We frequently hear people ask, “When is the next hard market going to come?” And by that they typically mean double-digit increases in premium growth for a sustained period of time. Of course, no one knows. But perhaps more importantly, we think what they’re really asking is, when will premium volume grow faster than losses and expenses, helping to deliver an underwriting profit?
Underwriting profits were common before the 1980s. In fact, 40 of the 60 years before 1980 the P/C industry had a combined ratio below 100. In the decade of the 1930s, although the country was caught in the midst of the Great Depression, there were seven years with underwriting profits. And in the 1940s, including the war years, all 10 years were profitable from an underwriting perspective. Eight of the 10 years of the 1950s, and nine of the 20 years of the 1960s and 1970s also recorded underwriting profits.
But then underwriting profits vanished. Not a single underwriting profit was recorded in the 25 years from 1979 through 2003. And even though that streak ended in 2004, underwriting profits are anything but the norm they were in the 1930s, 1940s, and 1950s. In the eight years from 2004 through 2011, only three tallied underwriting profits. What’s going on here?
A Look at the Past
In order to understand the present and have reasonable expectations about the near-term future, we need to look at the past — especially the 1930s through 1950s. Some things are quite similar. For example, back then, insurers had never seen high investment income last for a prolonged period of time so they never expected investments to subsidize underwriting losses. Because of the fact they had low investment income insurers during those years knew they had to rely on underwriting if they wanted to be successful.
What’s different? Today there’s more insured value in harm’s way. As a result, insured catastrophe loss experience is a higher proportion of loss payments than before. Also, inflation in the late 1970s and early 1980s boosted bond interest yields, and in the 1980s and ’90s, we had a roaring stock market. We relied heavily — perhaps too heavily — on investment.
The soft commercial market since 2004 was perpetuated by the 2007-2009 “Great Recession.” Demand for insurance dropped, exacerbating an overall decline in pricing.
The Great Recession was officially declared over in June 2009, but unemployment remains uncomfortably high at 8.5 percent in December 2011 and the economy continues to expand at a fairly sluggish pace. Ongoing weak economic conditions are clearly making it more difficult for insurers to move rates where they ought to be even if they are actuarially justified — it’s simply a matter of supply and demand. It’s also true that some insurance commissioners may be fearful of getting caught in a political and media quagmire if they approve rate increases, however actuarially justified they may be.
Rate Changes in 2012
As we move through 2012, various insurance lines will be moving at different paces in terms of price firming. Leading the way is workers’ compensation due to very poor underwriting performance where the combined ratio in 2011 was in the 118 percent to 119 percent range. Increases in commercial property (including business interruption) follow due to high catastrophe losses and somewhat higher reinsurance prices. Most of the casualty lines, whether we’re talking about general liability, directors and officers, etc., are lagging behind.
If we’re pinning our hopes on a hard market rescuing us, thinking that we don’t have to do anything differently, we’re on the wrong track. The world doesn’t stay the same, it does change and we need to adapt. Investment earnings today simply cannot offset large scale underwriting losses.
In the years ahead, customers need to be smarter about applying the full range of risk management strategies so that when they do buy insurance, the policies are structured closer to the optimum insurance configuration of losses that are low frequency and high severity in nature. With the bottom line under pressure, insurers are likely to walk away from unprofitable business. When insurers behave in this economically rational manner, they won’t have to worry about whether a hard market is on its way. They’ll already be way ahead of the game.
Hartwig, Ph.D., CPCU, is president of the Insurance Information Institute. Since joining the I.I.I. in 1998 as an economist and becoming chief economist in 1999, Dr. Hartwig has focused his work on improving understanding of key insurance issues across all industry stakeholders including media, consumers, insurers, producers, regulators, legislators and investors. Follow him on Twitter.