Net Income and Return on Net Worth
Lower catastrophe losses and strong investment results combined to make 1997 a banner year for the U.S. property/casualty insurance industry.1. For purposes of this analysis, the U.S. property/casualty industry is defined as all property/casualty companies domiciled in the United States, including excess and surplus insurers and domestic insurers owned by foreign parents. The data in this report excludes foreign subsidiaries of U.S. insurance groups. All figures are represented net of reinsurance, unless otherwise noted. The industry's net income after taxes climbed 45.7% in 1997 to a record $35.6 billion. (See Table 1.) Statutory surplus, or net worth, grew 21.4% to an all-time high of $310.2 billion.
The industry's GAAP 2. GAAP stands for Generally Accepted Accounting Principles, the accounting basis used by most industries. Unless otherwise stated, the figures in this report are based on Statutory Accounting Practices (SAP), the accounting basis used by insurers when preparing the Annual Statements they submit to regulators.rate of return on average net worth (RONW) also improved, rising to 11.3% in 1997 from 9.3% in 1996. However, even with the improvement in its RONW, the property/casualty insurance industry remained less profitable than many other industries.
Summary of Financial Results
Property/Casualty Insurance Industry, 1996-1997
|Underwriting Gain (Loss)|
|Miscellaneous Income (Loss)|
|Operating Income (Loss)|
|Realized Capital Gains (Losses)|
|Federal Income Taxes (Credit)|
|Net income After Taxes|
|Return on Average Net Worth (GAAP)|
NOTES: Figures may not balance because of rounding
*Difference in percentage points.
The industry's statutory combined ratio — a key measure of losses and expenses per dollar of premium — improved to 101.7% last year from 105.8% in 1996. The statutory underwriting loss declined to $6.1 billion in 1997 from $16.7 billion in 1996. Underwriting results improved despite continued lackluster premium growth. The industry's net written premium rose only 3.3% in 1997, after rising just 3.4% in 1996, 3.6% in 1995, and 3.7% in 1994.
The effect of anemic premium growth on underwriting profitability was more than offset by a favorable trend in incurred loss and loss adjustment expenses (LLAE). Reported LLAE declined in 1997 by $8.2 billion, or 4.0% — the first decline in LLAE since 1993.
Much of the decline in LLAE resulted from lower catastrophe losses and a reduction in newly recognized environmental and asbestos (E&A) losses. The property/casualty industry incurred just $2.6 billion in catastrophe losses in 1997, compared with $7.3 billion in 1996. And ISO estimates that E&A losses declined to $1.9 billion in 1997 from $5.1 billion in 1996.
Other analyses in this report indicate that the industry's reported LLAE may have been understated because of continuing deterioration in the adequacy of the industry's reserves for losses other than E&A. Though estimates of reserve adequacy are subject to considerable uncertainty, ISO's preliminary estimates indicate that industry reserve adequacy deteriorated by $5.0 billion to $14.0 billion in 1997, after deteriorating by a similar amount in 1996. ISO will update these preliminary estimates later this year when more complete data is available.
When ISO adjusts the data for swings in catastrophe losses, E&A losses, and possible changes in reserve adequacy for losses other than E&A, a different financial picture emerges. The industry's restated LLAE increased 0.1% in 1997. The industry's adjusted combined ratio declined just 1.0 percentage point last year. And, despite that decline, the industry's adjusted combined ratio for 1997 was the second worst since 1992, the first year for which data is available on this basis. The industry's adjusted GAAP RONW increased only 0.1 percentage point in 1997.Investment Income and Capital Gains
The industry also benefited from record realized capital gains last year. Realized gains rose 15.8% to $10.7 billion in 1997, after increasing 54.1% in 1996.
The industry's total capital gains (realized and unrealized combined) surged 78.4% in 1997 to $40.2 billion. And, for the three years 1995 to 1997, the industry posted a cumulative total of $90.5 billion in total capital gains. These gains reflect the strength in financial markets during that period. The Standard & Poor's 500 index of common stock prices has risen at a compound average annual rate of 28.3% for the past three years. During the same span of time, the industry's total capital gains on common stock averaged 22.8% of the industry's holdings of common stock at the beginning of each year.Surplus and Leverage
Components of Surplus Change
Property/Casualty Insurance Industry, 1996-1997
|Prior Year-End Surplus|
|Operating Income (Loss)|
|Realized Capital Gains (Losses)|
|Federal Income Taxes (Credit)|
|Net Income After Taxes|
|Dividends to Stockholders|
|Unrealized Capital Gains (Losses)|
|Miscellaneous Surplus Changes|
|Change in Year-End Surplus|
NOTE: 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 risk each dollar of surplus supports. Last year, the industry's premium-to-surplus ratio fell below 1.0 for the first time on record, dropping to 0.89 in 1997 from 1.05 in 1996. The industry's loss-reserves-to-surplus ratio also declined last year, falling to 1.17 from 1.43 in 1996. That decline, which reflects possible deterioration in loss-reserve adequacy, brought the loss-reserves-to-surplus ratio to its lowest level since 1972, when it was 1.12.
