Lax capital management is destroying shareholder value in the US property/casualty insurance industry, says a new report.

And the US property/casualty sector is overcapitalised -- by as much as $100 billion.

The study was published last week by Risk Management Solutions (RMS) and Oliver, Wyman & Company (OW) in the inaugural issue of the Journal of Risk Finance , an Institutional Investor journal.

The US property/casualty industry currently has $430 billion in available capital, the report said, although it estimated that the industry needs between $325 and $365 billion in equity capital to support its risks to the industry average solvency standard.

Overall, the excess capital is not only a drag on industry profitability, but it is contributing to the downward spiral of price competition referred to as a "soft market''.

Study co-author Peter Nakada, a director in OW's risk management practice, commented: "The excess capital in the P&C industry should either be returned to shareholders, or deployed to support expansion into new products or geographies.'' Mr. Nakada continued: "The 20 to 30 percent excess capital creates a significant drag on companies' return on equity, as is evidenced by the recent poor total return performance of the S&P 500 P&C index. Reducing capital by 20 to 30 percent would result in a 25 to 35 percent increase in the industry's ROE.'' The study is believed to be the first to estimate industry capital requirements based on measuring all risks, including asset risk, interest rate risk, catastrophe risk, non-catastrophe insurance risk, and operating risk, on an integrated basis.

Entitled "A catalyst for improved capital management in the property & casualty insurance industry,'', the study also examines the risk economics of individual business lines. For example, the study reveals that insurers' catastrophe-exposed liabilities are the largest single driver of capital requirements. Of the $325 billion in equity capital needed to support the P&C industry to an A.M. Best `A' solvency standard, 32 percent can be attributed to catastrophe risk alone. Study co-author Hemant Shah, senior vice president and co-founder of RMS, said: "When attributed with the appropriate amount of capital, the average risk-adjusted returns of those business lines exposed to catastrophe risk are a paltry four to five percent, falling far below the averages for the overall insurance industry and comparable benchmarks in other financial institutions.'' Mr. Shah continued: "While certain insurers have managed to stand out through superior underwriting and portfolio management, the overall industry must either achieve greater diversification within its property portfolios, increase prices to reflect the carrying costs of such risks or develop more efficient mechanisms to finance its catastrophe exposures.'' In addition to catastrophe risk, the study quantified that other drivers of capital requirements include the market risk of insurer's equity investments (25 percent), risk from non-catastrophe liabilities (19 percent), interest rate risk from asset/liability mismatch (12 percent), operating risk (10 percent), and credit risk (2 percent).

The analysis is based on a set of proprietary methodologies developed jointly by OW and RMS to assist property/casualty insurers and reinsurers in managing risk, capital and shareholder value across all risk types.

The analysis considered 1,100 P&C (re)insurance companies, with data obtained from publicly available information from annual statements and reports.

Catastrophe risk data was obtained from RMS proprietary databases and models, while data on stock index returns and interest rates were collected from industry standard data sources.