SAN DIEGO, April 19, 2004 — Market dynamics are bringing an end to the double-digit increases in commercial insurance costs experienced during the hardest market since the mid-1980s, an industry leader said today.
In remarks at the Risk and Insurance Management Society's Annual Conference here, ISO Chairman,President and CEO Frank J. Coyne said a prolonged period of poor profitability contributed to firming in commercial line rates beginning in mid-1999. But "rate increases have been losing steam, dwindling last September to less than half of what they were at their peak."
"Fundamentally, the price and availability of insurance are determined by the law of supply and demand," said Coyne. Improvements in insurer profitability and growth in insurance capacity are contributing to increases in supply, thus alleviating upward pressure on the cost of insurance, said ISO's chief executive.
"But to understand where insurance markets are headed, you need to understand why things got the way they are," said Coyne. "Ask yourself what rate of return on capital it would it take to entice you into the insurance business, then look at the data on insurer profitability, and you'll know why insurance has gotten more expensive."
Going back 20 years to 1984, insurers achieved a healthy 15 percent rate of return on surplus (equity) only once — in 1986 — and actually posted a negative rate of return in 2001, according to ISO.
"The good news for insurers is that their rate of return for 2003 was more than eight times their rate of return in 2002," said Coyne. "The bad news is that their rate of return for 2003 was just 9.4 percent — not a lot of profit for assuming all the risk inherent in their business. Indeed, if anything is remarkable about the state of insurance markets, it's the signs that the next soft market may be approaching — even though insurers' rate of return was just 9.4 percent in 2003."
Coyne noted insurers' 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. Coyne said the declines in the industry's rate of return made reductions in supply and increases in prices inevitable.
Besides reductions in supply and increases in prices, another consequence of insurers' poor profitability is a "dramatic reduction in the number of private insurers serving the U.S. marketplace," from 1,272 in 1990 to just 938 in 2002.
A deeper look at industry data shows "insurance markets have been battered by circumstances that cut deeply into supply, starting with abysmal underwriting results," said ISO's chairman. In the 20 years from 1960 to 1979, the combined ratio — the percentage of each premium dollar spent on claims and expenses — averaged 100.4. "That is, insurers lost about one-half cent on every dollar of premium they wrote." During the next 20 years, from 1980 to 1999, the combined ratio averaged 108.5. "That is, insurers lost almost nine cents on every dollar of premium. So far this decade, the combined ratio has averaged 108.3, about the same as the average for the two decades ending in 1999."
Other circumstances also contributed to reduced capacity and subsequent price firming, said Coyne. Insurers' ability to use investment income to offset underwriting losses was diminished by declines in interest rates. In addition, double-digit declines in stock markets during the three years ending 2002 led to capital losses that cut deeply into insurers' capacity, as did the horrific losses the industry suffered from the September 11 terrorist attack in 2001. In addition, industry capacity was cut by insurers' need to add to their loss reserves.
Based on recent price firming and a decline in catastrophe losses from unusually high levels in 2003, Coyne projected the industry's combined ratio would improve from last year's 100.1 to 98.8 this year — the industry's best since 1978 when it achieved a combined ratio of 97.4. But with current investment results, tax rates and financial leverage, ISO calculates the industry would have to achieve a combined ratio of 94.3 to reach a 15 percent rate of return.
As underwriting profitability improves in 2004, rate increases will continue moderating, said Coyne. "ISO also projects premium growth will dwindle to 4.7 percent from 9.8 percent last year."
To underscore the extent to which the underwriting cycle is driven by industry capacity, Coyne noted insurer surplus dropped more than 5 percent in the third quarter of 1999 when rates started heading upward, while rate increases gained momentum through mid-2002 as surplus trended downward, falling nearly 20 percent from its peak in the second quarter of 1999.
And with industry surplus having risen to a record $347 billion at year-end 2003, "is it any coincidence competition is returning?"
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