Insurer Financial Results: 1995

June 1996
Executive Summary

Net Income and Return on Net Worth
The property/casualty insurance industry earned record after-tax income of $20.1 billion in 1995, surpassing the previous record of $19.3 billion in 1993. Compared with results in 1994 — a year marked by high catastrophe losses and weak investment results — net income after taxes in 1995 increased 85.3%, and return on average net worth increased from 5.6% to 8.2%. Table 1 summarizes insurers' overall financial results for the past two years. A significant decrease in underwriting losses and increases in realized capital gains and investment income were the main reasons for the $9.3 billion increase in industry net income.

Table 1
Summary of Financial Results

Property/Casualty Insurance Industry
($ Billions)
Combined Ratio 1994
Underwriting Income (Loss)$(22.2)$(17.3)$4.9-21.9%
Investment Income33.736.22.57.5
Miscellaneous Income (Loss)
Operating Income (Loss) 11.6 19.2 7.6 65.4
Realized Capital Gains1.75.84.1248.8
Federal Income Taxes2.44.92.5102.5
Net Income After Taxes 10.9 20.1 9.3 85.3
Return on Average Net Worth (GAAP)5.6%8.2%2.6*NM

NOTES: Figures may not balance because of rounding.
NM=Not Meaningful
*Difference in percentage points.

Catastrophe losses were significantly lower in 1995 than in 1994, but 1995 still ranks as the third-worst year for catastrophe losses. Total insured catastrophe losses amounted to $8.3 billion.

With the stock market soaring in 1995, the industry's total capital gains rose to $26.3 billion, compared with a small capital loss in 1994. Realized capital gains increased $4.1 billion from $1.7 billion in 1994 to $5.8 billion in 1995. Unrealized capital gains totaled $20.5 billion in 1995, compared with unrealized capital losses of $1.8 billion in 1994. Because of significantly improved underwriting results in 1995, insurers relied less on available capital gains to bolster income. Realized capital gains accounted for only 23.2% of statutory pretax income in 1995. This contrasts with the results in 1993, another record-breaking year for profits, when the industry's realized capital gains accounted for 40.3% of statutory pretax income.

Net investment income grew 7.5% in 1995. After five years of record low growth, including two years of declines, 7.5% is the largest increase since 1989. Investment income grew even though interest rates fell significantly. Average yields on ten-year U.S. Treasury bonds dropped from 7.1% in 1994 to 6.6% in 1995, but the embedded yield on the industry's portfolio of invested assets remained 5.7% — its lowest level since 1977.

While insurers' statutory pretax income increased 88.4% in 1995, their federal income taxes increased 102.5%. Insurers paid $4.9 billion in federal income taxes, resulting in an effective tax rate of 19.4%. In 1994, this rate was 18.1%. But the 1995 effective tax rate remained much lower than the average effective tax rate of 20.6% for the prior eight years since the Tax Reform Act of 1986 took effect.

In 1995, the property/casualty industry's surplus, or statutory net worth, grew $38.4 billion, or 19.9%, to $231.7 billion. Total capital gains of $26.3 billion and operating income of $19.2 billion were the primary contributors to the change in surplus. Stockholder dividends offset the industry's new funds of $6.9 billion. Federal income taxes and miscellaneous charges against surplus account for the rest of the difference. (See Table 2.)

Table 2
Components of Surplus
Property/Casualty Insurance Industry
($ Billions)
Operating Income$11.6$19.265.4%
Realized Capital Gains1.75.8248.8
Federal Income Taxes2.44.9102.5
Net Income After Taxes 10.9 20.1 85.3
Dividends to Stockholders6.37.010.9
New Funds6.86.90.8
Unrealized Capital Gains (Losses)(1.8)20.5NM
Miscellaneous Surplus Change(1.5)(2.2)48.6
Change in Year-End Surplus8.138.4372.7
Year-End Surplus$193.3$231.719.9%

NOTES: Figures may not balance because of rounding.
NM=Not Meaningful

Underwriting Results
Continuing the industry's seven-year pattern of slow growth, written premiums rose just 3.3% in 1995, held back by an approximate 10% drop in workers' compensation written premium. Industry average premium growth during the eight years from 1988 to 1995 was 3.8%.

Despite a combination of high catastrophe losses and high environmental and asbestos (E&A) losses, the industry's underwriting results in 1995 were better than the results in any year since 1988, with the combined ratio declining to 106.3%. Based on a sample of insurers representing 60% to 90% of the industry's 1994 premium volume by line, the pure loss ratio of allied lines (including earthquake) dropped from 230% to 68%; homeowners dropped from 75% to 70%; commercial multiple peril dropped from 66% to 61%; workers' compensation dropped from 61% to 55%; and medical malpractice dropped from 48% to 40%. Only general liability experienced significant deterioration, with its pure loss ratio increasing from 69% to 83%. This deterioration was due to rising E&A losses.

