P/C Insurers’ Net Income Rose, Operating Income Fell in First Half

U.S. property/casualty insurers’ net income rose $1.6 billion to $26.0 billion in first-half of 2014 while pretax operating income fell $1.9 billion to $23.9 billion in first-half 2014, a decrease driven by lower gains on both underwriting and investments.

Net gains on underwriting fell to $0.3 billion from $2.2 billion in first-half 2013 including mortgage and financial guaranty (M&FG) insurers. The industry’s combined ratio deteriorated to 98.9 percent from 98.0 percent for first-half 2013, according to ISO and the Property Casualty Insurers Association of America (PCI).

Insurers’ net investment income dropped $0.3 billion to $23.0 billion.

Reflecting insurers’ net income after taxes, policyholders’ surplus grew to a record-high $671.6 billion at June 30, 2014, from $653.4 billion at year-end 2013. The increase in insurers’ net income after taxes is the net result of a decline in pretax operating income, an increase in realized capital gains on investments, and a small reduction in federal and foreign income taxes.

Insurers’ realized capital gains on investments rose $3.3 billion to $7.2 billion in the first half of 2014 from $3.9 billion in the first half of 2013.

With policyholders’ surplus rising more rapidly than insurers’ net income after taxes, insurers’ overall profitability as measured by their annualized rate of return on average policyholders’ surplus slipped to 7.8 percent in first-half 2014 from 8.1 percent in first-half 2013 despite the increase in insurers’ net income.

The property/casualty industry’s 7.8 percent annualized rate of return for first-half 2014 was the net result of double-digit rates of return for mortgage and financial guaranty (M&FG) insurers and single-digit rates of return for other insurers. Excluding M&FG insurers, the industry’s annualized rate of return fell to 7.7 percent in first-half 2014 from 8.5 percent in first-half 2013.

“Insurers are strong, well capitalized, and well prepared to pay future claims,” said Robert Gordon, PCI’s senior vice president for policy development and research. “But it only takes one powerful storm to disrupt countless lives and cause tens of billions in damage, and this hurricane season is far from over.”

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.

Questions

Even though net income was up a bit, the results raise questions about insurers’ earnings going forward, according to Michael R. Murray, ISO’s assistant vice president for financial analysis.

“While insurers’ net income rose modestly in first-half 2014, the deterioration in underwriting results and the drop in investment income both raise questions about the quality or sustainability of insurers’ earnings,” said Murray. “Other factors raising questions about the quality or sustainability of earnings include the extent to which underwriting results benefited from favorable reserve development and the extent to which insurers’ net income benefited from realized capital gains dependent on developments in financial markets.”

Murray said insurers’ overall rate of return remained “subpar compared with long-term historical norms, and insurers now need much better underwriting results just to be as profitable as they were in the past.” Insurers’ 7.8 percent annualized rate of return fell short of insurers’ 9.0 percent average overall rate of return for the 55 years from the start of ISO’s annual data in 1959 to 2013, even though the 98.9 percent combined ratio for first-half 2014 was 5.0 percentage points better than the 103.9 percent average combined ratio for the past 55 years.

Underwriting Results

Insurers’ net gains on underwriting dropped to $0.3 billion from $2.2 billion in first-half 2013 as growth in premiums fell short of growth in the cost of providing insurance protection.

Net written premiums rose $9.5 billion, or 4.0 percent, to $246.4 billion for first-half 2014 from $236.9 billion for first-half 2013. Net earned premiums rose $9.7 billion, or 4.2 percent, to $237.8 billion from $228.2 billion.

Net loss adjustment expenses (LLAE) after reinsurance recoveries rose $10.1 billion, or 6.4 percent, to $168.1 billion in first-half 2014 from $158.0 billion in first-half 2013 as other underwriting expenses rose $1.5 billion, or 2.2 percent, to $68.5 billion in first-half 2014 from $67.0 billion in first-half 2013.

The increase in overall net LLAE reflects increases in both catastrophe and non-catastrophe losses.

ISO estimates that private insurers’ net LLAE from catastrophes rose $2.6 billion to $13.0 billion in first-half 2014 from $10.3 billion in first-half 2013. The $13.0 billion in net LLAE from catastrophes is primarily attributable to catastrophes that struck the United States. Net LLAE excluding catastrophes rose $7.5 billion, or 5.1 percent, to $155.1 billion through six-months 2014 from $147.6 billion through six-months 2013.

