Insurers’ Income, Surplus Rise Despite Record Catastrophe Losses

The U.S. property/casualty insurance industry’s net income after taxes rose 4.4 percent, or $1.2 billion, to $28.8 billion in nine-months 2005 from $27.6 billion in nine-months 2004. Reflecting the industry’s income, its consolidated surplus, or statutory net worth, increased 5.2 percent, or $20.4 billion, to $414.3 billion at September 30 from $393.8 billion at year-end 2004, according to ISO and the Property Casualty Insurers Association of America (PCI).

The industry’s net income and surplus increased despite record catastrophe losses. Including losses from Hurricanes Dennis, Katrina, Ophelia and Rita, direct insured property losses due to catastrophes through nine-months 2005 totaled $47.6 billion — nearly double the $27 billion in direct insured property losses due to catastrophes through nine-months 2004, according to ISO’s Property Claim Services (PCS) unit. Adjusting for losses covered by residual market mechanisms and foreign reinsurers, ISO estimates that private insurers’ net catastrophe losses through nine-months 2005 totaled $27 billion to $32 billion — up from $15.8 billion through nine-months 2004.
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Reflecting sharply higher net catastrophe losses, the industry suffered a $2.8 billion net loss on underwriting through nine-months 2005 — a $6.1 billion adverse swing from the $3.2 billion net gain on underwriting through nine-months 2004.

The figures are consolidated estimates for all private property/casualty insurers based on reports accounting for about 96 percent of all business written by private U.S. property/casualty insurers.
With the hurricanes in the first nine months of 2005 generating 2.3 million insurance claims, repairs to many properties not yet completed, and supply shortages leading to price increases that make it difficult to estimate repair costs, total insured losses from those storms could rise significantly in the months to come. But based on records back to 1949 and adjusting for inflation, direct losses from catastrophes through nine months have already risen to a new record high, with inflation-adjusted direct catastrophe losses through nine-months 2005 exceeding those through nine-months 1992 when Hurricane Andrew struck by 57.9 percent.

“Given the massive catastrophe losses absorbed by insurers in nine-months 2005, the increase in income and surplus during the first three quarters of the year is a testament to the underlying financial health of the industry. But we can’t afford to lose sight of the fact that, as bad as Hurricanes Katrina and Rita were, insurers and the public remain exposed to far more devastating catastrophes that could strain insurers’ ability to fulfill their obligations to policyholders,” said Gregory Heidrich, PCI senior vice president for policy development and research. “According to PCS, Hurricane Katrina caused a record $38.1 billion in direct insured losses to property. But catastrophe modeling by AIR Worldwide shows we face the prospect of hurricanes causing more than $100 billion in damage. Even as we applaud insurers’ success coping with the catastrophes of 2005, we must do more to assure that insurers and the people they serve will survive when even more devastating storms strike.”

“The other valuable lesson from the hurricanes of 2005 is that, as daunting as the prospect of a super catastrophe is, severity is not the only issue,” said John J. Kollar, ISO vice president for consulting and research. “There were five catastrophic hurricanes in 2004 and five more in 2005 including Wilma, and meteorological experts say we’re in a cycle of increased storm activity that could last for decades. Sound risk management requires insurers to prepare for a sustained increase in the frequency of catastrophic storms. Insurers must take a hard look at their exposures, pricing, underwriting, reinsurance arrangements and the amount of capital they need to support the risk they take on.”
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Net investment income — primarily dividends from stocks and interest on bonds — grew 25.9 percent to $36.4 billion in nine-months 2005 from $29 billion in nine-months 2004. Insurers’ investment income in nine-months 2005 benefited from $3.3 billion in one-time-only special dividends that one insurer received from an investment subsidiary. Excluding those special dividends, investment income rose 14.6 percent to $33.2 billion in nine-months 2005, as insurers’ average holdings of cash and invested assets grew 9.8 percent and the annualized yield on cash and invested assets rose to 4.1 percent in nine-months 2005 from 4 percent in nine-months 2004.

