Aon Study Reports Homeowners ROE Still Improving but at Slower Rate

December 1, 2003

Aon recently announced the results of Aon Re Worldwide’s second follow-up study of return on capital in the U.S. homeowners insurance marketplace.

The results of the study reportedly reveal further improvement in expected return, although the rate of improvement has slowed. The homeowners insurance line continues to produce a prospective return on equity (ROE) that is substantially less than its cost of capital.

According to Bryon Ehrhart, president of Aon Re Services, the reason for the slowing in improvement can mostly be attributed to the fact that “companies feel like they have taken substantial actions in the 25 percent to 30 percent and even 50 percent to 60 percent rate increases over the last 18 to 24 months. At that rate, people are trying to understand really just where they settle out economically. I believe if they conclude as we have in the study, they’ll see the need to further the rate increases.”

The findings of the update indicate that the homeowners insurance industry is estimated to have increased its rates by 4.8 percent in the first half of 2003, versus 7.8 percent in the prior six months. The average increase for new rate filings in the last six months was 11.1 percent, versus 12.5 percent in the prior six months.

Based on filings through June/July 2003, the estimated prospective ROE for homeowners lines is 6.3 percent compared to six months ago when the expected return was 5.9 percent. A year ago the expected return was 4.8 percent. This update for the first time includes rate-filing information for the state of Texas, and takes into consideration rate reductions recently ordered in that state.

Ehrhart continued, “Heading into 2004, we’re seeing that the return on equity is as published in the study, 6.3 percent. We still think that is slightly less than half of the cost of capital for the lines, so we say the homeowners product is still a negative EVA (economic value added) product.

“In the last year, we haven’t seen a significant number of companies pulling out of the homeowners market. What you have here is different than in the commercial side or in medical malpractice where some significant players have pulled out of entire classes. Insurers are not offering the homeowners product on a whim or as a specialty product. They’re offering it because it is an important part of their personal lines strategy. Most insurers in homeowners are trying to maintain a product that serves their policyholder base, without destroying economic value in their company. We really have not seen the ins and outs other than maybe a couple of specialty companies that have perhaps taken advantage of the opportunity to enter the market.”

This study by Aon Re is the third in a series to provide an update on the economic status of the market given the history of inadequate or negative returns experienced by many homeowners insurance providers, and the challenges faced by companies in order to continue to provide this coverage. The study provides a prospective look taking into consideration changes that have been filed, and is adaptable to assess prospective return on capital for individual companies. The study shows that the outlook for homeowners insurers is improving, but further actions to improve underwriting results and management of capital are needed.

When asked what actions are needed to improve underwriting results and management of capital, Ehrhart noted, “That really goes to the concept that rates alone are not going to be your savior. You need to make good judgments about risk selection. You can’t have too much aggregate in one particular area and you need to have the right reinsurance program in place for the capital base that you have and that you recover that cost of reinsurance from the right policyholders.”

Ehrhart said independent agents “should understand that while there have been significant changes in both the pricing and terms of homeowners insurance products, it really has been a struggle for carriers. By and large, they’re really struggling to continue to provide a product that they can faithfully represent as making sense for both the policyholder as well as the company. They understand that homeowners insurance, because of the associated catastrophe risk, consumes enormous capital and presents real enterprise risk. It may frustrate the agents from time to time with the terms and conditions and pricing changes that have occurred in the last 18 to 24 months, but our study reveals that those changes are necessary to fulfill the promise of the product.”

The analysis involved with this study included the rate filings of the top five homeowners insurers in each state for the states that represent 80 percent of the U.S. population.

“You continue to have challenges in the more populous states that have catastrophe risks like California, Texas and Florida,” Ehrhart said. “Those are the areas where the prospective ROE’s are really estimated to be the lowest. Texas, in particular, has really had some of everything—mold, tropical storms, hurricanes, tornadoes and hail events.”

Aon ( plans to continue annual updates of the study hereafter.

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