U.S. Property and Casualty insurance companies are enjoying a very profitable underwriting year in 2013. For the last few years, private passenger auto insurancehas been the profit center of the industry with home insuranceand commercial insurance posting poor underwriting results due to weather-related property losses. 2013 has been a record low year for hurricanes, tornadoes, and wildfires. That follows several years of horrific property losses due to weather.
Many industry pundits point to high underwriting profits and wonder why premiums aren’t being reduced.
Companies, like Travelers, think it’s premature to price their coverage as if the bad weather is behind us, but there are dozens of other considerations that go into setting premiums.
Some companies don’t want large premium growth. I once worked for a CFO who believed an insurance company should never go beyond a 1:1 ratio of net written premium to policyholder surplus. He felt that a low ratio allowed the company to mitigate the risk taken on the underwriting side. It was his opinion that insurance companies could take risk in either their investments or their underwriting, but not both. The insurance industry tends to historically have a ratio of 1.4:1. The large rate increases over the last few years have diminished some companies’ appetites for new business.
That isn’t to say a more assertive ratio isn’t possible. Progressive, who is more aggressive, usually has a ratio north of 3:1. Berkshire Hathaway-owned GEICO also breaks from the norm running as high as 3.9:1 in recent years. Conversely, another large Buffett-owned company, National Indemnity, is currently running at a very low .7:1. GEICO, as a rule, has a corporate strategy of writing low liability limits. Their exposure in any one loss is much smaller than the typical risk written by National Indemnity. Because of what they do as risk-bearers there is more philosophical consistency between the two companies than what readily appears.
Predicting industry trends can be dicey because insurance companies do many illogical things. They can be run by people who are greedy, incompetent, risk-aversive, or at a point in their career where they just don’t care. It’s wrong to assume that every insurance company is trying daily to maximize underwriting profit. It is also wrong to assume that they have all the tools needed to make proper decisions.
A lot of astute investors won’t put their money in an insurance company because it is so hard to know if their numbers are valid. Insurance is a highly regulated industry, yet there are many conjectural numbers involved, such as loss reserves.
Insurance company executives can be slaves to their own numbers and fall into the trap of believing their own inaccuracies. Some insurance companies have unknowingly underpriced their products based on under-reserved losses from the past providing an indication of profitability going forward that proves to be inadequate.
I spent the first twelve years of my forty-three year career working for insurance companies. My duties often included collecting account currents from agencies. The amount of bookkeeping required to correct our errors was startling.
In the past it hasn’t been at all uncommon for companies to take months, and even years, to bill account current premiums. I once had a $300,000 premium go nine months before the company billed my agency. I had properly billed the insured and had collected the money. Property/Casualty agents are entitled to the income they derive from the money they hold for companies, so my agency had a nice additional amount of investment income that year. Had that company set future rates based on the relationship between the earned premium and the loss ratio, the earned premium would have been grossly understated for those nine months.
Insurance companies tend to move in the same direction at times because the reinsurance market governs much of their activity. Reinsurers provide “insurance” for insurance companies. Annually negotiated treaties (agreements between insurance companies and reinsurers) can make a real difference quite quickly in many companies’ appetites and pricing.
Companies also move in the same direction because that can be the safest career move for a corporate employee.
Years ago I was in a position of filing farm insurance rates for a medium-sized Midwest company. I followed the practice of the company, which was to compile competitor information, determine what pricing would sell, and set our rate mainly on a competitive position.
Some companies don’t make quick moves because they have weak leadership. Over the last twenty-five years or so the insurance companies with strong central leadership have done the best financially. Those would include Progressive, GEICO, AIG, Travelers, and Mercury.
High profits normally are followed by rate cutting in the “supply and demand” world of insurance . . . but not always, and certainly not universally.