The number of independent property/casualty groups declined 8% to 10% in 1999, and A.M. Best expects one third of the remaining groups to lose operating autonomy by 2005.
Under more immediate pressure, 10% to 12% may lose their autonomy within 12 to 24 months. While consolidation will continue within the large company segment, a significant number of local market competitors still battle for a dwindling share of the premium.
Roughly 1,050 property/casualty organizations operate in the United States today, and 12% of these groups control almost 90% of the total market. The top 10 groups alone write nearly 44% of the market premium, up from 41% two years ago. The passage of the Financial Services Act of 1999, ongoing commercial lines deregulation and consumers' growing internet use to buy goods and services are presenting companies with new challenges and new competitors.
In 1999, A.M. Best continued its study of companies and groups “at risk” of losing operating independence given mounting competitive pressures. This study utilized our comprehensive database, which carries financial data on almost all of the industry's participants. Each company's profitability trends, business persistency traits, and balance sheet flexibility were evaluated and measured against their peers to determine which entities had characteristics making them particularly vulnerable to today's market environment.
What we saw in 1999
Roughly 8% to 10% of the groups operating in 1998 were subject to some form of consolidation during 1999, with additional entities currently party to announced transactions that have not yet closed. More than half of the affected companies were identified as “at risk” due to chronic underperformance and financial constraints in A.M. Best's 1998 consolidation study.
Strategic factors drove the remainder of the consolidation with newly formed partnerships enabling individual companies to exploit complementary products, distribution systems, and client bases, under an increased capital base. Last year, A.M. Best cited many of these groups as being under near-term pressure to consolidate given numerous strategic drivers. The reinsurance sector has been particularly active because of the heightened global pressures these companies face. Accordingly, this segment has become increasingly concentrated as mergers and acquisitions escalate across national borders.
Also during 1999, we noted a divestiture of personal lines operations by large multiline groups, such as CNA Financial and St. Paul, as necessary operational efficiencies within this sector could not be achieved. Activity involving the spin-off of non-core operations has increased as companies restructure and retool their operations to focus on core competencies. Vesta, Centris and Nationwide sold their reinsurance books while Jefferson-Pilot exited the group medical insurance market selling this business to United Healthcare.
Despite the escalation of mergers and acquisitions over the past several years, a large number of entities continue to exhibit poor performance and a lack of overall financial fortitude, calling into question their ongoing viability.
Of the 1,050 remaining property/casualty domestic groups, A.M. Best believes 10% to 12% are at risk in the near term of losing their operating autonomy due to poor operating fundamentals and weak market positioning. The typical company in this “at risk” group has less than $15 million in surplus and has suffered a reduction in premium volume from competition. Its combined ratio is roughly 10 points higher than its peer composite; this disadvantage comes equally from expense inefficiencies and higher loss-cost trends than the norm.
As a result, it has recorded year-over-year negative operating returns and surplus has declined. These companies will continue to be challenged by escalating market forces.
A preview to future events may be found by reviewing consolidation in the banking industry and the factors driving mergers and acquisitions in that industry. These include the search for greater efficiency, better use of technology, regulatory changes, increased diversification, and the opportunity to offer a broader array of products and services. Interestingly, these are the same issues driving consolidation within the insurance industry. The consolidation of the banking industry has been underway for more than a decade, with a drop of roughly 30% in the number of US banks in operation between 1988 and 1997. Consolidation activity in the insurance industry has only recently accelerated as companies come under increased pressure for quality service and competitive returns from policyholders and shareholders alike.
Given the factors converging within the property/casualty industry, mergers and acquisitions will accelerate, furthering consolidation in the insurance industry and across all financial services sectors. Former restrictions segregating banking, insurance and brokerage functions have resulted in the most fragmented financial services system in the world. In contrast, a few major players dominate financial services in Europe and Canada. The removal of regulatory barriers, combined with the impact of technological advances, will dramatically alter the competitive landscape, resulting in many more companies losing operating autonomy over the next five years.
Elizabeth Farrell is assistant vice president, property/casualty division, at A.M. Best Co.