First Nine-Month Net Gain on Underwriting in at Least 19 Year Drives Increase in U.S. Property/Casualty Industry's Net Income

JERSEY CITY, N.J., Dec. 20, 2004 — Benefiting from profits on underwriting, the U.S. property/casualty insurance industry's net income after taxes rose 28.3 percent to $26.7 billion in the first nine months of 2004 from $20.8 billion in the first nine months of 2003. Reflecting the growth in the industry's income, its surplus, or statutory net worth, increased $22 billion, or 6.3 percent, to $369 billion at September 30 of this year from $347 billion at year-end 2003, according to ISO and the Property Casualty Insurers Association of America (PCI).

The industry's surplus as of September 30 would have been a record if not for inflation. But surplus remained 5.2 percent below its inflation-adjusted peak of $389.1 billion at June 30, 1998.

"Strong underwriting results drove the increases in insurers' net income and surplus, with insurers earning $2.8 billion in net gains on underwriting through nine months despite major hurricane losses. Prior to 2004, insurers suffered net losses on underwriting during the first nine months of every year since at least 1986, when our quarterly records begin," observed John J. Kollar, ISO vice president for consulting and research.

"The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — improved 2.4 percentage points to 97.9 percent through nine-months 2004 from 100.3 percent through nine-months 2003. At 97.9 percent, the combined ratio for nine-months 2004 was the best nine-month combined ratio in at least 19 years," Kollar added.

"Increases in investment income and realized capital gains also contributed to the growth in insurers' net income and surplus," said Roger Kenney, PCI assistant vice president for research. "Net investment income — primarily dividends from stocks and interest on bonds — grew 3.9 percent to $28.7 billion through nine-months 2004 from $27.7 billion through nine-months 2003. And insurers realized $6.5 billion in capital gains on investments in the first nine months of 2004, up from $5.6 billion in the first nine months of 2003. Surplus also benefited from $1 billion in unrealized capital gains not included in income."

The figures are consolidated estimates for all private property/casualty insurers based on reports accounting for 96 percent of all business written by private U.S. property/casualty insurers.

"Reflecting the increase in net income, the industry's annualized rate of return on average surplus rose to 9.9 percent for nine-months 2004 from 9.2 percent for nine-months 2003," observed Kenney. "The industry's annualized rate of return through nine months has bounced back from a low of negative 1.1 percent for nine-months 2001 to its highest level since the 10 percent annualized return for nine-months 1998."

"But insurance is a cyclical business and improved profitability seems to have sparked increased competition that threatens to undermine underwriting results going forward," said Kollar. "ISO MarketWatchTM data show that actual rate changes on renewals for commercial insurance policies turned positive in mid-1999 and gained momentum through July 2002, when they peaked at 12.9 percent. But since then, rate changes on renewals dwindled to just 3.1 percent in June 2004 — less than a quarter of what they were at their peak. And the Council of Insurance Agents and Brokers third-quarter 2004 rate survey indicates commercial insurance prices fell an average of 5.9 percent for accounts of all sizes. Other indicators pointing to softening in insurance markets include the spread between written premium growth and GDP growth. That spread has turned negative, with premium growth through nine-months 2004 falling 2.2 percentage points short of the 6.7 percent increase in GDP versus year-ago levels. In the first nine months of 2003, premium growth exceeded GDP growth by 5.2 percentage points," Kollar noted.

"As good as results through nine-months 2004 were, they would have been much better if not for the four hurricanes in the third quarter — Charley, Frances, Ivan and Jeanne," said Kenney. "ISO's Property Claim Services (PCS) unit estimates those storms caused $21.6 billion in direct losses. Allowing for losses covered by residual market mechanisms, the Florida Hurricane Catastrophe Fund and foreign reinsurers, private U.S. insurers suffered an estimated $10.3 billion to $12.3 billion in net losses from the third-quarter hurricanes."