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 RONW for the Fortune 500 companies in 1997 was 14.9% — 2.8 percentage points higher than the 12.1% RONW earned by large insurers 4. This study classifies an insurer as "large" if the insurer accounts for more than 0.5% of the industry's net written premium in a given year. In 1997, thirty-nine large insurers each wrote more than $1.39 billion in premium. and 3.6 percentage points higher than the 11.3% RONW earned by the industry overall.
Longer-term data indicates that insurers have a history of being less profitable than the Fortune 500. From 1983 to 1997, the median RONW for the Fortune 500 averaged an estimated 13.6% — 3.9 percentage points higher than the 9.7% average RONW for large insurers and 4.2 percentage points greater than the 9.4% average RONW for the entire property/casualty industry.
Analyses in this report also compare insurers' profitability with that of firms in a broad array of other industries, using data obtained from Standard & Poor's COMPUSTAT service. During the ten years from 1987 to 1996 (the latest year for which complete COMPUSTAT data was available), the RONW for 113 noninsurance industries averaged 13.4% — 3.5 percentage points higher than the insurance industry's 9.9% average RONW for the period. In a ranking from most to least profitable during that ten-year period, insurance ranked 67 out of 114 industries. And the results were similar when ISO lengthened the analysis to include the ten years from 1977 to 1986.
Insurance Stock Performance
Insurers' capacity to provide protection to policyholders depends upon insurers' ability to attract and retain the capital necessary to bear risk. For stock insurers, the ability to attract and retain capital depends, in turn, on such insurers' ability to offer attractive rates of return to investors.
In this report, we compare the Standard & Poor's (S&P) property/casualty insurance index and the S&P multiline insurance index — measures of insurance stock performance 5. As of year-end 1997, these composites together consisted of fourteen insurers that collectively accounted for 27.7% of total property/casualty industry net written premium and 47.6% of stock-company written premium. Multiline insurers write both property/casualty and life/health insurance. — with the S&P 500 — a widely used measure of the stock market overall — to assess how investors in insurance stocks have fared.
In 1997, investors in the S&P property/casualty index earned a total rate of return6. Total rates of return include price appreciation and dividends. Dividends are assumed to be reinvested quarterly. of 45.4%. Investors in the S&P multiline index earned a total return of 52.5%. Investors in the market overall, as measured by the S&P 500, earned 33.3% on their money — a substantial return relative to historical norms, but less than that enjoyed by investors in the S&P insurance indexes.
Investors in the insurance indexes also did well over the long term. The average annual total rate of return 7. In keeping with the approach used in most investment analyses, this analysis cites compound average annual rates of return. Unless otherwise specified, the average rates of return quoted elsewhere in this report are simple averages. to investors in the S&P property/casualty index over the twenty years ended December 31, 1997, was 17.1%. Investors in the S&P multiline index would have earned an average annual return of 18.0%. Both of these long-term averages exceeded the 16.6% average total return to investors in the S&P 500 over the same period. But, to achieve those higher returns, an investor in insurance stocks had to accept greater volatility in annual returns.
Several factors may explain insurance stocks' superior performance despite the property/casualty industry's relatively low GAAP rates of return. Segment analyses included in this report show that stockholder-owned insurers have been more profitable than the industry overall. Other analyses show that insurers' profitability on an economic basis has exceeded their profitability on a GAAP basis. And the increase in merger and acquisition activity in the insurance industry may have led some investors to place a premium on insurance stocks.
GAAP rates of return exclude unrealized capital gains from income and do not allow for other important factors that affect insurers' economic value, something that may be particularly important to investors. In 1997, insurers' rate of return on an economic basis was 14.8% — 3.5 percentage points higher than their GAAP RONW. And, from 1988 to 1997, insurers' economic return averaged 11.7% — 2.4 percentage points greater than their average GAAP RONW during the same period.
