Ernst & Young: Transition Ahead for P/C Insurers

In 2008, the impact of the financial crisis on the U.S. property/casualty (P/C) insurance industry has been isolated, sparing the industry from serious impairment. Still, the outlook for 2009 includes greater risks to the industry from continued volatility, according to the Ernst & Young Global Insurance Center's U.S. property/casualty industry outlook for 2009.

Ernst & Young has identified seven areas that P/C insurers need to address in 2009:

1. Redirect focus on premium pricing. In most P/C business segments, pricing levels have remained soft for the past four years. Early signs of pricing negotiations show that the market is firming in most lines. Insurers and reinsurers focusing their concerns on loss volatility and the potential for megalosses in highly developed, catastrophe-prone locations should contribute to price stabilization. At the same time, losses in directors and officers and errors and omissions products are likely to result in price increases in those markets.

2. Monitor claims inflation risk. The economic climate is likely to continue in a volatile pattern that drives claims costs. In spite of the deepening recession and rising concerns about deflation, over the longer term the industry will have to consider the massive deficit spending undertaken by the federal government. Insurers' exposure to inflationary risk can be fundamentally different from the factors that drive inflation in the broader economy: medical costs, construction costs and tort issues continue to account for the lion's share of the industry's inflation trend.

3. Prepare for changes in regulatory oversight. Momentum for change in the insurance regulatory structure is building. As a result of recent market events, including the federal involvement in the banking industry, it is almost certain that the industry will face increased and more intrusive regulation. This is likely to include closer monitoring of activities and financial performance and to require greater consistency and transparency.

4. Prepare for changes in accounting requirements. Moving forward, a thorough understanding of accounting issues will be critical as companies prepare to adopt a new financial reporting platform. With the expected convergence of U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards, companies are beginning to prepare for the anticipated change to a market-consistent framework. Insurers, too, must plan for those changes, which will include significant operational modifications.

5. Address effective expense control. In the past decade, expense ratios have been steadily rising. In 2008, for the P/C industry overall, underwriting, acquisition and general expense ratios, as a percentage of premiums, are expected to reach 27.5%, higher than any year since 1999. Premiums and sales should have grown in tandem, but this has not happened. As a result, the P/C industry is likely to see more expense-cutting in 2009, but the cuts must be strategic or they could result in more troubles.

6. Rethink risk modeling. P/C insurers will need to incorporate lessons learned into their risk management functions. A significant finding in the past year is that companies should not rely too fully on risk models, but should make them part of an organization's overall risk management process. It is the role of senior management to review and adjust these models within the framework of real-world trends and influences.

7. Watch for new M&A activity. The current financial crisis has created a unique landscape for insurance M&A. In fact, the total insurance properties currently available for sale exceeds all the M&A activity for the past several years combined. Some companies will emerge from the current situation with strong balance sheets and use a portion of their capital to fund acquisitions. However, they will likely wait until the depth of the current economic downturn, and its impact on operating performance, is better understood.

The complete 2009 U.S. property/casualty industry outlook can be found at www.ey.com/insurance.