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The U.S. property/casualty industry’s net gain on underwriting rose $1.4 billion, or 20.8 percent, to $8.4 billion in first-quarter 2006 from $6.9 billion in first-quarter 2005. The combined ratio — a key measure of losses and other expenses per dollar of premium — improved to 91.2 percent from 92.2 percent.
The $8.4 billion net gain on underwriting is the largest experienced any quarter since the start of records extending back to 1986. Similarly, the 91.2 percent combined ratio for first quarter 2006 is the best for any quarter since 1986.
The industry’s consolidated surplus — its assets minus its liabilities — rose $13 billion, or 3 percent, to $440.1 billion at March 31, 2006, from $427.1 billion at December 31, 2005, according to ISO and the Property Casualty Insurers Association of America (PCI).
Much of the increase in underwriting profits is directly attributable to a decline in first-quarter weather-related catastrophe losses. And despite higher profits on underwriting, the industry’s net income after taxes fell $0.7 billion, or 3.8 percent, to $16.7 billion in first-quarter 2006 from $17.4 billion in first-quarter 2005, as investment income declined and federal income taxes increased.
The ISO and PCI industry figures for first-quarter 2006 are consolidated estimates for all private property/casualty insurers based on reports that account for at least 96 percent of all business written by private U.S. property/casualty insurers.
Catastrophe losses fell $0.7 billion, or 30.7 percent, to $1.5 billion in the first three months of this year from $2.1 billion in the first three months of 2005, according to ISO’s Property Claim Services unit.
“The decline in catastrophe losses accounts for six-tenths of the improvement in the industry’s combined ratio in first-quarter 2006,” said Gregory Heidrich, the PCI’s senior vice president for policy development and research. “With year-to-date catastrophe losses as of June 27 totaling $4.5 billion, or $1.4 billion more than the $3.1 billion in catastrophe losses in first-half 2005, we already know that underwriting results for the first-half of this year will not benefit from a decline in catastrophe losses,” added Heidrich.
“And we have to brace ourselves for more bad news on catastrophe losses as the year plays out. While weather forecasts are subject to considerable uncertainty, meteorological experts ranging from Dr. Bill Gray and his team at Colorado State University to the National Oceanic and Atmospheric Administration and the Tropical Storm Risk Consortium are projecting that this hurricane season will be far worse than average,” said Michael R. Murray, ISO assistant vice president for financial analysis. “On average, there are fewer than 10 named storms each year, but the experts are saying there will be somewhere between 13 and 17 this hurricane season. And Dr. Gray’s team says there is an 82 percent chance that an intense hurricane — category 3 or higher — will hit the U.S. this year. These are very bad odds, given that the average for the last century is 30 percentage points lower at 52 percent,” added Murray.
“Other reasons to expect the news on catastrophe losses to get worse and underwriting results to deteriorate include traditional seasonal patterns,” said Heidrich. “During the 57 years from the start of Property Claim Services’ records in 1949 to 2005, more than half of all catastrophe losses — 53.5 percent — have occurred in the third quarter. And in nine of the past 10 years, full-year underwriting results were worse than first-quarter results.”
Reported figures for first-quarter 2006 and first-quarter 2005 reflect three special developments that affected how results for the periods compare. In first-quarter 2006, one large insurer stopped reporting financial results as a property/casualty insurer and instead began reporting financial results as a health insurer. Also in first-quarter 2006, another insurer changed the accounting for $0.7 billion paid to its foreign parent in 2005, reducing both first-quarter 2006 reported new funds paid in and first-quarter 2006 dividends to shareholders by that amount. And in first-quarter 2005, one insurer received $2.3 billion in nonrecurring special dividends from an investment subsidiary, inflating industry investment income for the period.
Adjusted for these special developments, industry first-quarter 2006 net income after taxes increased $1.7 billion, or 11.4 percent, from $15 billion in first-quarter 2005. Also adjusted for special developments, first-quarter 2006 net gains on underwriting increased $1.5 billion, or 22.1 percent, from $6.9 billion a year earlier, and surplus increased $15.9 billion, or 3.8 percent, from $424.2 billion at year-end 2005.
Based on reported results, growth in net written premiums slowed to 1.9 percent versus year-ago levels in first-quarter 2006 from 2.4 percent in first-quarter 2005. Adjusted for special developments, written premiums increased 2.5 percent in first-quarter 2006 — 0.6 percentage points more than they rose based on reported results but less than half of the 5.1 percent average annual rate of increase in premiums during the 10 years ending 2005.
