US property & casualty outlook: sources of optimism from a difficult starting point

We expect US P&C industry profitability to improve this year and next after a weak 2022. Return on equity (ROE) fell last year on the back of high inflation and payouts for an active natural catastrophe year, headlined by Hurricane Ian. Reserves adequacy is also coming into question: slowdown after more than 15 consecutive years of favorable development, and set to deteriorate with higher wage and medical inflation in 2024.

Overall, however, the outlook is brighter: underwriting actions have been taking inflation into account, inflation itself is easing, and gains from reinvesting the portfolio at higher yields are accruing. We expect a narrowing of the gap between commercial and personal lines loss ratios – nearly 20 ppt in 2022 – amidst divergent trends within commercial lines: rate increases in property have surged; in liability, gains are slowing. We forecast premium growth of 7.5% in 2023 and 5.5% in 2024, with ROE improving to 8.0% and 9.5%, respectively.

• We expect US P&C industry ROE to be significantly better in 2023 and 2024 compared to 2022.
• We estimate ROE to reach 8.0% in 2023 and 9.5% in 2024 on higher premium rates and investment yields.
• We forecast premiums to grow by 7.5% in 2023 and 5.5% in 2024.
• Slowing rate gains in commercial liability will likely be partly offset by acceleration in property and personal lines.
• Reserve adequacy poses a key downside risk if inflation causes losses to develop more than expected.

We expect notable improvement in US P&C industry ROE this year and next on higher underwriting and investment income. We forecast ROE to reach 8 we expect notable improvement in US P&C industry ROE this year and next on higher underwriting and investment incom.0% in 2023 and 9.5% in 2024. Compared with 2022 ROE of 2.5%, our 2023 estimate would be the strongest year-on-year improvement since 2009. Last year the industry saw an underwriting loss of USD 23 billion¹ and net investment income of USD 49 billion. Realized capital gains were marginally negative for the first year since 2009, offsetting the benefit from higher interest rates. Looking forward, rate actions taken in response to underwriting deterioration will show up in earnings, investment gains from higher interest rates are accruing and inflation has passed its peak. Financial stability risks came to the fore in the first quarter, highlighting the potential for credit downgrades and associated higher capital requirements. Other downside risks include a more severe than expected recession or a resurgence of high inflation this year or in 2024. The latter would adversely impact insurers' exposure and premium growth, claims costs, investment yields and capital gains.

We forecast the industry combined ratio to improve to 100% in 2023 and 98.5% in 2024. The industry net combined ratio reached 102.4% in 2022, driven by inflation that raised loss severities across most lines of business. Natural catastrophes added 6.9 ppt² to the combined ratio, above the prior 10-year average (6.2% on the combined ratio) but below the five-year (7.3%). We expect loss severities to ease as US headline CPI inflation decelerates to our forecast 4.0% in 2023 and to 2.8% in 2024, setting the stage for improved underwriting results as rate gains outpace claims costs. But, with high catastrophe activity early in 2023, the path to underwriting profits might not be smooth: tornadoes, rain and wind storms contributed to above-average 1Q 2023 catastrophe claims.

Favorable reserves development is slowing. In the face of persistent inflation, reserves adequacy is a key issue. The sustainability of reserve releases – which have been consistent for over 15 years – is being stressed by inflation. We expect wages and healthcare costs to rise faster than overall inflation by next year, which could weaken reserve adequacy and slow the anticipated profitability improvement because of higher-than-expected claims from prior accident years. These primarily affect liability exposures, which accounted for 52% of industry premiums in 2022, but 87% of loss reserves at the end of the year. It is challenging to make a conclusive assessment of reserve adequacy given a slew of idiosyncratic factors affecting industry data – from court backlogs, the inflation shock, and changing consumer, transportation, and workplace behaviors. What is clear from statutory  data is that the pace of favorable reserves development has decelerated, it has been concentrated in workers' comp since 2017 (Figure 1), and it is largely due to reserve releases from accident years 2020 and 2021, when initial loss ratio selections reflected COVID conservatism.

Personal auto physical damage had its worst result in over 25 years in 2022, with a direct loss ratio more than 20 ppt above the average of the 25 years preceding, and 12 ppt above the second-highest, which was 2021. On earned premiums of USD 113 billion in 2022, the gap implies over USD 23 billion of extra claims costs compared to the historical average. Elevated used car prices, which seem to have peaked, were a main driver of claims inflation in 2022. The cost of repairs has also increased and will likely contribute to higher claims costs even as the used vehicle market softens. We expect rapid improvement in motor profitability for 2023 as approved rate increases outpace severity indicators. As of March, auto insurance prices have risen substantially: up 15% yoy  according to the CPI and 10% yoy based on our estimate derived from statutory rate filing data.³

Rate trends in commercial lines are bifurcating. The latest CIAB survey reported that average rates for commercial lines increased by 8% yoy in 4Q22, roughly in line with the 8.1% gain in 3Q22 (see Table 3). Property jumped up nearly 17% after rising 12% in 3Q22. Conversely, rate gains in liability lines decelerated with few exceptions (medical malpractice and broker E&O). General liability increased 5% quarter-on-quarter after 6% in 3Q22, and commercial auto rate increases slowed slightly to 7.6% from 8.2%. Cyber and D&O have grabbed headlines for their rapid deceleration, although the starting point for cyber is much higher. By one estimate, D&O rates are expected to decrease by 20% or more in 2023, depending on industry, amidst continued increases in commercial rates overall.⁴ We continue to expect rate increases through 2023 with inflation, natural catastrophes and geopolitical uncertainties continuing to put upward pressure on claims and operating costs.

We expect growth in  nominal direct premiums written (DPW) to slow to a still-strong 7.5% in 2023 and to 5.5% in 2024. DPW grew 8.4% in 2022 compared to 2021, with slowdown in the second half of the year. The weakening liability market reflected in lower 4Q2022 growth rates. Premiums for the other liability claims-made line (primarily D&O and E&O) were nearly flat for the full year (see Table 2). This line is relatively protected from inflation and rate increases have decelerated rapidly after quick rises in 2020-22. However, D&O claims from bank failures have caused a re-assessment of potential exposures, which may support market softening. Partly as a result of the slowdown in professional liability, the gap between commercial and personal lines growth rates has started to close. We continue to expect overall growth to be driven by rate gains alongside weak exposure increases, with US real GDP – a general proxy – forecast to grow 0.9% in 2023 and 0.8% in 2024.

We expect the average investment yield to climb to 3.5% in 2023 and 3.7% in 2024 as recurring yields continue to rise. In 2022 portfolio yields were low (2.7%), largely due to negative realized capital gains. We expect improvement in capital gains by the end of 2023. Despite a decline in reinvestment yields in 1Q23, they remain comfortably above rates on maturing securities. We estimate the 2023 reinvestment yield at 5.2%. We forecast one more quarter-point rate increase to bring the upper bound of the Fed funds target range to 5.25% this year before ending next year at 3.75%, and the 10-year Treasury yield at 3.7% and 3.2% in 2023 and 2024.