Sector remains healthy but competition creates challenges for profitability, says E&Y

Spirited competition between property & casualty (P/C) insurers will continue in 2011, as many of the factors that have caused the soft market in recent years remain in play, according to Ernst & Young.

"The good news is that the P&C industry is financially healthy," said Peter Porrino, Global Director of Insurance, Ernst & Young's Global Insurance Center. "However, this fact will create significant challenges for insurers in the months ahead as the soft market continues to depress prices."

The prolonged economic recovery, ongoing price competition, and low investment returns have decreased the industry's profit margins, and will continue to do so according to E&Y’s Global Insurance 2011 report.

E&Y identified six issues that will influence the property/casualty industry in 2011. These are listed in full below:

1. Operating in a sluggish US economy

Tighter purse strings among businesses and consumers in the slow-to-heal US economy have reduced net premiums for P/C insurers, prompting declines in industry revenues and earnings. Commercial lines, which incurred the largest net premium decreases between 2006 and 2010, are expected to remain stunted in 2011. The decreases in net premiums have been accompanied by falling investment yields, which have shrunk steadily since 2005. This is compressing the industry's operating margins, which increases the risk that insurers will delay needed or advantageous investments in infrastructure improvements in underwriting, marketing and customer service.

2. Enduring the soft underwriting cycle

By better understanding the dynamics of the industry's underwriting cycle, individual insurers can separate their performance from the pack. Overperformers have a firmer grasp on pricing trends because they better monitor the factors contributing to the industry's cyclicality. These insurers analyze all cyclical indicators available to develop their pricing outlook, including underwriting cash flow, loss reserve adequacy, reinsurance capacity, catastrophe losses, policy terms and conditions, loss retentions and other data. Monitoring cyclical trends by line of insurance is crucial to responding to a pricing turn.

3. Leveraging analytics to drive the growth agenda

In the price-competitive P/C market, insurers that have strategically collected, analyzed and modeled both legacy and new data streams will gain a competitive advantage. The vast supply of digital information is guiding new sources of economic value, and providing fresh insight into markets, customers, suppliers, partners, and the enterprise. Predictive modeling has been effectively employed in personal lines underwriting where variables such as credit scoring have proven valuable. Underwriting applications to commercial markets have shown promise, but are less mature.

4. Effectively transitioning to the new accounting standards

The likely development of new accounting standards for insurance creates both risks and opportunities. While many insurers will treat the transition as a compliance exercise, others will leverage the opportunity to reorganize and refine their systems, reporting and risk controls to position the company for success in the new environment. The two proposed accounting changes -- the IASB's Exposure Draft on Insurance Contracts and the FASB Discussion Paper on its Preliminary Views on Insurance Contracts -- will alter the measurement basis for insurance contracts and require increased disclosure. The likely impact of these changes is higher earnings volatility and possibly increased capital pressure.

5. Anticipating regulatory and legislative developments

New national and international laws pose unintended consequences for US P/C insurers in 2011 and beyond. The impact of two recent pieces of legislation -- the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Patient Protection and Affordable Care Act -- remains unclear as the supporting regulatory structure is being built. Solvency II will also impact the insurance market. Rather than simply react to the legislative and regulatory changes, US P/C insurers can monitor them closely and interact with regulators to help shape their eventual outcome.

6. Analysing opportunities for managing excess capital

US P/C insurers struggling with sluggish organic growth because of the soft market and the weak economy can deploy excess capital by expanding their businesses and making share repurchases. M&A activity is expected to continue at a moderate pace in 2011. As the slower-growth environment continues into 2011, insurers must look for ways to maximize capital returns, and find options that balance these returns with the risks they present.