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Outlook for property/casualty industry remains negative

By Standard and Poor's

The property/casualty industry’s operating performance is strong, but has been trending downward over the past 18 months.

Standard & Poor’s near-term outlook for the U.S. property/casualty industry remains negative primarily because of persistent soft market conditions and questionable pricing practices that may lead to profit and capital decline. The strong economy and bull equity market that helped support the currently overcapitalized market may not be sustainable — while the impact of favorable loss cost trends, tame catastrophe losses, and the harvesting of past loss reserve redundancies is decreasing. The property/casualty industry’s operating performance is strong, but has been trending downward over the past 18 months. Standard & Poor’s projects the combined ratio to increase to approximately 107.0 in 1999 vs. 105.7 in 1998. On an absolute basis, Standard & Poor’s believes the industry’s current capitalization is strong. However, the quality of capital is under pressure given deteriorating earnings and questionable loss reserve adequacy. In the near-term, Standard & Poor’s expects premium growth to be flat as the industry remains fiercely competitive. As a result, Standard & Poor’s expects downgrades to exceed upgrades in 1999.

Ratings actions and distribution

Standard and Poor’s rating actions for the first four months of 1999 is consistent with our negative near-term view of the property/casualty industry. Through April 25, downgrades have exceeded upgrades by a ratio of 1.6 to 1 with 45 downgrades vs. 29 upgrades, while the outlook for major insurers such as Chubb Insurance, CNA Financial, Liberty Mutual and Nationwide were changed from stable to negative. Chart 1 provides a distribution of financial strength ratings as of May 24, 1999.

Standard & Poor's Financial Strength Ratings Distribution as of May 24, 1999


Percent of companies
receiving rating

















What the ratings mean

Industry profile

Standard & Poor’s believes that the soft market conditions of the U.S. property/casualty industry continue to persist. The now familiar story of excess capacity chasing decreasing premium is still the case. Figure 2 depicts the property/casualty insurance industry as a market continuum. Standard & Poor’s asserts that the U.S. property/casualty industry is currently between stage B and C, closer to stage C.

During the early stages of the continuum, the market’s capital profile had benefited from macroeconomic drivers that include the extraordinarily long bull equity market run, strong economy, and favorable interest rate environment. In addition, the soft reinsurance market allowed primary carriers to secure more protection at a lower price that have resulted in low probable maximum loss (PML) exposures. Specifically, companies such as USAA and Farmers have net PMLs as a percentage of surplus of 6 percent to 7 percent for a 250-year catastrophic event. In addition, the industry’s strong operating performance (driven by favorable loss trends, the harvesting of past loss reserve redundancies, and generally tame catastrophe losses) bolstered capitalization.

Figure 2

Stage A Stage B Stage C Stage D
Excess capitalization Continued top line pressure Earnings decline Lower capitalization
Decreaseing premium growth Inadequate pricing Deteriorating capital Higher premium growth


Standard & Poor’s believes that, apart from cyclical changes, permanent structural changes have occurred that altered the competitive landscape of the property/casualty industry. The growth of the alternative markets, regulatory changes (such as the repeal of the minimum workers compensation rate law, commercial lines deregulation, and pending repeal of Glass-Steagall), and consolidation among brokers have increased competition and toughened the operating environment considerably. While other changes such as improved catastrophe modeling, the implementation of cost cutting technology, and a shift toward lower cost managed care have enhanced risk management and productivity while lowering costs.

Against the backdrop of increasing competition, companies such as Hartford, Allstate, Farmers and others, have focused on expanding their distribution channels by investing in multiple delivery systems to diversify revenue sources and promote top-line growth. However, this strategy comes at the cost of higher expense ratios. The challenge to these companies going forward will be the integration and management of the multiple channels, which often times compete against one another, to justify the high investment start-up costs. Standard & Poor’s views the growth of fee-based services as another revenue diversification effort of the industry. Insurer’s traditional role of risk retainer has shifted to multiple roles of risk retainer, facilitator, consultant, and manager. Examples include fee-based advisory services, third party administrators, and risk management offshoots of insurance companies.

