P/C Insurers’ Profitability Drops in First-Half of 2006

The U.S. property/casualty insurance industry’s net income after taxes fell 9.3 percent to $28.3 billion in first-half 2006 from $31.2 billion in first-half 2005 as investment results deteriorated. Reflecting the decline in net income after taxes, the industry’s annualized rate of return on average surplus (net worth) fell to 13 percent in first-half 2006 from 15.6 percent in first-half 2005, according to ISO and the Property Casualty Insurers Association of America (PCI).

Contributing to the declines in net income after taxes and overall profitability, the industry’s net investment income — primarily dividends from stocks and interest on bonds — dropped 3.5 percent to $24.5 billion in the first half of this year from $25.4 billion in the first half of last year. Realized capital gains on investments (not included in net investment income) tumbled 66.4 percent to $0.9 billion in first-half 2006 from $2.6 billion in first-half 2005. Combining net investment income and realized capital gains, overall net investment gains fell 9.3 percent to $25.4 billion through first-half 2006 from $28 billion through first-half 2005.

Also contributing to the declines in net income after taxes and overall profitability, the industry incurred $12.3 billion in federal income taxes in first-half 2006 — 20.3 percent more than the $10.2 billion in income taxes the industry incurred in first-half 2005.

The figures are consolidated 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.

Partially offsetting the deterioration in investment results and the increase in income taxes, insurers’ net gains on underwriting increased to $15.1 billion in first-half 2006 from $12.8 billion in first-half 2005. The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — improved 1 percentage point to 92 percent in the first half of 2006 from 93 percent in the first half of 2005.

“While the hurricane season isn’t over and the potential for catastrophic losses from a natural disaster still remains, insurers’ underwriting results for first-half 2006 were very solid,” said Genio Staranczak, PCI chief economist. “At 92 percent, the combined ratio for first-half 2006 was the best first-half combined ratio since the start of quarterly records extending back to 1986. Insurers also earned profits on underwriting in the first-half of 2005, but catastrophe losses in the second half quickly erased those underwriting profits and more. It is also important to put first-half results in perspective. Insurers lost money on underwriting in the first half of each year from 2003 back to 1986. Summing first-half results for the past 21 years, the industry is still $129 billion in the red on underwriting.”

“Even if we aren’t struck by any major storms, we are already seeing signs that recent results are spurring increased competition in insurance markets not exposed to hurricanes and that increased competition will eventually undermine premium growth and underwriting results,” noted Michael R. Murray, ISO assistant vice president for financial analysis. “While stories about price increases and insurance availability problems in coastal states hammered by Hurricanes Katrina, Wilma and Rita continue to appear almost daily, the countrywide CPI for tenants’ and household insurance dropped 1.5 percent in second-quarter 2006 compared to its level a year earlier, and the CPI for motor vehicle insurance rose a scant 0.3 percent — far less than the 4 percent increase in consumer prices overall. Moreover, commercial insurance rates fell an average of 3 percent countrywide for accounts of all sizes, according to the Council of Insurance Agents and Brokers.”

Pre-tax operating income — the sum of net gains or losses on underwriting, net investment income and miscellaneous other income — climbed 2.3 percent to $39.7 billion in first-half 2006 from $38.8 billion in first-half 2005, even though miscellaneous other income fell to $0.1 billion in the first half of 2006 from $0.7 billion in the first half of 2005.

The property/casualty insurance industry’s consolidated surplus, or statutory net worth, increased 4.6 percent to $445.5 billion at June 30 from $425.8 billion at year-end 2005. The $19.7 billion increase in the industry’s consolidated surplus in first-half 2006 compares with a $17.5 billon increase in first-half 2005.

The increase in surplus in first-half 2006 consisted of $28.3 billion in net income after taxes, $4.6 billion in unrealized capital gains on investments (not included in net income) and $1 billion in new funds paid in (new capital raised by insurers), less $12.8 billion in dividends to shareholders and $1.4 billion in miscellaneous charges against surplus.

