In its report, “Journey III: The Next Frontier in Property and Casualty Insurance—The Challenge to Profitable Growth,”
The consulting firm came to this conclusion after examining industry returns since 2002, the sustainability of improved returns and the implications for companies competing in a more disciplined and competitive market.
The industry has seen seven consecutive years with industry profits well in excess of the cost of capital, and the profits for each year from 2003 to 2009 exceeded the industry’s best normalized profit year from 1988 to 2002, according to the report.
“Looking at shifts in industry structure over the last 10 years and using our collective experience in serving many of the largest insurers, we have developed a perspective on whether recent improvements are likely to be sustainable or simply the result of a hard market that will revert, as before, to a push for share and inadequate pricing, followed by poor returns,” the report states.
While the industry still faces some significant challenges in the near-term—rates that have lost ground to loss cost inflation, and interest rates that remain depressed— McKinsey & Co. says pricing will firm up and longer-term returns will be far healthier than they were before the paradigm shift.
The report states that this shift is rooted in three factors: the exit of undisciplined capacity, strengthened risk management skills and stronger foundational pillars. And these factors contribute to a positive outlook for insurers.
Specifically, industry returns in personal and standard commercial lines should be attractive, with negative forces self-correcting in the medium term. The report states that these lines have two structural advantages:
• Consistently weak underwriting companies hold a small share of capital
• New entrants face major barriers to entry, including high infrastructure costs and the decentralized skill requirements in underwriting, claims and distribution
“The outlook would be even more positive if companies, especially those with below-average underwriting results, resolved to fully reprice segments of their books consistent with loss cost realities,” the report states. “The cross-subsidies on every company’s books continue to depress industry results.”
Specialty and E&S lines don’t fare as well as the others.
“These businesses present low barriers to entry, given less frequent losses and a higher concentration of business at both the underwriter and channel level,” the report says. “The good news is that few new entrants have staying power; building an enduring business takes more than hiring experienced underwriters. Companies with mature business models and excellent skill levels have enjoyed strong returns over time.”
