In a provocative recent post, Steve Mildenhall characterized the phenomenon of “disappearing risk,” and showed in detail how frequency and severity trends have been declining in a number of the insurance industry’s core businesses over the past few decades. Such a development, of course, represents a double-edged sword for the industry. On the one hand, lower losses bring higher profits in the short term. But, on the other hand, if risk truly is in secular decline—i.e., if the raison d’etre of the insurance industry really is disappearing—then the long term growth prospects of the industry come into question. It was this latter issue that Steve focused on in the latter part of his piece by indentifying some possible growth areas in property catastrophe and mega-liability risks.
I found this inquiry fascinating and wanted to dig deeper. Is the property-casualty industry really in a state of terminal decay? And, if so, what will reverse the process?
Let’s start with a longer term perspective on the industry. In the figure below, I plot my estimates of the ratio of total property-casualty industry premiums to national output over the last century.
What we see here is that the 20th century overall was really a period of spectacular growth for property-casualty insurance. The industry surged in relation to the economy, going from about 1% of GNP in 1900 to 3% by 2010. Yet, paradoxically, the manifestation of the “disappearing risk” problem facing the industry in 1900, one the eve of a century of spectacular growth, was arguably much more severe than it is now. In 1900, more than 90% of the industry’s business was fire insurance (and I mean that literally—insurance coverage at the turn of the century featured a narrow focus on the fire peril). And, although it may not have been fully appreciated at the time, the fire risk was in the process of receding dramatically. The 20th century yielded all sorts of developments in building codes, fire protection infrastructure, and other technologies that would reduce fire risk. In particular, although a few major city fires struck the United States after 1900, the scourge of urban conflagration largely disappeared in the 20th century. Today, traditional fire insurance is but a tiny part of the industry portfolio and a shadow of its former self.
How did the industry thrive as it did in the 20th century when loss risk in one of its core lines (in reality, its only core line) was in the process of imploding? The answer is that, although the fire risk may have been disappearing, risk was reappearing on insurer’s books in other forms. With hindsight, we know why. Mass production of automobiles (starting in 1902), a sea change in the litigation environment (referred to as “The Liability Explosion” by Stanford Professor Lawrence Friedman), and a great expansion in the nature of property coverage all helped to make risk reappear in the 20th century. In simple terms:
- Insurers started covering more property.
- Insurers started covering property against more perils.
- New risks emerged, especially those related to third-party liability claims, and insurers covered them.
Will history repeat itself, and, if so, how? The dark side lurking in the figure above is that most of the obvious growth in the industry occurred before the 1970’s. If we look at the 1970 to 2010 period (which was the focus of Steve’s piece) one can make a strong case that growth in relation to the economy has at least stalled and may even be declining. There are a number of possible factors that may be causing risk in the industry’s core markets to “disappear” now, including tort reform and safer cars.
We know how the “disappearing risk” crisis facing the industry was resolved after 1900. What about now, in 2013? Is risk disappearing? And where will it reappear? What additional property can the industry cover? Is there low-hanging fruit in terms of covering additional perils? Are risks of third party claims receding? Are new insurable risks emerging? In subsequent posts I’ll examine each of these issues in turn and evaluate what prospects they offer for the industry’s future.