Jersey City, N.J. — The U.S. property/casualty insurance industry's net income after taxes rose 10.7% to $32.6 billion in first-half 2007 from $29.4 billion in first-half 2006. Fueled by the industry's net income, policyholders' surplus—insurers' net worth measured according to Statutory Accounting Principles—increased $26.5 billion to $512.8 billion at June 30, 2007, from $486.2 billion at year-end 2006.
But the insurance industry's overall profitability as measured by its annualized rate of return on average policyholders' surplus (or statutory net worth) slipped to 13.1% in first-half 2007 from 13.5% in first-half 2006 as underwriting results deteriorated. Net gains on underwriting fell 4.1% to $14.4 billion in first-half 2007 from $15 billion in first-half 2006. The combined ratio—a key measure of losses and other underwriting expenses per dollar of premium—worsened to 92.7% in the first half of this year from 92% in the first half of 2006, according to Jersey City, N.J.-based ISO Properties Inc. and Des Plaines, Ill.-based 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% of all business written by private U.S. property/casualty insurers.
The deterioration in underwriting reflects weakness in premium growth as a result of escalating competition in insurance markets. Net written premiums grew $0.3 billion to $223.4 billion in first-half 2007 from $223.1 billion in first-half 2006, with written premium growth slowing to 0.1% in the first half of this year from 2.9% in the first half of last year. Net earned premiums rose $3.1 billion to $217.9 billion in first-half 2007 from $214.8 billion in first-half 2006, as earned premium growth slowed to 1.4% in the first half of 2007 from 2.6% in the first half of 2006.
"At 0.1% in first-half 2007, net written premium growth was the weakest for any first half in at least two decades. The previous record low for first-half premium growth was 1% in 1999, with first-half premium growth ranging as high as 13% in 1987," says Michael Murray, ISO's assistant vice president for financial analysis. "Market surveys and U.S. government data indicate that escalating competition and declines in the price of insurance are cutting into premium growth. According to the Council of Insurance Agents and Brokers' second-quarter 2007 market survey, commercial premium rates declined 11.8% on average for all sizes of accounts. And the consumer price index (CPI) for motor vehicle insurance increased just 0.4% in first-half 2007 compared with its level a year earlier, even though the CPI for motor vehicle repairs rose 3.5%. Similarly, despite ongoing problems in some coastal property insurance markets exposed to hurricanes, the CPI for tenants' and household insurance rose just 0.8% year to date through June, even though the CPI for repair of household items rose 4.5%."
Murray believes that while there is no specific connection to the first-half 2007 industry financial results, technology and, in particular, the application of advanced analytics to ever larger and more granular databases is transforming business processes at every link in the insurance value chain from marketing to loss adjudication to reinsurance decision making and enterprise risk management. "This, in turn, is affecting competitive dynamics in insurance markets and, to some extent, overall insurance industry results," he says. "For example, more and more insurers are using sophisticated predictive modeling to price and underwrite individual personal auto risks based on their own unique characteristics. The insurers with this capability have a competitive advantage over those without it. But even those with the best of today's technology can't afford to stand still. Next generation predictive models for personal auto—models based on hundreds of statistically validated predictive variables—have already been developed, and they will shift the playing field once again. And, what we've seen in personal auto insurance is beginning to spread to homeowners insurance and even the commercial lines."
"Other evidence that escalating competitive pressures are cutting into premium growth includes the gap between premium growth and overall economic growth," says Genio Staranczak, PCI chief economist. "In first-half 2007, net written premiums were up 0.1% from a year ago, while the nation's gross domestic product, which takes into account both inflation and real growth, increased 4.6% during the same time frame. That premiums barely rose as GDP grew at a relatively healthy pace is an indication that intensifying competition is leading to lower prices for most coverages in most locations, though property insurance increases are evident in some coastal areas."
Written premium growth failed to keep pace with increases in loss and loss adjustment expenses. Overall net loss and loss adjustment expenses (after reinsurance recoveries) increased $1.5 billion, or 1.1%, to $142.9 billion in first-half 2007 from $141.4 billion in first-half 2006. But excluding catastrophe losses, ISO estimates that net loss and loss adjustment expenses increased $6.6 billion, or 5%, to $139.1 billion in first-half 2007 from $132.5 billion in first-half 2006.
According to ISO's Property Claims Services (PCS) unit, catastrophes occurring in first-half 2007 caused $3.6 billion in direct insured losses to property (before reinsurance recoveries)—down from the $6.5 billion in direct insured losses to property due to the catastrophes occurring in first-half 2006. Including additional development of losses from the catastrophic hurricanes of 2005, ISO estimates that the net catastrophe losses included in insurers' financial results fell to $3.8 billion in the first half of 2007 from $8.9 billion in the first half of 2006.
Premium growth also failed to keep pace with increases in other underwriting expenses—primarily acquisition expenses, expenses associated with underwriting, pricing and servicing insurance policies and premium taxes. Other underwriting expenses rose $2.2 billion, or 3.8%, to $60 billion in first-half 2007 from $57.8 billion in first-half 2006.
