This article provides an update regarding recent trends in the property and casualty (P&C) insurance industry (prior article dated February 2014). In particular, the article discusses the impact of market conditions on the growth and profitability of the P&C industry by analyzing macroeconomic conditions, political developments, catastrophic events, and technological innovations, as well as other factors that may influence the performance of the industry moving forward.
In 2018, the US economy advanced more than it has since 2015. 1 The unemployment rate decreased, wages and salaries increased, and inflation levels remained around the congressionally established target. To offset inflation anticipated from economic growth, the US Federal Reserve (the "Federal Reserve") implemented a more restrictive monetary policy and raised the target federal funds rate from 2.25 to 2.50 percent in December 2018. 2 Despite a record-breaking stock market and an increasingly powerful consumer, the Federal Reserve changed direction, cutting the rate by a quarter-point in July 2019. 3 According to the Federal Reserve, the rate was cut as risk management for the slowing global economy and due to "muted inflation pressures."
Thus far, 2019 has been a banner year for the stock market, and insurers have seen meaningful gains in their investment income from common stock dividends. 4 However, with less than 20 percent of portfolios invested in common stocks, P&C insurers' investment portfolios predominately consist of fixed income securities that depend heavily on the federal funds rate. 5 Consequently, the federal funds rate is a key driver in determining the profits of P&C insurers. Further reductions in the federal funds rate, which is already near its historic low, would result in lower fixed-income rates and reduced returns to P&C insurers.
Forecasted gross domestic product (GDP) growth is projected to trend down from 3.0 percent in 2018 to 1.8 percent in 2021, as forecasted at the Federal Open Market Committee meeting in June 2019. 6 Hikes to the federal funds rate in 2018 led to higher yields on shorter-term bonds while longer-term bonds expanded at a slower rate, reflecting investors' long-term expectations for a potential economic slowdown. These conditions led to an inverted yield curve in March of 2019 that investors have previously interpreted as a reliable recession indicator, which, if it occurred, would curtail economic and industry growth.
The Tax Cut and Jobs Act of 2017 significantly reduced the corporate income tax rates of P&C insurers, thus boosting their profitability. It also introduced a deemed repatriation provision, allowing companies to bring capital to the United States from foreign subsidiaries at lower tax rates. 7 In addition, the changes in accounting rules for internal transactions with foreign affiliates led to revisions and terminations of reinsurance agreements with offshore affiliates, which helped to improve P&C insurers' profits.
On the other hand, trade disputes have continued between the United States and China, contributing to investors' expectations for an economic slowdown in the future. 8 These disputes over tariffs and trade rules have resulted in higher market volatility in 2018 and the first half of 2019. If a trade deal is not made in the months to come, the US economy and, consequently, the stock market will presumably suffer.
The amount and the extent of catastrophes that take place in a given year are key determinants of P&C insurers' profitability. In 2017, Hurricanes Harvey, Irma, and Maria were responsible for a combined $104 billion in catastrophic losses associated with policy payouts, making it one of the worst years on record. 9 The trend continued in 2018, the third-worst year for US insured catastrophe losses since 1980, with $50 billion in losses from Hurricanes Florence and Michael, as well as losses from more frequent West Coast wildfires that have continued in 2019. These conditions are challenging insurers to do more with less, prompting P&C insurers to adapt new technology to improve their efficiency and reduce costs.