“Even with remarkable underwriting results for first-quarter 2006, the industry’s statutory rate of return on average surplus for the 12 months ending March was just 10.1 percent — down from 11.2 percent for the 12 months ending March 2005. Furthermore, we are already seeing signs of an increase in competition that could undermine insurers’ profitability,” observed Murray. The ISO executive noted that written premium growth peaked at 16.8 percent in the third quarter of 2002 and has since dwindled to only about one-seventh of that even after adjusting for special developments.
“ISO MarketWatch data shows a similar trend, with premium rate increases on commercial renewals for the MarketWatch lines as a group peaking at 12.9 percent in July 2002. But since then, rate increases have become rate decreases, with rates on commercial renewals dropping 1.5 percent versus year-ago levels in December 2005. And the Council of Insurance Agents and Brokers’ first-quarter 2006 market survey shows that commercial insurance rates have continued to decline, dropping 2.7 percent in the first quarter,” added Murray.
“Government economic data also suggests that competition in insurance markets is intensifying,” said Heidrich. “In third-quarter 2002 when premium growth peaked, written premium growth exceeded current dollar GDP (gross domestic product) growth by 12.9 percentage points. By first-quarter 2004, the spread between premium growth and GDP growth had turned negative, and in first-quarter 2006, premium growth adjusted for special developments fell 4.4 percentage points short of the 6.9 percent increase in GDP,” added Heidrich.
“In addition to rising prices, we’re also hearing about availability problems in coastal states in the wake of last year’s record-setting $61.2 billion in catastrophe losses. The countrywide softening in insurance markets and the problems in coastal insurance markets are both natural consequences of the law of supply and demand,” added Murray. “With the capacity to underwrite insurance risk depending on insurers’ surplus, or net worth, and with total industry surplus at a record high, nobody should be surprised that insurance markets are softening countrywide. On the other hand, with last year’s catastrophe losses in states such as Mississippi and Louisiana exceeding all the premiums private insurers charged for property insurance in those states during the past 20 years and with numerous sources reporting that reinsurance costs are rising sharply, nobody should be surprised that insurance has become scarce in coastal markets,” added Murray.”
“Fortunately for consumers and businesses in coastal markets, the law of supply and demand also implies that, at some point, higher prices will attract more capacity to those markets,” said Heidrich. “Right now, the system is rebalancing itself — adjusting to Hurricanes Rita, Katrina and Wilma and what those storms taught the world about the risks we face.”
Based on reported results, the industry’s pretax net investment gains — the sum of realized capital gains and net investment income (primarily dividends earned from stocks and interest on bonds) — dropped $1.6 billion, or 10.3 percent, to $13.6 billion in first-quarter 2006 from $15.2 billion in first-quarter 2005.
“The slow growth in investment income (adjusted for special developments) reflects weakness in the yield on cash and invested assets. Based on reported data, insurers’ average holdings of cash and invested assets rose 7.8 percent versus year-ago levels in first-quarter 2006 to $1.1 trillion, and insurers’ average holdings increased about the same amount after adjusting for special developments affecting the data,” said Murray. “But the adjusted annualized yield on insurers’ holdings declined to 4.2 percent in first-quarter 2006 from 4.4 percent in first-quarter 2005, even though the Federal Reserve Board has raised its benchmark short-term interest rate 16 times since June 2004. In fact, the Fed’s actions have had little effect on longer-term investment yields, with the yield on 10-year Treasury notes averaging 4.58 percent in first-quarter 2006 — 0.02 percentage points less than the 4.60 percent that it averaged during the quarter the Fed started raising short-term rates,” added Murray.
The industry’s pretax operating income — the sum of its gain or loss on underwriting, its net investment income and other miscellaneous income — fell $0.6 billion, or 2.9 percent, to $20.1 billion in first-quarter 2006 from $20.7 billion in first-quarter 2005. Miscellaneous other income changed little, rising to near zero in first-quarter 2006 from negative $0.1 billion in first-quarter 2005.
Combining the industry’s operating income and its realized capital gains, its net income before taxes declined $0.1 billion, or 0.4 percent, to $22 billion in first-quarter 2006 from $22.1 billion in first quarter 2005. Despite the $0.1 billion decline in net income before taxes, the industry incurred $5.3 billion in income taxes in first-quarter 2006 — up $0.6 billion, or 12 percent, from the $4.7 billion in income taxes insurers incurred in first-quarter 2005.
Adjusted for special developments, first-quarter 2006 pretax operating income rose $1.8 billion, or 9.6 percent, from $18.3 billion in first-quarter 2005. Also adjusted for special developments, first-quarter 2006 net income before taxes increased $2.3 billion, or 11.4 percent, from $19.7 billion in first-quarter 2005. (Special developments had only a negligible effect on income taxes.)
