Strong competition and efforts by state regulators to hold down homeowners insurance rates have driven a slight decline in the prospective return on equity in the homeowners line of insurance for 2008, with this year's prospective ROE at 6.5 percent versus 7 percent in 2007, according to an annual analysis by Aon Re Global.

Also weighing down the countrywide return on equity - by 0.3 percent - is the expected assessment of residual market facilities, insurance vehicles which provide coverage to homeowners unable to obtain coverage in the private insurance marketplace. Residual market facilities have grown substantially in market share since the start of the decade.

Prospective ROE in "hurricane-exposed states" is 6.0 percent, and in "non-hurricane states" prospective ROE is 7.1 percent, according to Aon Re Global's analysis. To improve returns on equity to 14 percent, rates in hurricane-exposed states need to rise an estimated 35.3 percent, while rates in non-hurricane states need to be increased by 12.9 percent.

Hurricane-exposed states are those that extend from Texas to Maine.

"Insurance companies in the hurricane states need more capital to protect against catastrophic loss, and this means that larger rate increases are needed to improve the return on capital to an attractive level," said Randall E. Brubaker, FCAS, senior vice president with Aon Re Services.

A well-designed reinsurance program may reduce an insurance company's rate-level needs. A study released by Aon Re Global in September 2008 found reinsurance continues to be one of the most accretive forms of capital available in the industry. Equity risk premiums and credit risk spreads are significantly more expensive, and the incremental benefit of reinsurance as a form of underwriting capital has become even more pronounced.

"Reinsurers have a varying appetite for additional risk based on whether an insurance company's underwriting portfolio offers the reinsurer diversification, or further concentration of risk," said Kenneth Selzer, executive vice president with Aon Re Global. "We take this into consideration in advising our clients on the optimal mix of equity and reinsurance capital, and also in the placement of their programs in the reinsurance marketplace."