Pre-tax operating income — the sum of gains or losses on underwriting, net investment income and other miscellaneous income — climbed $9.4 billion, or 42.9 percent, to $31.2 billion through nine-months 2004 from $21.8 billion through nine-months 2003. Improvement in underwriting results accounts for much of the increase in operating income, with the $2.8 billion in net gains on underwriting in nine-months 2004 constituting an $8.7 billion positive swing from the $5.9 billion in net losses on underwriting in nine-months 2003. Net investment income increased $1.1 billion to $28.7 billion in nine-months 2004 from $27.7 billion in nine-months 2003. Other miscellaneous income dropped to negative $381 million in nine-months 2004 from $14 million in nine-months 2003.

Net investment gains — the sum of net investment income and realized capital gains (losses) — rose $1.9 billion, or 5.8 percent, to $35.2 billion in nine-months 2004 from $33.3 billion in nine-months 2003.

Partially offsetting the $9.4 billion increase in pre-tax operating income and the $0.9 billion increase in realized capital gains, the industry's federal income taxes rose $4.4 billion to $11 billion in nine-months 2004 from $6.6 billion in nine-months 2003. Reflecting the changes in pre-tax operating income, realized capital gains and federal income taxes, insurers' net income after taxes rose $5.9 billion, or 28.3 percent, to $26.7 billion in nine-months 2004 from $20.8 billion in nine-months 2003.

The net gain on underwriting in nine-months 2004 amounts to 0.9 percent of the $307.1 billion in premiums earned during the period. The net gain on underwriting through nine-months 2004 contrasts with a net loss on underwriting through nine-months 2003 amounting to 2 percent of the $287.4 billion in premiums earned during the period.

Underwriting results improved even though premium growth slowed. Written premiums climbed $13.8 billion to $321.2 billion in nine-months 2004 from $307.5 billion in nine-months 2003, but written premium growth slowed to 4.5 percent in nine-months 2004 from 9.7 percent in nine-months 2003. Earned premiums rose $19.8 billion to $307.1 billion in nine-months 2004 from $287.4 billion in nine-months 2003, but earned premium growth slowed to 6.9 percent in nine-months 2004 from 11.1 percent in nine-months 2003.

"Reflecting developments in insurance markets, premium growth climbed fairly steadily from 1.8 percent in nine-months 1999 to a peak of 13.8 percent in nine-months 2002 but has been slowing ever since. At 4.5 percent, written premium growth through nine months had dropped to its slowest pace since the 1.8 percent increase in nine-months 1999," said Kollar. "Similarly, at 6.9 percent, earned premium growth through nine months had dropped to its slowest pace since the 3.8 percent increase for nine-months 2000."

Overall net loss and loss adjustment expenses increased $6.9 billion, or 3.2 percent, to $223.7 billion in nine-months 2004 from $216.8 billion in nine-months 2003. ISO estimates that U.S. insurers' net loss and loss adjustment expenses after reinsurance recoveries in nine-months 2004 included $14.5 billion to $16.5 billion in catastrophe losses. On a direct basis before recoveries from foreign reinsurers and the Florida Hurricane Catastrophe Fund, overall catastrophe losses including those covered by residual market mechanisms rose $15.6 billion, or 151.9 percent, to $25.8 billion in nine-months 2004 from $10.2 billion in nine-months 2003, according to ISO's PCS unit. The $25.8 billion in direct catastrophe losses during nine-months 2004 compares with an average of $9.3 billion during the first nine months of each of the 10 years from 1994 to 2003.

Using the midpoint of the range for U.S. insurers' net catastrophe losses in nine-months 2004, ISO estimates non-catastrophe loss and loss adjustment expenses rose $1.6 billion, or 0.8 percent, to $208.2 billion in nine-months 2004 from $206.6 billion a year earlier.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $4.2 billion, or 5.6 percent, to $79.8 billion in the first nine months of this year from $75.6 billion in the first nine months of last year.

