Low Interest Rates Pose Challenge to U.S. Insurers and Reinsurers, Says Experts Panel at Joint Industry Forum

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NEW YORK, January 16, 2015 — Property/casualty (P/C) insurers have had to improve their underwriting performance and generate premium growth to offset sluggish investment income returns, according to a panel of insurance industry experts who convened this week at the Property/Casualty Insurance Joint Industry Forum. 

Dr. Robert Hartwig, president of the Insurance Information Institute (I.I.I.), who moderated the six-member “Experts Panel: A View from the Outside Looking In,” asked experts to look back at the industry’s related performance highlights and lowlights in 2014.

From a reported point of view, the industry’s results were reasonably good, said Vincent J. (V.J.) Dowling, managing partner, Dowling & Partners. “There was approximately an 8 percent return on equity in a 2 percent interest rate environment; that’s probably not bad. If you look back over time, if the industry is earning 700 [basis points] over 10-year Treasury on new business, they are doing well. That said, the reported results of the industry are always a lagging indicator, they’re not reflective of what’s actually happening in the business,” he noted.  “The underlying results are not nearly as good as that 8 percent would indicate.” 

On the investment side, Dowling said that “the investment income we are earning on the embedded portfolio is somewhere between 30 and 40 basis points higher than the new money rate so we’re over-earning there as well. Every time a bond matures, that money is reinvested at a lower rate, putting pressure on the returns. When you put all those numbers together, I would suggest that the industry probably earned about a 5 – 6 percent return on equity last year and that is not commensurate with the risk the industry is taking.” 

On the commercial side, Dowling said there are increasing lines of business where rates are down or the loss costs are now exceeding the rate increases. “So if we’re starting at 5 – 6 [percent] and going south, we may be in for some tough sledding.” 

Reviewing the current outlook of the personal lines, commercial lines and reinsurance segments, Matthew C. Mosher, senior vice president of rating services, A.M. Best Company noted that there is a stable outlook on the personal side. “There is clearly pressure in that marketplace in terms of efficiency of scale, pressure for consolidation in terms of bundling and just the size issue that benefits the law of large numbers, the amount of data and quality of data that you’re able to bring to pressure in terms of pricing and the things you can do with the more data that you have,” he said. “You don’t see the wide fluctuations on the personal side like on the commercial side and reinsurance. It tends to stay more on pace with loss costs. Obviously favorable loss costs and frequency numbers in auto is always a driving force there and has been for many years.”

On the commercial side, Mosher said “we have a negative outlook there. That gets to the direction of ratings and one of the key things is the reserve issue. You do have stronger companies that maintain a solid reserve base, but a larger number are facing pressure in terms of reserves and we expect to see more and more adverse development on the smaller and mid-size type companies that might be pressured in terms of their position in the marketplace.”

For reinsurance the issue is dealing with rate pressure, the terms and conditions of all the new entrants, and the alternative capital, Mosher said. “There’s also the shrinking reserves that are driving that.”

The home and auto insurance business has been working through a number of disruptive forces that we haven’t seen in a very long time, said Brian Sullivan, editor and publisher Auto Insurance Report and Property Insurance Report. “We have profound changes in infrastructure for personal lines companies that are changing the dynamic of mid-size companies,” he added. “Up until now giant companies have always had a tremendous competitive advantage, especially in auto; there’s an assumption that you’re going to wind up with a handful of giants,” he explained. “But you have these claims systems and policy management core infrastructure systems that are sold by third parties that are enabling those little companies to actually match or have superior throughput to giant companies,” he noted. “If you have bad infrastructure, if you’re bad at data analysis and you’re not good at managing your distribution channel, you’re going to be crushed; it doesn’t matter how big you are.” 

From an investment bank perspective, Thomas B. Leonardi, senior insurance advisor, Evercore, and former Connecticut insurance commissioner, said that since there haven’t been any significant CAT events recently and there has been dividend growth, the property/casualty insurance industry is still an attractive area for the traditional investor. “As to the alternative investors, that’s been deemed one of the top disruptive factors in the industry right now,” he said.

“If you look at insurance, securities and CAT bonds, what were very high rates of return in a prolonged artificially low interest rate environment, low level of correlation of asset risk compared to other asset classes that in particular pension funds might have, and there haven’t been any significant losses to date on these CAT bonds or ILS securities,” Leonardi said. “It’s not a small piece any more, it’s $25 billion. The other thing to keep in mind on the reinsurance side, this a very high margin business, that it’s eroding the traditional reinsurers. These bonds were covering risks four years ago that were generating 7 or 7 ½ percent; all of a sudden these same risks are 3 or 3 ½ percent.”

Leonardi added that as a former regulator, he didn’t think regulators fully understand the risks that this market is presenting to the industry.

From a behavioral economics standpoint, Dr. Hartwig noted that this period of relatively subdued CAT losses will not persist, and asked what public policymakers and insurers can do to change people’s behavior when considering disaster preparedness and increase the level of protection for homeowners and business owners who are vulnerable to natural disaster risk. 

Howard C. Kunreuther, the James G. Dinan Professor; Professor of Decision Sciences and Business and Public Policy at the Wharton School noted that emotions play a role. “There’s a notion prior to a disaster, ‘it’s not going to happen to me, I don’t need to protect myself,’” he said. “How do we change that? One way is to note that the best return on an insurance policy, is no return at all; celebrate the fact you haven’t had a loss.” Professor Kunreuther continued, “Focus on a worse-case scenario, and then ask them, ‘What would you do if you didn’t have protection?’” 

Dr. Hartwig asked Randy J. Maniloff, an attorney at White and Williams LLP of Philadelphia, his view of the cyber environment.  “Right now the insurance industry is out there aggressively marketing cyber policies,” he said, noting there are probably too many companies selling it now. Having read various reports indicating only one-third of all U.S. companies had coverage for the economic fall-out of a data breach, Maniloff challenged the premise, arguing the take-up rate for these policies has “been extremely low” and is not as high as the companies would like it to be. 

The Property/Casualty Insurance Joint Industry Forum was created to provide leaders from the widest spectrum of the industry with an opportunity to meet with each other in discussion of topics of general interest. Participants included nearly 250 representatives from property/casualty insurance and reinsurance companies and organizations.

The sponsoring organizations of the Forum represent a broad range of insurance interests and audiences. They include: ACORD, American Insurance Association, the Association of Bermuda Insurers and Reinsurers, The Geneva Association, Insurance Institute for Business & Home Safety, Insurance Information Institute, Insurance Institute for Highway Safety, International Insurance Society, National Association of Mutual Insurance Companies, National Council on Compensation Insurance, National Insurance Crime Bureau, Property Casualty Insurers Association of America, Property & Liability Resource Bureau, Reinsurance Association of America, The Institutes and Verisk Analytics.

THE I.I.I. IS A NONPROFIT, COMMUNICATIONS ORGANIZATION SUPPORTED BY THE INSURANCE INDUSTRY.

Insurance Information Institute, 110 William Street, New York, NY 10038; (212) 346-5500; www.iii.org