First Underwriting Profit Since 1978, Investment Gains Send Industry’s Net Income and Surplus to Record Highs

Benefiting from a rare profit on underwriting and investment gains, the U.S. property/casualty insurance industry’s net income after taxes rose 29 percent to a record $38.7 billion in 2004 from $30 billion in 2003.

Reflecting the industry’s income and unrealized capital gains on investments, its surplus, or statutory net worth, increased $46.5 billion, or 13.4 percent, to a record $393.5 billion at year-end 2004 from $347 billion at year-end 2003, according to ISO and the Property Casualty Insurers Association of America (PCI).

In nominal terms, the industry’s income in 2004 exceeded all previous full-year amounts. But adjusted for inflation, the industry’s income remained 10.6 percent below the all-time high in 1997. However, the industry’s surplus at year-end 2004 surpassed all previous year-end amounts, both before and after adjusting for inflation.

“Strong underwriting results powered the increase in insurers’ net income, with insurers’ $5 billion net gain on underwriting in 2004 constituting a $9.9 billion positive swing from their $4.9 billion net loss on underwriting in 2003. Prior to 2004, insurers suffered a net loss on underwriting every year since 1978. Insurers’ net gains on underwriting last year are all the more remarkable in view of the five catastrophic hurricanes that struck in 2004,” observed John Kollar, ISO’s vice president for consulting and research.

“The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — improved 2 percentage points to 98.1 percent in 2004 from 100.1 percent in 2003. At 98.1 percent, the combined ratio for 2004 was the best since the 97.4 percent combined ratio for 1978,” Kollar added.

“Increases in investment income and realized capital gains also contributed to the growth in insurers’ net income,” said Gregory Heidrich, the PCI’s senior vice president for policy development and research. “Net investment income — primarily dividends from stocks and interest on bonds — grew 2.4 percent to $39.6 billion in 2004 from $38.6 billion in 2003. And insurers realized $9.3 billion in capital gains on investments in 2004, up from $6.6 billion in 2003.”

Surplus also benefited from $9.9 billion in unrealized capital gains on investments not included in income.

The figures are consolidated estimates for all private property/casualty insurers based on reports accounting for 96 percent of all business written by private U.S. property/casualty insurers.

“Reflecting the increase in net income, the industry’s rate of return on average surplus rose to 10.5 percent last year from 9.5 percent in 2003,” observed Heidrich. “The industry’s rate of return has bounced back from a low of negative 2.3 percent in 2001 to its highest level since the 13.1 percent rate of return in 1997.”

“Still, insurance is a cyclical business. Improved profitability and the growth in capacity as measured by surplus seem to have sparked increased competition that threatens to undermine underwriting results going forward,” said Kollar.

“ISO MarketWatch data show that actual rate changes on renewals for commercial insurance polices turned positive in mid-1999 and gained momentum through July 2002, when they peaked at 12.9 percent.

“But since then, rate changes on renewals dwindled to just 2.1 percent in September 2004 — less than a sixth of what they were at their peak. And the Council of Insurance Agents and Brokers’ fourth-quarter 2004 survey indicates commercial insurance prices fell an average of 7 percent for accounts of all sizes. The spread between premium growth and GDP growth also indicates softening insurance markets. That spread has turned negative, with premium growth in 2004 falling 2 percentage points short of the 6.6 percent increase in GDP last year. In 2003, premium growth exceeded GDP growth by 4.5 percentage points,” Kollar noted.

“As good as insurers’ results were in 2004, they would have been even better if not for the five hurricanes in the third quarter — Charley, Gaston, Frances, Ivan and Jeanne. ISO’s Property Claim Services (PCS) unit estimates those storms and other catastrophes caused $27.5 billion in direct insured property losses last year — more than twice the $12.9 billion in direct losses from catastrophes in 2003,” said Heidrich. “Allowing for losses covered by residual market mechanisms, the Florida Hurricane Catastrophe Fund and foreign reinsurers, private U.S. insurers suffered an estimated $15.5 billion to $17.5 billion in net losses from catastrophes in 2004. If catastrophe losses had stayed at the level they were in 2003, insurers’ combined ratio would have improved all the way to 97.3 in 2004 — 0.8 percentage points better than the actual combined ratio for 2004 based on reported results and 2.8 percentage points better than the combined ratio for 2003,” Heidrich added.