Pricing is stable to modestly decreasing and is at unattractive levels.

As of mid-year 1999, the large price decreases witnessed in 1998 in the commercial lines segment have started to abate. There is evidence of rate stabilization from industry leaders, such as AIG, St. Paul and Chubb, and brokers, Marsh & McLennan Cos. Inc. and Aon Corp. However, Standard & Poor’s does not believe that pricing for the commercial lines segment, or indeed for the general property/casualty industry, is hardening. Rather, pricing is stable to modestly decreasing and is at unattractive levels. For example, price decreases last fall that ranged from 5 percent to 14 percent for lines such as general liability, workers' compensation, commercial multi-peril, commercial auto, and commercial property have dropped to a range of 2 percent to 6 percent this spring.

Another event that may provide moderate rate increase pressure in certain workers compensation and reinsurance markets is the Unicover Pool debacle, which Standard & Poor’s does not view as a solvency threatening event to the industry. Nevertheless, Standard & Poor’s believes that amidst continued growth and profitability pressures as well as increased competition, various commercial, medical malpractice, and surplus lines companies have responded by pushing into new and potentially riskier products, in addition to participating in price wars to maintain market share. An accommodating environment for potential pricing and reserving inadequacy, surprise loss reserve, and profitability restructuring announcements have become more common as attested to by Frontier Insurance, Acceptance, Orion, Fairfax and others. Standard & Poor’s believes that surprise announcements will be forthcoming from other companies.

Further exacerbating the pricing environment of the property/casualty industry are greater than expected price decreases in the personal lines segment. Market leaders, State Farm and Allstate, have lowered private passenger auto rates in California, the largest auto market, four times within the last two and a half years by 19.3 percent and 18.1 percent respectively.

Merger and acquisition activity will continue as companies combine for economies of scale.

Standard & Poor’s believes that general market hardening is still 24 to 36 months away. Hardening for the entire industry will be spurred by either a decrease in capital of at least 15 percent or prolonged negative operating cash flows that will require asset liquidations to meet ongoing business needs. Specific events that may accelerate the industry’s hardening are one (or more) major catastrophes, but it would have to be of a magnitude that is greater than the $23 billion in insured losses caused by Hurricanes Andrew and Iniki in 1992, or a significant and sustained downturn of the equity market.

Merger and acquisition activity will continue as companies combine for economies of scale, distribution diversification, product/market expansion, and other reasons. An example includes Allstate’s intention to purchase the personal lines business of CNA announced during the second quarter of 1999. The transaction valued at $1.2 billion is consistent with Allstate’s strategy to continue diversifying its distribution channels. The Hartford is currently expanding the non-standard auto operations of Omni, which was purchased for product expansion purposes. Although Standard & Poor’s believes that diversification and expansion is strategically important for companies to remain competitive, the realization of synergies and the management of different distribution channels and cultures are harder than most suspect. In addition, operating expenses may be affected by higher restructuring costs and lower-than-expected merger-related synergistic benefits.

Table 1 provides an outline of Standard & Poor’s outlook by segment as well as expectations for the next 18 to 24 months and a quick synopsis of current conditions. Standard & Poor’s outlook differs by segment with the near-term outlook for the overall U.S. property/casualty industry remaining negative. This is primarily due to persistent soft market conditions that prevail for the overall market and questionable pricing practices that may lead to profit and capital decline. In the near-term, Standard & Poor’s expects premium growth to be flat. Although the prospects for the general industry are not favorable, Standard & Poor’s believes that the more proactive market leaders with strong business focus and quality balance sheets will squeeze out the smaller and less differentiated players and gain greater market share and penetration.

Table 1


Current Conditions


(18 to 24 months)

Commercial lines Weak pricing, tough competition, reserve releases, consolidations and more restructurings


Poor top-line growth, continued consolidations, more restructuring, and new product related expenses, questionable profitability and more reserve surprises, potential capital deterioration
Surplus lines Soft market, strongly capitalized, regulatory pressure, strong competition from standard and alternative risk carriers, potentially poorer risk selections


Continued encroachment from other carriers / commercial lines deregulation, declining growth, more pressure for new risk initiatives, potential pricing adequacy issues
Medical malpractice Generally overcapitalized, reserve releases, increasing competition (national and regional carriers) and changing characteristics of providers (larger groups, more leverage), pricing pressure


Questionable pricing, questionable profitability, potential capital deterioration, strategic realignments
Workers compensation — California Highly competitive market, consolidations to date , reduced over capacity.


