PCI White Paper: Insurer Profitability Must Be Viewed Over Long Term

A white paper published by the Property Casualty Insurers Association of America (PCI) shows that insurance industry profitability must be evaluated over the long term and that loss costs, not investment return, are the primary factor affecting profits and pricing.

PCI conducted the study to examine the profitability trends of the property/casualty industry and determine the reasons for insurers’ improved financial results over the past year. Recently released first quarter financial results have prompted calls from some industry critics for tougher regulatory controls on the insurers.

“Property/casualty insurers reported a 226 percent increase in net income from 2002 to 2003 due to a significant improvement in underwriting experience and a strong comeback in the overall U.S. economy,” said Diana Lee, PCI’s assistant vice president, research and author of the white paper. “While this increase is substantial, insurer profits are modest when compared to other industries and viewed over the long term. From 1993 to 2002 the return on equity for property/casualty insurers was 7.0 percent while the all-industry composite of Fortune magazine’s industrial and service sectors is 13.1 percent.”

The white paper points out that the industry’s return to “rate adequacy” (the level at which premiums nearly matched losses and expenses) resulted in significantly lower underwriting losses in 2003. While still operating at an underwriting loss, more prudent underwriting and pricing accuracy were the primary reasons for industry profitability. PCI acknowledged that a $2.7 billion increase in net investment gains also contributed to the industry’s positive overall financial results.

“When considering the impact of investment income on insurance prices, it’s important to note that rates are developed on a prospective basis,” said Lee. “Insurers use historical data to determine an accurate premium to cover future costs. Actuarial standards – and laws and regulations in most states – prohibit rates from being set to recoup losses from previous periods.”

Other highlights of this analysis include the following:

· More than half of property/casualty insurers’ assets is invested in the bond market; nonaffiliated bonds represent 55 percent of the portfolio. On the other hand, nonaffiliated common and preferred stocks make up about 11 percent of total assets. Because of the conservative nature of property/casualty insurance company investments, rates are not strongly influenced by the strength or weakness of the equities market. However, even in a poor economy, investment income helps hold down the cost of premiums for consumers and helps the property/casualty industry earn a modest return.

· There are dramatic fluctuations in year-to-year results, as underwriting profits range from -1.2 percent of net earned premiums to -18.8 percent of net earned premiums from 1984 through 2003. This volatility demonstrates the inherent risk of the insurance enterprise, as projected costs in the rate making process often do not match or even approximate actual costs.

· The two primary drivers of rate levels are the underlying costs associated with claims, making up about 82 percent of the premium during the last 20 years, and the underwriting expenses comprising about 26 percent of the premium.

“The insurance industry’s return to profitability is encouraging news to industry executives, state regulators, the investment community, and consumers,” said Lee. “A profitable insurance industry means that insurers have the financial resources to fulfill the ‘promise to pay’ – the cornerstone of any insurance contract. This is important to state regulators because undercapitalized and insolvent insurers drain resources from other companies and leave consumers unprotected. Moreover, a profitable industry means that companies can attract investment capital to expand their business and write more policies for more people.”