Insurer Financial Results: 1996

June 1997
Executive Summary

Net Income and
Return on Net Worth

The property/casualty insurance industry's statutory net income grew 17.0% in 1996, to a record $24.1 billion. The industry's surplus increased 11.5%, to an all-time high of $256.5 billion. Improvement in reported underwriting results, modest growth in investment income, and unusually large capital gains benefited both the industry's income and surplus.

Nonetheless, the industry's GAAP rate of return was virtually unchanged in 1996, rising to 8.8% from 8.7% in 1995. (See Table 1.) These recent rates of return fall short of both the returns earned by other industries and longer-term norms for insurers themselves.

Underwriting Results
The industry's combined ratio, a key measure of underwriting profitability, improved to 105.9% in 1996 from 106.4% in 1995. Consistent with this result, the industry's statutory underwriting loss declined by 4.9%, to $16.8 billion.

Underwriting results improved despite the continuation of lackluster premium growth. The industry's net written premiums rose 3.5% in 1996, after rising 3.6% in 1995 and 3.7% in 1994.

Table 1
Summary of Financial Results
Property/Casualty Insurance Industry
($ Billions)
1995
1996
Difference
Percent
Change
Combined Ratio
106.4%
105.9%
-0.5*
NM
Underwriting Income (Loss)
$(17.7)
$(16.8)
$0.9
-4.9%
Investment Income
36.8
37.6
0.7
2.0
Miscellaneous Income (Loss)
0.3
(0.6)
-0.9
-282.9
Operating Income (Loss)
19.5
20.2
0.7
3.6
Realized Capital Gains
6.0
9.6
3.6
59.5
Federal Income Taxes (credit)
4.9
5.6
0.7
14.3
Net Income after Taxes
20.6
24.1
3.5
17.0
Return on Average Net Worth (GAAP)
8.7%
8.8%
0.1*
NM

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

Continuing slow growth in the industry's loss and loss adjustment expenses led to the improvement in underwriting profitability. Lower catastrophe losses, reduced costs for past environmental and asbestos (E&A) claims, and deterioration in reserve adequacy limited growth in the industry's loss and loss adjustment expenses to 2.9% in 1996. Catastrophe losses receded from $8.3 billion in 1995 to $7.4 billion in 1996, and ISO estimates that newly emerging E&A losses declined from $11.0 billion in 1995 to $5.8 billion last year. ISO also estimates that the industry weakened its reserves for other losses by $7.9 billion in 1996, and ISO will update this preliminary estimate later this year when more complete data is available.

When ISO adjusted the data for swings in catastrophe losses, E&A losses, and changes in the adequacy of reserves for losses other than E&A, a different picture emerged. If not for those factors, ISO estimates that the industry's loss and loss adjustment expenses would have increased by 4.9% in 1996 instead of rising just 2.9%. The industry's combined ratio would have deteriorated by 0.9 percentage points instead of improving by 0.5 percentage points. And the industry's GAAP rate of return would have fallen by 1.0 percentage point instead of increasing by 0.1 percentage points.

Investment Income and Capital Gains
Growth in the industry's net investment income slowed to 2.0% in 1996 from 9.3% in 1995. Investment income growth in 1996 was the weakest on record except for the back-to-back declines in investment income in 1992 and 1993. Declines in interest rates during the past couple of years contributed to the slowing in investment income growth.

Sharply higher realized capital gains offset the slow growth in investment income. The property/casualty industry realized $9.6 billion in capital gains in 1996, 59.5% more than the $6.0 billion realized in 1995.

The industry's total capital gains (realized gains plus unrealized gains) dropped to $23.5 billion in 1996 from a record $27.7 billion in 1995. Nonetheless, 1996 was the second best year ever in terms of total capital gains. The industry's strong total capital gains reflect the strength in financial markets during the past two years. The Standard & Poor's 500 index of common stock prices rose 34.1% in 1995 and 20.3% in 1996.

Surplus and Leverage
The property/casualty industry's statutory surplus increased by $26.5 billion, or 11.5%, to a record $256.5 billion as of year-end 1996. (See Table 2.) The growth in surplus resulted from $20.2 billion in operating income, $9.6 billion in realized capital gains, $13.9 billion in unrealized capital gains, and $4.1 billion in new funds paid in, less $5.6 billion in federal income taxes, $8.7 billion in dividends to stockholders, and $6.9 billion in miscellaneous charges against surplus.

Table 2
Components of Surplus Change
Property/Casualty Insurance Industry
($ Billions)
1995
1996
Percent
Change
Operating Income
$ 19.5
$ 20.2
3.6%
Realized Capital Gains
6.0
9.6
59.5
Federal Income Taxes (Credit)
4.9
5.6
14.3
Net Income after Taxes
20.6
24.1
17.0
Dividends to Stockholders
(8.2)
(8.7)
6.1
New Funds
7.1
4.1
-42.7
Unrealized Capital Gains (Losses)
21.7
13.9
-36.0
Miscellaneous Surplus Changes
(3.7)
(6.9)
89.5
Change in Year-End Surplus
36.7
26.5
-27.8
Year-End Surplus
$230.00
$256.5
11.5%

NOTES: Figures may not balance because of rounding.

