P/C Industry’s Net Income Surges, But Slowing Premium Growth May Hamper Further Progress, Says III

According to results released by the Insurance Information Institute, the U.S. property/casualty industry’s net income after taxes rose to $21.1 billion in the first nine months of 2003 from $5 billion through nine-months 2002, as both underwriting and investment results improved. Reflecting the industry’s income and unrealized capital gains on investments, its surplus, or statutory net worth, increased 12.1 percent to $319.9 billion at Sept. 30 from $285.4 billion at year-end 2002, according to Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).

The increase in net income and the growth in surplus through nine-months 2003 confirm the industry’s continuing recovery from the soft markets of the 1990s. Yet, even with the 320.6 percent increase in net income through nine-months 2003, the industry’s income during the period was 22.8 percent below its income through nine-months 1997. Surplus as of Sept. 30 this year was $19.4 billion, or 5.7 percent below its peak of $339.3 billion at June 30, 1999.
“Reflecting the sharp increase in income through nine-months 2003, insurers’ profitability improved significantly, with the industry’s annualized rate of return on average surplus rising to 9.3 percent during the period from 2.4 percent during the first nine months of 2002,” observed John J. Kollar, ISO vice president for consulting and research. “The industry’s annualized rate of return through nine months has bounced back from a low of minus 1.1 percent during the first three quarters of 2001 to its highest level since the
10 percent for nine-months 1998. While the progress rebuilding profitability is encouraging, only time will tell whether insurers ever regain profitability like the 13.3 percent annualized rate of return for nine-months 1997 or the 15.1 percent rate of return for full-year 1986.”

Despite higher catastrophe losses, pre-tax operating income climbed 159.5 percent to $22.1 billion for nine-months 2003 from $8.5 billion for nine-months 2002. Operating income is the sum of gains or losses on underwriting, net investment income, and other miscellaneous income.

Spurring improvement in the industry’s results, net losses on underwriting decreased 68.8 percent in nine-months 2003 to $5.7 billion from $18.2 billion in nine-months 2002.

Net investment income — primarily dividends from stocks and interest on bonds — grew 3.2 percent to $27.7 billion for nine-months 2003 from $26.9 billion for nine months 2002.

Operating income through nine-months 2003 also benefited from $106 million in miscellaneous other income, up from negative $94 million in nine-months 2002.

The figures are consolidated estimates for all private property/casualty insurers based on the reports of insurers that account for 96 percent of all business written by private U.S. property/casualty insurers.

Also contributing to the increase in net income, U.S. property/casualty insurers realized $5.9 billion in capital gains on investments in nine-months 2003 — a sharp contrast to the $1.3 billion in capital losses realized in nine-months 2002. Net investment gains — the sum of net investment income and realized capital gains (losses) — grew 31.3 percent to $33.6 billion for nine-months 2003 from $25.6 billion for nine-months 2002.

The industry’s federal income taxes climbed to $6.9 billion for nine-months 2003 from $2.2 billion for nine-months 2002, partially offsetting the increase in pre-tax operating income and the positive swing in realized capital gains.

Underwriting results improved as premium growth outpaced growth in loss and loss-adjustment expenses, other underwriting expenses, and dividends to policyholders. Net written premiums climbed $28.3 billion to $308.6 billion in nine-months 2003, but premium growth versus year-ago levels slowed to 10.1 percent from 13.8 percent in nine-months 2002. Nonetheless, the 10.1 percent increase in written premiums in the first nine months of 2003 is the second largest increase in premiums through nine months since 1987, when premiums for the period rose 10.9 percent.

Earned premiums climbed 11.6 percent in nine-months 2003 to $288.7 billion, with earned premium growth accelerating slightly from the 11.4-percent increase for nine-months 2002.

“The significant improvement in underwriting and overall results through nine-months 2003 is very welcome, and we believe underwriting results will improve further as rate increases in insurance markets continue working their way into earned premiums and down to insurers’ bottom line,” said Don Griffin, NAII assistant vice president for business and personal lines. “To insurers’ credit, much of the progress to date reflects increased attention to the fundamentals of our business — solid underwriting, cost-based pricing, and careful claim settlement. Now, the 64-thousand-dollar question is how long will insurers maintain their focus on the fundamentals? Each improvement in insurers’ results makes it that much harder to resist the temptation to ignore the fundamentals and go for market share,” said Griffin.

“The current hard market is already showing its age. Written premium growth climbed fairly steadily from 1.8 percent in nine-months 1999 to a peak of 13.8 percent in nine-months 2002 but has since slowed to 10.1 percent in nine-months 2003,” added Kollar. “What’s more, ISO MarketWatch data show rate changes on renewals of commercial policies are losing momentum. Rate changes on renewals first turned positive in July 1999 and accelerated for three years, peaking at 12.9 percent versus year-ago levels in July 2002. But, since then, rate changes on renewals have been slowing, dropping to just 7.7 percent this past June. And recent market surveys suggest that rate increases have continued to moderate, with rates for some coverages and market segments now flat to down. All else being equal, insurers will have an increasingly difficult time maintaining growth in net income as rate increases wane.”

