Net Income and Return on Net Worth
Record low premium growth, increased catastrophe losses, and declining investment income led to deterioration in the industry's overall results in 1998.1. 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 lines 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 fell 16.1% last year to $30.9 billion. The industry's GAAP2. 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 state insurance regulators. rate of return on average net worth (RONW) dropped to 8.4% in 1998 from 11.6% in 1997. (See Table 1.)
In 1998, the industry's statutory combined ratio – a key measure of losses and expenses per dollar of premium – worsened, climbing 4.0 percentage points to 105.7% from 101.6% in 1997.3. Throughout this report, figures may not balance because of rounding. The industry's net underwriting loss after dividends to policyholders nearly tripled, growing to $16.7 billion in 1998 from $5.8 billion in 1997.
The industry's net written premium growth continued to slow in 1998, falling to a record low 1.4% from an already low 2.9% in 1997. The effect of anemic premium growth on underwriting profitability was compounded by an unfavorable trend in incurred loss and loss adjustment expenses (LLAE). Reported LLAE rose by $12.8 billion, or 6.5%, in 1998, after declining by $8.7 billion in 1997. Much of the increase in LLAE resulted from higher catastrophe losses. In 1998, the property/casualty industry incurred $10.1 billion in catastrophe losses, compared with $2.6 billion in 1997.
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 LLAE reserves for losses other than environmental and asbestos (E&A). Though estimates of reserve adequacy are subject to considerable uncertainty, ISO's preliminary estimates indicate that industry reserve adequacy deteriorated by between $4 billion and $12 billion in 1998, after deteriorating by a similar amount in 1997.
In recent years, swings in catastrophe losses, E&A losses, and possible changes in the adequacy of reserves for other losses have all had a significant effect on insurers' reported financial results. When ISO adjusts reported results for catastrophes, E&A losses, and changes in reserve adequacy, a somewhat different picture emerges. In 1998, the industry's adjusted combined ratio rose just 1.0 percentage point to 105.5% from 104.5% the year before. The industry's adjusted GAAP RONW fell just 1.3 percentage points to 8.5% last year from 9.8% in 1997. Nonetheless, the adjusted RONW has been declining since 1992, the first year for which data is available on this basis. The 8.5% adjusted RONW for 1998 is only about half of the 16.4% adjusted RONW for 1992.
Investment Income and Capital Gains
In 1998, the industry's reported net investment income dropped a record 4.6%. Since the start of ISO's records in 1959, investment income declined just two other times. The decline in investment income in 1998 reflects special, nonrecurring dividends received by two insurers in 1997 as affiliated life insurance operations were spun off. Excluding those special dividends, the property/casualty industry's investment income grew 0.9% in 1998 – the lowest positive rate of growth in investment income on record.
The industry's realized capital gains rose 72.0% to $18.6 billion in 1998 from $10.8 billion in 1997. The second consecutive record high in realized gains partially offset the deterioration in underwriting results and the decline in reported investment income.
The industry's record realized capital gains in 1998 may reflect decisions by some insurers to sell assets at a gain to raise cash and bolster income in the wake of increased catastrophe losses. Last year's record capital gains may also reflect merger and acquisition activity within the industry. When two insurers combine, one or both may need to change their mix of investments so that the overall portfolio of the combined entities conforms to their joint investment strategy. This process can trigger the realization of capital gains or losses. In 1998, at least one insurer realized substantial gains on its investment portfolio as it changed investments at the request of its new parent. Excluding 1997 and 1998 results for that insurer, the industry's realized capital gains rose 49.3% in 1998.
Insurers posted record realized capital gains despite lower overall capital gains. The industry's total capital gains (realized and unrealized combined) dropped 27.9% in 1998 to $28.7 billion. Nonetheless, for the four years 1995 to 1998, the industry posted a cumulative total of $118.7 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 27.9% for the past four years. During the same time span, the industry's holdings of common stock appreciated at a compound average annual rate of 20.1%.
Surplus and Leverage
The property/casualty industry's surplus grew $25.0 billion, or 8.1%, to a record $333.5 billion at year-end 1998. (See Table 2.) The growth in surplus consisted of $23.0 billion in operating income, $28.7 billion in total capital gains, and $5.1 billion in new funds paid in, less $10.7 billion in federal income taxes, $13.3 billion in stockholder dividends, and $7.7 billion in miscellaneous charges.
