Absence of Hurricane Losses Proves Beneficial to Insurers’ Bottomline

Driven by a sharp decline in catastrophe losses from hurricanes and other natural disasters in 2006, the U.S. property/casualty industry posted a $24.4 billion net gain on underwriting through nine months. The net gain on underwriting through nine-months 2006 stands in stark contrast to the $2.5 billion net loss on underwriting through nine-months 2005.

The industry’s positive underwriting results contributed to an increase in its net income after taxes to $44.9 billion in nine-months 2006 from $29.7 billion in nine-months 2005. Reflecting the increase in net income after taxes, the industry’s annualized rate of return on average policyholders’ surplus (net worth) rose to 13.4 percent in nine-months 2006 from 9.8 percent in nine-months 2005, according to ISO and the Property Casualty Insurers Association of America (PCI).

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.

Catastrophe Losses
According to ISO’s Property Claim Services (PCS) unit, direct insured losses from catastrophes dropped to $7.6 billion in nine-months 2006 from $51.1 billion in nine-months 2005.

“Much of the improvement in insurers’ underwriting and overall results is attributable to the decline in catastrophe losses from the record level experienced in nine-months 2005, as Hurricanes Katrina and Rita slammed into the Gulf Coast,” noted Michael R. Murray, ISO assistant vice president for financial analysis. “Allowing for losses from Katrina and Rita that didn’t emerge until after insurers closed their books for nine-months 2005 and factoring out losses covered by residual market insurers, the Florida Hurricane Catastrophe Fund and foreign insurers, ISO estimates the catastrophe losses included in private U.S. insurers’ net financial results declined by $17.3 billion to $10.1 billion in nine-months 2006 from $27.5 billion in nine-months 2005. ISO also estimates that catastrophe-related net loss adjustment expenses declined to $0.5 billion in nine-months 2006 from $0.9 billion in nine-months 2005, contributing another $0.4 billion to the improvement in underwriting results.”

“While the fact that no major hurricanes hit the U.S. in 2006 was certainly good news for the millions of consumers still recovering from the devastating impact of the 2004 and 2005 storm seasons, we view this development as an anomaly rather than a trend,” said Genio Staranczak, PCI’s chief economist. “Natural catastrophes still pose a huge threat to consumers and businesses along the Gulf and Atlantic Coasts. The industry, state and federal governments, private businesses and individuals must continue to better prepare themselves by ensuring that financial reserves are adequate, strengthening building codes and land use regulations, and putting in place catastrophe recovery plans to speed relief to those who need it after a disaster occurs.”

ISO and the PCI noted that modeling by AIR Worldwide indicates that hurricanes causing $100 billion or more insured losses are a very real possibility and that large population centers in the West and Midwest face the prospect of a major earthquake. A repeat of the 1906 San Francisco earthquake could cause $108 billion in insured losses, while a repeat of the 1812 New Madrid earthquake could cause $88 billion in insured losses, according to AIR.

Underwriting Results
The improvement in underwriting results in nine-months 2006 reflects both growth in premiums and a decline in loss and loss adjustment expenses.

Net written premiums climbed $16.5 billion to $337.8 billion in nine-months 2006 from $321.3 billion in nine-months 2005, with written premium growth accelerating to 5.1 percent in nine-months 2006 from negative 0.2 percent in nine-months 2005. Net earned premiums rose $14.9 billion to $325.4 billion in nine-months 2006 from $310.5 billion in nine-months 2005, with earned premium growth accelerating to 4.8 percent in nine-months 2006 from 0.8 percent in nine-months 2005.

Overall loss and loss adjustment expenses declined $17.9 billion, or 7.8 percent, to $212.2 billion in nine-months 2006 from $230 billion in nine-months 2005. Non-catastrophe loss and loss adjustment expenses declined $0.1 billion, or 0.1 percent, to $201.5 billion in nine-months 2006 from $201.6 billion a year earlier.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $5.5 billion, or 6.7 percent, to $87.7 billion in the first three quarters of this year from $82.2 billion in the first three quarters of last year.

Dividends to policyholders rose 47.1 percent to $1.1 billion in nine-months 2006 from $0.7 billion in nine-months 2005.

The net gain on underwriting in nine-months 2006 amounts to 7.5 percent of the $325.4 billion in premiums earned during the period, whereas the net loss on underwriting in nine-months 2005 amounted to 0.8 percent of the $310.5 billion in premiums earned during that period.

