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Hard market, soft market—What does
the future hold?
Definitive predictions for 2010 are hard to come by
By Phil Zinkewicz
As 2009 drew to a close, we looked back on a year of frustration and confusion, with the property/casualty market remaining soft despite the projections of a year earlier when it was hoped the market would harden in the third quarter. Although the economic downturn started in 2008, it was in 2009 that we began to feel the impact of rising unemployment, the closing of small commercial establishments and the shrinking of credit markets. The year 2008 was only a taste of what the industry was destined to experience the following year. That was the frustration.
The confusion has come about because this soft market is not a typical one. Usually the property/casualty market remains soft for a prolonged period of time because investment earnings tempt insurers to lower their guard on the underwriting side. But investment yields were disastrous in the beginning of 2009 and have only rebounded in recent months. Yet the market remains soft. Will the market harden in 2010? Industry observers do not appear to be optimistic.
S&P report card is mixed
In an “industry report card” from Standard & Poor’s, titled “Outlook Remains Negative for Most North American Insurance Sectors,” S&P paints a somewhat bleak picture of what we can expect. On the personal lines side, S&P says that, while financial results for the first half of 2009 were relatively sound, volatile weather patterns and inconsistency in credit markets are causing many insurers to post lower net income compared to a year earlier. “As a result, our outlook for the personal lines insurance sector remains negative,” the report says.
The report continues: “Higher catastrophe activity and diminished favorable reserve re-estimates in the second quarter are likely to lead to a rise in the combined ratio. Competition for personal lines business continues to be highly aggressive and, based on second quarter earnings information, pricing remains intense. In general, reduced vehicle and home sales continue to stunt new business for both auto and homeowners insurance, though customer retention remains at solid levels.”
The S&P report says that changes in the equity markets, the economy and the weather continue to create difficult operating conditions for personal lines companies.
“On the positive side, we believe most personal lines insurers are well positioned to manage through the current uncertainties and difficulties. Most rated personal lines insurers’ capital adequacies are strong, and many companies maintain capital that is redundant at the rating level. Still, we remain watchful of how these insurers will cope with potential capital strain. Additionally, though most personal lines insurers typically aren’t taking excessive investment or leverage risk on their balance sheet, there is generally still notable volatility in the value of their assets across most classes.”
As for commercial lines, S&P says that insurers’ capital bases continue to be hurt by the asset side of their balance sheets, reflecting the high degree of volatility in global equity markets. “The steep decline in the stock market in the fourth quarter of 2008 continued in the first quarter of 2009 and, despite an upturn in March, the sharp decline in equity values was the primary cause of a $19 billion decline in the property and casualty industry’s statutory surplus.”
The report continues: “Net premiums declined 6%, reflecting the deterioration in pricing during 2008. On the positive side, surveys that track commercial lines pricing show progressively smaller year-to-year price declines. Some companies have reported that pricing for their books of business was generally flat for the second quarter of 2008 and, in some cases, modestly higher. Still, a general upturn in pricing seems to have been slowed by the weak economy and the reluctance of insurance buyers to absorb price increases as they look to cut their own costs. Because of these pressures, we have a negative outlook on the U.S. commercial lines property and casualty sector.”
Willis Group says market may harden
In a report to risk managers, Willis Group Holdings also expresses a “watch, wait and see” view of market changes in 2010. “When we last reported on market conditions in April 2009, we—like many others—warned of a hardening market,” says the report. “The combination of poor loss experience ($52.5 billion in losses in 2008), rising reinsurance costs (10%-15% and 20%-30% for cedants with poor loss experience), and a poor investment climate cautioned us to brace for tightening market conditions by mid-2009. The hard market lasted a month, if that. In 2009, there has been very little in the way of loss experience (either risk or CAT losses). Combined with decreased demand due to the recession, the result is a surplus capacity vying to maintain existing accounts and competing for new business.”
The report continues: “The typical industry barometers concur: Commercial property pricing is stable. Renewal rates on most accounts are currently ranging between a 5% decrease and a 5% increase compared to this same time last year, with ‘flat’ as the most common result. The major exception is accounts with significant values exposed to loss from coastal windstorms, particularly along the Gulf Coast.”
The report does not predict when the market will harden, but it warns risk managers to be wary of that possibility in 2010. “While undoubtedly appreciating the windfall of softening rates, risk managers must also consider the issues of market security and counterparty risk as never before.”
Towers Perrin sees uncertainty
Thomas McIntyre, principal in Towers Perrin’s insurance consulting practice, also talks of uncertainty in the property/casualty market. “After several years of price decreases, for the first time things began a slight change for the better in 2009,” he says. “By the second quarter, we were seeing some rate increases, albeit small ones. However, according to some broker surveys, there may have been a resurgence of soft market conditions by the third quarter.”
McIntyre said that the poor economic conditions have definitely affected the property/casualty business. “Certainly company book values have been hit pretty hard. The shock to company balance sheets plus expense pressures caused a good many companies to stagnate in 2009.”
Asked when and if he sees a hardening of the market, McIntyre said that everyone expected the soft market to run its course in 2009, but it didn’t happen. “If you look at 2011, there is a concern about inflation and its effects on claims payouts. How hard will company reserves be hit? All these things should cause insurers to hold the line on pricing. Will that happen? We have to wait and see.”
In terms of how proposed legislation might affect the property/casualty industry, McIntyre pointed to an “odd situation” pertaining to McCarran-Ferguson. “As it is written, McCarran-Ferguson is a limited antitrust exemption that allows insurance companies to share information for rating purposes. But it talks about insurers that are regulated by the states. If the industry becomes regulated by the federal government, what will happen to McCarran-Ferguson? It is an interesting question.”
I.I.I. sees no hardening
Finally, Dr. Robert Hartwig, president of the Insurance Information Institute, told Rough Notes that 2010 will probably not see a true hardening of the market. “Barring a major catastrophe, the market will be moving sideways in terms of pricing and rates will be flat,” he says. “Although there has been a capital erosion, that erosion is not enough to bring about a hard market. The industry has sufficient capital to tide it over. The insurance industry has fared better during the current financial crisis than banks. Banks have been falling right and left. But insurers entered the financial crisis better capitalized than banks.”
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