Leverage ratios, such as the premium-to-surplus ratio and the LLAE-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 to its third consecutive record low. The premium-to-surplus ratio dropped to 0.84 in 1998 from 0.90 in 1997 and 1.05 in 1996. The industry's LLAE-reserves-to-surplus ratio also declined last year, falling to 1.09 from 1.18 in 1997 and 1.43 in 1996. The 1998 decline in the LLAE-reserves-to-surplus ratio brought the ratio to its lowest level since 1968, when it was 0.97.
The downward trend in leverage ratios suggests that the industry's financial condition has improved. But interpretation of leverage ratios is not straightforward. The declines in leverage ratios in recent years may reflect deteriorating reserve adequacy and the effect of competition on premiums, as well as positive operating results and capitals gains. The decline in the LLAE-reserves-to-surplus ratio may also reflect a change in insurers' mix of business. The percentage of premiums attributable to the long-tailed lines declined from 55.7% in 1992 to 52.1% in 1997, the latest year for which complete data is available.4. For purposes of this analysis, the long-tailed lines of insurance comprise commercial auto liability, general liability (including products liability), medical malpractice, personal auto liability, workers' compensation, and reinsurance. Because claims for those lines of business take a relatively long period of time to settle, insurers hold proportionately more reserves for those lines.
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 1998 was 14.4% – 6.1 percentage points higher than the 8.3% RONW earned by large insurers5. This study classifies an insurer as "large" if the insurer accounts for more than 0.5% of the industry's net written premiums in a given year. In 1998, thirty-five large insurers each wrote more than $1.4 billion in premiums. and 6.0 percentage points higher than the 8.4% 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 1998, the median RONW for the Fortune 500 averaged an estimated 13.6% – 4.0 percentage points higher than the 9.7% average RONW for large insurers and 4.3 percentage points greater than the 9.3% 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 1988 to 1997 (the latest year for which complete COMPUSTAT data was available), the RONW for 154 noninsurance industries averaged 11.3% – 1.9 percentage points higher than the insurance industry's 9.4% average RONW for the period. In a ranking from most to least profitable during that ten-year period, insurance ranked 99 out of 155 industries. The results were similar when ISO lengthened the analysis to include the ten years from 1978 to 1987.
Mergers and Market Concentration
Based on data compiled by Conning & Company, the 117 mergers and acquisitions in the property/ casualty insurance industry in 1998 surpassed the record 111 that occurred in 1997. The reported dollar value of property/casualty mergers and acquisitions in 1998 – $55.8 billion – also set a new record. Notable deals in 1998 included Berkshire Hathaway Inc.'s $21.4-billion acquisition of General Re Corp.6. The number and value of property/casualty mergers and acquisitions in 1998 exclude the merger of Travelers Group Inc. with Citicorp, a noninsurer.
Despite the continuing 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, countrywide data indicates that the industry remains far from concentrated.
ISO's analysis for individual lines of insurance shows that, even as the industry has consolidated on an all-lines basis, the markets for some individual lines have become less concentrated. In particular, countrywide premium data indicates that the markets for commercial auto, commercial multiperil, fire and allied lines, medical malpractice, and workers' compensation were all less concentrated in 1997, the latest year for which complete data is available, than they were in 1980. Concentration in the markets for homeowners, personal auto, and general liability insurance did increase, but not enough for those markets to be deemed concentrated.
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 lines 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 state insurance regulators.
3. Throughout this report, figures may not balance because of rounding.
4. For purposes of this analysis, the long-tailed lines of insurance comprise commercial auto liability, general liability (including products liability), medical malpractice, personal auto liability, workers' compensation, and reinsurance. Because claims for those lines of business take a relatively long period of time to settle, insurers hold proportionately more reserves for those lines.
5. This study classifies an insurer as "large" if the insurer accounts for more than 0.5% of the industry's net written premiums in a given year. In 1998, thirty-five large insurers each wrote more than $1.4 billion in premiums.
6. The number and value of property/casualty mergers and acquisitions in 1998 exclude the merger of Travelers Group Inc. with Citicorp, a noninsurer.