The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — improved 8.4 percentage points to 91.5 percent in the first three quarters of 2006 from 99.9 percent in the first three quarters of 2005.

Two special developments affected the reported trends in premiums and losses through nine-months 2006. Last year, one insurer ceded $6 billion in premiums and the same amount of loss and loss adjustment expenses to its foreign parent. And earlier this year, one insurer stopped reporting as a property/casualty insurer and began instead reporting as a health insurer. If not for those developments, industry written premiums would have increased 3.8 percent in nine-months 2006, and loss and loss adjustment expenses would have declined 9.4 percent.

“At an adjusted 3.8 percent, written premium growth in nine-months 2006 fell far short of growth in the economy,” added Murray. “U.S. gross domestic product (GDP) — a dollar measure of national output — rose 6.6 percent in the first three quarters of 2006 compared with its level a year earlier. That premiums rose only about half as much as GDP is an indication that insurers’ recent results are spurring competition and leading to lower prices in many insurance markets, despite ongoing problems in specific markets exposed to natural catastrophes.”

“Other evidence that insurers’ recent results are spurring competition and leading to lower prices includes a report from The Council of Insurance Agents and Brokers that commercial insurance prices fell an average of 5.3 percent for all sizes of accounts in third-quarter 2006 and trends in government Consumer Price Indexes for personal lines coverage,” said Staranczak. “Countrywide, the CPI for Tenants’ and Household Insurance fell 1 percent in third-quarter 2006 compared with its level a year earlier, and the CPI for Motor Vehicle Insurance rose just 0.4 percent — far less than the 3.3 percent increase in consumer prices overall.”

Investment Results
Contributing to the increases in net income after taxes and overall profitability, the industry’s net investment income — primarily dividends from stocks and interest on bonds — grew 2.4 percent to $37.5 billion in the first nine months of this year from $36.6 billion in the first nine months of last year. But realized capital gains on investments (not included in net investment income) tumbled 66.2 percent to $1.5 billion in nine-months 2006 from $4.3 billion in nine-months 2005. Combining net investment income and realized capital gains, overall net investment gains fell 4.8 percent to $38.9 billion through nine-months 2006 from $40.9 billion through nine-months 2005.

Combining the $1.5 billion in realized capital gains in nine-months 2006 with the $12 billion in unrealized capital gains during the period, insurers posted $13.5 billion in overall capital gains in the first three quarters of 2006 — up from $3.8 billion in overall capital gains during the first three quarters of 2005.

“The increase in overall capital gains to $13.5 billion in nine-months 2006 from $3.8 billion in nine-months 2005 reflects developments in financial markets,” said Murray. “In the first nine months of 2006, the S&P 500 rose 7 percent — five times the 1.4 percent increase in the S&P 500 in the first nine months of 2005. With respect to the outlook for capital gains going forward, the S&P 500 rose 6.2 percent from the end of the third quarter through December 21, suggesting insurers’ fourth-quarter results will benefit from additional capital gains.”

Pretax Operating Income and Federal Income Taxes
Pretax operating income — the sum of net gains or losses on underwriting, net investment income and miscellaneous other income — climbed 78 percent to $62.1 billion in nine-months 2006 from $34.9 billion in nine-months 2005, even though miscellaneous other income fell to $0.2 billion in the first three quarters of 2006 from $0.8 billion in the first three quarters of 2005.

Partially offsetting the effect of the increase in operating income on insurers’ net income after taxes, the industry incurred $18.7 billion in federal income taxes in nine-months 2006 — nearly double the $9.4 billion in income taxes the industry incurred in nine-months 2005.

Policyholders’ Surplus
The property/casualty insurance industry’s statutory net worth, or policyholders’ surplus, increased 9.8 percent to $467.6 billion at September 30 of this year from $425.8 billion at year-end 2005. The $41.8 billion increase in policyholders’ surplus in nine-months 2006 compares with a $22.9 billon increase in nine-months 2005.

The increase in surplus in nine-months 2006 consisted of $44.9 billion in net income after taxes, $12 billion in unrealized capital gains on investments (not included in net income) and $2.8 billion in new funds paid in (new capital raised by insurers), less $16.3 billion in dividends to shareholders and $1.5 billion in miscellaneous charges against surplus.

