Homeowners' ROE Outlook October 8
Homeowners: Growing, Profitable, and Continued Opportunities to Differentiate through Innovation The past several editions of this study described homeowners as a growth engine for the industry. While personal auto and many commercial segments struggled to get past go, homeowners remained steady besting not only other insurance lines but also the overall US economy. The good news is that the line continues to grow: 7 direct written premiums reached USD9B versus USDB the year prior. Quarterly results through June 8 showed to percent growth, while US GDP is up to percent and personal auto, a laggard through, is within reach of 8 percent premium growth both through second quarter 8. Should the industry be celebrating homeowners to percent growth or asking what happened? Reasons to Celebrate The ROE for homeowners in this year s study is. percent, up from the prior study s estimate of. percent. Rate increases drove premium trend that outpaced expense and loss inflationary pressures, bolstering profitability. A federal income tax overhaul also provided an extra push to this year s ROE. Excluding Florida, the ROE hits 9. percent, up from last year s 9. percent. Further, states hit or exceeded our hurdle of a percent return on allocated capital and states reported expected combined ratios at or below. Overall the line is healthy, providing expected longterm underwriting profitability, and has many segments posting exceptional performance. Restrictions on the Celebration Growth and a healthy ROE of 8. percent, as published in our study, attracted heavier competition that slowed positive rate activity and squeezed ROEs. Coupled to an economy that was barely making percent annual progress on GDP, the slowdown in rate activity (and even headline rate decreases in some cases) lead to a leveling (but thankfully no contractions) of topline premium growth. Pressure came from two sides: () Non-traditional specialists Growth, profitability, and perceived market opportunities attracted interest from carriers outside the homeowners line, including large personal auto writers. Further, coastal property specialists, such as the carriers that dominate the Florida marketplace, expanded out of their home markets. Finally, homeowners is an attractive line for startups and InsurTech players using both full stack insurers and MGA or partnership models. The combined effect of these entrants drives increased sophistication applied to homeowners underwriting and squeezing of profits. () Established Carriers Facing an uncertain future with personal auto due to the future of transportation, established (and often very large) personal lines carriers emphasized increasing their market share in the homeowners space. This results in carriers fighting for share via pricing, aggressively seeking niche corners of the homeowners market that were previously left to boutique players, and adding sophistication to their distribution and underwriting efforts. Looking Forward Savvy long-term strategy is what will sort winners from losers in the battle for the future of the homeowners line. Increased data and better systems to link data to product means better identification and service of niche opportunities. Low value dwelling, mass affluent, high value home, coastal, and X-Zone flood are all examples of product segments, with specialized coverage needs, where Aon helps carrier clients optimize their books and serve potential policyholders. Contacts Paul Eaton Veronica Van Dyke paul.eaton@aon.com veronica.van.dyke@aon.com Greg Heerde Adam Dawson greg.heerde@aon.com adam.dawson@aon.com Homeowners ROE Outlook 8
August 8 prospective ROE at current rates Countrywide ROE estimate: % Prospective ROE percent Less than to to 7 to 9 and above ROE study methodology The basis of the prospective ROE estimate is industry state and aggregate statutory filing data including reported direct losses, expenses, payout pattern, and investment yields. We replace actual historical catastrophe losses as measured by Property Claims Services with a multi-model view of expected catastrophe loss. On-leveling of direct premiums to current rates uses rate filings of the top insurance company groups by state. Finally, estimated capital requirements and reinsurance costs consider a nationwide personal lines company writing both home and auto business at a capitalization level consistent with an A.M. Best A rating. The ROE estimates exclude earthquake shake losses as the premium and losses for that coverage are recorded on a separate statutory line of business. Change in prospective ROE from previous year 8% % % % %.% 7 ROE +.% Net premium trend +.% +.% Taxes Volatility & capital costs +.% +.% 8 ROE The diversification available to a nationwide personal lines insurer impacts the ROE calculation. For instance, homeowners business in California diversifies Gulf and East Coast hurricane exposure for a nationwide insurer. A California standalone would incur higher capital and reinsurance costs than the California portion of a nationwide insurer with similar premium volume in the state. Similar results are to be expected for any other regional or single state insurer. 8 ROE observations The 8 nationwide ROE estimate of. percent shows improvement from our 7 estimate of. percent. Four insights emerged when comparing ROE drivers from 8 versus 7: () Positive rate trend outpaced increases in losses and expenses, adding to underwriting profitability and boosting ROE bps. () Tax reform at the end of 7 adds an estimated bps to the ROE; full realization of tax impacts will be clearer in 8 and later financial statements as carriers adapt to a new tax regime. () Capital requirements are flat overall compared to 7, but changes in A.M. Best s capital adequacy model altered the balance between catastrophe and non-catastrophe capital charges and influenced the state-level ROEs up to +/-bps. () Reinsurance costs are also flat when compared to 7; this is most noteworthy because the industry held pricing constant despite an impactful year of catastrophes in 7 including Harvey, Irma, Maria, and record wildfire losses in California. Softening reinsurance costs cumulatively added over bps of ROE in our study since. Homeowners ROE Outlook 8
