According to a special report published by Fitch Ratings, more competitive property and casualty (P&C) insurance premium rates and the potential for reduced favorable reserve development as well as higher catastrophe losses in 2015, are leading to a forecast toward break-even underwriting results and lower returns on equity (ROEs) in the future.

The report, titled U.S. Property/Casualty Insurance Profit Fundamentals, reviews fundamental drivers of profitability for the P&C insurance industry and gives some perspective on where the industry is headed. 

Pressure on performance

The two drivers of profitability and ROE for U.S. P&C insurers are underwriting and investments. Underwriting returns are a function of underwriting profit and loss margins and operating leverage (premiums/equity). The investment contribution to ROE depends on the investment yield and asset leverage (invested assets/equity). Changes in other profit drivers over time (lower asset yields and reduced asset and operating leverage) have driven the potential ROE for a given combined ratio significantly lower over time.

U.S. P&C insurers generated underwriting profits in the last two years. In trying to sustain this underwriting performance, P&C insurers are pressured by heightened price competition and diminished loss reserve strength that will reduce earnings benefits from favorable prior-period development. The industry statutory return on surplus (ROS) is forecast to decline to 6.5% in 2015 from 8.1% in 2014.

Underwriting performance and profitability

Underwriting performance is the most volatile and influential determinant of profitability for P&C insurers. Results are influenced by variability in competitive forces that influence premium rates, losses from catastrophe events and volatility in loss cost trends.

Declines in other profit drivers mean that maintaining or improving returns on capital depends on better underwriting performance. For the U.S. P&C industry, a 10% statutory return on adjusted ROS currently corresponds with a 7% underwriting margin or a 93% combined ratio, whereas a decade earlier a 99% combined ratio would generate a 10% industry ROS.

For additional information and to get your copy of the report, visit the Fitch Ratings Insurance Sector.