P/C Insurers’ Underwriting, Investment Results Deteriorate in First Quarter

The U.S. property/casualty insurance industry’s net income after taxes fell to $8.2 billion in first-quarter 2008 from $16.2 billion in first-quarter 2007.

Contributing to the $8 billion, or 49.3 percent, decline in net income in first-quarter 2008, the industry posted $0.6 billion in net losses on underwriting — an $8.9 billion adverse swing from the $8.3 billion in net gains on underwriting in first-quarter 2007, according to Insurance Services Office (ISO) and the Property Casualty Insurers Association of America (PCI).

The combined ratio rose to 99.9 percent in first-quarter 2008 from 91.7 percent in first-quarter 2007. The combined ratio was the highest for any first quarter since 2002.

Catastrophe losses were the highest amount for any first quarter since 1994.

Reflecting the decline in net income, the industry’s annualized rate of return on average policyholders’ surplus dropped to 6.4 percent in first-quarter 2008 from 13.2 percent in first-quarter 2007, according to Insurance Services Office (ISO) and the Property Casualty Insurers Association of America (PCI).

That was the second lowest first quarter return in more than 20 years.

Investment results deteriorated, with net investment gains declining $2.8 billion, or 18.8 percent, to $12.2 billion in the first three months of 2008 from $15 billion in the first three months of 2007.

Partially offsetting these developments, insurers’ miscellaneous other income rose $2.1 billion to $0.2 billion through the first three months of 2008 from negative $1.8 billion through the first three months of 2007, and insurers’ income taxes fell $1.6 billion to $3.6 billion from $5.2 billion.

“Insurers’ 6.4 percent annualized rate of return for first-quarter 2008 was the second lowest first-quarter annualized rate of return in the past 23 years and 4.5 percentage points below insurers’ 10.9 percent average first-quarter rate of return since the start of ISO’s quarterly data in 1986,” said Michael R. Murray, ISO’s assistant vice president for financial analysis.

Murray said results for the insurance industry overall were affected “significantly by deterioration in results for mortgage and other financial guaranty insurers.”

ISO estimates that, excluding mortgage and other financial guarantee insurers, the insurance industry’s annualized rate of return on average surplus declined to 9.5 percent in first-quarter 2008 from 13.5 percent in first-quarter 2007, as the industry’s net income fell 24.2 percent.

The drop in returns may not be over.

“Seasonal patterns in the data suggest that insurers’ rate of return will decline further this year,” said David Sampson, PCI president and chief executive officer. “Insurers’ profitability in the first quarter usually exceeds their profitability later in the year, partly because of the timing of weather-related catastrophe losses. The Atlantic hurricane season runs from June 1 to November 30, and the experts are predicting an unusually active hurricane season this year.”

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.

Underwriting Results
Net written premiums fell $0.8 billion to $110.5 billion in first-quarter 2008 from $111.3 billion in first-quarter 2007, with the 0.7 percent decline in written premiums in first-quarter 2008 contrasting with a 0.8 percent increase in first-quarter 2007. Similarly, net earned premiums dropped $0.6 billion to $107.9 billion in first-quarter 2008 from $108.5 billion in first-quarter 2007, with the 0.6 percent decline in earned premiums in first-quarter 2008 contrasting with a 1.9 percent increase in the first three months of 2007.

“Written premiums have now declined versus year-ago levels for four successive quarters. This is absolutely unprecedented, based on ISO’s quarterly data extending back to 1986,” said Murray. “Prior to second-quarter 2007, written premiums declined in just two quarters — fourth-quarter 1991 and third-quarter 2005. Market surveys and economic data indicate that escalating competition and declines in the price of insurance cut into premiums.”

According to the Council of Insurance Agents and Brokers’ first-quarter 2008 market survey, rates for commercial insurance policies declined an average of 13.5 percent for all sizes of accounts. Moreover, as net written premiums dropped 0.7 percent in first-quarter 2008, the nation’s gross domestic product rose 4.7 percent.

“That premiums declined as GDP increased is an indication that intensifying competitive pressures led to lower prices for most coverages in most locations, though property insurance remains scarce and expensive in some coastal areas,” said Murray.

Unlike premiums, overall loss and loss adjustment expenses increased $7.7 billion, or 11 percent, to $78 billion in first-quarter 2008 from $70.3 billion in first-quarter 2007. Non catastrophe loss and loss adjustment expenses rose $5.7 billion, or 8.3 percent, to $74.6 billion in first-quarter 2008 from $68.9 billion in first-quarter 2007. Direct insured losses from catastrophes more than doubled to $3.4 billion in first-quarter 2008 from $1.3 billion in first-quarter 2007, according to ISO’s Property Claim Services unit.

The $3.4 billion in catastrophe losses through first-quarter 2008 is the highest amount for any first quarter since 1994, when $12.5 billion in losses from the Northridge earthquake drove the total for the quarter up to $14.5 billion.

“We are seeing the impact of severe weather damaging wind, large hail, flooding, tornadoes, and other disasters. Through June 20, second-quarter 2008 catastrophe losses totaled $4.9 billion — $2.6 billion more than the catastrophe losses for all of second-quarter 2007, which doesn’t bode well for second-quarter underwriting results,” said Sampson.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $0.5 billion, or 1.6 percent, to $30.1 billion in first-quarter 2008 from $29.6 billion in first-quarter 2007.

Dividends to policyholders in first-quarter 2008 totaled $0.4 billion, up from $0.3 billion in first-quarter 2007.

The $0.6 billion net loss on underwriting in first-quarter 2008 amounts to 0.5 percent of the $107.9 billion in net earned premiums for the period — a sharp swing from first-quarter 2007, when an $8.3 billion net gain on underwriting amounted to 7.6 percent of the $108.5 billion in net earned premiums for that period.