Mergers and Market Concentration
Based on data compiled by Conning & Company, the 111 mergers and acquisitions in the property/ casualty insurance industry in 1997 broke the record 82 set in 1996. The reported dollar value of property/casualty mergers and acquisitions in 1997— $30.9 billion — also set a new record. Notable deals in 1997 included the $18.7-billion merger of Zurich Insurance Company and the parent of the Farmers Insurance Group (British American Financial Services, the insurance arm of U.K.-based B.A.T. Industries, plc), and SAFECO Corporation's $3.1-billion acquisition of American States Financial Corporation.
Despite the recent flurry of merger and acquisition activity in the property/casualty industry, quantitative measures based on long-term data show that the industry has been consolidating slowly over time. And, based on standards established by the U.S. Department of Justice, the industry remains far from concentrated.
ISO's analyses of individual lines of insurance show that, even as the industry has consolidated on an all-lines basis, the markets for some individual lines have become less concentrated. In particular, the markets for workers' compensation, medical malpractice, commercial auto, and commercial multiperil insurance were all less concentrated in 1996, the latest year for which complete data is available, than they were in 1980.
Employment and Productivity Trends
Employment in the property/casualty industry has declined in recent years, perhaps partly because of mergers and acquisitions. Since 1991, employment in the industry has fallen 31,000, or 5.5%, to 531,000 in 1997, as total private-sector employment grew 12.8 million, or 14.2%, to 102.6 million.
Long-term trends in inflation-adjusted premium per employee and in inflation-adjusted pure losses per employee indicate that property/casualty insurers have achieved productivity gains. Inflation-adjusted premium per employee rose 41.8% to $522,000 in 1997 from $368,000 in 1970. Inflation-adjusted losses per employee rose 42.4% to $309,000 in 1997 from $217,000 in 1970.
Whether productivity gains have benefited insurers' bottom lines depends on whether those gains have exceeded increases in labor costs. Premium per dollar of employee expense 8. Employee expense includes salaries, payroll taxes, and other employee-welfare related costs, such as health insurance premiums paid by insurers on behalf of their employees. declined to 8.5 in 1996 (the latest available year) from 10.3 in 1980 (the first available year). Losses per dollar of employee expense declined to 5.5 in 1996 from 6.6 in 1980. The available data thus indicates that productivity gains have not flowed down to insurers' bottom lines.
Slow premium growth during the 1990s suggests that competitive pricing is one reason that productivity growth has not led to improved profitability. Trends in wage rates may be another. The average hourly earnings of production workers in the property/casualty industry rose 177.9% from 1980 to 1997. During the same period, the average hourly earnings of all production workers in the finance, insurance, and real estate sector rose 130.0%. The earnings of all private, nonagricultural production workers increased 84.1%. The relatively rapid increase in the average wage paid by property/casualty insurers may reflect the changing skills sought by insurers, with automation having eliminated many clerical jobs.
1. For purposes of this analysis, the U.S. property/casualty industry is defined as all property/casualty companies domiciled in the United States, including excess and surplus insurers and domestic insurers owned by foreign parents. The data in this report excludes foreign subsidiaries of U.S. insurance groups. All figures are represented net of reinsurance, unless otherwise noted.
2. GAAP stands for Generally Accepted Accounting Principles, the accounting basis used by most industries. Unless otherwise stated, the figures in this report are based on Statutory Accounting Practices (SAP), the accounting basis used by insurers when preparing the Annual Statements they submit to regulators.
3. Effective with Annual Statements for 1997, insurers must deduct interest on surplus and capital notes, as well as investment expenses, when reporting their net investment income. ISO estimates that this accounting change reduced the industry's reported 1997 investment income by about 1.0%.
4. This study classifies an insurer as "large" if the insurer accounts for more than 0.5% of the industry's net written premium in a given year. In 1997, thirty-nine large insurers each wrote more than $1.39 billion in premium.
5. As of year-end 1997, these composites together consisted of fourteen insurers that collectively accounted for 27.7% of total property/casualty industry net written premium and 47.6% of stock-company written premium. Multiline insurers write both property/casualty and life/health insurance.
6. Total rates of return include price appreciation and dividends. Dividends are assumed to be reinvested quarterly.
7. In keeping with the approach used in most investment analyses, this analysis cites compound average annual rates of return. Unless otherwise specified, the average rates of return quoted elsewhere in this report are simple averages.
8. Employee expense includes salaries, payroll taxes, and other employee-welfare related costs, such as health insurance premiums paid by insurers on behalf of their employees.