Dividends to policyholders declined 2.9 percent to $0.8 billion in nine-months 2004.

The $22 billion increase in the industry's consolidated surplus in nine-months 2004 compares with a $34.8 billon increase in nine-months 2003. The increase in surplus in nine-months 2004 consisted of $26.7 billion in net income after taxes, $1 billion in unrealized capital gains on investments and $4.5 billion in new funds paid in, less $8.8 billion in dividends to stockholders and $1.4 billion in miscellaneous charges against surplus.

The $1 billion in unrealized capital gains in nine-months 2004 is down 91.5 percent from the $11.2 billion in unrealized capital gains in nine-months 2003.

The $4.5 billion in new funds paid in during nine-months 2004 is down 28.9 percent from the $6.3 billion in new funds paid in during nine-months 2003.

The $8.8 billion in dividends to stockholders in nine-months 2004 is up 60.7 percent from the $5.5 billion in dividends to stockholders in nine-months 2003.

The $1.4 billion in miscellaneous charges against surplus through nine-months 2004 constitutes a $3.3 billion adverse swing from the $1.9 billion in miscellaneous additions to surplus through nine-months 2003.

Combining realized and unrealized capital gains, insurers posted $7.4 billion in overall capital gains on investments in nine-months 2004 — down $9.4 billion, or 56 percent, from the $16.8 billion in overall capital gains in nine-months 2003.

"The decline in insurers' total capital gains on investments is a reflection of developments in financial markets," commented Kollar. "In the first nine months of 2004, the S&P 500 rose 0.2 percent — far less than the 13.2 percent increase in the S&P 500 through nine-months 2003. But with the S&P 500 having risen 8.2 percent from September 30 to December 15 and other major stock market indexes also having risen since September, we can expect that insurers' total capital gains will increase in the fourth quarter. Beyond that, any projection for capital gains is only as good as the underlying forecast for stock prices."

"Developments in financial markets also affect investment income," said Kenney. "The 3.9 percent increase in investment income in nine-months 2004 is the net result of a 12.8 percent increase in insurers' average holdings of cash and invested assets and an 8 percent decline in the yield on those assets. The Federal Reserve Board did raise its target interest rate for the fifth time in five and half months on December 14, but that day the yield on 10-year Treasury notes was just 4.14 percent — 56 basis points below the 4.70 percent that it was on June 29, the day before the Fed's first move. If investment yields don't recover and escalating competition in insurance markets cuts into underwriting cash flows that fund new investments, we could see some weakness in investment income going forward."

Third-Quarter Results
Sharply higher catastrophe losses drove the industry's consolidated net income after taxes down 45.7 percent to $3.4 billion in third-quarter 2004 from $6.3 billion in third-quarter 2003. The industry's net income for third-quarter 2004 reflects the excess of $3.3 billion in pre-tax operating income and $1.6 billion in realized capital gains on investments over $1.5 billion in federal income taxes.

The industry's third-quarter pre-tax operating income of $3.3 billion is down from $6.4 billion in third-quarter 2003. Third-quarter 2004 operating income consisted of $6.1 billion in net losses on underwriting, $9.8 billion in net investment income and $0.4 billion in miscellaneous charges against income.

The $6.1 billion in net losses on underwriting is about twice the $3 billion in net losses on underwriting in the third quarter of 2003. Contributing to the deterioration in underwriting results, direct insured losses from catastrophes rose to $22.4 billion in third-quarter 2004 from $3.7 billion in third-quarter 2003, according to ISO's PCS unit. The $22.4 billion in catastrophe losses during third-quarter 2004 compares with an average of $3.6 billion in third-quarter catastrophe losses during the 10 years from 1994 to 2003. Adjusting third-quarter 2004 direct insured losses from catastrophe for losses covered by residual market mechanisms, the Florida Hurricane Catastrophe Fund and foreign reinsurers, ISO estimates that U.S insurers' net results for the third quarter included between $11.1 billion and $13.1 billion in catastrophe losses.

