P/C Insurers’ Profits Fell in Q1 as Underwriting Losses Grew

Private U.S. property/casualty insurers’ net income after taxes dropped to $7.8 billion in first-quarter 2011 from $8.9 billion in first-quarter 2010, with insurers’ annualized rate of return on average policyholders’ surplus decreasing to 5.6 percent from 6.8 percent.

Reflecting insurers’ $7.8 billion in net income after taxes, policyholders’ surplus rose $7.8 billion, or 1.4 percent, to a record $564.7 billion at March 31, 2011, from $556.9 billion at December 31, 2010.

Driving the declines in insurers’ net income and overall rate of return, net losses on underwriting grew to $4.5 billion in first-quarter 2011 from $1.8 billion in first-quarter 2010. The combined ratio deteriorated to 103.3 percent in first-quarter 2011 from 101.1 percent in first-quarter 2010, according to ISO and the Property Casualty Insurers Association of America (PCI).

Partially offsetting the deterioration in underwriting results, net investment gains grew $1 billion to $13.5 billion in first-quarter 2011 from $12.6 billion in first-quarter 2010. In addition, miscellaneous other income rose $0.1 billion to $0.5 billion in the first quarter of 2011 from $0.4 billion in the first quarter of 2010, and insurers’ federal and foreign income taxes dropped $0.5 billion to $1.8 billion from $2.3 billion.

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.

While the declines in property/casualty insurers’ net income and return on surplus in first-quarter 2011 may be bad news for insurance companies, overall surplus rose to a record high, meaning insurers should have the financial resources necessary to cover claims even if this year’s hurricane season is as bad as the experts predict, said David Sampson, PCI’s president and CEO.

Combining insurers’ record $564.7 billion in policyholders’ surplus, their $560.8 billion in loss and loss adjustment expense reserves, and their $202.7 billion in unearned premium reserves as of March 31, 2011, insurers had $1.3 trillion to pay claims and meet other contingencies.

“Nonetheless, the devastatingly deadly EF5 tornado that struck Joplin, Missouri, last month and other tragic events around the globe — such as the monstrous earthquake and tsunami that struck northeast Japan in March — should serve as vivid reminders that catastrophes can strike anywhere at any moment,” said Sampson.

With mounting net losses on underwriting driving the decline in insurers’ net income and overall profitability in first-quarter 2011, insurers continued to face substantial headwinds in their core business — underwriting.

“While there were some positive developments that bode well, there have also been some negative developments that suggest insurers’ results will get worse,” said Michael R. Murray, ISO’s assistant vice president for financial analysis.

On the plus side of the ledger, net written premiums rose for the fourth consecutive quarter, with net written premiums rising in first-quarter 2011 by the largest amount since third-quarter 2006.

On the negative side, Murray said, catastrophes striking the United States in second-quarter 2011 had already caused $14.7 billion in direct insured losses to property — more than double the $6.4 billion in direct insured losses from all the catastrophes that occurred in second-quarter 2010 — and second-quarter 2011 catastrophe losses are expected to rise further when losses from four recent events are added to the tally.

Also, while increases in stock markets helped fuel insurers’ capital gains on investments in first-quarter 2011. Stocks have fallen recently, suggesting that insurers’ results for second-quarter 2011 may suffer from capital losses on investments.

“Yet these near-term negatives could have positive implications farther down the road to the extent that they erase some of insurers’ excess capacity and thereby hasten a turn in the insurance pricing cycle,” said Murray.

The property/casualty insurance industry’s 5.6 percent annualized rate of return for first-quarter 2011 was the net result of a negative rate of return for mortgage and financial guaranty insurers and a single-digit rate of return for other insurers. ISO estimates that mortgage and financial guaranty insurers’ rate of return on average surplus for first-quarter 2011 was negative 17.7 percent, up from negative 66 percent for first-quarter 2010. Excluding mortgage and financial guaranty insurers, the industry’s rate of return dropped to 6.1 percent for first-quarter 2011 from 8.3 percent for first-quarter 2010.

