It is the world’s only super power and yet the number of reinsurers in the United States continues to drop. Ronald Gift Mullins takes on the mammoth task of assessing one of the world’s most complex and dynamic insurance markets.

The colossal economic engine that is the United States, with just 4.5% of the world’s population, generates more than 31% of the $3.7trn total global insurance premiums, making it number one among all nations. Japan is second with 12.4%. According to a Swiss Re Sigma study, total US insurance premium volume of non-life and life & health in 2006 amounted to $1.168tn, an increase of 5.3% over the prior year.

Around 1.4 million people are employed in the US life & health, property & casualty and reinsurance sectors. An additional 888,200 work in agencies, brokers and other insurance related activities, according to the US Bureau of Labor Statistics.

There are close to 2,650 US property casualty insurance companies. The majority of these are part of larger entities. US property casualty net written insurance premiums totalled $443.8bn in 2006, up from $425.7bn in 2005, according to data from the Insurance Services Office. Assets of the P/C industry amounted to $1.5trn in 2006. The US property casualty industry’s policyholder surplus, according to AM Best, grew $25.4bn, or five percent, to $528.1bn through the first nine months of 2007 from $502.7bn at year-end 2006.

Net premiums written divide 51.7% for commercial lines and 48.3% for personal lines. The largest line in 2006 by net premiums written was private passenger auto with $160.5bn, followed by homeowners multiple peril of $55.8bn. The top five US writers of P/C insurance by direct premiums written are State Farm, AIG, Zurich, Allstate and Travelers.

What is most extraordinary about the US P/C industry is that not since the late 1940s has the industry produced three consecutive years of underwriting profits as appears possible for years 2006, 2007 and 2008. For 2007, AM Best predicts the industry will generate a net income of $59.2bn and an underwriting profit of $19.3bn. The rating agency put this down to “sustained underwriting discipline” in a softening market.

The combined ratio for 2006 was 92.4%. Estimates are that 2007 will be 93%, and 2008 is predicted, barring massive catastrophes, to have a combined ratio below 100%. It is a fact that for the first time since 1977 and 1978, the US P/C industry will report its second consecutive underwriting annual profit in 2007.

There are 1,259 life & health insurance companies in the US. Premiums for 2006 in the life & health sector added up to $583.6bn, up 10.5% from $528.1bn in 2005. Direct premiums written for group/individual annuities of $310.6bn ranked as the number one line in the sector, accounting for more than 50% of the total sales in the life & health industry for 2006. The five leading writers of life insurance by direct premiums written in 2006 were AIG, Metropolitan, Prudential of America, ING America Insurance Holding Group and John Hancock.

Where have all the reinsurers gone?

The number of US reinsurers and affiliates of foreign reinsurers has been declining for years. In fact, there is no sizeable, independent stock reinsurer now domiciled in the US. In the third quarter of 2007, there were just 21 US reinsurers or affiliates of foreign reinsurers writing $28.1bn gross premiums compared to a group of 38 in 1998 with $19.4bn in written premiums, according to the Reinsurance Association of America (RAA). In 2006, the reinsurers reported an underwriting gain of $1.3bn (94.9% combined ratio), the first in many a year, and after nine months of 2007, the group reported an underwriting gain of $1.2bn (and a combined ratio of 94.1%). Since there were no major losses in the fourth quarter of 2007, the US reinsurance industry will also achieve an almost unheard-of record – an underwriting profit for two consecutive years.

Top five reinsurers operating in the US by gross premium written are Swiss Re America, National Indemnity (Berkshire Hathaway), XL Reinsurance America, Munich Re America and Transatlantic/Putnam Reinsurance.

“The United States, with just 4.5% of the world's population, generates more than 31% of the $3.7trn total global insurance premiums

Pessimistic shadows

Casting a shadow over the continued profitable trend of the reinsurance industry is the fact that the January renewals brought an obvious softening of rates. According to Guy Carpenter, property catastrophe reinsurance rates fell by nine percent across all markets, as buyers, knowing there were few major catastrophes in 2007, hammered reinsurers to lower their rates or enrich terms and conditions.

A report by Willis Group indicates that the reinsurance industry has returned to its pattern of chasing risks with increasing inadequate premiums. Willis sees rates declining in aerospace, casualty, US healthcare, life accident and health, marine, non-marine retrocession, surety and workers’ compensation.

“There certainly was no shortage of events in 2007, but the fact that frequency trumped severity led to balance sheet strength,” says Sean Mooney, Guy Carpenter’s chief economist, in its report. “Excluding a major shock, we anticipate soft market conditions to prevail in most reinsurance markets for a number of years.”

