Jersey City, N.J. - The U.S. property/casualty insurance industry's net income after taxes dipped to $15.8 billion in first-quarter 2007 from $16.7 billion in first-quarter 2006 and $17.7 billion in first-quarter 2005. Reflecting the declines in net income, the property/casualty industry's annualized rate of return on average policyholders' surplus (statutory net worth) dropped to 12.9% in first-quarter 2007 from 15.5% in first-quarter 2006 and 17.9% in first-quarter 2005, according to Jersey City, N.J.-based ISO Properties Inc. and Des Plaines, Ill.-based Property Casualty Insurers Association of America (PCI).  

Contributing to the $0.9 billion, or 5.5%, decline in net income in first-quarter 2007, the industry's net gain on underwriting receded to $8.3 billion in the first three months of this year from $8.4 billion in the first three months of 2006, as net written premium growth versus year-ago levels slowed to 0.8% in first-quarter 2007 from 1.8 % in first quarter 2006. Also contributing to the decline in net income, the industry's federal income taxes rose to $5.4 billion in first-quarter 2007 from $5.3 billion in first-quarter 2006. But much of the decline in first-quarter net 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. 

"Insurers' 12.9% rate of return for first-quarter 2007 was 1.8 percentage points above insurers' 11.1% average first-quarter rate of return since the start of ISO's quarterly data in 1986, but it fell short of the rates of return typically earned by firms in other industries," says Michael Murray, ISO's assistant vice president for financial analysis. "During the 24 years from 1983 to 2006, the comparable rate of return for the Fortune 500 averaged 13.9%, and escalating competition in insurance markets suggests insurers' rate of return will fall further below that earned by firms in other industries rather than rise to meet it."

"Seasonal patterns in the data also suggest that insurers' rate of return will decline later this year," says Genio Staranczak, PCI's chief economist. "Insurers' profitability in the first quarter usually exceeds their profitability later in the year, in part because of the timing of weather-related catastrophe losses. The Atlantic hurricane season runs from June 1 to November 30."

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.   

Underwriting Results

Net written premiums grew $0.9 billion to $111.4 billion in first-quarter 2007 from $110.5 billion in first-quarter 2006, but written premium growth slowed to 0.8% in the first quarter of this year from 1.8% in the first quarter of last year. Similarly, net earned premiums rose $2 billion to $108.6 billion in first-quarter 2007 from $106.6 billion in first-quarter 2006, as earned premium growth slowed to 1.9% during the first three months of 2007 from 2.7% during the first three months of 2006. 

"At 0.8% in first-quarter 2007, net written premium growth was the weakest for any first quarter since 1992," says Murray. "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' first-quarter 2007 market survey, commercial premium rates declined 11.3% on average for all sizes of accounts. And in May, the CPI for motor vehicle insurance declined 0.3% compared with its level a year earlier, while the CPI for motor vehicle repairs rose 2.8%. And despite ongoing problems in some coastal property insurance markets exposed to hurricanes, the CPI for tenants and household insurance rose a scant 0.1% countrywide—far less than the 4.2% increase in the CPI for repair of household items." 

"Other evidence that escalating competitive pressures are cutting into premium growth includes the gap between premium growth and overall economic growth," says Staranczak. "In first-quarter 2007, net written premiums were up 0.8% from a year ago, while the nation's gross domestic product (GDP), which takes into account both inflation and real growth, increased 4.6% during the same time frame. That premiums grew only about one-sixth as much as GDP is an indication that intensifying competition is leading to lower prices for most coverages in most locations, though property insurance remains scarce and expensive in some coastal areas."

Overall loss and loss adjustment expenses increased $1.1 billion, or 1.6%, to $70.4 billion in first-quarter 2007 from $69.3 billion in first-quarter 2006. Noncatastrophe loss and loss adjustment expenses rose $1.3 billion, or 1.9%, to $69.1 billion in first-quarter 2007 from $67.8 billion in first-quarter 2006. But according to ISO's Property Claim Services (PCS) unit, direct insured losses from catastrophes dropped to $1.3 billion in the first three months of 2007 from $1.5 billion in the corresponding portion of 2006.

Other underwriting expenses—primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes—rose $1.1 billion, or 3.8%, to $29.6 billion in first-quarter 2007 from $28.6 billion in first-quarter 2006.

Dividends to policyholders in first-quarter 2007 totaled $0.3 billion, essentially unchanged from dividends to policyholders in first-quarter 2006. 

The $8.3 billion net gain on underwriting in first-quarter 2007 amounts to 7.6% of the $108.6 billion in net earned premiums for the period, whereas the $8.4 billion net gain on underwriting in first-quarter 2006 amounted to 7.9% of the $106.6 billion in net earned premiums for that period.  

