Yet were it only so simple that a recovering economy and positive premium growth would cure all that ails the insurance industry. There are many other powerful economic, political and demographic forces that will shape the p&c insurance industry in 2011 and beyond, including diminished investment earnings, a new regulatory structure and the continued deterioration of the tort environment.

THE ECONOMIC OUTLOOK FOR 2011: A REBUILDING YEAR

Foremost on the minds of insurers, agents and brokers is what the recovering economy will mean for them on both the top and the bottom lines.

Looking at the top line—and putting aside the issue of rates for the moment—the recovering economy is unambiguously good news for insurers and producers alike. Consider the following exposure drivers:

• Employment and Payrolls

While unemployment remained stubbornly high throughout 2010, hovering just below 10 percent, more than 1.2 million private sector jobs were created during the year. When jobs are created, payrolls expand. Indeed, the payrolls of private employers—the exposure base for workers' compensation insurers—expanded by an estimated $175 billion in 2010.

Job growth is expected to accelerate in 2011, which will likely swell payrolls by an additional $200 billion (or more) in 2011.

• New Car/Light Truck Sales

After falling to 10.3 million vehicles in 2009, down 39 percent from a peak of 16.9 million vehicles in 2005, new car/truck sales rose to an estimated 11.5 million units in 2010.

A further increase to 12.8 million vehicles is expected in 2011, much to auto insurers' delight. 

 • Industrial Production and Capacity Utilization

Industrial production is expected to expand by approximately 4.5 percent in 2011 following an estimated gain of 6 percent in 2010.

Industrial production had plunged by as much as 17.6 percent in the midst of the financial crisis during the first quarter of 2009. Capacity utilization at the nation's factories and utilities—at 75.2 percent in November 2010—was well above its recession low of 68.2 percent recorded in June 2009 but remains well below the long-run 80.9 percent average from 1972 to 2008).

Renewed strength in both of these metrics indicates increased demand for commercial property and liability insurance needed in the production process as well as on the finished goods produced. Additional demand is generated as increased transportation of goods drives commercial auto, inland marine and marine coverage.

At the same time, the number of business bankruptcy filings is beginning to fall, helping to preserve existing demand for insurance products and services and their associated revenue streams.

• New Housing Starts

Construction of new homes bottomed out at 560,000 units in 2009, down an astounding 72 percent amid the housing crash from 2.07 million units in 2007. The plunge affected home insurers as well as insurers with books of business tied to the construction, contracting and home supply industries.

The forecast is for a very gradual and tepid recovery, to 590,000 units in 2010 and 690,000 in 2011. For home insurers this means extremely slow exposure growth, especially as new homes being built today are generally smaller and less expensive to insure than homes in the pre-crash era.

Many commercial insurers will continue to find it difficult to grow their construction book of business as investment in residential and nonresidential real estate remains moribund and cash-strapped state and local governments continue to lack the resources to invest in infrastructure.

Of course, demand for insurance (exposure) is not the only factor driving the industry's top line. Rate is equally if not more important and on this front the message remains decidedly mixed.

Personal lines, which accounts for approximately 50 percent of all premiums written, entered 2011 with realized rate gains in both the private passenger auto and homeowners lines.

According to federal statistics, private passenger auto insurance prices were up about 5 percent, although shopping and other consumer behaviors (e.g., moving to a higher deductible) reduce the net gain to insurers to roughly 3 percent. The increase is notable given that private passenger auto insurance is the largest of all p&c lines, accounting for more than one-third of all industry premiums.

The cost of homeowners insurance is up approximately 2 to 3 percent.

In commercial lines, however, renewals heading into early 2011 were still slightly negative, according to most price indexes.

FAVORED REGIONS, FAVORED INDUSTRIES

The Great Recession is generally viewed as having wrought indiscriminant destruction across the entire American economic landscape. The reality of the Great Recession's destructive force is something quite different, with the experience of individual states, regions and industries varying widely.

Unemployment rates, for example, during the recession ranged from more than 15 percent in the hardest hit states, such as Michigan, to as little as 4 to 5 percent in others, such as North Dakota.

In terms of economic growth (and exposure creation), the economies of a surprising number of states continued to grow throughout the recession while others languished. In 2009, real (inflation-adjusted) economic growth in Oklahoma led the nation at 6.6 percent, while Nevada's economy contracted by 6.4 percent.

The enormous divergence in fortunes among the states—and their subsequent ability to recover—has important implications for insurers. Some p&c insurers may find themselves well situated to seize on the early opportunities that the uneven recovery affords, while others remain too tightly tethered to a regional footprint or industry mix beset with continuing economic problems.

If there was a "sweet spot" for insurers during the Great Recession it was clearly the swath of states stretching from Texas northward through the Plains and Mountain states. Most of these states were not major participants in the housing bubble and therefore avoided the harshest effects of the ensuing collapse. In addition, most of these states are pro-business and have high exposure to favored industries as discussed below.

Regional differences in the pace of recovery are the norm in the wake of every recession. Likewise, growth in certain industries will outpace others. Industries likely to lead the way in the recovery from the Great Recession include health care (irrespective of Republican efforts to reshape legislation passed in 2010), agriculture, energy (traditional and alternative), natural resources, technology, transportation and export-oriented sectors.

Insurers with high exposure to these industries are well positioned to realize early stage growth.

As the recovery matures, retailing, recreation and hospitality, travel, and possibly even manufacturing will show more dynamic growth.

Construction, unfortunately, remains a laggard due to a glut in residential and nonresidential real estate, lingering credit market woes and strained public sector budgets.

 IT'S NOT JUST THE ECONOMY, STUPID!

The economy will be a major influence on the p&c insurance industry's top line in 2010, but the bottom line is something altogether different—and underwriting performance, not the economy, in the long run is the most important driver of bottom line results.

Indeed, with a combined ratio of approximately 100 in 2010 (excluding mortgage and financial guaranty insurers), insurers find themselves for the second year in a row at the razor's edge of underwriting profit and loss. Last year's breakeven underwriting performance, as in 2009, was possible only because catastrophe losses were no more than average and because prior year reserve releases knocked three to four points off the combined ratio.

Catastrophe losses in the future are more likely to surge than shrivel, and the pool of excess reserves available for release after seven years of declining commercial insurance prices is becoming quite shallow.

Managing for an underwriting profit is critical.

Other critical factors include managing for the new investment paradigm—one in which the rate of return on fixed income securities (which account for two-thirds of industry investments) is suppressed by Federal Reserve monetary policy. The effect is that investment income is slumping and providing less of an offset for future underwriting losses.

Landmark legislation in the form of last year's Dodd-Frank Wall Street Reform and Consumer Protection Act represents yet another hurdle for insurers to clear in 2011. While the industry was largely successful in avoiding the imposition of inappropriate bank-style regulation, the current implementation and rulemaking phase of the Act poses a number of risks.

First, insurers are legitimately concerned that the newly created Federal Insurance Office, while in principle a source of information and expertise within the Treasury Department, could suffer from mission creep, with the FIO being laden down with responsibilities that duplicate those already performed by the states or worse, adopting an activist agenda, which could prove costly and confusing to insurers and consumers alike.

The dawn of each new year poses a unique set of challenges, and 2011 is no exception.

The long-awaited strengthening economy, on the other hand, brings with it many opportunities for growth—the first in several years.

The ages-old test for insurers will be to manage those opportunities in a way that paves the road for sustained profitability in the years ahead.