But dividends to policyholders were essentially unchanged at $0.6 billion in both first-half 2007 and first-half 2006.
The $14.4 billion net gain on underwriting in first-half 2007 amounts to 6.6% of the $217.9 billion in net premiums earned during the period, whereas the $15 billion net gain on underwriting in first-half 2006 amounted to 7% of the $214.8 billion in net premiums earned during that period.
"Despite the deterioration in underwriting results, the 92.7% combined ratio for first-half 2007 is the second best for any first half since 1986, when ISO's quarterly records begin. Even so, underwriting results weren't good enough for insurers to achieve the rate of return typically earned by firms in other industries," Murray says. "With first-half 2007 investment results, financial leverage and tax rates, ISO estimates that the combined ratio would have had to improve to 91.5% in order for insurers to have earned the 13.9% long-term average rate of return for the Fortune 500. Moreover, with today's low interest rates and investment yields, insurers must now post significantly better underwriting results just to be as profitable as they once were. For example, insurers' 92.7% combined ratio for first-half 2007 was 11.4 percentage points better than their combined ratio for first-half 1987. But even with that much improvement in underwriting results, insurers' 13.1% annualized rate of return for first-half 2007 was 2% below insurers' annualized rate of return for first-half 1987."
The industry's net investment income—primarily dividends from stocks and interest on bonds—grew $1.6 billion, or 6.6%, to $26.1 billion in first-half 2007 from $24.5 billion in first-half 2006. Realized capital gains on investments (not included in net investment income) more than quadrupled, rising to $4.2 billion in first-half 2007 from $0.9 billion in the first half of last year. Combining net investment income and realized capital gains, overall net investment gains climbed 19.3% to $30.3 billion in first-half 2007 from $25.4 billion in first-half 2006.
Combining the $4.2 billion in realized capital gains in first-half 2007 with $6.3 billion in unrealized capital gains during the period, insurers posted $10.5 billion in overall capital gains in the first half of 2007—up $5 billion, or 91.9%, from $5.5 billion in overall capital gains in the first half of 2006.
"The 6.6% increase in property/casualty insurers' net investment income in first-half 2007 is the result of two developments," Staranczak says. "Insurers' average holding of cash and invested assets rose 8.6%. But the annualized yield on insurers' cash and invested assets fell to 4.24% in first-half 2007 from 4.32% in first-half 2006. Prospectively, we may see slowing in the growth of investment income as softening prices in insurance markets cut into premiums and the cash available to fund new investments. In addition, the Federal Reserve Board cut its target for a key benchmark interest rate—the federal funds rate—by 50 basis points to 4.75% on September 18. If continuing problems in subprime credit markets and weakness in the economy lead to further cuts in interest rates, lower yields will likely take a bite out of insurers' investment earnings."
"The near doubling of insurers' total capital gains in first-half 2007 reflects developments in financial markets," Murray says. "In the first half of 2007, stock prices as measured by the S&P 500 rose 6%—more than three times the 1.8% increase in the S&P 500 in the first half of 2006. Going forward, the S&P 500 rose 1.5% from June 30 through September 21, and other major stock indexes—such as the NASDAQ and New York Stock Exchange composites and the Dow Jones Industrial Average—also rose during the period. This suggests insurers' results for nine-months 2007 may benefit from some additional capital gains on investments. Beyond that, it all depends on future developments in financial markets."
Pretax operating income—the sum of net gains or losses on underwriting, net investment income, and miscellaneous other income—fell 1.6% to $39.1 billion in first-half 2007 from $39.7 billion in first-half 2006. The $0.6 billion decline in operating income is the net result of the $0.6 billion decline in net gains on underwriting, the $1.6 billion increase in net investment income, and a $1.6 billion decline in miscellaneous other income to negative $1.5 billion in first-half 2007 from positive $0.2 billion in first-half 2006. The decline in miscellaneous other income reflects a special transaction in which one U.S. insurer assumed $9.3 billion in liabilities from a foreign entity in exchange for considerations valued at $7.1 billion, some tax benefits, and the opportunity to earn investment income on the funds held to pay down the liabilities.
The insurance industry's net income after taxes rose $3.2 billion to $32.6 billion in first-half 2007 from $29.4 billion in first-half 2006, as a $3.3 billion increase in realized capital gains on investments more than offset the $0.6 billion decline in pretax operating income. The industry's net income after taxes also benefited from a decline in income taxes. Federal and foreign income taxes declined $0.5 billion, or 4.4%, to $10.7 billion in the first-half of 2007 from $11.1 billion in first-half 2006.
Fueled by the industry's net income, policyholders' surplus increased 5.5% to $512.8 billion at June 30, 2007, from $486.2 billion at year-end 2006. Other additions to surplus in first-half 2007 included $6.3 billion in unrealized capital gains on investments (not included in net income) and $1.4 billion in new funds paid in (new capital raised by insurers). These additions were partially offset by deductions from surplus, including $11.7 billion in dividends to shareholders and $2.1 billion in miscellaneous charges against surplus.