The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium—rose to 91.7% in first-quarter 2007 from 91.1% in first-quarter 2006, with the change in the combined ratio reflecting imbalances between the growth in premiums and the costs of providing insurance. 

"The combined ratio for first-quarter 2007 is the second best for any first quarter since 1986 (when ISO's quarterly records begin), but it wasn't good enough for insurers to achieve the rate of return typically earned by firms in other industries," says Murray. "With first-quarter 2007 investment results, financial leverage, and tax rates, ISO estimates that the combined ratio would have had to improve to 89.6% in order for insurers to have earned the 13.9% long-term average rate of return for the Fortune 500.

Moreover, insurers must now post better underwriting results just to be as profitable as they once were. For example, in first-quarter 1987, when the industry's combined ratio was 103.9%, the annualized rate of return on average surplus was 15.9%—3 percentage points higher than the industry's 12.9% rate of return for first-quarter 2007, even though the combined ratio was 12.2 percentage points worse than the 91.7% combined ratio for the first quarter of this year." 

Investment Results

The industry's net investment income—primarily dividends from stocks and interest on bonds—grew 10% to $12.9 billion in first-quarter 2007 from $11.7 billion in first-quarter 2006. But realized capital gains on investments (not included in net investment income) declined 2.6% to $1.8 billion in the first three months of 2007 from $1.9 billion in the corresponding period of 2006. Combining net investment income and realized capital gains, overall net investment gains rose 8.3%to $14.7 billion in first-quarter 2007 from $13.6 billion in first-quarter 2006.

Combining the $1.8 billion in realized capital gains in first-quarter 2007 with the $0.1 billion in unrealized capital gains during the period, insurers posted $1.9 billion in overall capital gains in the first quarter of 2007—down from $5.9 billion in overall capital gains in the first quarter of 2006.

"The 10% increase in property/casualty insurers' net investment income in first-quarter 2007 is the result of two developments," says Murray. "Insurers' average holding of cash and invested assets rose 7.9%. And the annualized yield on insurers' cash and invested assets increased to 4.23% in first-quarter 2007 from 4.15% in first-quarter 2006. Prospectively, we may see slowing in the growth of investment income as softening prices in insurance markets cut into premiums and the new cash available to fund growth in investment portfolios."

"The 67.2% decline in insurers' total capital gains in first-quarter 2007 reflects developments in financial markets," says Staranczak. "In the first quarter of 2007, stock prices as measured by the S&P 500 rose a barely noticeable 0.2%— far less than the 3.7% increase in the S&P 500 in first-quarter 2006. Similarly, the NASDAQ composite rose just 0.3% in the first quarter of this year—much, much less than the 6.1% increase in that stock index the first quarter of last year. Going forward, the S&P 500 rose 5.4% from the end of the first-quarter through June 25, which suggests insurers' results for the second quarter will benefit from additional capital gains on investments. Beyond that, it all depends on future developments in financial markets."

Pretax Operating Income

Pretax operating income—the sum of net gains or losses on underwriting, net investment income, and miscellaneous other income—declined 3.9% to $19.4 billion in first-quarter 2007 from $20.1 billion in first-quarter 2006. The $0.8 billion decline in operating income is the net result of the $0.2 billion decline in net gains on underwriting, the $1.2 billion increase in net investment income, and a $1.8 billion decline in miscellaneous other income to negative $1.8 billion in first-quarter 2007 from near zero in first-quarter 2006. The decline in miscellaneous other income reflects the previously mentioned 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.

Policyholders' Surplus

Policyholders' surplus, the property/casualty insurance industry's statutory net worth, increased 1.9% to $496.6 billion at March 31, 2007, from $487.1 billion at year-end 2006. The $9.4 billion increase in policyholders' surplus in first-quarter 2007 is 29.3% less than the $13.4 billion increase in first-quarter 2006. 

The increase in surplus in first-quarter 2007 consisted of $15.8 billion in net income after taxes, $0.1 billion in unrealized capital gains on investments (not included in net income), and $1.2 billion in new funds paid in (new capital raised by insurers), less $5.8 billion in dividends to shareholders and $1.8 billion in miscellaneous charges against surplus.

The $0.1 billion in unrealized capital gains in first-quarter 2007 is down from $4 billion in first-quarter 2006. 

The $1.2 billion in new funds paid in during the first three months of 2007 is up from $0.3 billion in the first three months of 2006.

The $5.8 billion in dividends to shareholders in the first quarter of 2007 is up 11.5% from $5.2 billion in the first quarter of 2006.

The $1.8 billion in miscellaneous charges against surplus in first-quarter 2007 is 25.9%less than the $2.5 billion in miscellaneous charges against surplus in first-quarter 2006.

Sources: ISO Properties Inc., Property Casualty Insurers Association of America and Insurance Information Institute

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