June 2, 2011 by Canadian Underwriter
A combined ratio (COR) of 100% no longer generates sufficient return on equity in today’s depressed investment environment, according to Urs Uhlmann, senior vice president and head of Zurich Global Corporate.
“At the beginning, I said one hundred just doesn’t cut it anymore,” Uhlmann said, referencing a slide in his presentation that showed historical returns on equity (ROE) based on the U.S. P&C industry’s combined ratios. “No it doesn’t.”
“A combined ratio of 100[%] in 2009-10 generated about 7.5% return on equity – certainly not enough – compared to in the mid-2000s. In 2005, a 100 [per cent] combined [ratio] was about a 10% ROE.”
Uhlmann made the point in his presentation to the Captives & Corporate Insurance Strategies Summit in Toronto on June 1. He was asked to speak about emerging trends for property and casualty insurance companies in the current economic climate.
“Clearly, the investment environment is hampering the generation of the results,” Uhlmann said, referencing low interest rates, and hence lower investment yields for insurers. “If you want to know the impact of a change of 1% on the investment return on your combined ratio, it’s actually quite significant.”
For example, based on 2008 invested assets and earned premiums, a U.S. insurer had to reduce its combined ratio by 1.8% in personal lines — or by 3.6% in commercial lines — to offset a 1% decline in investment yield, in order to maintain a constant ROE.
Basically put, an insurer’s combined ratio (COR) is derived from dividing claims costs by premium collected. A number more than 100% indicates an insurer is losing money. A number below 100% suggests an insurance company is profitable, because more premiums have been collected than claims paid out.
Up until recently, a 100% COR suggested a break-even point for property and casualty insurers. With a 100% COR, U.S. insurers used to be able to generate a return on equity (ROE) of between 9% and 16%. But Uhlmann’s presentation slides showed a 99.7% COR in 2010 Q3, aided by lower catastrophe losses and more reserve releases, nevertheless produced a comparatively meager ROE of only 7.7%. And in 2009, a 99.5% COR generated a return on equity of only 7.3%
In comparison, a 100.6% COR in 1979 generated an ROE as high as 15.9%, and in 2005 a COR of 100.1% resulted in an ROE of 9.6%