Why Insurance Rates Have Lost Their Old Bounce

Hurricane Andrew. The Los Angeles riots. The Chicago flood. A record number of tornadoes. Hurricane Iniki. The December nor'easter. In 1992, insurers got slammed by 'em all. While such catastrophes wreaked unprecedented financial havoc on property/casualty insurers, some executives and analysts see good news for the industry emerging out of the wreckage. After five years of vicious price competition, they feel the prospect of big losses--as much as $16 billion from Andrew--will permit, even force, the industry to raise its prices. That expectation has buoyed stocks of many insurers, pushing some, such as Chubb Corp. and American Insurance Group Inc., near 52-week highs.

There's only one problem: It hasn't happened yet. To be sure, prices have taken off in some specialty lines of insurance, such as reinsurance, and inched up in a few standard lines and in certain regions--homeowner's insurance in Florida being the obvious example. But most of the increases aren't near the magnitude seen in previous turns of the insurance pricing cycle. And rates for casualty insurance, which covers liability or loss from accidents, haven't even budged. "A lot of the forces that were supposed to move this market simply haven't materialized," says Richard Moscicki, a consultant with Tillinghast, a Towers Perrin actuarial consulting company.

RATE RESCUE. What's keeping prices down? Although the industry faces big losses, most insurers have made a killing in their investment portfolios as a result of falling interest rates, which permitted them to reap huge capital gains on bond portfolios. Experts on the industry posit that it has yet to experience the sort of financial pain that permits big price hikes to stick. Until the industry works through its windfall, recurring industry predictions of "imminent" price hikes may be wishful thinking.The main problem, some industry-watchers say, is that there's too much capital. "Structural excess capacity is the reason why this downturn has gone further than people would have said that it would go in 1988 and 1989," says Orin S. Kramer, a consultant based in Fort Lee, N. J. "It is driven by a fundamental supply-and-demand problem. And though insurers had good intentions coming out of their last downturn, they haven't become more disciplined on pricing."

EXPERTS DISAGREE. In light of Hurricane Andrew, many investors and Wall Street analysts don't agree with Kramer's assessment. "An industry that can lose 10% of its capital in one incident in my opinion is not overly capitalized," states David Seifer, a vice-president and analyst with Donaldson, Lufkin & Jenrette Securities Corp. If one accepts that the industry is under-reserved by 10% to 25%, estimates widely bandied about, then "you have to take from $40 billion to $75 billion out of surplus," he adds. "I'd say the level of pain is here. . . . If you've got no cash, I don't know what the next level of pain is."

Reacting to the impact of catastrophe losses on reserves, some parent companies had to bolster the resources of their property/casualty units. These units got some $5.5 billion in capital, topping 1987's previous record of $4.2 billion. The biggest infusion came from Prudential Insurance Co., which put $900 million into PRUPAC, its property/casualty subsidiary. "After Andrew, PRUPAC was technically insolvent," says John Snyder, a senior vice-president with A. M. Best Co., the large insurance-rating agency. "It didn't have any surplus."But insurance executives say the pain still isn't sufficient to push up prices. "Clearly, there's no return to any kind of pricing environment that would signal a hard market," says Frederic G. Marziano, president of Continental Insurance Co. Even in Florida, only 8 of the 163 filings in 1993 before the state insurance commission for rate increases were for more than 25%.

WORST YEAR EVER. To be sure, some measures of the financial performance of insurers have been dismal. In 1992, the industry paid out a record $1.16 in claims for every $1 in premiums written. With interest rates down, investment income, which usually offsets underwriting losses, declined for the first time in 50 years. And in 1992, according to the Insurance Information Institute, the industry's rate of return--net income after taxes, as a percent of equity--was 3.7%, after hovering around 10% in the 1980s.

But these factors were more than offset by insurers' capital-gains bonanza. Capitalizing on the drop in interest rates, insurers sold $250 billion of the $400 billion of bonds in their portfolios. Since bonds are carried at amortized cost on a statutory accounting basis, selling them produced realized capital gains--to the tune of $9 billion.

The impact of this bonanza was dramatic. Industry surplus, assets minus liabilities, increased 2.7% in 1992, to $163 billion. "The cycle should not turn yet," says industry critic J. Robert Hunter, president of the National Insurance Consumer Organization in Alexandria, Va. "Even with the incredible disasters of 1992, the industry's surplus grew, so it shows you how incredibly powerful their portfolios are."

How long the boosts to surplus will forestall big price hikes isn't clear. Some analysts point out that cash raised from the bond sales has been reinvested at relatively low rates, which will reduce the cushion insurers have against future losses. The investment income that "the industry enjoyed immensely won't be there to be harvested in 1993," says A. M. Best's Snyder. "The industry has been able to pull a rabbit out of the hat every time. I don't see the rabbit in 1993 that will save them from underwriting losses."

MORE SELF-INSURERS. Yet even if the effects of the windfall wear off, several broader trends may mitigate the insurance price cycle. Indeed, some experts see an evolution toward longer and deeper "soft" markets and briefer and shorter hard markets. Corporate risk managers, who are becoming highly sophisticated insurance shoppers, are self-insuring more and more of their risks, and such alternative methods are gaining market share. That means insurers are competing for a market whose growth rate is declining.

If these trends continue and a big swing in prices doesn't materialize, insurers might find themselves in a very different ballgame, one with new rules. "The industry has been conditioned to think in terms of cycles," says Paul Hasse, a principal with consulting firm McKinsey & Co. "But industry dynamics have changed, and many companies are beginning to rethink their fundamental operating strategy. They have become more focused on their core businesses and operating skills and less concerned with trying to game the cycle." For many insurance executives, learning to price their product without payingregard to cycles might be even more uncomfortable than another Hurricane Andrew.

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