Pre-tax operating income — the sum of gains or losses on underwriting, net investment income and other miscellaneous income — climbed $10.4 billion, or 30.7 percent, to $44.1 billion in 2004 from $33.8 billion in 2003. The growth in pre-tax operating income would have been even stronger if miscellaneous other income had not fallen to negative $0.5 billion in 2004 from negative $44 million in 2003.

Net investment gains — the sum of net investment income and realized capital gains (losses) — rose $3.6 billion, or 8 percent, to $48.9 billion in 2004 from $45.3 billion in 2003.

Partially offsetting the $10.4 billion increase in pre-tax operating income and the $2.7 billion increase in realized capital gains, the industry’s federal income taxes rose $4.3 billion to $14.7 billion in 2004 from $10.3 billion in 2003. Reflecting the changes in pre-tax operating income, realized capital gains and federal income taxes, insurers’ net income after taxes rose $8.7 billion to $38.7 billion in 2004.

The net gain on underwriting in 2004 amounts to 1.2 percent of the $412.6 billion in premiums earned during the year. The net gain on underwriting in 2004 contrasts with a net loss on underwriting in 2003 amounting to 1.3 percent of the $386.3 billion in premiums earned during that year.

Underwriting results improved even though premium growth slowed. Written premiums climbed $18.8 billion to $423.3 billion in 2004 from $404.4 billion in 2003. But written premium growth slowed to 4.7 percent in 2004 from 9.4 percent in 2003. Similarly, earned premiums rose $26.3 billion to $412.6 billion in 2004 from $386.3 billion in 2003, but earned premium growth slowed to 6.8 percent in 2004 from 10.9 percent in 2003.

“Reflecting developments in insurance markets, premium growth climbed fairly steadily from 1.8 percent in 1998 to a peak of 14.3 percent in 2002 but has been slowing ever since. At 4.7 percent, written premium growth last year had dropped to its slowest pace since the 1.9 percent increase in 1999,” said Kollar. “Similarly, at 6.8 percent, earned premium growth last year had dropped to its slowest pace since the 6.0 percent increase in 2001.”

Overall net loss and loss adjustment expenses increased $10.9 billion, or 3.8 percent, to $299.5 billion in 2004 from $288.7 billion in 2003. ISO estimates non-catastrophe loss and loss adjustment expenses rose $7.5 billion, or 2.7 percent, to $283.3 billion in 2004 from $275.8 billion a year earlier.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $5.7 billion, or 5.7 percent, to $106.4 billion last year from $100.7 billion in 2003.
Dividends to policyholders declined 11.7 percent to $1.6 billion in 2004 from $1.9 billion in 2003.

The $46.5 billion increase in the industry’s consolidated surplus in 2004 compares with a $61.6 billon increase in 2003. The increase in surplus in 2004 consisted of $38.7 billion in net income after taxes, $9.9 billion in unrealized capital gains on investments, $8.3 billion in new funds paid in and $2.8 billion in miscellaneous additions to surplus, less $13.3 billion in dividends to stockholders.

* The $9.9 billion in unrealized capital gains in 2004 is down 60.4 percent from $25 billion in 2003.
* The $8.3 billion in new funds paid in during 2004 is down 26.5 percent from $11.3 billion a year earlier.
* The $13.3 billion in dividends to stockholders in 2004 is up 45.9 percent from $9.1 billion in 2003.
* The $2.8 billion in miscellaneous additions to surplus in 2004 is down $1.6 billion from $4.4 billion in 2003.

Combining realized and unrealized capital gains, insurers posted $19.2 billion in overall capital gains on investments in 2004 — down $12.4 billion, or 39.2 percent, from $31.6 billion in 2003.