As technology evolves, so does its application in the industry. Several recent technological developments have the potential to greatly impact the industry. One example is virtual claims adjusting, which allows insurers to remotely measure losses, quantify damages, and process customer payments more efficiently. Adopting virtual claims adjusting provides a competitive advantage as speed and transparency of claims are critical to customer satisfaction. Insurers are also moving to mobile claims adjusting to better serve customers with a greater level of personalization. Customers can now check or make changes to their policies on the go, and the integration of new technology is helping to improve both underwriting and claims processing. The expansion of the Internet of things (IoT), which allows for everyday objects to be connected to the Internet via sensors and devices, will continue to advance the industry. IoT allows insurers to better understand customer needs and mitigate risk by utilizing remote monitoring technology to collect real-time property insights. Finally, blockchain technology has the potential to streamline many back-office operations and lead to stronger data infrastructure. 10
The P&C industry is no longer cyclical between "hard" (i.e., higher insurance premiums) and "soft" (i.e., lower insurance premiums) market cycles as it was 10 years ago. For years, the market fluctuated between insurance providers underpricing their underwriting standards to generate accelerated growth and then attempting to compensate a few years later, leading to a hard market where prices increased from 10 to 50 percent upon renewal. This ultimately led to a division between underwriters and agencies as they became aware of the market cycle, and the cycle gradually evened out, leading to a persistent soft market for over the last decade. Currently, there is excess surplus and high profitability in the industry, indicating the likelihood of a hard market cycle is low. 11
Net premiums written (NPW) displayed notable growth in 2018. Since 2013, NPW have experienced a steady growth track, increasing from $477 billion in 2013 to $617.4 billion in 2018. 12 Direct premiums written (DPW) for P&C companies grew as well, albeit gradually. Total DPW increased in 2018, and a record high dollar amount was reported for the industry at year-end. This expansion has continued in 2019 and is expected to continue as it mirrors economic growth. "P/C Direct Premium Written Up 4.2% in Q1: Demotech," The Insurance Journal, June 17, 2019. This premium growth occurred despite the significant excess existent capital in the industry. Thus, it is not surprising that net income has improved for the P&C insurer industry. Historically, industry net income declined annually from 2013 to 2017 but rebounded in 2018 as the industry showed a year-over-year 69 percent increase in net income. 13
The industry's combined ratio, or the sum of an insurer's losses and expenses divided by their earned premium, is often used to measure the profitability of an insurance company and to gauge the performance of its daily operations. The positive factors impacting the industry caused a decline from the 10-year historic average combined ratio of 101 percent to a projected 98 percent for 2019 with normalized catastrophe losses and continued reserve releases, a favorable outlook for the industry. 14 For year-end 2018, insurers reduced their prior claim reserves of $658.7 billion by $8.8 billion, which is lower than the 5-year historical average reduction of $9.5 billion. 15 Despite the lower reserve reduction, the industry still managed to boost profits due to higher premiums and investment income, supported by a strong US economy in 2018.
There are several factors to consider when assessing the risk of the P&C insurer industry. These include the inherent risk of underwritten premiums and the risks associated with the insurer's portfolio. Most insurers' portfolios are both conservative and liquid so that the company has accessible funds in the case they are needed for a claim-related expense.
Liability loss-cost trends still outpace rate increases, which may not be sustainable for some companies in the long-term. 16 Further, catastrophe losses have been more substantial than historical averages in recent years, and that trend could continue in the future. 17 Finally, the utilization of technology is forcing industry participants to consider cyber risk, including data breaches and imposter fraud. All of these factors present real challenges for the P&C insurer industry to overcome in coming years.
The "Average Forward P/E Multiple" graph below presents the average 1-year forward price-to-earnings (P/E) multiples from the last 5 years for a group of publicly traded companies (the "Industry Group") that are representative of the P&C insurance segment of the insurance industry.
The companies that comprise the Industry Group are listed as follows.
The Allstate Corp.
The Chubb Corp.
Cincinnati Financial Corp.
Donegal Group, Inc.
Erie Indemnity Co.
First American Corp.
Hallmark Financial Services, Inc.
Mercury General Corp.
Safety Insurance Group, Inc.
Selective Insurance Group, Inc.
State Auto Financial Corp.
The Hanover Insurance Group, Inc.
The Travelers Companies, Inc.
W.R. Berkley Corp.
White Mountains Insurance Group
These companies' P/E multiples provide an indication regarding the value of the company as well as the state of the insurer market. The "Average Forward P/E Multiple" graph above depicts the soft pricing cycle of the P&C insurer market since June 2014, with multiples generally fluctuating between 12x and 14x, excluding the price spike in 2017. Pricing in 2017 was largely due to the extreme catastrophes that took place during that year, causing an increase in demand and price. Multiples returned to their previously soft levels in 2018 and have remained at similar levels in 2019 due to industry-wide surplus capital.
The P&C industry performed particularly well in 2018 and 2019, but it will be difficult to sustain such results moving forward. Concerns have been raised about an economic slowdown in 2020 with the potential of a full-fledged recession. The outcome of the ongoing trade disputes between the United States and China, as well as among other nations, will also have a large impact on the global economy. GDP growth is expected by many economists to trend downward in the upcoming years. Also, despite speculation regarding the federal funds rate, the direction of interest rates remains uncertain.
In conclusion, regardless of the strong recent performance, many factors, including the volatile global economy, increase in large-scale catastrophes, and evolving technology, will present challenges for the industry moving forward. However, the significant surplus capital that exists in the industry will help P&C insurers to combat these challenges and will also likely help maintain the soft market that has persisted over the past decade. For P&C insurers to maintain positive momentum moving forward, it will be necessary to focus on improving operational efficiency, while boosting productivity and lowering costs with new technology and customizing products and services to meet the needs of the digital consumer. 18 Companies that are able to do so, while still practicing disciplined underwriting and managing strong diversified investment portfolios, will position themselves well compared to others in the industry.
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