The $6.3 billion in unrealized capital gains in first-half 2007 is up $1.7 billion, or 37.9%, from $4.6 billion in first-half 2006.
The $1.4 billion in new funds paid in during the first six months of 2007 is up $0.3 billion, or 32.7%, from $1.1 billion in the first six months of 2006.
The $11.7 billion in dividends to shareholders in the first half of 2007 is down $1.2 billion, or 9.5%, from $12.9 billion in the first half of 2006.
The $2.1 billion in miscellaneous charges against surplus in first-half 2007 compares with $3.2 billion in miscellaneous charges against surplus in first-half 2006.
"The increase in surplus going into the hurricane season is certainly welcome news for both insurers and policyholders," Staranczak says. "Though Hurricane Humberto caused relatively little damage when it surprised everybody and hit Texas, the hurricane season doesn't end until November 30. We could still get walloped like we did in 2005, and the growth in surplus further assures that insurers will have the resources to provide financial protection to their customers in the event that we do."
"With insurers' ability to provide financial protection to their customers dependent on surplus, the increase in surplus may also translate into an increase in the supply of insurance," Murray says. "An increase in the supply of insurance would put further downward pressure on prices in insurance markets, cutting into insurers' profitability but certainly benefiting consumers."
The industry's consolidated net income after taxes for second-quarter 2007 amounted to $16.4 billion, up 29.6% from the $12.6 billion in net income for second-quarter 2006. The industry's net income for second-quarter 2007 consisted of $19.7 billion in pretax operating income and $2.1 billion in realized capital gains on investments, less $5.4 billion in federal and foreign income taxes.
The industry's second-quarter pretax operating income of $19.7 billion is up 0.5% from $19.6 billion in second-quarter 2006. Second-quarter 2007 operating income consisted of $6.1 billion in net gains on underwriting, $13.2 billion in net investment income and $0.4 billion in miscellaneous other income.
The $6.1 billion in net gains on underwriting in second-quarter 2007 is down 7.6% from $6.6 billion in second-quarter 2006. Net gains on underwriting dropped even though direct insured losses from catastrophe losses fell to $2.3 billion in second-quarter 2007 from $5 billion in second-quarter 2006, according to ISO's PCS unit.
Second-quarter 2007 net gains on underwriting amount to 5.6% of the $109.4 billion in premiums earned during the period, down from 6.1% of the $108.3 billion in premiums earned during second-quarter 2006.
The industry's combined ratio deteriorated to 93.8% in second-quarter 2007 from 92.8% in second-quarter 2006. Nonetheless, the industry's combined ratio for second-quarter 2007 was the second best for any second quarter since 1986, when ISO's quarterly data begins.
The $6.1 billion in net gains on underwriting is after deducting $0.3 billion in premiums returned to policyholders as dividends, with dividends to policyholders essentially unchanged from their level in second-quarter 2006.
Written premiums fell $0.6 billion to $112.1 billion in second-quarter 2007 from $112.7 billion in second-quarter 2006, with second-quarter written premium growth dropping to negative 0.6% in 2007 from 4% in 2006 and a cyclical peak of 14.4% in second-quarter 2002. At negative 0.6% in second-quarter 2007, written premium growth was the weakest for any second quarter on record, with the previous record low for second-quarter written premium growth being positive 1.1% in second-quarter 1999.
"Quarterly net written premiums have declined just three times since 1986, with written premiums dropping versus year-ago levels in second-quarter 2007, third-quarter 2005, and fourth-quarter 1991," Staranczak says. "The decline in third-quarter 2005 resulted from a special transaction in which one insurer ceded $6 billion in premiums to its foreign parent, but the decline in second-quarter 2007 is a reflection of increasingly intense competition in many insurance markets."
Murray, believes the net written premiums will affect insurers' profitability going forward. "Insurers calculate their underwriting gains by subtracting the cost of providing insurance during a period from the premiums earned during the period," he says. "Less written premium now means less earned premium and smaller profits later, because written premium is the amount charged when a policy is sold but that premium is earned over the term of the policy as coverage is provided. The million- or billion-dollar question at this point is whether competition will escalate as it has in the past to the point where profits become losses, and only time will tell."
The $13.2 billion of net investment income is up $0.4 billion, or 3.3%, compared with investment income in second-quarter 2006.
The $0.4 billion in miscellaneous other income is up $0.2 billion from $0.2 billion in second-quarter 2006.
The $2.1 billion in realized capital gains is a $3.1 billion positive swing from the $1 billion in realized capital losses in second-quarter 2006.
Combining net investment income and realized capital gains, the industry posted $15.3 billion in net investment gains in second-quarter 2007, up 30.1% from $11.8 billion a year earlier.
Unrealized capital gains on investments increased to $6.2 billion in second-quarter 2007 from $0.6 billion in second-quarter 2006. Combining realized and unrealized capital gains, the insurance industry posted $8.3 billion in overall capital gains in second-quarter 2007—an $8.8 billion positive swing from the $0.5 billion in overall capital losses in second-quarter 2006.
Sources: ISO Properties Inc., Property Casualty Insurers Association of America and Insurance Information Institute
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