“Insurers’ overall rate of return for first-quarter 2011 was clearly subpar,” said Sampson. He said insurers’ 5.6 percent annualized rate of return for the period was 4 percentage points less than their 9.6 percent average annualized first-quarter rate of return for the past ten years. Moreover, insurers’ rate of return remained far below benchmarks like the 13.9 percent long-term average rate of return for the Fortune 500.

Underwriting Results

Net losses on underwriting grew to $4.5 billion in first-quarter 2011 from $1.8 billion in first-quarter 2010, a $2.7 billion increase, as growth in LLAE and other underwriting expenses outpaced growth in premiums earned.

Net written premiums rose $3.7 billion, or 3.5 percent, to $108.6 billion for first-quarter 2011 from $104.9 billion for first-quarter 2010. Net earned premiums rose $2.1 billion, or 2 percent, to $104.8 billion from $102.7 billion.

Net LLAE (after reinsurance recoveries) rose $4 billion, or 5.4 percent, to $78.5 billion in first-quarter 2011 from $74.5 billion in first-quarter 2010.

Other underwriting expenses — primarily acquisition expenses; expenses associated with underwriting, pricing, and servicing insurance policies; and premium taxes — rose $0.8 billion, or 2.9 percent, to $30.4 billion in first-quarter 2011 from $29.5 billion in first-quarter 2010.

Dividends to policyholders remained essentially unchanged at $0.5 billion.

Overall LLAE increased despite a decline in LLAE from catastrophes striking the United States. ISO estimates that private insurers’ net LLAE from such catastrophes fell $0.7 billion to $2 billion in first-quarter 2011 from $2.7 billion in first-quarter 2010.

According to ISO’s Property Claim Services (PCS) unit, catastrophes striking the United States in first-quarter 2011 caused $1.9 billion in direct insured losses (before reinsurance recoveries) for all insurers (including residual-market insurers and foreign insurers) — down $0.7 billion from $2.6 billion in first-quarter 2010.

Excluding the LLAE attributable to U.S. catastrophes, overall net LLAE rose $4.7 billion, or 6.5 percent, to $76.5 billion in first-quarter 2011 from $71.8 billion in first-quarter 2010.

For those U.S. insurers that cover or reinsure property overseas, first-quarter 2011 financial results included LLAE from events such as the earthquake and tsunami that struck northeastern Japan on March 11 and the earthquake that struck Christchurch, New Zealand, on February 22 (February 21 UTC). Estimating the amount of LLAE from foreign catastrophes included in U.S. insurers’ financial results is difficult, but the available information suggests that U.S. insurers’ net LLAE for first-quarter 2011 included between $2 billion and $5 billion in LLAE attributable to catastrophes striking elsewhere around the globe.

Total net LLAE for both first-quarter 2011 and first-quarter 2010 was reduced by downward revisions to the estimated ultimate cost of claims incurred in prior years and consequent releases of LLAE reserves. Such downward revisions and releases dropped to $4.5 billion in first-quarter 2011 from $5.6 billion in first-quarter 2010. Excluding those amounts, net LLAE increased $2.9 billion, or 3.7 percent, to $83 billion in first-quarter 2011 from $80.1 billion in first-quarter of 2010.

The 3.5 percent increase in total industry net written premiums in first-quarter 2011 was the first increase in first-quarter net written premiums since 2007 and the largest since 2004, when first-quarter net written premiums rose 4.8 percent. “Moreover — and possibly sending a signal about the nature of things to come — year-to-year comparisons improved for each of the three major subsectors of the industry tracked by ISO,”  said Murray.

Net written premium growth for insurers writing predominantly personal lines accelerated to 3.8 percent in first-quarter 2011 from 2.2 percent in first-quarter 2010, with premium growth for insurers writing more balanced books of business increasing to 3.1 percent from negative 1.4 percent. Premium growth for insurers writing predominantly commercial lines rose to 3.5 percent from negative 5.3 percent, though first-quarter 2011 net written premiums for insurers writing predominantly commercial lines may have benefited to some extent from premiums paid by foreign insurers to reinstate reinsurance coverage.

