Weak Investment Results Throw Curve at P/C Insurers’ Recovery at Nine-Month Mark

Thanks to strong premium growth and lower catastrophe losses, the U.S. property/casualty industry earned $9.3 billion in net income after taxes through nine-months 2002, in sharp contrast to the $2.6 billion net loss through nine-months 2001. But the industry’s surplus, or net worth, fell 5.6 percent to $273.3 billion at Sept. 30 from $289.6 billion at year-end 2001, as a result of capital losses on investments, according to Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).

Net written premiums for nine-months 2002 rose 13.6 percent versus year-ago levels to $279.8 billion, and the catastrophe losses included in insurers’ financial results declined to $3.9 billion through nine-months 2002 from $16.3 billion through nine-months 2001. Reflecting these positive developments, the industry’s net loss on underwriting fell 51.4 percent to $18 billion for nine-months 2002 from $37.1 billion for nine-months 2001. The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — improved to 104.9 percent for nine-months 2002, 9.5 percentage points better than the 114.4 percent for the same period last year.

The figures are consolidated estimates for the entire industry based on the reports of insurers that account for 96 percent of the U.S. property/casualty insurance business.

“The decline in catastrophe losses accounts for 5.2 percentage points of the 9.5-percentage-point improvement in the industry’s combined ratio for nine-months 2002,” John Kollar, ISO vice president for consulting and research, said.

“The news is not that catastrophe losses fell from 2001 levels elevated by terrorism losses, but that almost half of the improvement in underwriting results came from premium growth in excess of growth in non-catastrophe losses and other expenses. Firming in insurance markets is finally benefiting underwriting results. All else being equal, premiums might grow in proportion to the economy. But, every year from 1988 to 2000 with just one exception, premium growth fell short of economic growth, with the cumulative shortfall coming to 52.5 percent. That situation finally reversed in 2001, with premium growth exceeding GDP growth by 0.6 percent. The positive spread between premium growth and GDP growth widened substantially in 2002, but not nearly enough to make up for the cumulative shortfall that developed over 13 years,” Kollar added.

Improvement in underwriting results drove the industry’s net income higher, despite declines in investment income and realized capital gains on investments. Net investment income — primarily dividends earned from stocks and interest on bonds — declined 5.4 percent to $26.4 billion in nine-months 2002 from $28 billion in nine-months 2001. Insurers realized $3.1 billion in capital gains on investments in nine-months 2002, down 53.9 percent from $6.7 billion in the first nine months of last year. Combining net investment income and realized capital gains, the industry’s net investment gain through nine-months 2002 amounted to $29.5 billion, down 14.8 percent from $34.6 billion through nine-months 2001.

“The 5.4 percent decrease in investment income versus year-ago levels reflects a decline in the yield on investments,” Don Griffin, NAII assistant vice president for business and personal lines, commented. “Insurers’ average holdings of cash and invested assets during the first nine months of 2002 were 1.6 percent above their average holdings of cash and invested assets in the first nine months of 2001, but the annualized yield on cash and invested assets during the period fell 6.9 percent versus year-ago levels. With market interest rates languishing near 40-year lows and the Federal Reserve having cut its benchmark discount rate to 0.75 percent on November 6, low yields are apt to impede the growth of investment income going forward,” Griffin added.

Also limiting the improvement in the industry’s overall net income after taxes, insurers’ income from other miscellaneous operations amounted to negative $103 million through nine-months 2002, compared with negative $46 million through nine-months 2001, and the industry’s federal income taxes rose to $2.1 billion from $51 million.

Netting realized capital gains of $3.1 billion through nine-months 2002 against $28 billion in unrealized capital losses, the industry suffered $25 billion in overall capital losses through nine-months 2002. The $28 billion in unrealized capital losses on investments caused the industry’s surplus to drop $16.3 billion during the first nine months of 2002, even as the industry earned $9.3 billion in net income after taxes.

“The capital losses on investments and the decline in surplus through nine-months 2002 are a direct result of weakness in stock markets,” Kollar said. “The S&P 500 declined 29 percent during the first-nine months of the year. Since then, stock prices have recovered a bit from their lows, with the S&P 500 rising 9.1 percent from the end of the third quarter through Friday, December 13. Whether insurers will enjoy capital gains or suffer capital losses going forward depends on whether recent increases in stock prices mark the start of the next bull market or prove to be just a blip in the bear market that has cut 39.5 percent from the S&P 500 since year-end 1999,” Kollar added.

Growth in net written premiums accelerated to 13.6 percent versus year-ago levels in nine-months 2002 from 8.6 percent in nine-months 2001. The 13.6 percent increase is the largest percentage increase in premiums through nine months since 1986, when premiums rose 23 percent versus year-ago levels.

“Even with the strength in premium growth, insurers’ recovery from the terrorist attack on September 11, 2001, remains far from complete,” Griffin observed. “The industry’s annualized rate of return on average surplus for the first nine months of 2002 was just 4.4 percent — well below recent and long-term norms and not high enough to attract the capital insurers will need to keep up with society’s ever-increasing demand for insurance protection,” Griffin added.

“Paradoxically, the federal terrorism backstop provided by the Terrorism Risk Insurance Act of 2002 may actually increase the risk-adjusted rate of return demanded by investors supplying capital to the insurance industry,” Kollar said. “Before the act, insurers were able to exclude terrorism coverage from many commercial policies. Now, insurers must offer terrorism coverage, and, even with the federal backstop, some may suffer substantial terrorism losses as a result of the high deductibles and the 10 percent participation in losses above deductibles specified by the law. Mandating terrorism coverage makes the insurance business riskier, at least in the short term, because of all the uncertainty about losses from future terrorist attacks, how the backstop will actually work, and whether insurers will be able to buy reinsurance protection against future attacks.”

“The new federal law also increases the pressure on insurers to learn how to underwrite, price and manage terrorism risk,” Griffin went on to say. “For example, effective immediately, insurers must disclose how much they are charging for terrorism coverage when writing new commercial policies. Given there is almost no historical data for pricing terrorism coverage, insurers will need to rely on models such as those developed by AIR Worldwide.”

Overall loss and loss-adjustment expenses increased 0.5 percent to $205.4 billion in nine-months 2002 from $204.4 in nine-months 2001, as non-catastrophe loss and loss-adjustment expenses rose 7.1 percent to $201.4 billion in nine-months 2002 from $188.1 billion a year earlier.

According to ISO’s Property Claim Services (PCS) unit, catastrophe losses through nine months totaled $3.9 billion, down from the estimated $16.3 billion in catastrophe losses actually included in insurers’ financial results for nine-months 2002. The $16.3 billion reflects ISO’s estimate that insurers’ reported financial results for nine-months 2001 included $9 billion in net losses after reinsurance from the terrorist attack on September 11 and $7.3 billion in losses from other catastrophes during the first nine months of last year.

ISO estimates that U.S. insurers’ losses from the terrorist attack will ultimately be between $15 billion and $25 billion for all lines on a net basis after reinsurance recoveries and that the tab for all insurers worldwide will ultimately range from $30 billion to $50 billion. ISO’s PCS unit estimates that property and business-interruption losses from the attack will ultimately total $20.3 billion and that property and business-interruption losses from all catastrophes through nine-months 2001 will ultimately total $27.6 billion.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose 9.8 percent to $70.1 billion in the first nine months of this year from $63.9 billion in the first nine months of last year.

For the full report, log onto: www.iso.com.