At a meeting of insurance executives in New York in January 2008, Ramani Ayer, chairman and CEO of The Hartford, brought up a speed bump which could restrain acceleration of price reductions. The obstacle, according to Ayer, is that primary insurers cannot get the really cheap reinsurance they need in order to have a free fall of primary insurance rates. “Reinsurance as a group today tends to be more disciplined on price,” he says. “As a buyer, I would say reinsurers, because they are still disciplined, will make money at the levels where we have bought coverage. They’re not going nuts.”

Anthony Kuczinski, CEO of Munich Re America, says that in the 2008 renewal season, reinsurers tried to hold onto their discipline, “but prices deteriorated more than they should have.” Julianne Jessup, head of research at Benfield, observes that there is a difference of discipline now compared to ten or 15 years ago. She says that everyone always talks about the death of the cycle, but it continues to exist. “There have been changes though,” she continues. “There is now a huge framework of discipline around the market.”

ERM strengthening

How much of this increased discipline of the reinsurance and insurance P/C industry can be attributed to enterprise risk management (ERM) cannot be readily determined. Yet it is evident that a more prudent and thoughtful management philosophy within the past several years has had considerable influence on the operations and results of insurance and reinsurance companies.

Increasingly, leading companies in the industry are implementing ERM as a framework under which they can most profitably manage their various categories of risk, portfolios and product development. Time and implementation will determine whether ERM will at last be the rational force that will flatten the reccurring, self-destructive insurance cycles that have plagued the insurance and reinsurance sectors for a half century and more.

The major rating agencies have integrated ERM into their credit and claims paying examination and evaluation of insurers and reinsurers. One of the key differentiators between companies assessed by Standard & Poor’s as having strong or excellent ERM and companies with adequate ERM is that they recognise that “risk cannot actually be fully represented by a single parameter, no matter how robust the models used.... A fully matured ERM programme will attempt to assess all of the aspects of the risks of the firm. From a practical point of view, it is likely that these multiple views of risk might conflict and make management decisions complicated. In these cases the risk manager will need to understand why the different views tell a different story and which of those different stories becomes important enough to drive the actions of the firm.”

“For the first time since 1977 and 1978, the US P/C industry will report its second consecutive underwriting annual profit in 2007

It is unlikely any insurer or reinsurer will have crippling losses from the subprime mortgage crisis. Guy Carpenter attributed the lack of a significant impact to the “conservative investment behaviour” among reinsurers. In a statement, Willis reported that the negative impact of the subprime debacle appears limited on reinsurers. It did predict that losses are ultimately anticipated in specialty segments such as directors’ & officers’ (D&O) and errors & omissions policies. D&O insurers could see up to $3bn in losses through 2009, Guy Carpenter said. Swiss Re recently revealed a writedown of around $1bn, largely from exposure to subprime paper via two credit swaps.

Regulatory agenda

With 2008 being a presidential election year and the hopefuls galloping at full speed, it is doubtful that any meaningful federal legislation affecting the insurance or reinsurance industry will be considered until after the new president is installed in 2009.

One vital law was passed in December 2007 – the Terrorism Risk Insurance Program Reauthorization Act of 2007 – which reinstates the federal backstop for terrorism risk and extends it for seven years to 31 December 2014. Little was changed from the previous law except that domestic acts of terrorism are now covered. Not included were losses for group life nor the make-available requirement for coverage for nuclear, biological, chemical or radiological events.

In 2007, Congress considered the National Insurance Act of 2007, which would create an optional federal charter for a single national framework for insurance regulation. Insurers opting for a federal charter and federal regulation would lose the limited antitrust immunity granted to state-regulated insurers under the McCarran-Ferguson Act. With such strong opposition to passage of this bill from the National Association of Insurance Commissioners (NAIC) and other insurance associations, there is little likelihood it will be considered in 2008.

Once again, the accusation arose that US affiliates of reinsurance parents based in offshore jurisdictions with low or no corporate income taxes are avoiding paying US income taxes on premiums earned in the US. At a hearing at a federal subcommittee in September, pros and cons for passing a law to prohibit this practice were delivered. Neither side has a clear idea as to how much income tax has been lost, or how much could be gained if the law were changed. Since the hearing was only exploratory, no immediate further action has been scheduled.

There has been some movement on adjusting or eliminating the 100% collateral rule for foreign reinsurers, but since this is within the governance of the NAIC and its working committees, any change will come slowly and probably not in 2008.

The regulatory agenda may not experience much change until a new president is firmly ensconced in the White House, but that does not mean 2008 will be a dull year for the US reinsurance industry. With the US insurance and reinsurance industries turning in considerable profits for a rare two years in a row, how this abnormal situation will affect management of these companies will certainly be of prime interest as 2008 unfolds.

Ronald Gift Mullins is an insurance journalist based in New York City.