“The deterioration in underwriting profitability as measured by the combined ratio is a particular cause for concern, because today’s low investment yields, together with the long-term decline in investment leverage that helped insulate insurers from the ravages of the financial crisis and the Great Recession, mean insurers need better underwriting results just to be as profitable as they once were,” said Sampson.

Insurers’ annualized rate of return for first-quarter 2011 fell short of insurers’ annualized first-quarter rate of return for 10 of the 11 years from 1986 to 1996, even though insurers’ combined ratio for first-quarter 2011 was better than their combined ratio for the first quarter of each of those 11 years. As a result, insurers’ 5.6 percent annualized rate of return for first-quarter 2011 was 4.8 percentage points lower than their 10.3 percent average annualized first-quarter rate of return for 1986 to 1996, while insurers’ 103.3 percent combined ratio for first-quarter of 2011 was 4.3 percentage points better than their 107.6 percent average first-quarter combined ratio for 1986 to 1996.

The $4.5 billion in net losses on underwriting in first-quarter 2011 amounted to 4.3 percent of the $104.8 billion in net premiums earned during the period, whereas the $1.8 billion in net losses on underwriting in first-quarter 2010 amounted to 1.7 percent of the $102.7 billion in net premiums earned during that period.

Reflecting the residual weakness in the economy, mortgage and financial guaranty insurers continued to suffer disproportionate losses on underwriting, said Murray. Though mortgage and financial guaranty insurers’ combined ratio improved 54.6 percentage points to 176.9 percent for first-quarter 2011 from 231.5 percent for first-quarter 2010, their combined ratio for first-quarter 2011 was 74.7 percentage points worse than the 102.2 percent combined ratio for the industry excluding mortgage and financial guaranty insurers.

Mortgage and financial guaranty insurers’ net written premiums grew 4.9 percent to $1.3 billion for first-quarter 2011. But their net earned premiums fell 5.9 percent to $1.5 billion in first-quarter 2011 from $1.6 billion a year earlier, with the 54.6-percentage-point improvement in mortgage and financial guaranty insurers’ combined ratio driven by a 32.1 percent drop in their loss and loss adjustment expenses to $2.3 billion in first-quarter 2011 from $3.4 billion in first-quarter 2010. Mortgage and financial guaranty insurers’ other underwriting expenses rose to $0.4 billion in first-quarter 2011 from $0.3 billion a year earlier.

Excluding mortgage and financial guaranty insurers, industry net written premiums rose 3.5 percent in first-quarter 2011 to $107.2 billion, earned premiums increased 2.2 percent to $103.3 billion, loss and loss adjustment expenses grew 7.1 percent to $76.2 billion, other underwriting expenses increased 2.7 percent to $30 billion, and dividends to policyholders were virtually unchanged at $0.5 billion. As a result, the combined ratio for the industry excluding mortgage and financial guaranty insurers rose 3.1 percentage points to 102.2 percent for first-quarter 2011 from 99 percent for first-quarter 2010.

Investment Results

Insurers’ net investment income — primarily dividends from stocks and interest on bonds — increased 8.3 percent to $12.6 billion in first-quarter 2011 from $11.6 billion in first-quarter 2010. Insurers’ realized capital gains on investments were essentially unchanged at $1 billion in both first-quarter 2011 and first-quarter 2010. Combining net investment income and realized capital gains, overall net investment gains rose 7.6 percent to $13.5 billion in first-quarter 2011 from $12.6 billion in first-quarter 2010.

Combining the $1 billion in realized capital gains in first-quarter 2011 with $3.9 billion in unrealized capital gains during the period, insurers posted $4.9 billion in overall capital gains in first-quarter 2011 — down $0.9 billion compared with insurers’ $5.8 billion in overall capital gains on investments in first-quarter 2010.

The growth in insurers’ investment income in first-quarter 2011 was a result of special developments, according to Sampson. In particular, insurers’ investment income in first-quarter 2011 benefited from $1 billion that one insurer received from a major noninsurance operation acquired in early 2010 and $0.4 billion in special dividends that the same insurer received from a foreign subsidiary. Excluding those items, insurers’ net investment income declined $0.5 billion, or 4 percent, to $11.1 billion in first-quarter 2011 from $11.6 billion in first-quarter 2010.

