The Way Forward in the Property/Casualty Business

Near-Term Cycles, Long-Term Trends, and the Power of Disruptive Innovation

By Michael Murray

The latest financial data indicates the property/casualty industry is on the mend. But commercial insurance markets are still softening, insurers face a dizzying array of emerging risks, and we are witnessing an explosion in data and analytics that is forcing reinvention at every link in the value creation chain.

Breakthroughs in technology and analytics are disrupting the competitive landscape in ways that will benefit some insurers at the expense of others. To survive and prosper, insurers will need huge volumes of high-quality data from a vast array of sources, systems capable of analyzing and executing against that data, and the people to make it all work. Moreover, insurers will need to connect systems and processes in ways enabling information from each link in the value creation chain to create additional value at other links.

U.S. property/casualty insurers' overall financial results improved through nine-months 2010, with net income rising 62.2% versus its level a year earlier and policyholders' surplus climbing $54.1 billion to $544.8 billion as of September 30 last year. Moreover, insurers' annualized rate of return on surplus increased to 6.7% for nine-months 2010 from 4.6% for nine-months 2009.

Figure 1
Return on Average Surplus Trends

return on average surplus trends

Reflecting the intensity of competition in insurance markets and declines in investment yields, private property/casualty insurers' average overall rate of return dropped by nearly half from 13.7% in the 1970s to 6.9% in the decade ending 2009.

But there are some significant negatives within insurers' overall results for nine-months 2010. In particular, net losses on underwriting nearly doubled, growing to $6.2 billion, and net investment income fell 2.5%.

While insurers' recent results include the first increase in nine-month written premiums since 2006, the growth in premiums wasn't shared equally. Premiums for commercial lines insurers fell 2.8%, as premiums for personal lines insurers rose 3.2% and premiums for insurers writing balanced books of business increased 2.1%.

Leverage ratios suggest excess capacity will continue weighing on many insurance markets for some time to come. Leverage ratios provide simple measures of the amount of risk supported by each dollar of surplus and thus provide insight into insurers' capacity utilization. Using 12-month premiums, the premium-to-surplus ratio as of September 30, 2010, was 0.77 — less than it was any year from 1959 to 2009 and only about half the 1.50 average ­premium-to-surplus ratio for those 51 years. Similarly, the ratio of loss and loss adjustment expense reserves to surplus as of last September 30 was 1.02 — far below the 1.43 average for 1959 to 2001.

Beyond the current insurance cycle, various long-term trends shed light on the likely nature of things to come. In particular, net written premium growth dwindled from 12.1% per year in the 1970s to 3.8% per year in the decade ending 2009, with net written premiums declining for an unprecedented three consecutive years in 2007, 2008, and 2009. Moreover, insurers' overall rate of return on average policyholders' surplus fell from 13.7% in the 1970s to 6.9% in the decade ending 2009. (See Figure 1.)

The long-term declines in premium growth and insurers' rate of return reflect the intensity of competition in insurance markets. Other consequences of the intensity of competition include a dramatic decline in the number of private property/casualty insurers serving the United States. At year-end 1990, there were 1,272. Though the numbers have stabilized a bit in recent years, there were just 957 at year-end 2009. Very nearly a quarter were driven from the field or absorbed by competitors in just 19 years. (See Figure 2.)

Figure 2
Private Property/Casualty Insurers (1990 to 2009)

In just 19 years, very nearly a quarter of all private property/casualty insurers were driven from the field or absorbed by stronger competitors. But the intensity of competition is separate and apart from the nature of competition. Now there is a growing chasm between those insurers using state-of-the-art analytics to achieve competitive advantage and those who aren't. private property/casualty insurers

Perhaps even more important, the nature of competition in insurance markets is changing. Now, there is a growing chasm between those insurers using state-of-the-art technology to apply sophisticated analytics to massive volumes of highly granular data from a multitude of sources and those insurers who aren't — a growing chasm between the "haves" and the "have nots." Increasingly, the "haves" will be able to write business at the margins they target. The "have nots" risk falling victim to adverse selection.

According to International Data Corporation (IDC), there were 800 exabytes of data in 2009. If all of it were stored on DVDs, the stack would reach the moon and back. And IDC projects that, by 2020, there will be 44 times as much. More important, the volume of potentially useful data is also exploding. One U.S. government website — — provides access to more than 300,000 data sets, with 194 new data sets added to the site in just one recent 30-day period.

Moreover, data is now taking a multitude of forms, such as free-form text, recorded audio messages, digital photos, video images, satellite imagery, and many others. Harnessing huge volumes of new data in many forms to make better decisions is a daunting challenge, but the opportunities are real. For example, ISO's FireLineTM uses satellite imagery to help insurers pinpoint wildfire hazards.

Combined with plunging data storage costs and dramatic increases in computing power, the explosion in the amount and types of data is fueling a revolution in analytics that is enabling leading-edge insurers not just to understand what has already happened but to anticipate what will happen and optimize their decisions.

Using predictive modeling and other advanced analytics, insurers are able to identify the underlying drivers of loss, quantify their effects, and thus price risk with unprecedented precision. Where regulators balk at allowing insurers to use advanced analytics to price risk, insurers may use the same analytics to make smarter underwriting decisions. And where regulators balk at allowing insurers to use advanced analytics for underwriting, insurers may use the same analytics to make smarter marketing decisions — shaping the flow of applications to build a more profitable book.

One insurer famous for its pioneering use of credit provides a powerful example of how sophisticated analytics and other ­dis­ruptive innovations can affect competitive dynamics. When that insurer began pilot-testing credit in 1991, it was the thirteenth largest personal auto insurer, with 1.2% of the market. Five years later, when it rolled out widespread use of credit, it was the sixth largest, and its market share had more than doubled to 2.8%. Finally, as of 2009, that insurer had overtaken two more competitors, and its market share had more than doubled again to 7.6%, with the insurer generating superior underwriting results even as it took business from rivals.

Michael R. Murray is assistant vice president of financial analysis at ISO.