Financial Crisis May Affect Insurance Pricing, Capacity

Insurance consultant Towers Perrin reported yesterday that the current financial crisis may have cut the industry's surplus – an important measure of claims-paying capacity or capital – by over 40 billion in the 3rd quarter. The firm also projected an 80 billion reduction in surplus for the year. See a press release about the report here

The study cites several reasons for the reduction in capital, including:
  • Stock market losses in companies' investment portfolios.
  • Catastrophe losses incurred during a hurricane season that produced 15 Atlantic storms and 15 in the Pacific.
  • Deteriorating underwriting results during a prolonged period of depressed insurance rates (known in the business as a "soft market").

Now, compared to crises in the banking and investment sectors of the economy, the insurance industry is in good shape. Because its purpose is to transfer risk from its clients, insurers have been held to a much more conservative reserving standard than those businesses. They must have a strong financial safety net to allow them to pay claims, even in the worst of circumstances. 

And the system has worked. The insurance industry successfully weathered 9/11, killer hurricanes Andrew, Hugo  and Katrina  without threat of a government bailout  or late-night fire sales of insurance companies. 

But if Towers Perrin's predictions are accurate, this could be the beginning of a time of rising insurance rates (known as a "hard market"). Property rates, especially in coastal areas, have increased the past few years, but auto and liability insurance rates have dropped significantly the past few years. This trend could reverse quickly in the face of shrinking industry surplus.  Stay tuned!