Leverage ratios, such as the premium-to-surplus ratio and the loss-reserves-to-surplus ratio, provide a simple measure of how much business, or risk, each dollar of surplus supports. In 1996, the industry's premium-to-surplus ratio declined to 1.05 — the lowest premium-to-surplus ratio on record. The industry's loss-reserves-to-surplus ratio fell to 1.43 — its lowest level in more than 20 years.

Comparisons with Other Industries
The Fortune 500 consists of the 500 largest industrial and service corporations in the United States. ISO estimates that the median GAAP rate of return on average net worth for the Fortune 500 companies was 15.2% in 1996 and that this rate of return averaged 13.5% from 1983 to 1996. Large insurers' GAAP rate of return in 1996 was 6.0 percentage points lower, and their average rate of return from 1983 to 1996 was 3.9 percentage points lower. Insurers compared even less favorably when ISO broadened the analysis to include data for all insurers.

During the insurance cycle from 1988 to 1995, the GAAP rate of return on average net worth for 127 noninsurance industries averaged 11.9% — 2.8 percentage points more than the average rate of return for the property/casualty industry. In a ranking from most to least profitable, insurance ranked 79 out of 128 industries. The results were similar when ISO lengthened the analysis to include data for the insurance cycle from 1978 to 1987.

Mergers, Acquisitions, and Market Concentration
Based on data reported by Conning & Company, the number of mergers and acquisitions among property/casualty insurers rose irregularly from 24 in 1988 to a record 82 in 1996. The announced value of those transactions has ranged from a low of $1.9 billion in 1993 to a high of $11.5 billion in 1995. The value of mergers and acquisitions in 1996 — $8.1 billion — was second only to the record set in 1995.

ISO's analysis shows that the industry has been consolidating gradually since 1980. However, based on the Herfindahl-Hirschman Index (HHI) used by the Department of Justice (DOJ) to evaluate market concentration, the property/casualty industry remains far from concentrated. The DOJ deems industries with HHIs below 1,000 "unconcentrated." The HHI for the property/casualty industry rose from 229 in 1980 to 306 in 1996.

But the markets for some lines of insurance have become less concentrated over time. In 1995, the HHIs for fire and allied lines, commercial automobile, commercial multiperil, workers' compensation, and medical malpractice were lower than they were in 1980.

ISO's analysis also indicates that the distribution of business within the property/casualty industry has changed over time. The market shares of the very largest insurers have grown at the expense of other large insurers. In particular, the market share of the top four property/casualty insurers rose from 21.6% in 1986 to 26.6% in 1996. The collective market share for the fifth to fiftieth largest insurers declined from 54.4% to 46.4% during the same span of time, while the market share for all other insurers increased from 24.0% to 27.0%.

Insurance Segments
Agency insurers' net written premiums increased 2.1% in 1996, as direct writers' premiums grew 5.2%. Reflecting the difference in premium growth, agency insurers' return on average surplus declined from 11.1% in 1995 to 8.5% in 1996, as direct writers' return on surplus increased from 9.4% to 11.1%.

Stock insurers' premiums rose 2.3% in 1996, while mutual insurers' premiums grew 4.0%. Despite slow premium growth, stock insurers' statutory return on average surplus rose from 10.8% in 1995 to 12.0% in 1996. Mutual insurers' return on surplus fell 1.0 percentage point last year, to 6.9%.

The premiums written by large insurers increased 4.4% in 1996, while the premiums written by medium and small insurers grew 1.8% and 7.7%, respectively. [1]1. For this analysis, ISO defined large insurers as those that wrote more than 0.5% of industrywide net written premium and small insurers as those that wrote less than 0.025% of industrywide premium. Large insurers' premium growth contributed to improvement in their rate of return, with large insurers' statutory return on average surplus increasing by 1.3 percentage points in 1996, to 10.7%. Medium insurers' return on surplus was virtually unchanged in 1996 at 10.1%, and small insurers' return on surplus fell 3.9 percentage points, to 7.4%, despite relatively rapid premium growth.

Reinsurers' premiums rose 4.1% in 1996, after rising 12.0% in 1995, according to the Reinsurance Association of America. Industrywide premiums rose just 3.5% in 1996, after increasing 3.6% in 1995. Reflecting reinsurers' comparatively strong premium growth over the past two years, reinsurers' statutory return on year-end surplus increased 4.5 percentage points, to 10.3%, in 1996. The comparable rate of return for the industry rose only 0.4 percentage points, to 9.4%.

1. For this analysis, ISO defined large insurers as those that wrote more than 0.5% of industrywide net written premium and small insurers as those that wrote less than 0.025% of industrywide premium.