P/C Insurers Post First Half Profit Despite Underwriting Losses

September 16, 2010

Private U.S. property/casualty insurers’ net income after taxes rose to $16.5 billion in first-half 2010 from $6 billion in first-half 2009, with insurers’ overall profitability as measured by their annualized rate of return on average policyholders’ surplus increasing to 6.3 percent from 2.6 percent.

Reflecting insurers’ $16.5 billion in net income and other developments in first-half 2010, policyholders’ surplus — insurers’ net worth measured according to Statutory Accounting Principles — rose $19.1 billion, or 3.7 percent, to $530.5 billion at June 30, 2010, from $511.4 billion at year-end 2009.

Insurers’ net investment gains — the sum of net investment income and realized capital gains (or losses) on investments — grew $13.3 billion to $25.8 billion in first-half 2010 from $12.5 billion in first-half 2009, powering the increases in the insurance industry’s net income, overall rate of return, and policyholders’ surplus.

Partially offsetting the improvement in investment results, insurers’ net losses on underwriting grew to $5.1 billion for six-months 2010 from $2.1 billion for six-months 2009. The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — deteriorated to 101.7 percent for six-months 2010 from 100.8 percent for six-months 2009, 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.

“Property/casualty insurers’ positive results for first-half 2010 are yet another testament to the conservative investment strategies and superior risk management that enabled insurers to emerge from the financial crisis and great recession essentially unscathed,” said David Sampson, PCI’s president and CEO.

Sampsons aid that combining insurers’ $530.5 billion in policyholders’ surplus as of June 30 with their $556.1 billion in loss and loss adjustment expense reserves and their $202.3 billion in unearned premium reserves, means insurers have nearly $1.3 trillion on hand to pay claims and meet other contingencies — up from $1.2 trillion at June 30, 2009.

“This means we can all be confident that insurers have the financial resources to fulfill their obligations to policyholders when catastrophes strike,” he said.

“Insurers’ positive results for first-half 2010 make it easy to overlook the ongoing challenges facing insurers. With the recovery from the great recession remaining agonizingly slow and competition in commercial insurance markets continuing to escalate, top-line premiums remained flat and insurers’ rate of return remained far below benchmarks like the 13.9 percent long-term average rate of return for the Fortune 500,” said Michael R. Murray, ISO’s assistant vice president for financial analysis.

Murray said that insurers’ 6.3 percent annualized rate of return for first-half 2010 was also 3.1 percentage points less than the 9.4 percent average annualized first-half rate of return for the insurance industry based on quarterly data extending back to 1986.

“Because of today’s low investment returns and the same long-term decline in investment leverage that helped insulate insurers from the financial crisis, insurers must now achieve better underwriting results just to be as profitable as they once were,” Murray said, noting that in first-half 1986, insurers achieved a 14.1 percent annualized rate of return with a combined ratio of 108.9 percent. Insurers’ annualized rate of return for first-half 2010 was 7.8 percentage points lower even though the combined ratio was 7.2 percentage points better.

The property/casualty industry’s 6.3 percent annualized rate of return for first-half 2010 is the net result of negative rates of return for mortgage and financial guaranty insurers and single-digit rates of return for other insurers. ISO estimates that mortgage and financial guaranty insurers’ annualized rate of return on average surplus for first-half 2010 was negative 43.2 percent, up from negative 76.4 percent for first-half 2009. Excluding mortgage and financial guaranty insurers, the industry’s annualized rate of return rose to 7.5 percent in the first half of 2010 from 4.6 percent in the first half of 2009.

Underwriting Results

Much of the $2.9 billion increase in net losses on underwriting to $5.1 billion in first-half 2010 reflects a decline in net earned premiums. Though net written premiums were essentially unchanged at $212.5 billion in first-half 2010 and first-half 2009, net earned premiums fell $4 billion, or 1.9 percent, to $207.1 billion through six-months 2010 from $211.2 billion through six-months 2009 as a result of previous declines in written premiums.

Tempering the effects of the decline in earned premiums, net LLAE (after reinsurance recoveries) fell $2 billion, or 1.3 percent, to $151.9 billion in the first half of 2010 from $153.9 billion in the first half of 2009.

About a fifth of the decline in overall LLAE is attributable to a drop in the net LLAE caused by catastrophes striking the United States. ISO estimates that private insurers’ net LLAE from such catastrophes dropped $0.4 billion to $8.3 billion in first-half 2010 from $8.7 billion in first-half 2009, with net catastrophe LLAE for first-half 2009 including some late-emerging losses from Hurricane Ike in 2008.

According to ISO’s Property Claim Services (PCS) unit, catastrophes striking the United States in first-half 2010 caused $7.9 billion in direct insured losses (before reinsurance recoveries) for all insurers (including residual-market insurers and foreign insurers and reinsurers), up $0.2 billion compared with the direct insured losses caused by catastrophes striking the United States in first-half 2009 and $2 billion more than the $6 billion average for first-half direct catastrophe losses during the past ten years.