Moderately hardening prices, improved profitability in the next few years (despite rising cost trends)
Workers compensation — Remaining markets Difficult pricing conditions, most efficiency gains and reforms have already been realized.


Rising medical costs, reduced favorable loss costs, and aging workforce, pressure on future margins
Personal lines — Homeowners Mature market, strongly capitalized, reinsurance over capacity, benefited from strong economy (housing boom) and better cat risk management techniques


Continued pursuit of market share/growth, decreasing top-line growth, potential profit issues
Personal lines — Personal automobile Strongly capitalized, favorable loss trends have led to very good operating performance, reinsurance over capacity, higher than expected price decreases over the past 18 months


Continued pursuit of growth coupled with price decreases , decreasing top-line growth. Increasing medical cost trends coupled with lower top-line growth, potential profit issues

Operating performance/capitalization

The property/casualty industry’s operating performance is nominally strong with poor fundamentals. Furthermore, it has been trending downward over the past 18 months. Standard & Poor’s expects the downward trend to continue in the near-term and is a major factor in our the negative outlook. Statutory pretax operating return on revenue is respectable at approximately 8 percent for 1998. However this has been supported primarily by the strength of the personal lines segment. In particular, the auto insurance industry has bolstered results as favorable loss trends continued. Loss frequency had fallen as a result of beneficial changes to driver demographics and habits as well as enhanced anti-fraud measures. Loss severity has decreased due to lower medical costs produced by managed care together with generally safer car designs and roads.

Prospectively, Standard & Poor’s anticipates industry pretax returns to fall roughly by one-quarter to a range of 5.5 percent to 6 percent. The commercial lines segment will be negatively affected by poor top-line growth, potential Y2K liabilities, falling net investment income, and lower loss reserve cushions. While, personal lines results will not be as bright due to decreasing gains associated with favorable loss trends and premium rate reductions instituted in the past 24 months. In addition, first quarter 1999 catastrophe losses are the second highest in the last five years. Standard & Poor’s does not expect immediate ratings changes following tornado damage in Oklahoma, Kansas, and Texas because of the strong capitalization of the individual companies that were affected. Nevertheless, operating performance for the year will be adversely affected. Furthermore, reserve adequacy becomes questionable with premium growth of 3 percent and 2 percent for the entire industry in 1997 and 1998 (in a decreasing average premium environment), while loss and LAE reserve growth has been at a dismal negative 0.5 percent and positive 0.4 percent. Operating expenses will also be higher due to the resolution of Y2K compliance issues, product development costs, and potentially higher restructuring costs. The combined ratio of commercial lines and personal lines insurers were at 107.4 and 102.2 at year-end 1998 with the entire industry recording a 105.7. Standard & Poor’s projects the combined ratio to grow to approximately 109.0 and 103.2 for the two segments with the entire industry recording a 107.0 in 1999.

Standard & Poor’s views the industry’s current capitalization as very strong based on a capital adequacy ratio in the high AA to AAA range. Capitalization is also strong based on net operating leverage of about 0.85, which is the industry’s more traditional measure of capital adequacy. Nevertheless, Standard & Poor’s discounts this measure because it is not a risk-adjusted measure of capital adequacy and does not capture exposure from a pricing adequacy standpoint. Standard & Poor’s capital model compares adjusted surplus against business needs and factors in expectations of potential investment and credit losses.

On an absolute basis, Standard & Poor’s views the industry’s capitalization as strong, but the quality of capital is growing more suspect given deteriorating earnings and questionable loss reserve adequacy. Furthermore, realized and unrealized capital gains, which are unreliable and non-sustainable, have spurred capital growth over the past four years. Standard & Poor’s expects capital to remain strong in the near term but the potential for deterioration is considerable and growing.


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