The combined ratio rose to 99.9 percent in first-quarter 2008 from 91.7 percent in first-quarter 2007, with the change in the combined ratio reflecting imbalances between the declines in premiums and the increases in the costs of providing insurance. The 99.9 percent combined ratio for first-quarter 2008 was the highest for any first quarter since 2002, when the combined ratio was 102.2 percent.

“Marked deterioration in underwriting results for mortgage and other financial guarantee insurers had a significant effect on results for the industry overall,” said Murray. “Though mortgage and financial guarantee insurers’ net written premiums rose 10.8 percent to $2.2 billion in first-quarter 2008, their loss and loss adjustment expenses soared 570.3 percent to $5 billion, and their combined ratio jumped to 266.6 percent in first-quarter 2008 from 69.6 percent in first-quarter 2007. Excluding mortgage and financial guarantee insurers, industry net written premiums fell 0.9 percent, loss and loss adjustment expenses rose 5 percent, and the combined ratio increased to 96.7 percent in first-quarter 2008 from 92.1 percent in first-quarter 2007.”

Investment Results
Insurers’ overall net investment gains dropped $2.8 billion, or 18.8 percent, to $12.2 billion in first-quarter 2008 from $15 billion in first-quarter 2007. Net investment income fell 2.1 percent to $12.7 billion in first-quarter 2008 from $12.9 billion in first-quarter 2007. Realized capital losses on investments (not included in net investment income) in first-quarter 2008 totaled $0.5 billion– a $2.6 billion adverse swing from the $2.1 billion in realized capital gains on investments in first-quarter 2007.

Combining the $0.5 billion in realized capital losses in first-quarter 2008 with $9.9 billion in unrealized capital losses during the period, insurers posted $10.4 billion in overall capital losses in the first quarter of 2008 — down $12.6 billion from the $2.2 billion in overall capital gains in the first-quarter of 2007.

Sampson blamed the 2.1 percent decrease in net investment income on two developments. Insurers’ average holdings of cash and invested assets rose 3.8 percent. But the increase in insurers’ holdings was more than offset by a decline in the annualized yield on their portfolios, which fell to 4 percent in first-quarter 2008 from 4.25 percent in first-quarter 2007.

“We may see further declines in investment income if softening prices in insurance markets cut into premiums and the new cash available to fund growth in investment portfolios. Other considerations clouding the outlook for investment income include the possibility that weakness in the economy or problems in credit markets will lead the Federal Reserve Board to further cut interest rates,” Sampson said.

He said that the swing to capital losses on investments in first-quarter 2008 from capital gains on investments in first-quarter 2007 reflects developments in financial markets. “In the first quarter of 2008, stock prices as measured by the S&P 500 fell 9.9 percent — a sharp contrast to the 0.2 percent increase in the S&P 500 in first-quarter 2007. Similarly, the New York Stock Exchange Composite fell 9.7 percent in first-quarter 2008 — a sharp contrast to the 1.3 percent increase in that index in first-quarter 2007. Going forward, stock markets have moved little since the end of first-quarter 2008, with the S&P 500 falling 0.4 percent from the end of the first quarter through June 20 and the New York Stock Exchange Composite rising 0.4 percent during the period. This suggests insurers’ overall capital gains through six-months 2008 will be little changed from their overall capital gains through first-quarter 2008,” Murray said.

Pretax Operating Income
Pretax operating income declined 36.4 percent to $12.3 billion in first-quarter 2008 from $19.4 billion in first-quarter 2007. The $7.1 billion decline in operating income is the net result of the $8.9 billion adverse swing to net losses on underwriting from net gains on underwriting, the $0.3 billion decline in net investment income, and the $2.1 billion positive swing in miscellaneous other income to $0.2 billion from negative $1.8 billion in first-quarter 2007.

Policyholders’ Surplus
Policyholders’ surplus declined 0.4 percent to $515.6 billion at March 31, 2008, from $517.9 billion at year-end 2007. The $2.3 billion decrease in policyholders’ surplus in first-quarter 2008 contrasts with a $9.4 billion increase in first-quarter 2007.

“Even with the dip in surplus in first-quarter 2008, financial leverage ratios suggest the industry is well positioned for the hurricane season,” said Sampson. “Leverage ratios provide simple measures of the amount of risk supported by each dollar of policyholders’ surplus. The premium-to-surplus ratio fell to 0.85 for the 12 months ending March 31, 2008, from 0.90 for the 12 months ending March 31, 2007; and the ratio of loss and loss adjustment expense reserves to surplus held steady at 1.04. Both leverage ratios are near historic lows based on data extending back to fourth-quarter 1986.”

Additions to surplus in first-quarter 2008 included insurers’ $8.2 billion in net income after taxes, $4.4 billion in new funds paid in (new capital raised by insurers), and $1.4 billion in miscellaneous changes in surplus. But those additions were more than offset by $9.9 billion in unrealized capital losses on investments (not included in net income) and $6.4 billion in dividends to shareholders.

The $4.4 billion in new funds paid in during the first three months of 2008 is up from $1.2 billion in the first three months of 2007.
The $1.4 billion in miscellaneous additions to surplus in first-quarter 2008 compares with $2.3 billion in miscellaneous charges against surplus in first-quarter 2007.

The $9.9 billion in unrealized capital losses in first-quarter 2008 compares with $0.1 billion in unrealized capital gains in first-quarter 2007.

The $6.4 billion in dividends to shareholders in the first quarter of 2008 is up 9.7 percent from $5.9 billion in the first quarter of 2007.

Sources:
Insurance Services Office
www.iso.com
Property Casualty Insurers Association of America
www.pciaa.net