The $4.6 billion in unrealized capital gains in first-half 2006 constitutes a $9.9 billion positive swing from the $5.3 billion in unrealized capital losses in first-half 2005. Combining the $4.6 billion in unrealized capital gains in first-half 2006 with the $0.9 billion in realized capital gains during the period, insurers enjoyed $5.5 billion in overall capital gains during the first half of 2006, with those gains constituting an $8.2 billion swing from insurers’ $2.7 billion in overall capital losses during the first half of 2005.

The $1 billion in new funds paid in during first-half 2006 is down 58.7 percent from $2.4 billion in first-half 2005.

The $12.8 billion in dividends to shareholders in first-half 2006 is up from $7.7 billion in first-half 2005.

The $1.4 billion in miscellaneous charges against surplus in the first half of this year is down from $3.1 billion in the first six months of 2005.

Underwriting results continue to improve
Overall underwriting results improved even though catastrophe losses increased. Catastrophes caused $5.3 billion in insured property losses in first-half 2006, up 71.8 percent from $3.1 billion in first-half 2005, according to ISO’s Property Claim Services (PCS) unit.

The improvement in underwriting results in first-half 2006 reflects the excess of growth in premiums over growth in loss and loss adjustment expenses, other underwriting expenses and dividends to policyholders.

Net written premiums climbed $6.4 billion to $223.3 billion in first-half 2006 from $216.9 billion in first-half 2005, with written premium growth accelerating to 2.9 percent in first-half 2006 from 2.2 percent in first-half 2005. Net earned premiums rose $5.7 billion to $215 billion in first-half 2006 from $209.3 billion in first-half 2005, but earned premium growth slowed to 2.7 percent in first-half 2006 from 3.2 percent in first-half 2005 and a cyclical peak of 11.8 percent in first-half 2003. At 2.7 percent, first-half earned premium growth had slowed to its slowest pace since 1999, when earned premiums grew 0.9 percent.

Overall loss and loss adjustment expenses increased $0.2 billion, or 0.1 percent, to $141.3 billion in first-half 2006 from $141.1 billion in first-half 2005. Non-catastrophe loss and loss adjustment expenses declined $2 billion, or 1.4 percent, to $136 billion in first-half 2006 from $138 billion a year earlier.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $3 billion, or 5.5 percent, to $58 billion in the first half of this year from $54.9 billion in the first half of last year.

Dividends to policyholders rose 16.9 percent to $0.6 billion in first-half 2006 from $0.5 billion in first-half 2005.

The net gain on underwriting in first-half 2006 amounts to 7 percent of the $215 billion in premiums earned during the period, up from 6.1 percent of the $209.3 billion in premiums earned in first-half 2005.

“Premiums and losses both would have grown faster if not for a special development affecting reported results,” noted Staranczak. “Earlier this year, one insurer stopped reporting as a property/casualty insurer and began reporting as a health insurer instead. If not for that change in reporting, industry written premiums would have increased 3.5 percent in first-half 2006, and losses would have risen 0.9 percent.”

“Even at an adjusted 3.5 percent, written premium growth in first-half 2006 fell far short of growth in the economy,” added Murray. “U.S. gross domestic product (GDP) — a dollar measure of national output — rose 6.9 percent in first-half 2006 compared to its level a year earlier. That premiums rose only about half as much as GDP is another indication that competition is leading to lower prices in many insurance markets, despite ongoing problems in specific markets affected by last year’s record catastrophe losses.”

Reported figures for first-half 2006 and first-half 2005 also reflect two other special developments that affected how results for the periods compare. In first-half 2006, one insurer engaged in a complex series of transactions as it prepared itself to be sold by its noninsurer parent. Consequent to those transactions, the insurer posted $0.5 billion in nonrecurring dividends that added to its investment income and net income after taxes. Also consequent to those transactions, the same insurer posted $1.7 billion of realized capital losses that flowed through net income and an offsetting amount of unrealized capital gains. And, in first-half 2005, another insurer received $3.1 billion in nonrecurring dividends from an investment subsidiary as it monetized assets. If not for these special developments, industry net income after taxes would have risen $1.2 billion, or 4.3 percent, to $29.5 billion in first-half 2006 from $28.3 billion in first-half 2005. Industry surplus would have increased $22.7 billion in first-half 2006 instead of $19.7 billion.