If catastrophe losses had been at long-term average levels, underwriting income would have been $10.5 billion greater in 1994 and $4.1 billion greater in 1995. (See Table 3.) In addition, the 1995 combined ratio would have been 104.6%, rather than 106.3%. The catastrophe-adjusted combined ratio for 1995 was the second best since 1980 and just 0.5 percentage points above 1994's catastrophe-adjusted combined ratio of 104.1%. Taking tax effects into account, the industry's 1995 return on net worth would have been 9.2%, rather than 8.2%.

Table 3
The Effect of Catastrophes
($ Billions)
Catastrophe Losses$5.7$14.5*$8.3
Underwriting Income$(17.8)$(22.2)$(17.3)
Combined Ratio106.9%108.4%106.3%
Return on Net Worth11.0%5.6%8.2%
Adjusted For Catastrophes
Adjusted Catastrophe Losses$4.0$4.0$4.2
Adjusted Underwriting Income$(16.1)$(11.7)$(13.2)
Adjusted Combined Ratio106.1%104.1%104.6%
Adjusted Return on Net Worth11.2%9.2%9.2%

*Reflects an adjustment for losses from the Northridge, California, earthquake ceded to foreign reinsurers.

E&A losses have dragged down industry results in recent years, although most of these losses came from claims against policies issued before 1986. ISO estimates that the industry incurred $30.4 billion in losses and allocated loss adjustment expenses (ALAE) for E&A exposures in the last five years. The industry incurred $10.1 billion of that in 1995. In the absence of E&A losses, the industry's combined ratio would have been 2.5 percentage points lower, on average, over the last five years, and 4 percentage points lower in 1995.

Adjusting for the effects of E&A and catastrophe losses in 1995 further highlights the apparent improvement in underwriting results for business not related to either catastrophe coverage or E&A coverage on pre-1986 policies. The 1995 combined ratio, adjusted to long-term average catastrophe levels and to exclude E&A losses, is 100.6% — 1.4 percentage points lower than in 1994 and 5.7 percentage points lower than its 1995 unadjusted level. However, if insurers weakened reserves not related to E&A exposures, it is possible that this result overstates the improvement.

Comparisons with Other Industries
From 1978 to 1994, property/casualty insurers' returns on net worth averaged 10.7%, compared with an average of 11.9% for other industries in Standard & Poor's COMPUSTAT data base. In a ranking of industries from most to least profitable during these years, property/casualty insurance ranked 36 out of 56 industries. In 1995, a record year for after-tax income, the industry's rate of return on net worth increased to 8.2%. Nonetheless, this percentage is still significantly lower than the industry's long-term average and the 14.8% median return on net worth for the Fortune 500 in 1995.

Uncertainties Affecting the Property/Casualty Insurance Industry
Though both insurers' net income and surplus rose sharply in 1995, the outlook for insurers and the property/casualty industry remains uncertain. The challenges confronting insurers include:

  • Continuing exposure to vast catastrophe losses — During the seven years ending 1995, inflation-adjusted catastrophe losses totaled $74.8 billion. This total was $24.8 billion, or 50%, more than all such losses during the 39 years from 1950 to 1988.
  • Potential financial responsibility for cleaning up thousands of the nation's hazardous waste sites — ISO estimates that insurers have recognized (paid or reserved for) at least $22.7 billion in environmental losses through year-end 1995. Some recent studies estimate that insurers' undiscounted ultimate cost for cleaning up abandoned hazardous waste sites could range from $25 billion to $91 billion.
  • The possibility of a major restructuring of the property/casualty industry through mergers and acquisitions — Data compiled by Conning & Company indicates that the number of mergers and acquisitions in the U.S. property/casualty industry rose from 33 in 1993 to 68 in 1995. The reported dollar value of property/casualty mergers and acquisitions has risen even more sharply, climbing from $1.9 billion in 1993 to $11.5 billion in 1995.
  • Potential further inroads by alternative providers, including insureds themselves — Various estimates indicate that self-insurance, captives, risk retention groups, and similar alternative insurance mechanisms account for perhaps 33% to 44% of the commercial risk financing market. Substantial pieces of the U.S. insurance market have also been lost to government entities and foreign firms.
  • Effect of judicial decisions on state regulation — Despite the McCarran-Ferguson Act, federal involvement in the insurance industry has grown over the years.
  • Adapting to new technologies that may revolutionize distribution mechanisms and other aspects of the insurance business — The rise of the Internet and the World Wide Web may well revolutionize commerce in general and the business of insurance in particular.
  • The ever-present possibility of sudden reversals in financial markets — The Standard & Poor's (S&P) 500 rose 34.1% in 1995, but it has declined in more than one out of every five years from 1970 to 1995 and, at times, it has fallen precipitously. During 1973 to 1974, the S&P 500 plunged 42%.