The $12 billion in unrealized capital gains in nine-months 2006 constitutes a $12.5 billion positive swing from the $0.5 billion in unrealized capital losses in nine-months 2005.

The $2.8 billion in new funds paid in during nine-months 2006 is down 56.7 percent from $6.4 billion in nine-months 2005.

The $16.3 billion in dividends to shareholders in nine-months 2006 is up from $9.9 billion in nine-months 2005.

The $1.5 billion in miscellaneous charges against surplus in nine-months of this year is an improvement from the $2.9 billion in such charges in nine-months 2005.

Third-Quarter Results
The industry’s consolidated net income after taxes for third-quarter 2006 amounted to $16.5 billion, an $18 billion positive swing from the $1.5 billion net loss after taxes in third-quarter 2005. The industry’s net income for third-quarter 2006 reflects the excess of $22.3 billion in pretax operating income and $0.6 billion in realized gains on investments over $6.4 billion in federal income taxes.

The industry’s third-quarter pretax operating income of $22.3 billion contrasts with its $4 billion in pretax operating losses in third-quarter 2005. Third-quarter 2006 operating income consisted of $9.3 billion in net gains on underwriting, $13 billion in net investment income and $0.1 billion in miscellaneous other income.

The $9.3 billion in net gains on underwriting in third-quarter 2006 is a $24.6 billion positive swing from the $15.2 billion in net losses on underwriting in third-quarter 2005. Much of the improvement in third-quarter underwriting results reflects a decline in catastrophe losses from their record high in third-quarter 2005. Direct insured catastrophe losses fell to $1.3 billion in third-quarter 2006 from $48 billion in third-quarter 2005, according to ISO’s PCS unit. Factoring out catastrophe losses covered by residual market mechanisms, the Florida Hurricane Catastrophe Fund and foreign insurers — and adjusting for the delayed emergence of losses from the hurricanes of 2005 — ISO estimates that the catastrophe losses and loss adjustment expenses included in private U.S. insurers’ net financial results fell to $1.5 billion in third-quarter 2006 from $25.2 billion a year earlier.

Third-quarter 2006 net gains on underwriting amounted to 8.4 percent of the $110.4 billion in premiums earned during the period, in contrast to third-quarter 2005 net losses on underwriting amounting to 15.1 percent of the $101.2 in premiums earned during that period.

The industry’s combined ratio improved to 90.6 percent in third-quarter 2006 from 114.2 percent in third-quarter 2005. At 90.6 percent, the industry’s combined ratio was the best for any quarter since at least 1986, when ISO’s quarterly records begin.

The $9.3 billion in net gains on underwriting is after deductions for $0.5 billion in premiums returned to policyholders as dividends, with dividends to policyholders more than doubling from $0.2 billion in third-quarter 2005.

Written premiums rose to $114.5 billion in third-quarter 2006 from $104.4 billion in third-quarter 2005, with third-quarter written premium growth accelerating to 9.7 percent in 2006 from negative 4.8 percent in third-quarter 2005 based on reported results. But adjusted for one insurer that stopped reporting as a property/casualty insurer in 2006 and began reporting instead as a health insurer and for a special transaction in third-quarter 2005 in which one insurer ceded $6 billion in premiums to its foreign parent, written premiums increased 4.4 percent in third-quarter 2006.

The $13 billion in net investment income is up 15.8 percent from $11.2 billion in the same period last year.

The $0.6 billion in realized capital gains is down $1.1 billion from $1.7 billion in third-quarter 2005.

Combining net investment income and realized capital gains, the industry posted $13.6 billion in net investment gains in third-quarter 2006, up 5 percent from $12.9 billion a year earlier.

Unrealized capital gains on investments rose 54.3 percent to $7.4 billion in third-quarter 2006 from $4.8 billion in third-quarter 2005. Combining realized and unrealized capital gains, the insurance industry posted $8 billion in overall capital gains in third-quarter 2006 — a $1.5 billion, or 22.9 percent, increase from the $6.5 billion in overall capital gains in third-quarter 2005.

Miscellaneous other income was essentially unchanged at $0.1 billion in both third-quarter 2006 and third-quarter 2005.

Net income would have risen more in third-quarter 2006 if not for an increase in the industry’s federal income taxes. The industry’s federal income taxes rose to $6.4 billion — a $7.2 billion adverse swing from the $0.8 billion in income taxes recovered by insurers in third-quarter 2005.

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