Pretax Operating Income

Pretax operating income — the sum of net gains or losses on underwriting, net investment income, and miscellaneous other income — fell $1.6 billion, or 15.9 percent, to $8.6 billion for first-quarter 2011 from $10.2 billion for first-quarter 2010. The $1.6 billion decrease in operating income was the net result of the $2.7 billion increase in net losses on underwriting, the $1 billion increase in net investment income, and the $0.1 billion increase in miscellaneous other income to $0.5 billion for first-quarter 2011 from $0.4 billion for first-quarter 2010.

Mortgage and financial guaranty insurers’ operating income rose to negative $0.7 billion in first-quarter 2011 from negative $1.4 billion in first-quarter 2010. Excluding mortgage and financial guaranty insurers, the insurance industry’s operating income fell $2.3 billion, or 19.8 percent, to $9.4 billion in first-quarter 2011 from $11.7 billion in first-quarter 2010.

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-quarter 2011 totaled $7.8 billion, down 12.2 percent from $8.9 billion for first-quarter 2010. The $1.1 billion decrease in net income was the net result of the $1.6 billion decrease in operating income and the $0.5 billion decrease in federal and foreign income taxes to $1.8 billion for first-quarter 2011 from $2.3 billion a year earlier.

Mortgage and financial guaranty insurers’ net income after taxes rose to negative $0.5 billion for first-quarter 2011 from negative $1.8 billion for first-quarter 2010. Excluding mortgage and financial guaranty insurers, the insurance industry’s net income after taxes dropped $2.4 billion, or 22.2 percent, to $8.3 billion for first-quarter 2011 from $10.7 billion for first-quarter 2010.

Policyholders’ Surplus

Policyholders’ surplus increased $7.8 billion to $564.7 billion at March 31, 2011, from $556.9 billion at year-end 2010. Additions to surplus in first-quarter 2011 included insurers’ $7.8 billion in net income after taxes, $3.9 billion in unrealized capital gains on investments (not included in net income), $1.5 billion in new funds paid in (new capital raised by insurers), and $0.4 billion in miscellaneous additions to surplus. Those additions were partially offset by $5.7 billion in dividends to shareholders.

Insurers’ unrealized capital gains on investments dropped to $3.9 billion in first-quarter 2011 from $4.8 billion in first-quarter 2010.

The $1.5 billion in new funds paid in during first-quarter 2011 was down from a record-high $22.7 billion in first-quarter 2010 but close to the $1.6 billion average for all first quarters since 1986, when ISO’s quarterly records begin.

The $0.4 billion in miscellaneous additions to surplus in first-quarter 2011 compared with $1.3 billion in miscellaneous charges against surplus in first-quarter 2010.

The $5.7 billion in dividends to shareholders in first-quarter 2011 was down $0.4 billion, or 6.4 percent, from $6.1 billion in first-quarter 2010.

Key leverage ratios suggest that insurance industry as a whole is exceptionally well capitalized at this point, with both the ratio of 12-month premiums to surplus and the ratio of loss and loss adjustment expense reserves to surplus falling to new record lows in first-quarter 2011 based on quarterly data extending back to 1986, according to Murray. He said these leverage ratios provide simple measures of the amount of risk supported by each dollar of surplus — the lower the leverage ratios, the more likely an insurer has the financial wherewithal to absorb shock losses and other adverse developments. With the premium-to-surplus ratio dropping to 0.75 in first-quarter 2011 from 1.88 in fourth-quarter 1986 and the ratio of loss and loss adjustment expense reserves to surplus falling to 0.99 from a high of 2.15 in third-quarter 1990, the insurance industry is well positioned to come to the aid of policyholders during the hurricane season this year, he said.

“But to the extent that these same leverage ratios provide insight into insurers’ capacity utilization and the potential supply of insurance, they help explain why some commercial insurance markets have remained so soft for so long,” Murray said.

Source: ISO, PCI