Catastrophe losses more than doubled in nine-months 2003, increasing to $10.1 billion from $4.1 billion in nine-months 2002, according to ISO’s Property Claim Services (PCS) unit. The $10.1 billion in catastrophe losses through nine-months 2003 compare with an average of $8.8 billion in catastrophe losses during the first nine months of the ten years from 1993 to 2002, and that ten-year average includes record losses from the terrorist attack on September 11, 2001.

Despite the sharp increase in catastrophe losses, overall loss and loss-adjustment expenses rose just 5.5 percent to $217.7 billion in nine-months 2003 from $206.2 billion in nine-months 2002. Noncatastrophe loss and loss-adjustment expenses rose 2.7 percent to $207.5 billion in nine-months 2003 from $202.1 billion a year earlier.

Other underwriting expenses — primarily acquisition expenses; other expenses associated with underwriting, pricing, and servicing insurance policies; and premium taxes — rose 8.9 percent to $75.9 billion in the first nine months of this year from
$69.7 billion in the first nine months of last year.

Dividends to policyholders dropped 7.1 percent to $852 million in nine-months 2003 from $917 million in nine-months 2002. The underwriting loss for nine-months 2003 amounts to 2 percent of the $288.7 billion in premiums earned during the period, down from 7.1 percent of the
$258.6 billion in premiums earned during the comparable period last year. The combined ratio — a measure of losses and other underwriting expenses per dollar of premium — improved to 100.3 percent for the first nine months of this year, 4.7 percentage points better than the 105 percent a year ago.

“The 100.3 percent combined ratio for the first three quarters of 2003 is the best nine-month underwriting result for any year since at least 1986, when our quarterly records begin,” said Kollar. “Nine-month results would have been even better if not for the increase in catastrophe losses. While the reported combined ratio improved 4.7 percentage points versus the same period last year, it would have improved by 6.8 percentage points had catastrophe losses stayed at the same level.”

The $34.5-billion increase in the industry’s consolidated surplus through nine-months 2003 contrasts with a $16.1-billon decline through nine-months 2002. The increase in surplus during the first nine months of 2003 consisted of $21.1 billion in net income after taxes, $13.9 billion in unrealized capital gains on investments, $4 billion in new funds paid in, and $1 billion in miscellaneous surplus changes, less $5.5 billion in dividends to stockholders.

The $13.9 billion in unrealized capital gains through nine-months 2003 contrast with $23.1 billion in unrealized capital losses through nine-months 2002.

The $4 billion in new funds paid in during nine-months 2003 is down 34.7 percent from the $6.2 billion in new funds paid in during nine-months 2002.

The $1 billion in miscellaneous additions to surplus through nine-months 2003 compare with $716 million in miscellaneous additions to surplus through nine-months 2002.

The $5.5 billion in dividends to stockholders in nine-months 2003 constitutes a 9.1 percent increase from the $5 billion in dividends to stockholders in nine-months 2002.

Combining realized and unrealized capital gains, insurers enjoyed $19.8 billion in overall capital gains on investments in nine-months 2003 — a $44.1 billion positive swing from the $24.3 billion in overall capital losses in nine-months 2002.

“The improvement in investment results reflects a combination of growth in insurers’ holdings of cash and invested assets and recent developments in financial markets,” noted NAII’s Griffin. “The 3.2-percent increase in investment income in nine-months 2003 is the net result of a 9.3 percent increase in insurers’ average holdings of cash and invested assets and a 5.6 percent decline in the yield on cash and invested assets. And the swing from overall capital losses during the first nine months of 2002 to overall capital gains during the first nine months of 2003 reflects the recovery in equity markets. Through September of this year, the S&P 500 rose 13.2 percent — a sharp swing from the 29-percent decline in the S&P 500 in the first nine months of 2002.”

“Near-term, insurers can look forward to further investment gains,” added Griffin. “The factors that bode well for investment gains include recent increases in interest rates and the strength in equity markets thus far in the fourth quarter. Recovering from a 45-year low of 3.33 percent last June, the average yield on ten-year Treasury notes rose to an average of 4.45 percent in August and has held fairly steady since, averaging 4.30 in November. In addition, with the S&P 500 having risen 9.4 percent from the end of the third quarter through Dec. 18, we can expect insurers to post some capital gains when reporting fourth-quarter results,” Griffin said.

ISO’s Kollar cautioned, however, that “as good as the near-term outlook for investment gains may be, insurers cannot rely on investment gains from fickle financial markets to achieve success over the long haul. History shows that the S&P 500 declined in 13 of the 43 years from 1960 to 2002 and that insurers suffered overall capital losses in 12 of those 13 years. History also shows that insurers’ investment income declined in six of the 11 years from 1992 to 2002,” observed Kollar. “If insurers want to regain profitability like the 15.1 percent return on average surplus they enjoyed in 1986, they need to continue focusing on the core fundamentals of the insurance business. To get a 15.1 percent rate of return with today’s investment results, financial leverage, and tax rates, insurers would need to get the combined ratio down to 94.6 percent — 5.6 percentage points better than the actual combined ratio through nine-months 2003 and 13.4 percentage points better than the
108.1 percent combined ratio for 1986, when the yield on ten-year Treasury notes averaged 7.7 percent.”