and asbestos losses on old business, as well as by deterioration in loss-reserve adequacy" said Coyne.
When ISO adjusted results by normalizing catastrophe losses, eliminating environmental losses and asbestos losses on past policies, and restating calendar-year losses as if insurers had maintained reserve adequacy, ISO found that loss growth actually outpaced premium growth from1995 to1999, in stark contradiction to reported results, said Coyne. "For the past two years, even reported losses have been rising faster than premium," he said, adding: "Last year, reported losses and lost-adjustment expenses grew more than twice as fast as the 2-percent growth in earned premium for all lines."
"The combined ratio sums up the tale on underwriting results and expense performance," said Coyne. "In the '70s, the industry made an underwriting profit in five years out of ten. But in the two decades since the 1970s, the industry has not once posted an annual underwriting profit."
Deterioration hit many lines of business. ISO's president noted that in 1999 combined ratios worsened severely in general liability, commercial multi-peril and workers compensation. For workers compensation, that key measure of profitability deteriorated nearly 13 points in the last two years to 113.5 at year-end 1999, despite widely enacted reforms and health-cost containment.
While underwriting deteriorated, "investment income hasn't helped much either," observed Coyne. He noted that investment income has declined for the past two years in a row – two of four years in the 1990s with such declines. Those were the only years among the past 40 that investment income fell.
He cited declining bond yields and fierce competition that decimated premium growth and left the industry with little new cash to invest. ISO estimates that the industry's 1999 operating cash flow at $13.7 billion hit its lowest level since 1984 – the bottom of the worst underwriting cycle in history.
Bringing together investment results and underwriting performance, the industry's GAAP return on net worth was 6.8 percent last year, down from 8.5 percent in 1998. Adjusted for catastrophes, environmental losses and deterioration in reserve adequacy, the industry's 1999 return on net worth was just 6.3 percent.
"Now you can earn 6.3 percent risk-free on a ten-year Treasury note," observed Coyne.
While some analysts cite agent surveys that show rates on renewals are firming, It may be too early to conclude that the pricing tide has turned, cautioned ISO's president. Other agent surveys found that rates on renewals for all major commercial lines except commercial auto declined in both 1998 and 1999, with workers compensation and commercial multi-peril dropping the most, said Coyne.
Despite bad news on the state of the property/casualty industry, Coyne said he is confident industry leaders can – and will – overcome present challenges.
"We've been through what seemed to be the worst of times before and survived," said Coyne. "Now, we see signs that astute industry leaders are innovating in all aspects of the business to respond to current conditions – by embracing technology, by serving the customer, and by delivering on credible value propositions."
Coyne urged insurance executives in his audience to "execute the fundamentals of solid underwriting – careful risk identification, thorough risk evaluation, cost-based pricing and excellence in claims handling. "These fundamentals, said Coyne, "will determine whether you win or lose."
Despite revolutionary changes in the nature of the insurance business, "the battle-tested rules still apply. Over the long-term, you can't generate profits if you ignore the fundamentals," said Coyne. "Consider costs when you price your products."