Ten year Property Claim Services loss experience vs. modeled average annual loss Countrywide: % -9 - - 9 8 - - - 9 - -9 - - - -9 - - - - - - - - - Loss ratio points Less than - - to - - to to 9 and above Five year Property Claim Services loss experience vs. modeled average annual loss The maps left and below show, in loss ratio points, the amount that catastrophe experience exceeds model average annual loss. Adjusting combined ratios for expected versus historical catastrophe loss is an important step to distinguish weather-related randomness from inadequately priced business. Historical catastrophes can distort measures of results at a state level, causing the noise to overwhelm the signal. While the state level adjustments can be significant, the ten year nationwide experience catastrophe loss ratio of points is meaningfully lower than the modeled expected catastrophe loss ratio of percent. The story for homeowners business at a national level is that a big one hasn t occurred in the ten year window. Even accounting for the impact of 7 s catastrophes, another event of USD billion would be required to unwind the industry s cumulative underwriting profits since 8 on a direct basis. Countrywide: % -9-7 9 - Direct combined ratio to achieve a percent return on allocated capital - - - - -9 - - - - - - - - -9 - - Loss ratio points Less than - - to - - to to 9 and above State-by-state results show significant variation between favorable and adverse loss results on a shorter horizon of five years, which is expected due to the catastrophe exposure inherent in the homeowners line. Catastrophes diversify through both time and geography, so taking a shorter view or smaller footprint increases volatility. Texas results write a nuanced story worth unpacking. The painful hail losses of the last five years caused a point erosion of the statewide loss ratio, which has been more than offset by favorable hurricane experience adding points to profitability. Given the impact of Harvey, Texas remaining favorable regarding hurricanes on a five year basis is a manifestation of the protection gap. Carriers avoided Harvey losses because of the cause: water instead of wind. Avoiding losses in the short term feels like a win, but the long-term opportunity will go to carriers that can find ways to cover more perils at fair prices. 9 9 9 9 9 9 9 9 Countrywide combined ratio: % 9 88 9 9 9 9 9 9 9 9 9 9 8 9 9 9 9 9 9 89 Combined ratios Less than 8 8 to 8 8 to 9 to 9 9 and above The percentages in the left map show the direct target combined ratios necessary to fund reinsurance costs and allocated capital for retained risk by state, including catastrophe and noncatastrophe risk. The targets are for a sample nationwide company only and will vary among individual companies due to state distribution of premiums, capital adequacy standards, target return on capital, allocation methodologies, reinsurance, and other considerations. For a diversified insurer with a footprint similar to the industry, the target combined ratios fall into three main categories: () Florida, () other hurricane exposed states, and () states not materially exposed to hurricanes.
Homeowners average approved rate change Countrywide: % - * Approved rate change Less than to to to and above *Rate filings not available The map on the left shows the average approved rate changes filed between January 7 and September 8 for the top homeowners groups by state that filed in the period. Positive rate activity ticked up slightly to percent overall versus percent in last year s study. Rate changes on both coasts, including California and Florida, show continued positive momentum from last year. Notably, Texas and North Carolina both had average rate changes of 7 percent in last year s study and show a smaller, but still positive, average rate change in the current exhibits. Florida continues to face challenges from assignment of benefits and claims adjustment cost issues that single digit rate changes are unlikely to full mitigate. Premium growth and rate change, to 8 Direct written premium ($bn) Rate level index ( =.) Average rate change (%) 7.. 7 7.. 77.8. 8 8..9 8.. 9.. 89.... 7 9..8 8 Direct written premiums increased from USD7 billion in to USD9 billion in 7 with a projected USD9B for 8 given prospective rate activity. A strong component of growth through was an emphasis on rate adequacy with indicated rate levels increasing nearly percent since. Policyholders changing carriers will prevent the industry from realizing the full aggregate benefit of the individual carriers rate actions. The S shape of the rate change curve suggests the line should be watched carefully. Rate activity shows some movement favoring increases versus the lowest activity observed in. We have yet to return to the positive rate momentum of the to period. Results of this year s study suggest the to percent rate increases are sufficient to keep pace with loss and expense inflationary pressures. As the overall economy continues to show strength, it will be important to stay ahead of any inflationary pressures that emerge. One dollar of homeowners premium* Attritional loss 7 Catastrophe loss LAE 9 Policy acquisition G&A TLFs Profit Our study suggests that, at prospective 8 rates and before income taxes, insurers keep slightly more than four cents of profit for every premium dollar they earn. That four cents of direct profit must then be shared between the primary carrier, reinsurance partners, and the US Treasury. *Due to rounding, the given graph adds to $.99 rather than $.
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