Noncatastrophe net LLAE fell $1.6 billion, or 1.1 percent, to $143.6 billion for first-half 2010 from $145.2 billion for first-half 2009. Downward revisions to the estimated ultimate cost of claims incurred in prior periods and consequent releases of LLAE reserves more than account for the decline in noncatastrophe LLAE, with LLAE reserve releases increasing $1.7 billion to $8.8 billion in first-half 2010 from $7.1 billion in first-half 2009.

Other underwriting expenses — primarily acquisition expenses; expenses associated with underwriting, pricing, and servicing insurance policies; and premium taxes — rose $0.8 billion, or 1.4 percent, to $59.6 billion in first‒half 2010 from $58.7 billion in first-half 2009. And dividends to policyholders increased $0.1 billion to $0.8 billion in the first six months of 2010 from $0.7 billion in the first six months of 2009.

“The absence of premium growth in first-half 2010 reflects the ongoing consequences of a once-in-a-generation economic storm. Average seasonally adjusted total private-sector employment fell 1.8 percent to 107.4 million in first-half 2010 from 109.4 million in first-half 2009, with the average unemployment rate climbing to 9.7 percent from 8.7 percent,” said Sampson. “The weakness in the economy reduced demand for insurance and thereby contributed to continued softening in commercial insurance markets.”

But Murray said the weakness in the economy may have also had a beneficial effect on claim frequency and claim severity and to the extent that loss experience has been better than insurers anticipated when they did their reserve analyses for year-end 2009, the weakness in the economy may have contributed to the reserve releases that benefited insurers’ results for first-half 2010. Excluding reserve releases, loss and loss adjustment expenses fell 0.2 percent to $160.7 billion in first-half 2010 from $161 billion in first-half 2009, net losses on underwriting rose to $13.9 billion from $9.3 billion, and the combined ratio jumped to 106 percent from 104.2 percent.”

The $5.1 billion net loss on underwriting for first-half 2010 amounted to 2.4 percent of the $207.1 billion in net premiums earned during the period, whereas the $2.1 billion net loss on underwriting for first-half 2009 amounted to 1 percent of the $211.2 billion in net premiums earned during that period.

“Reflecting the weakness in the economy and foreclosure rates, mortgage and financial guaranty insurers continued to suffer disproportionate losses on underwriting,” said Sampson.

Mortgage and financial guaranty insurers’ net written premiums declined 21.3 percent to $2.7 billion for first-half 2010, and their net earned premiums dropped 15.2 percent to $3.3 billion. With mortgage and financial guaranty insurers’ loss and loss adjustment expenses falling only 7.5 percent to $5.7 billion, their combined ratio deteriorated to 197.6 percent for first-half 2010 from 171.8 percent for first-half 2009. Excluding mortgage and financial guaranty insurers, industry net written premiums rose 0.3 percent, earned premiums fell 1.6 percent, loss and loss adjustment expenses dropped 1.1 percent, and the combined ratio rose to 100.1 percent for first‒half 2010 from 99.4 percent a year earlier.

Investment Results

Insurers’ net investment income — primarily dividends from stocks and interest on bonds — was unchanged at $23.6 billion in both first-half 2010 and first-half 2009. But insurers’ $2.2 billion in realized capital gains on investments in first-half 2010 constituted a $13.3 billion swing from insurers’ $11.1 billion in realized capital losses on investments in first-half 2009. Combining net investment income and realized capital gains, overall net investment gains more than doubled to $25.8 billion for the first six months of this year from $12.5 billion for the first six months of 2009.

Combining the $2.2 billion in realized capital gains in first-half 2010 with $6.8 billion in unrealized capital losses during the period, insurers posted $4.5 billion in overall capital losses for the first six months of 2010 — a $7.4 billion improvement from the $11.9 billion in overall capital losses on investments for the first six months of 2009.

“With insurers’ investment income being a function of investment yields and the amount of insurers’ cash and invested assets, insurers’ investment income was unchanged in first-half 2010 because of offsetting changes in investment yields and insurers’ investments,” said Murray. “In particular, insurers’ annualized yield on cash and invested assets dropped to 3.8 percent in first-half 2010 from 4 percent in first-half 2009 as insurers’ average holdings of cash and invested assets rose 5.1 percent.”

Pretax Operating Income

Pretax operating income — the sum of net gains or losses on underwriting, net investment income, and miscellaneous other income — fell $3.2 billion, or 14.5 percent, to $19.2 billion for first-half 2010 from $22.4 billion for first-half 2009. The $3.2 billion decrease in operating income was a result of the $2.9 billion increase in net losses on underwriting and a $0.3 billion decline in miscellaneous other income to $0.6 billion in first-half 2010 from $0.9 billion in first-half 2009.

