Sound Risk Management, Strong Investment Results Prove Positive for P/C Industry

U.S. property/casualty insurers managed to increase earnings and add to their capital base in 2005 despite record catastrophe losses, according to ISO and the Property Casualty Insurers Association of America (PCI). Sound risk management and strong investment results lead to the insurance industry’s net income after taxes rose 11.7 percent, or $4.5 billion, to $43 billion in 2005 from $38.5 billion in 2004. Reflecting the industry’s income, its consolidated surplus, or statutory net worth, increased 9.2 percent, or $35.8 billion, to $427.1 billion at year-end 2005 from $391.3 billion at year-end 2004.

Net income and surplus increased even though direct insured property losses due to catastrophes rose in 2005 to a record $57.7 billion – more than double the $27.5 billion in direct insured property losses due to catastrophes in 2004, according to ISO’s Property Claim Services (PCS) unit. Figures for catastrophe losses exclude those covered by the National Flood Insurance Program.

“But countrywide data for all lines often masks significant problems in specific markets and locations,” said Michael R. Murray, ISO assistant vice president for financial analysis. “For example, before reinsurance recoveries and excluding losses covered by residual market mechanisms, the hurricanes of 2005 caused $24.7 billion in insured losses to residential and commercial property in Louisiana – $3.1 billion more than all the premiums insurers charged for property insurance in the state during the 23 years from 1982 to 2004.

Similarly, in Mississippi, hurricanes caused $11.3 billion in insured damage to structures and their contents, exceeding all the premiums insurers charged for property insurance in the state during the 19 years from 1986 to 2004.”

“And, unfortunately, hurricane and severe weather experts are predicting another very active hurricane season,” said Gregory Heidrich, PCI senior vice president for policy development and research. “The latest predictions indicate a very high probability, 80 percent or more, of a major hurricane – a category 3, 4 or 5 storm – hitting the U.S. this year. According to Dr. Bill Gray’s team at Colorado State University, there is a 64 percent chance of a major hurricane striking the East Coast and a 47 percent chance of a major storm striking along the Gulf Coast. All of these odds are from one-and-a-half to twice as high as the annual odds during the past century. This means there is an extremely high probability that 2006 will turn out to be another very challenging year for insurers and the publics they serve.”

These consolidated industry results are estimates for all private property/casualty insurers based on reports accounting for at least 96 percent of all business written by private U.S. property/casualty insurers.

“The insurance industry’s financial results for 2005 attest to insurers’ risk management and, in particular, their use of reinsurance to spread risk globally. For example, Lloyd’s of London recently reported that it had received $5.7 billion in claims from the hurricanes that struck the U.S. last year,” said ISO’s Murray. “ISO’s analysis indicates foreign insurers and reinsurers will ultimately cover from $14 billion to $19 billion of the losses from last year’s catastrophes. But the cost of reinsurance for U.S. property risks in catastrophe-prone areas is now rising sharply, making it more expensive for primary insurers to provide coverage.”

Adjusting for losses covered by foreign reinsurers, residual market mechanisms and the Florida Hurricane Catastrophe Fund, ISO estimates that private insurers’ financial results for 2005 included net catastrophe losses totaling $31 billion to $36 billion – up from about $15 billion in 2004.

Reflecting higher net catastrophe losses, the industry suffered a $5.9 billion net loss on underwriting in 2005 – a $10.2 billion adverse swing from the $4.3 billion net gain on underwriting in 2004.

“Fortunately for both insurers and policyholders, last year’s catastrophes occurred at a time when increasing investment yields and rising stock markets bolstered insurers’ investment results,” said Heidrich.

Net investment income – primarily dividends from stocks and interest on bonds – grew 23.7 percent to $49.5 billion in 2005 from $40 billion in 2004. Insurers’ investment income in 2005 benefited from $3.2 billion in one-time special dividends that one insurer received from an investment subsidiary. Excluding those special dividends, investment income rose 15.8 percent to $46.3 billion last year, as insurers’ average holdings of cash and invested assets grew 9.2 percent and the yield on cash and invested assets rose to 4.3 percent in 2005 from 4 percent in 2004.

With improvement in investment results offsetting deterioration in underwriting results, the industry’s rate of return on average surplus edged up to 10.5 percent in 2005 from 10.4 percent in 2004. But excluding the $3.2 billion in special dividends one insurer received from an investment subsidiary, the industry’s rate of return dropped 0.6 percentage points to 9.8 percent in 2005.

Pre-tax operating income – the sum of gains or losses on underwriting, net investment income and miscellaneous other income – rose $0.5 billion, or 1.2 percent, to $44.5 billion in 2005 from $44 billion in 2004. Excluding nonrecurring special dividends, operating income fell $2.7 billion, or 6.1 percent, to $41.3 billion. Limiting the decline in adjusted operating income, miscellaneous other income rose $1.2 billion to positive $0.9 billion in 2005 from negative $0.3 billion in 2004.

Also contributing to the industry’s positive financial results for 2005, realized capital gains on investments rose $0.6 billion, or 6.3 percent, to $9.7 billion last year from $9.1 billion a year earlier.

The industry’s federal income taxes fell $3.4 billion, or 23.5 percent, to $11.2 billion last year from $14.6 billion in 2004.

Combining realized capital gains and net investment income, net investment gains rose $10.1 billion, or 20.5 percent, to $59.2 billion in 2005 from $49.1 billion a year earlier.

The net loss on underwriting in 2005 amounts to 1.4 percent of the $417.7 billion in premiums earned during the period, in contrast to the net gain on underwriting in 2004 amounting to 1 percent of the $413.8 billion in premiums earned during that period.

