After several years of above normal hurricane activity in the Atlantic-Caribbean basin, it appears that the El Nino weather pattern has delivered a very quiet season — so far. Reuters reports that the Atlantic hurricane season has been the quietest in more than a decade with just two hurricanes and a total of eight tropical storms:
“There was for all intents and purposes no hurricane damage in the United States this year,” Robert Hartwig, president of the Insurance Information Institute, told Reuters. “It’s something that will help the insurance industry create very favorable earnings comparisons in the third quarter compared to the third quarter of last year,” he said. Forecasters saw nothing on the horizon on Wednesday.
Although the peak has passed, the six-month season still has nearly seven weeks to run. It officially ends on November 30. “It’s not over,” said meteorologist Jill Hasling, president of Houston’s Weather Research Center, which monitors weather for the offshore oil industry. “There’s pretty warm water in the Gulf still,” she said. “If we get enough cold fronts in here and cool the water off, we’ll be clear for this season. But it hasn’t happened yet.”
What Does This Mean for Insurers in 2010?
As the article points out, insurers should show strong results for the third quarter compared to last year. However, a less often noted fact is that periods of strong underwriting profits tend to attract capital to the industry. This additional capital can often depress premium rates for the following year particularly in companies where underwriters are evaluated on premium volume. For insurers, a banner year can often be followed by aggressive pricing and lower underwriting profitability during the following year.
Berkshire Hathaway insurance units are well known for having strong underwriting discipline and rejecting inadequately priced business. However, this requires underwriters to be willing to show a shrinkage in overall premium volume. Here is what Warren Buffett had to say on this subject in his 2004 Chairman’s Letter to shareholders:
Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract last year but that it will continue to drop? In insurance, the urge to keep writing business is also intensified because the consequences of foolishly-priced policies may not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed (a form of self-deception that nearly destroyed GEICO in the early 1970s).
Finally, there is a fear factor at work, in that a shrinking business usually leads to layoffs. To avoid pink slips, employees will rationalize inadequate pricing, telling themselves that poorly-priced business must be tolerated in order to keep the organization intact and the distribution system happy. If this course isn’t followed, these employees will argue, the company will not participate in the recovery that they invariably feel is just around the corner.
To combat employees’ natural tendency to save their own skins, we have always promised NICO’s workforce that no one will be fired because of declining volume, however severe the contraction. (This is not Donald Trump’s sort of place.)
Of course, as the popular television show The Apprentice shows, there are more managers who seek to emulate Donald Trump than Warren Buffett.
Disclosure: The author owns shares of Berkshire Hathaway.