Net Income after Taxes

Combining operating income, realized capital gains (losses), and federal and foreign income taxes, the insurance industry’s net income after taxes for first-half 2010 totaled $16.5 billion — up from $6 billion for first-half 2009. The $10.6 billion increase in net income was the net result of the $3.2 billion decrease in operating income, the $13.3 billion swing to $2.2 billion in realized capital gains from $11.1 billion in realized capital losses, and a $0.5 billion decrease in federal and foreign income taxes to $4.9 billion in first-half 2010 from $5.3 billion a year earlier.

Policyholders’ Surplus

Policyholders’ surplus increased $19.1 billion to $530.5 billion as of June 30, 2010, from $511.4 billion at year-end 2009. Additions to surplus in first-half 2010 included insurers’ $16.5 billion in net income after taxes and $23.8 billion in new funds paid in. Those additions were partially offset by $6.8 billion in unrealized capital losses on investments (not included in net income), $12.7 billion in dividends to shareholders, and $1.7 billion in miscellaneous other charges against surplus.

The $23.8 billion in new funds paid in during first-half 2010 was up from $2.3 billion in first-half 2009 and is the largest amount for any first-half since the start of ISO’s quarterly data in 1986. The record-high $23.8 billion for first-half 2010 included $22.5 billion contributed to one insurer by its parent as the insurer absorbed a major acquisition outside the insurance space. The previous record high for first-half new funds was $4 billion in first-half 2008.

Second-Quarter Results

The property/casualty insurance industry’s consolidated net income after taxes rose 6.3 percent to $7.6 billion in second-quarter 2010 from $7.2 billion in second-quarter 2009. But property/casualty insurers’ annualized rate of return on average surplus dropped to 5.7 percent in second-quarter 2010 from 6.4 percent a year earlier because the growth in income failed to keep pace with the growth in average surplus.

Second-quarter 2010 net income for the entire insurance industry consisted of $8.9 billion in pretax operating income and $1.2 billion in realized capital gains on investments, less $2.5 billion in federal and foreign income taxes.

The industry’s second-quarter pretax operating income of $8.9 billion was down 30.5 percent from $12.8 billion in second-quarter 2009. Second-quarter 2010 operating income consisted of $3.3 billion in net losses on underwriting, $12 billion in net investment income, and $0.2 billion in miscellaneous other income. Excluding mortgage and financial guaranty insurers, operating income fell 14.4 percent to $9.5 billion in second-quarter 2010 from $11.1 billion in second-quarter 2009.

The $3.3 billion in net losses on underwriting in second-quarter 2010 constitutes a $3.7 billion swing from the $0.4 billion in net gains on underwriting in second-quarter 2009.

ISO estimates that the net catastrophe loss and loss adjustment expenses (after reinsurance recoveries) included in private U.S. insurers’ financial results rose to $5.6 billion in second-quarter 2010 from $5.2 billion a year earlier.

Excluding loss adjustment expenses, direct insured losses from catastrophes striking the United States in second-quarter 2010 totaled $5.4 billion, up $0.9 billion from the direct insured losses caused by catastrophes that struck the United States in second-quarter 2009, according to ISO’s PCS unit.

Second-quarter 2010 net losses on underwriting amounted to 3.1 percent of the $104.4 billion in premiums earned during the period, in contrast to second-quarter 2009 net gains on underwriting amounting to 0.4 percent of the $105.7 billion in premiums earned during that period.

The industry’s combined ratio deteriorated to 102.3 percent in second-quarter 2010 from 99.5 percent in second-quarter 2009.

The $3.3 billion in net losses on underwriting is after deducting $0.3 billion in premiums returned to policyholders as dividends, with dividends to policyholders down $0.1 billion from their level in second-quarter 2009.

Written premiums rose $1.4 billion, or 1.3 percent, to $107.6 billion in second-quarter 2010 from $106.2 billion in second-quarter 2009. The increase in quarterly written premiums was the first since first-quarter 2007, when written premiums rose 0.8 percent.

But earned premiums fell $1.3 billion, or 1.2 percent, to $104.4 billion in second-quarter 2010 from $105.7 billion in second-quarter 2009 as a result of previous declines in written premiums.

Excluding mortgage and financial guaranty insurers, net written premiums rose 1.6 percent in second-quarter 2010, earned premiums dropped 1 percent, loss and loss adjustment expenses increased 0.5 percent, and the combined ratio climbed to 101.2 percent from 100.4 percent in second-quarter 2009.

“Though small, the written premium growth in second-quarter 2010 is certainly welcome news, coming after 12 successive quarters of declines. But there are indications that the growth wasn’t shared equally by all insurers,” said Sampson. “In particular, the Consumer Price Index for tenants’ and household insurance rose 3.5 percent in second-quarter 2010 as the Consumer Price Index for motor vehicle insurance climbed 5.2 percent. But MarketScout’s Market Barometer for commercial lines dropped 3 percent. This suggests premiums for personal lines insurers rose while premiums for commercial lines insurers remained weak.”

The $12 billion in net investment income in second-quarter 2010 was up $0.1 billion, or 0.9 percent, compared with the $11.9 billion in net investment income in second-quarter 2009.

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