Based on reported results, overall net written premiums rose $1.6 billion, or 0.4 percent, to $425.7 billion in 2005 from $424.1 billion in 2004. Net earned premiums increased $3.9 billion, or 0.9 percent, to $417.7 billion in 2005 from $413.8 billion in 2004. Net loss and loss adjustment expenses rose $10.4 billion, or 3.5 percent, to $311.4 billion last year from $300.9 billion a year earlier.

But U.S. insurers’ reported underwriting results for 2005 were affected by a transaction ceding $6 billion in premiums and a similar amount of loss and loss adjustment expenses from one insurer to its foreign parent. Adjusted for this special transaction, net written premiums rose 1.8 percent, net earned premiums increased 2.4 percent, and net loss and loss adjustment expenses rose 5.5 percent.

At an adjusted 1.8 percent in 2005, net written premium growth equaled the record low set back in 1998, with written premium growth slowing from 4.9 percent in 2004, 9.4 percent in 2003 and a cyclical peak of 14.3 percent in 2002. Similarly, at an adjusted 2.4 percent in 2005, earned premium growth dwindled to its slowest pace since the 1.8 percent increase in 1999 — down from 7.1 percent in 2004, 10.9 percent in 2003 and 11.9 percent in 2002.

Though overall net loss and loss adjustment expenses increased $10.4 billion to $311.4 billion in 2005, non-catastrophe net loss and loss adjustment expenses fell $7.9 billion, or 2.8 percent, to $277.8 billion last year from $285.7 billion in 2004. Adjusted for a special transaction that ceded $6 billion of one insurer’s losses to its foreign parent, non-catastrophe loss and loss adjustment expenses fell $1.9 billion, or 0.7 percent, to $283.8 billion in 2005.

Other underwriting expenses – primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes – rose $3.5 billion, or 3.3 percent, to $110.3 billion in 2005 from $106.8 billion a year earlier.
Dividends to policyholders increased 9 percent to $1.9 billion last year from $1.7 billion in 2004.

Combined Ratio
The combined ratio – a key measure of losses and other underwriting expenses per dollar of premium – rose 2.6 percentage points to 100.9 percent in 2005. Nonetheless, the combined ratio for 2005 was the third best annual combined ratio since 1980, surpassed only by the 98.3 percent combined ratio for 2004 and the 100.1 percent combined ratio for 2003.

“Despite the deterioration in underwriting results as evidenced by the $10.2 billion swing to a $5.9 billion net loss on underwriting and the 2.6 percentage point increase in the combined ratio to 100.9 percent, slow premium growth suggests competition in many insurance markets is intensifying. Market surveys and economic data support this view,” said Murray.

The $35.8 billion increase in the industry’s consolidated surplus in 2005 compares with the $44.3 billon increase in 2004. The increase in surplus in 2005 consisted of $43 billion in net income after taxes and $14 billion in new funds paid in, less $3.2 billion in unrealized capital losses on investments, $15.2 billion in dividends to stockholders and $2.8 billion in miscellaneous charges against surplus.

The $3.2 billion in unrealized capital losses last year is a $13.8 billion adverse swing from the $10.6 billion in unrealized capital gains in 2004. Combining the $3.2 billion in unrealized capital losses in 2005 with the $9.7 billion in realized capital gains during the period, the industry posted $6.5 billion in overall capital gains last year, down from $19.7 billion during 2004 and $31.6 billion in 2003.

“The drop in insurers’ total capital gains on investments reflects developments in stock markets, with increases in the S&P 500 slowing to 3 percent in 2005 from 9 percent in 2004 and 26.4 percent in 2003,” said Heidrich. “But the situation remained far better than it was from 2000 to 2002, when three consecutive double-digit declines in the S&P 500 led to $35.7 billion in total capital losses. Insurers’ $57.8 billion in total capital gains from 2003 to 2005 certainly helped them withstand last year’s record catastrophe losses.”

The $14 billion in new funds paid in during 2005 is up 59.7 percent from the $8.8 billion in new funds paid in during 2004.
The $15.2 billion in dividends to stockholders in 2005 is up 8.3 percent from the $14 billion in dividends to stockholders a year earlier.
The $2.8 billion in miscellaneous charges against surplus in 2005 compares with $0.5 billion in miscellaneous additions to surplus in 2004.

“The $38.1 billion in direct insured losses to property from Hurricane Katrina should serve as a wake-up call to us all. It is easy to imagine storms causing $100 billion or more in losses,” said Heidrich. “When Hurricane Andrew made landfall near the small town of Homestead, Florida, it caused $15.5 billion in direct insured losses to property, according to ISO’s Property Claim Services unit. At the time, both insurers and modelers said losses would have been four times higher — some $60 billion — had Andrew made a direct hit on Miami. And in the 14 years since 1992, property values in coastal areas have more than doubled. That means that if Andrew were to hit Miami today, insured losses would be more than $120 billion.”

“Regardless of whether climate change is leading to increases in the number of storms or their intensity, analyses by ISO’s catastrophe modeling subsidiary, AIR Worldwide, indicate that catastrophe losses should be expected to double roughly every 10 years because of increases in construction costs, increases in the number of structures and changes in their characteristics,” said Murray. “AIR’s research shows that, because of exposure growth, the one in one-hundred-year industry loss grew from $60 billion in 1995 to $110 billion in 2005, and it will likely grow to over $200 billion during the next 10 years.”

Source: PCI, ISO, I.I.I.