Riding the cycles.

• Author: Kaelble, Steve
• Position: Property and casualty insurance - Industry Overview

Gone is the "three-years-up, three-years-down" trend of rates and profits in the property-and-casualty insurance industry.

Most businesses ride a cycle of some sort. Few, however, have cycles quite as predictable as those that once affected the property-and-casualty insurance business.

Starting about the end of World War II, P&C companies tended to spend three years on the up side, enjoying higher profits enabled by higher rates. Then, for three years, rates would fall and profits would all but vanish. On and on it went, three years up and three years down.

Industry observers say these amazingly predictable cycles are now history. The cycles these days are much more smooth, longer and less predictable. The trend seems to be on the down side in Indiana. And that means increasingly competitive rates for P&C insurance coverage, especially commercial policies.

What caused these cycles, and what happened to them? The experts aren't in total agreement. But the most widely held explanation is the power of competition--some companies would cut rates, leading other companies to follow suit, until everyone would figure out about the same time that rates were too low to allow a decent profit. Then they'd adjust them upward again.

"In the insurance industry, there are a lot of folks following other folks," explains H. Peter Hudson, president of Monroe Guaranty Insurance Co. in Carmel and a former Indiana insurance commissioner. It's not all that different from the airline industry, where follow-the-leader pricing is particularly obvious. "When people cut prices, other people cut prices."

The difference, however, between insurance and other industries, such as manufacturing, is that the carriers doing the selling and setting the prices never know for sure exactly what it will cost them to deliver their product. Make a refrigerator and you know how much you've spent on parts, labor and overhead. Sell insurance coverage and you have no way of knowing how much you'll pay out in claims until after the fact.

"We have to do an awful lot of hypothecating," Hudson says. And in the old days of the cycle, before powerful computers, that hypothecating would take some time. After a carrier would adjust rates, it would take as long as two years to accurately gauge the effect of that rate change, to see whether it brought about the desired effect on the bottom line. Then it would take perhaps another year to determine what the next adjustment should be. That fact...