“The decline in insurers’ total capital gains on investments is a reflection of developments in financial markets. During 2004, the S&P 500 rose 9 percent — only about one-third the 26.4 percent increase in the S&P 500 during 2003,” commented Kollar. “Moreover, with the S&P 500 having fallen 2.6 percent in first-quarter 2005 and other major stock market indexes also having declined so far this year, insurers may post capital losses, rather than capital gains, when they file their next set of financial statements. Beyond that, any projection for capital gains is only as good as the underlying forecast for stock prices.”

“Developments in financial markets also affect investment income,” said Heidrich. “The 2.4 percent increase in investment income in 2004 is the net result of an 11.7 percent increase in insurers’ average holdings of cash and invested assets and an 8.3 percent decline in the yield on those assets. Though the Federal Reserve Board has raised its target interest rate seven times since June 2004, with the most recent increase coming on March 22, the yield on 10-year Treasury notes on March 23 was just 4.61 percent — 9 basis points below the 4.70 percent that it was last June 29, the day before the Fed’s first move. If investment yields don’t recover and escalating competition in insurance markets cuts into underwriting cash flows that fund new investments, we could see some weakness in investment income going forward.”

Q4 results
The industry’s consolidated net income after taxes rose 26.1 percent to $11.6 billion in fourth-quarter 2004 from $9.2 billion in fourth-quarter 2003. The industry’s net income for fourth-quarter 2004 reflects the excess of $12.9 billion in pre-tax operating income and $2.8 billion in realized capital gains on investments over $4.1 billion in federal income taxes.

The industry’s fourth-quarter pre-tax operating income of $12.9 billion is up 8.2 percent from $11.9 billion in fourth-quarter 2003. Fourth-quarter 2004 operating income consisted of $2.2 billion in net gains on underwriting, $10.8 billion in net investment income and negative $0.1 billion in miscellaneous other income.

The $2.2 billion in net gains on underwriting is more than twice the $1 billion in net gains on underwriting in the fourth quarter of 2003. Contributing to the improvement in underwriting results, direct insured losses from catastrophes declined to $0.5 billion in fourth-quarter 2004 from $2.6 billion in fourth-quarter 2003, according to ISO’s PCS unit. The $0.5 billion in catastrophe losses during fourth-quarter 2004 compare with an average of $1.1 billion in fourth-quarter catastrophe losses during the 10 years from 1994 to 2003.

The fourth-quarter 2004 net gain on underwriting amounts to 2.1 percent of the $105.5 billion in premiums earned during the period, up from 1 percent of the $99 billion in premiums earned in fourth-quarter 2003.

The industry’s combined ratio improved to 98.8 percent in fourth-quarter 2004 from 99.5 percent in fourth-quarter 2003. The 98.8 percent combined ratio for fourth-quarter 2004 is the best fourth-quarter combined ratio since 1986, when ISO’s quarterly records begin.

The $2.2 billion in net gains on underwriting is after deductions for $0.8 billion in premiums returned to policyholders as dividends, with dividends to policyholders falling 19 percent from $1 billion in fourth-quarter 2003.

Written premiums rose to $102 billion in fourth-quarter 2004 from $97 billion in fourth-quarter 2003, but fourth-quarter written premium growth dropped to 5.2 percent in 2004 from 8.5 percent in 2003 and 15.8 percent in 2002. At 5.2 percent, fourth-quarter premium growth had dropped to its slowest pace since the 2.1 percent increase in fourth-quarter 1999.

* The $10.8 billion of net investment income is down 1.2 percent from $11 billion in fourth- quarter 2003.
* The negative $0.1 billion in miscellaneous other income is down from negative $59 million in fourth-quarter 2003.
* The $2.8 billion in realized capital gains is almost three times the $1 billion in realized capital gains in fourth-quarter 2003.

Combining net investment income and realized capital gains, the industry posted $13.7 billion in net investment gains in fourth-quarter 2004, up 14.1 percent from $12 billion a year earlier.

Topics Catastrophe Carriers USA Profit Loss Excess Surplus Underwriting Property Property Casualty