The improvement in underwriting results in first-quarter 2006 reflects the excess of growth in premiums over growth in loss and loss adjustment expenses, other underwriting expenses and dividends to policyholders. Based on reported data, net written premiums rose $2 billion to $110.6 billion in first-quarter 2006 from $108.5 billion in first-quarter 2005. Net earned premiums rose $2.8 billion, or 2.7 percent, to $106.6 billion in first-quarter 2006 from $103.8 billion a year earlier.
Overall loss and loss adjustment expenses changed little, declining 0.1 percent to $69.3 billion in first-quarter 2006 from $69.4 billion in first-quarter 2005, as a result of largely offsetting changes in catastrophe and noncatastrophe losses. As catastrophe losses declined $0.7 billion, other loss and loss adjustment expenses rose $0.6 billion, or 0.9 percent, to $67.9 billion in first-quarter 2006 from $67.3 billion in first-quarter 2005.
Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $1.3 billion, or 4.9 percent, to $28.6 billion in first-quarter 2006 from $27.2 billion a year earlier.
Dividends to policyholders increased $0.1 billion, or 21.5 percent, to $0.3 billion in first-quarter 2006.
“We have to anticipate that growth in noncatastrophe loss and loss adjustment expenses will accelerate, if only because of inflation,” observed Murray.
Adjusted for special developments, net written premiums increased $2.7 billion versus year-ago levels in first-quarter 2006. Earned premiums increased $3.4 billion, or 3.3 percent. Overall loss and loss adjustment expenses rose $0.5 billion, or 0.7 percent, as noncatastrophe loss and loss adjustment expenses rose $1.2 billion, or 1.7 percent. (Special developments did not have a material effect on other underwriting expenses or policyholder dividends.)
Based on reported data, the net gain on underwriting in first-quarter 2006 amounts to 7.9 percent of the $106.6 billion in premiums earned during the period — up from 6.7 percent of the $103.8 billion in premiums earned in first-quarter 2005.
The $13 billion increase in surplus in first-quarter 2006 consisted of $16.7 billion in net income after taxes, $4.1 billion in unrealized capital gains on investments and $0.3 billion in new funds paid in, less $5.3 billion in dividends to stockholders and $2.9 billion in miscellaneous charges against surplus.
The $0.3 billion in new funds paid in during first-quarter 2006 is down 73.8 percent from the $1.2 billion in new funds paid in during first-quarter 2005.
The $4.1 billion in unrealized capital gains on investments in first-quarter 2006 constitutes a $10.4 billion positive swing from the $6.3 billion in unrealized capital losses on investments in first-quarter 2005.
“Combining insurers’ realized capital gains on investments with their unrealized capital gains, insurers posted $6 billion in total capital gains in first-quarter 2006,” said Heidrich. “Insurers’ overall capital gains in first-quarter 2006 reflect developments in financial markets, with the S&P 500 rising 3.7 percent from year-end 2005 to March 31 as the NASDAQ composite climbed 6.1 percent. In the first quarter of 2005, insurers suffered $4.9 billion in total capital losses as the S&P 500 fell 2.6 percent and the NASDAQ dropped 8.1 percent. But the S&P 500 and the NASDAQ composite have both declined since the end of last March, with the S&P 500 giving back virtually all of its gains since the start of this year and the NASDAQ declining year-to-date as of June 26. This suggests that insurers’ results for first-half 2006 will not benefit from capital gains,” added Heidrich.
The $5.3 billion in dividends to shareholders in first-quarter 2006 is $1.1 billion, or 26 percent, more than the $4.2 billion in dividends to shareholders in first-quarter 2005.
The $2.9 billion in miscellaneous charges against surplus in the first three months of 2006 is a $3.3 billion adverse swing from the $0.4 billion in miscellaneous additions to surplus in the first three months of 2005.
Adjusted for special developments, surplus increased $15.9 billion in first-quarter 2006 — $3 billion more than growth in surplus based on reported data. The difference in the growth in surplus reflects the amount of surplus removed from the property/casualty industry when one insurer stopped reporting as a property/casualty insurer and began reporting as a health insurer. That change accounts for the $2.9 billion in miscellaneous charges against surplus in first-quarter 2006. Special developments did not affect the amount of net income after taxes or unrealized capital gains in first-quarter 2006. And the effects of special developments on new funds paid in and dividends to shareholders were offsetting.
Sources: ISO, PCI, I.I.I.