Reflecting the deterioration in underwriting results consequent to the increase in catastrophe losses, the industry’s annualized rate of return on average surplus declined to 9.5 percent in nine-months 2005 from 10.3 percent in nine-months 2004. Excluding $3.3 billion in special dividends one insurer received from an investment subsidiary, the industry’s annualized return through nine-months 2005 was 8.5 percent — 0.2 percentage points less than average annualized return through nine months from the start of ISO’s quarterly records in 1986 to 2004.

“The insurance industry’s profitability and healthy surplus in the wake of record catastrophe losses through nine months may turn out to be good news for insurance buyers who have been bracing for possible rate increases,” observed Heidrich. “With the price of insurance being determined by the law of supply and demand, and supply being determined by profitability and capacity, countrywide results through nine months may mean that rate increases could be largely limited to those lines and states directly affected by this year’s hurricanes.”

“But insurance markets are complex and there is still substantial uncertainty about the ultimate cost of this year’s hurricanes, the industry’s true profitability through nine-months 2005, and pending developments in insurance markets,” observed Kollar. “For example, reinsurers will bear ultimate responsibility for paying a disproportionate share of this year’s hurricane losses, eating into their surplus and their capacity to provide reinsurance coverage to primary insurers. Ordinarily, this would lead to upward pressure on prices in primary insurance markets as primary carriers attempt to pass along increases in the cost of reinsurance. But, attracted by possible increases in the price of reinsurance, new capital is already flowing into the reinsurance business. The effect of that new capital on pricing going forward will depend on how aggressively it is deployed and on how the amount of new capital compares to the amount of capital destroyed by this year’s catastrophes. But we won’t know ultimate insurerd losses from the hurricanes of 2005 for quite some time, as a result of complexities ranging from coverage issues to the impact of demand surge on repair costs.”

“Further complicating any assessment of the dynamics of reinsurance markets and how those dynamics will affect primary insurance markets, the unprecedented losses caused by this year’s hurricanes may change insurers’ perceptions of the amount of risk they’ve taken on and the amount of reinsurance they need,” added Heidrich.

Pre-tax operating income — the sum of gains or losses on underwriting, net investment income and miscellaneous other income — climbed $2.5 billion, or 7.9 percent, to $34.3 billion in nine-months 2005 from $31.8 billion in nine-months 2004, as increases in net investment income more than offset deterioration in underwriting results. In addition, miscellaneous other income rose to $0.7 billion in nine-months 2005 from negative $0.4 billion in nine-months 2004.
Largely offsetting the $2.5 billion increase in pre-tax operating income, realized capital gains on investments declined $2.1 billion, or 32.6 percent, to $4.3 billion in nine-months 2005 from $6.4 billion in nine-months 2004.

The industry’s federal income taxes fell $0.8 billion, or 7.6 percent, to $9.8 billion in the first nine months of 2005 from $10.6 billion in the first nine months of 2004.

Combining realized capital gains and net investment income, net investment gains rose $5.4 billion, or 15.3 percent, to $40.7 billion in the first nine months of 2005 from $35.3 billion in the first nine months of 2004.

The net loss on underwriting in nine-months 2005 amounts to 0.9 percent of the $309.9 billion in premiums earned during the period. The net gain on underwriting through nine-months 2004 amounted to 1.1 percent of the $308 billion in premiums earned during that period.

The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — rose 2.2 percentage points to 100 percent during the first nine months of 2005 from 97.8 percent a year earlier. Nonetheless, the combined ratio for nine-months 2005 was the second best combined ratio through nine months since the start of ISO’s quarterly records in 1986, surpassed only by the combined ratio through nine-months 2004.

The $20.4 billion increase in the industry’s consolidated surplus in nine-months 2005 compares with a $22.3 billon increase in nine-months 2004. The increase in surplus in nine-months 2005 consisted of $28.8 billion in net income after taxes and $6.3 billion in new funds paid in, less $0.4 billion in unrealized capital losses on investments, $9.6 billion in dividends to stockholders and $4.7 billion in miscellaneous charges against surplus.

Source: PCI, ISO, III