Archive for January, 2012

Despite our skepticism, the commercial lines pricing cycle continues apace.  Chubb confirmed in its Q4 earnings report that it is seeing pricing similar to Travelers in Commercial Lines, with average pricing up 6% in Q4 and about 3% for the year.  Interestingly, they also report the beginnings of price increase in Professional Indemnity, although only +1% in Q4 versus about 1% down for the year.

For comparison, we provide our analysis of renewal versus new business for Chubb’s Commercial Lines:

The underlying new business price change in Q4 was about -28%, worse than the -17% for the year.  Recall for Travelers that we calculated  -14% for Q4 and -22% for the year.  But also realize that, with a 56% non-cat loss ratio, Chubb’s average price level in Q4 is about 16% higher than Travelers, with a 65% loss ratio (making no allowances for mix difference).

Chubb is also still releasing reserves, even more strongly than in 2010 (for Commercial, 7 points in 2011 vs. 4 points in 2010).  This is all consistent with our view that Chubb emerged from the 2001-03 pricing cycle with one of the best constructed books of business of any US commercial carrier.  Given an 11% ROE in 2011 with above-average catastrophes and below-average yields, plus a newly-announced $1.2 billion stock buyback, Chubb does not appear to need much pricing, yet here we are.  It is this seeming disconnect from historical behavior that we think bears careful monitoring.

We are doing this calculation of likely new business price changes because we want to remind investors of the quality of this current cycle.  In a “classical” pricing cycle, new business would be going up, too, so what we are seeing is not a typical cycle.  As best we can tell, what we are seeing is a cycle driven by desire for increased profits.  This is very nice, but it’s never happened before.  What is normally needed are much higher loss levels, usually that come by surprise.  Given that we think more upside surprises are likely on the reserve front, we continue to be cautious, but do now think that sustained pricing is more likely in 2012 than we did previously.

Our working theory at present is that enough time has passed from the financial crisis that insurers are more willing to attempt to get price they likely wanted 3 years ago, but were afraid to push for given the financial condition of their customers.  This is tough to prove quantitatively, of course, but trying to find data and metrics to monitor this unusual pricing cycle will be a focus of our research this year.

Travelers reported Q4 operating EPS of $1.48 vs. SNL consensus estimates of $1.54.  But as was the case last quarter, the big question is the progress of potential price increases.  And this quarter, we see some progress on both renewal and new business pricing.  While new business pricing is still down, it appears to be down less than last quarter.  This is an important metric to gauge the health of any emerging pricing cycle.

It was a major point of contention last quarter that Travelers was reported increasing renewal pricing, yet its combined ratio deteriorated even excluding catastrophes and reserve development.  In Business Insurance, where Travelers reports sufficient data to attempt this analysis, the Q3 non-cat accident year loss ratio (AY LR) was 68.9% vs. 62.3% in Q3 2010.  Although Travelers reported renewal premiums increases of 4%, the implied underlying new business price change could have been a decrease of as much as 40%.

This quarter looks much better, and Q3 looks more like a fluke.  We have attempted the same analysis, using Travelers supplements and disclosures, for both 2011 Q4 and the full year.

The headline result for Q4 was 6% average renewal pricing across Business Insurance, with pockets as high as 8% in Commercial Accounts, for example.  But unless one is in a raging hard market, it is usually the case that new business will get a decrease on average.  That was still the case in Q4, but the results look better than Q3, and trend over the year looks good.  We estimate about a 14% new business price decline, averaging to a Q4 total nominal price change (new and renewal) of 1.7%.  The was an improvement over the full year, where assuming an average renewal price change of 3%, we get an implied new business price decrease of -22%, and -1.5% total price change.  So the average price change across all business in Q4 is 3 points better than the full year 2011.  That’s a big improvement.

Keep in mind that this analysis is rough, but hopefully reasonable.  The 3% assumed loss trend is a plug.  We have no ability to adjust for large losses or other distortions.  And the numbers we are pulling off of various Travelers graphs themselves are estimates.  Still, the direction of change looks good.  Travelers believes they will begin to see underwriting margin improvement in the first half of 2012, and we think this more likely that we would have 12 month ago.  Until and unless our forecast for re-emergence of favorable prior year development occurs, the trend looks to be for higher pricing near-term.