According to ISO’s Property Claim Services(PCS) unit, catastrophes striking the United States in first-half 2014 caused $12.4 billion in direct insured losses for all insurers (including residual market insurers and foreign insurers and reinsurers), up $2.5 billion compared with the $10.0 billion in direct insured losses caused by catastrophes striking the United States in first-half 2013 and $2.3 billion more than the $10.2 billion average for first-half direct catastrophe losses during the past 10 years.

The combined ratio deteriorated by 0.9 percentage points to 98.9 percent in first-half 2014 from 98.0 percent in first-half 2013.

“Rapid growth in net LLAE more than accounts for the deterioration in underwriting results in first-half 2014,” said Gordon. “If LLAE had risen at the same 4.2 percent rate as earned premiums instead of increasing 6.4 percent, the combined ratio would have improved 0.5 percentage points to 97.4 percent instead of rising 0.9 percentage points to 98.9 percent.”

M&FG insurers’ net written premiums fell 13.2 percent to $2.2 billion for first-half 2014 from $2.5 billion for first-half 2013, and their net earned premiums fell 16.3 percent to $2.4 billion from $2.9 billion. But M&FG insurers’ underwriting expenses were essentially unchanged at $0.7 billion for both first-half 2014 and first-half 2013, and M&FG insurers’ underwriting results benefited from a $1.6 billion, or 55.4 percent, decline in LLAE to $1.3 billion in first-half 2014 from $2.9 billion in first-half 2013.

Excluding M&FG insurers, industry net written premiums rose 4.2 percent in first-half 2014 to $244.2 billion, net earned premiums increased 4.5 percent to $235.4 billion, LLAE rose 7.6 percent to $166.8 billion, other underwriting expenses grew 2.2 percent to $67.8 billion, and dividends to policyholders dropped 6.3 percent to $0.9 billion. As a result, the combined ratio for the industry excluding M&FG insurers deteriorated to 99.0 percent for first-half 2014 from 97.6 percent for first-half 2013.

“Using 12-month trailing premiums, the premium-to-surplus ratio dropped to 0.72 as of June 30, 2014, from 0.76 a year earlier. And the ratio of loss and loss adjustment expense reserves to surplus fell to 0.86 as of June 30 this year from 0.94 as of June 30, 2013,” said Murray. “To the extent that these leverage ratios shed light on the amount of risk supported by each dollar of surplus, insurers are extremely well capitalized at this point and have ample capacity to meet increasing demand for coverage as the economy grows.”

He said the 0.72 premium-to-surplus ratio as of June 30 is only about half of the 1.45 average premium-to-surplus ratio based on annual data for the 55 years from 1959 to 2013. Similarly, the 0.86 LLAE-reserves-to-surplus ratio as of the end of first-half 2014 is far below the 1.39 average for the 55 years ending 2013.

Second-Quarter Results

Consolidated net income after taxes rose to $12.1 billion in second-quarter 2014, up $2.0 billion from $10.1 billion in second-quarter 2013. Property/casualty insurers’ annualized rate of return on average surplus increased to 7.3 percent in second-quarter 2014 from 6.6 percent a year earlier.

For the industry overall, net losses on underwriting shrank $0.2 billion to $2.1 billion in second-quarter 2014 from $2.3 billion in second-quarter 2013. ISO estimates that the net LLAE from catastrophes included in private U.S. insurers’ financial results rose to $9.8 billion in second-quarter 2014 from $7.9 billion a year earlier.

The industry’s combined ratio improved to 100.6 percent in second-quarter 2014 from 100.9 percent in second-quarter 2013.

Net written premiums rose $5.1 billion, or 4.2 percent, to $125.0 billion in second-quarter 2014 from $119.9 billion in second-quarter 2013. Excluding M&FG insurers, industry net written premiums rose 4.4 percent in second-quarter 2014 to $123.8 billion,

The combined ratio for the industry excluding M&FG insurers deteriorated to 100.7 percent for second-quarter 2014 from 100.1 percent for second-quarter 2013.