“The 3.5 percent decline in industry investment income in first-half 2006 is a result of special developments not expected to have an influence on investment income going forward,” said Staranczak. “Adjusted for three special developments affecting the data for first-half 2005 and first-half 2006, industry investment income increased 7.4 percent in first-half 2006 as insurers’ average holdings of cash and invested assets rose 7.7 percent.”

“The same special developments had less of an effect on insurers’ overall capital gains, with the swing from $2.7 billion in overall capital losses in first-half 2005 to $5.5 billion in overall capital gains in first-half 2006 reflecting developments in financial markets,” said Murray. “In the first half of 2005, the S&P 500, the Dow Jones Industrial Average, and the New York Stock Exchange Composite all declined. In the first half of this year, all three of these major market indicators rose, with the New York Stock Exchange Composite climbing 5.4 percent. With respect to the outlook for capital gains going forward, these major stock indexes have all risen since June 30 of this year, with the New York Stock Exchange Composite being up 9.5 percent year-to-date as of the close on September 28. All of this suggests that insurers’ results through nine-months will benefit from additional capital gains.”

Second-quarter results
The industry’s consolidated net income after taxes for second-quarter 2006 amounted to $11.6 billion, down 14.4 percent from the $13.6 billion in net income for second-quarter 2005. The industry’s net income for second-quarter 2006 reflects the excess of $19.6 billion in pre-tax operating income over $1 billion in realized capital losses on investments and $7 billion in federal income taxes.

The industry’s second-quarter pre-tax operating income of $19.6 billion is up from $18 billion in second-quarter 2005. Second-quarter 2006 operating income consisted of $6.6 billion in net gains on underwriting, $12.8 billion in net investment income and $0.2 billion in miscellaneous other income.

The $6.6 billion in net gains on underwriting in second-quarter 2006 is up 15.8 percent from $5.7 billion in second-quarter 2005. Net gains on underwriting increased even though catastrophe losses quadrupled to $3.8 billion in second-quarter 2006 from $0.9 billion in second-quarter 2005, according to ISO’s PCS unit.

Second-quarter 2006 net gains on underwriting amount to 6.1 percent of the $108.4 billion in premiums earned during the period, up from 5.4 percent of the $105.5 billion in premiums earned during second-quarter 2005.

The industry’s combined ratio improved to 92.8 percent in second-quarter 2006 from 93.9 percent in second-quarter 2005. At 92.8 percent, the industry’s second-quarter combined ratio improved to its best level since at least 1986, when ISO’s quarterly records begin.
The $6.6 billion in net gains on underwriting is after deductions for $0.3 billion in premiums returned to policyholders as dividends, with dividends to policyholders changing little since second-quarter 2005.
Written premiums rose to $112.8 billion in second-quarter 2006 from $108.4 billion in second-quarter 2005, with second-quarter written premium growth accelerating to 4 percent in 2006 from 2.1 percent in 2005. Nonetheless, second-quarter premium growth remains below the 5.1 percent that it was in 2004 and is down from a cyclical peak of 14.4 percent in 2002.

The $12.8 billion of net investment income is up 10.8 percent from $11.5 billion in the same period last year.

The $0.2 billion in miscellaneous other income is down 78.3 percent from $0.7 billion in second-quarter 2005.

The $1 billion in realized capital losses is a $2.2 billion adverse swing from the $1.2 billion in realized capital gains in second-quarter 2005.
Combining net investment income and realized capital gains, the industry posted $11.8 billion in net investment gains in second-quarter 2006, down 7.6 percent from $12.7 billion a year earlier.
Unrealized capital gains on investments dropped 38.7 percent to $0.6 billion in second-quarter 2006 from $1 billion in second-quarter 2005. Combining realized losses and unrealized capital gains, the insurance industry suffered $0.4 billion in overall capital losses in second-quarter 2006 — a $2.6 billion adverse swing from the $2.1 billion in overall capital gains in second-quarter 2005.