The property/casualty insurance industry looks set for its worst underwriting result ever for the 2001 account.

At the beginning of September, it was a truth universally acknowledged that the property/casualty insurance industry was going to report a fairly chronic set of results for 2001. Although insurers and reinsurers had finally appeared to take the bit between their teeth, dig in their heels and insist the market harden, this was going to be too late to rescue the ailing 2001 results. As James Auden, analyst with Fitch in Chicago, said in a recent report, “While underwriting results in 2001 were not previously (to the 11 September catastrophe) showing signs of material improvement relative to the prior year, losses relating to the attack will turn 2001 into one of the worst, if not ultimately the single worst underwriting period in industry annals.”

The first six months of 2001 showed significant growth in premium volumes, though the US property/casualty insurance market was continuing to report deteriorating operating results (see table). As Mr Auden pointed out, although net written premiums increased by 10% in the first half of this year, compared to the same period last year, the combined ratio deteriorated to 111.2% for 2001, compared to 108.8% in 2000. This deterioration was mainly driven by catastrophe losses, said Mr Auden, primarily due to tropical storm Allison. Figures issued by the Insurance Services Office at the end of August estimate Allison-related losses to be in the region of $2.5bn - the lion's share of the $3.2bn increase in catastrophe-related losses for the first six months of this year, compared with the total cat losses of $3.4bn in the first half of 2000.

Taking catastrophe losses out of the equation softens the picture somewhat: ratios converge, with the first six months of 2001 showing a combined ratio of 106.9%, compared with 106.4% for the same period in the previous year,

Earnings showed a violent deterioration, falling from $6.4bn in the first six months of 2000 to a loss of $1.9bn for the same period this year. Realising capital gains hiked the loss to a profit of $2.5bn - still massively down on the $10.5bn reported in the first half of 2000. Although in January Fitch had predicted a slight improvement in the industry's combined ratio to 109.2% for the whole of 2001, down from 110.1% for last year, this was beginning to look fanciful. Fitch had believed that rate increases over the course of this year would lead to improved underwriting performance, though this might have been mitigated by higher loss costs, particularly medical cost increases, as well as adverse developments on previous years and slightly higher catastrophe experience compared to the benign cat environment in 2000.

The largest loss
And 11 September resulted in the largest ever insured loss. That much is known already, though where the total figure will finally rest is still very much open. As Mr Auden pointed out, “in general, it has taken the industry at least two quarters for losses to fully develop. Given the magnitude and complexity of the attack losses, which encompass many lines of business, the development period will likely be longer.”

At the moment, estimates range between $30bn and £70bn, he said. “Companies are still raising their estimates,” he commented. Fitch has not made a formal estimate itself, but it is working on a figure in excess of $30bn. “If it reaches $70bn, it means coverage issues will have to go the other way,” he commented, meaning that issues such as the number of events which constitute the loss will be at the maximum, for example. However, there is still uncertainty with the figures being issued by re/insurers at the moment; some are working on the maximum possible loss to their organisation, while others are being less pessimistic in their estimates.

Finite contracts
In addition, Fitch has pointed out that certain related losses likely will not be identified because of the nature of finite risk reinsurance contracts. It anticipates that between $3bn and $6bn make fall through the reporting gap. As Fitch explained, “Finite risk reinsurance contracts require primary insurers to ultimately pay for a majority of ceded risks themselves. Ceded losses under finite contracts are effectively reimbursed to the reinsurer in future years through additional contracted premium payments paid by the primary insurer, or investment income on cash deposits placed by the primary insurer with the reinsurer.” Even so, the primary insurers are able to claim a recoverable from their reinsurers for the ceded losses under the finite contract, and will typically repay them later, smoothing their net reported losses following a catastrophe and spreading them over a number of years. In addition, the finite risk reinsurers will not be reporting the same level of losses as the primaries are showing as reinsurance recoverables because of different accounting practices between the two constituencies, so some related losses will effectively disappear. This is a reflection of the location of the organisations - the primary insurers will tend to be based in the US, while finite risk reinsurers tend to be located in offshore domiciles and subject to different accounting procedures. According to Fitch the results are likely to be:

  • a large cross-section of primary insurers and reinsurers which purchased finite retrocession covers will be taking credit for ceded balances that they will ultimately pay themselves. Thus a number of primary insurers' net losses recorded in 2001 will understate the true economic impact of the events, since future expenses for reimbursements to reinsurers will be unaccounted for in a future period and create a drag on future earnings; and
  • ceded balances reported by primary insurers will exceed assumed losses reported by reinsurers, both in the aggregate and for certain companies. The existence of finite covers will make it that much more difficult to judge how much of this gap is due to finite covers, and how much is due to a true misstatement of loss estimates.

    Even including these ‘invisible' losses, the industry is set to report a full year combined ratio of 115%, assuming the total WTC loss comes in towards the bottom end of current estimates, around $30bn. But life, unfortunately, is not that simple. Prior to the 11 September attack, it was becoming increasingly clear that the industry was looking at some adverse loss developments from prior year. As Mr Auden pointed out, “Since 2001 underwriting results will be poor, companies may have an added incentive to recognise prior reserve deficiencies before year end to improve balance sheet quality and foster improved underwriting results in future periods.” With the widely-heralded hardening of the market – rate increases up to 170% average over specific classes of business are currently being reported – this may be a wise management strategy.

    Rating watch
    A number of companies remain on rating watch, with Fitch keeping an eye on how their losses are developing, as well as any capital replenishment moves, whether through raising new funds or earnings. “There have been people with capital who have been sitting on the sidelines,” said Mr Auden. Now that rates are hiking and conditions are tightening, we could be witness to fast capital replacement from “opportunistic” investment sources, he said.

    “In aggregate, the industry is in pretty good shape,” commented Mr Auden. “The losses are generally in the larger companies with sufficient capital,” though another major catastrophe before the end of the year could have serious ramifications for the industry. At the moment, in the US market there is no organisation “on the radar screen for failure,” he said. Bar another large event in the next few months, the industry appears able to sustain the blows and write into another year.