The third-quarter 2004 net loss on underwriting amounts to 5.8 percent of the $104.9 billion in premiums earned during the period, up from 3.1 percent of the $98.2 billion in premiums earned in third-quarter 2003.

The industry's combined ratio deteriorated to 104.7 percent in third-quarter 2004 from 101.3 percent in third-quarter 2003. Nonetheless, the 104.7 percent combined ratio for third-quarter 2004 was the industry's second best third-quarter combined ratio since the 101.9 percent for third-quarter 1997.

The $6.1 billion in net losses on underwriting is after deductions for $0.3 billion in premiums returned to policyholders as dividends, with dividends to policyholders rising from $0.2 billion in third-quarter 2003.

Written premiums rose to $109.5 billion in third-quarter 2004 from $105.4 billion in third-quarter 2003, but third-quarter written premium growth dropped to 3.9 percent in 2004 from 8 percent in 2003 and 16.8 percent in 2002. At 3.9 percent, third-quarter premium growth had dropped to its slowest pace since the 3.4 percent increase in third-quarter 1999.

The $9.8 billion of net investment income is up 4.4 percent from $9.4 billion in the third quarter of last year.

The $0.4 billion in miscellaneous charges against income constitutes an adverse swing from the $4 million in miscellaneous additions to income in third-quarter 2003.

The $1.6 billion in realized capital gains is up 47.1 percent from the $1.1 billion in realized capital gains during third-quarter 2003.

Combining net investment income and realized capital gains, the industry posted $11.5 billion in net investment gains in third-quarter 2004, up 8.9 percent from $10.5 billion a year earlier.

OPERATING RESULTS FOR 2004 and 2003 ($ Millions)
NINE MONTHS 2004 2003
NET WRITTEN PREMIUM 321,225 307,472
NET EARNED PREMIUM 307,127 287,353
INCURRED LOSS & LOSS ADJUSTMENT EXPENSE 223,687 216,796
STATUTORY UNDERWRITING GAIN (LOSS) 3,668 (5,009)
POLICYHOLDERS' DIVIDENDS 820 844
NET UNDERWRITING GAIN (LOSS) 2,848 (5,854)
PRE-TAX OPERATING INCOME 31,216 21,837
NET INVESTMENT INCOME EARNED 28,748 27,676
NET REALIZED CAPITAL GAIN (LOSS) 6,452 5,583
NET INVESTMENT GAIN 35,200 33,259
NET INCOME (LOSS) AFTER TAXES 26,707 20,819
SURPLUS (CONSOLIDATED) 369,018 320,176
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES 455,608 417,741
COMBINED RATIO, POST-DIVIDENDS (%) 97.9 100.3
THIRD QUARTER 2004 2003
NET WRITTEN PREMIUM 109,460 105,355
NET EARNED PREMIUM 104,947 98,222
INCURRED LOSS & LOSS ADJUSTMENT EXPENSE 83,878 75,228
STATUTORY UNDERWRITING GAIN (LOSS) (5,792) (2,828)
POLICYHOLDERS' DIVIDENDS 293 210
NET UNDERWRITING GAIN (LOSS) (6,085) (3,038)
PRE-TAX OPERATING INCOME 3,314 6,392
NET INVESTMENT INCOME EARNED 9,845 9,426
NET REALIZED CAPITAL GAIN (LOSS) 1,626 1,105
NET INVESTMENT GAIN 11,471 10,531
NET INCOME (LOSS) AFTER TAXES 3,446 6,348
SURPLUS (CONSOLIDATED) 369,018 320,176
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES 455,608 417,741
COMBINED RATIO, POST-DIVIDENDS (%) 104.7 101.3

Release: Immediate

Contacts:
Michael R. Murray (ISO)
201-469-2339
mmurray@iso.com

Sue McKenna (PCI)
847-553-3615

Loretta Worters (III)
212-346-5500