Insurer Financial Results: 1999

Executive Summary

Net Income and Return on Net Worth
Near record low premium growth, increased loss and loss adjustment expenses, declining investment income, and lower realized capital gains led to deterioration in the industry's overall results in 1999. [1]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 to $22.2 billion last year from $30.8 billion in 1998. The industry's GAAP [2]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) dropped to 6.4% in 1999 from 8.5% the year before. (See Table 1.)

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Underwriting Results
In 1999, the industry's statutory combined ratio — a key measure of losses and expenses per dollar of premium — worsened, climbing 2.2 percentage points to 107.9% from 105.6% in 1998. [3]3. Throughout this report, figures may not balance because of rounding. The industry's net underwriting loss after dividends to policyholders ballooned by 39.5%, growing to $23.4 billion in 1999 from $16.8 billion in 1998.

The industry's net written premium growth remained near the record low set in 1998, with premium growth edging up to 1.9% in 1999 from 1.8% the year before. Continuing growth in incurred loss and loss adjustment expenses (LLAE) compounded the effect of anemic premium growth on underwriting profitability. Reported LLAE rose by $10.5 billion, or 4.9%, in 1999, after rising by $14.0 billion in 1998. The increase in LLAE last year occurred despite a decline in catastrophe losses. In 1999, the property/casualty industry incurred $8.3 billion in catastrophe losses, compared with $10.1 billion in 1998.

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 ISO's in-depth analysis of industry reserve adequacy at year-end 1999 will not be published until later this year, ISO's preliminary estimates indicate that industry reserve adequacy deteriorated by between $5 billion and $13 billion in 1999, after deteriorating by similar amounts in 1998 and 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 data for catastrophes, E&A losses, and changes in reserve adequacy, the industry's recent financial results appear somewhat worse. In 1999, the industry's adjusted combined ratio rose 3.2 percentage points to 108.7% from 105.5% the year before. The industry's adjusted GAAP RONW fell 2.8 percentage points to 5.8% last year from 8.6% in 1998. The industry's adjusted RONW has been declining since 1992, the first year for which data is available on this basis. The 5.8% adjusted RONW for 1999 is about one-third of the 16.3% adjusted RONW for 1992.

Investment Income and Capital Gains
The industry's reported net investment income dropped 3.3% in 1999 to $38.6 billion, after falling by a record 3.8% in 1998 to $39.9 billion. Since the start of ISO's records in 1959, investment income declined in just two other years — in 1993 by 3.2% and in 1992 by 1.5%. The decline in investment income last year is the net effect of two developments: a decline in the yield on cash and invested assets to 4.9% in 1999 from 5.1% the year before and an increase in average holdings of cash and invested assets to $793.7 billion from $781.4 billion.

The industry's realized capital gains dropped 24.0% to $13.7 billion in 1999 from $18.0 billion in 1998. Nonetheless, the industry's realized capital gains in 1999 were the second largest on record, exceeded only by those the year before.

The industry's large realized capital gains in 1999 and 1998 may reflect decisions by some insurers to sell assets at a gain to raise cash and bolster income in the wake of increased underwriting losses and declining investment income. The industry's realized 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 1999, insurers' total capital gains (realized and unrealized combined) dropped 57.9% to $11.9 billion, after having fallen by 29.0% to $28.3 billion in 1998. Despite recent declines, the industry posted a cumulative total of $130.2 billion in total capital gains during the five years from 1995 to 1999. 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 26.2% for the past five years. During the same time span, the industry's holdings of common stock appreciated at a compound average annual rate of 17.3%.

Surplus and Leverage
The property/casualty industry's surplus grew $2.9 billion, or 0.9%, to a record $336.3 billion at year-end 1999. (See Table 2.) The growth in surplus consisted of $13.9 billion in operating income, $11.9 billion in total capital gains, and $3.8 billion in new funds paid in, less $5.4 billion in federal income taxes, $15.9 billion in stockholder dividends, and $5.4 billion in miscellaneous charges. [4]4. For purposes of this analysis, miscellaneous surplus changes are the net result of all things affecting surplus other than operating income, capital gains, federal income taxes, dividends to stockholders, and new funds paid in. As such, miscellaneous surplus changes include changes in statutory penalties to surplus, aggregate write-ins for gains and losses in surplus, extraordinary taxes for prior years, and changes in non-admitted assets, as well as a variety of other items that affect surplus but do not flow through insurers' income statements. The percentage gain in surplus in 1999 was the smallest since 1984, when surplus declined by 3.1%.

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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 was virtually unchanged, edging up to 0.85 from a record low 0.84 in 1998. The industry's LLAE-reserves-to-surplus ratio also changed little in 1999, falling to 1.08 from 1.10 the year before.

Long-term data indicates a downward trend in the industry's premium-to-surplus ratio from a peak of 2.75 in 1974. And the industry's LLAE-reserves-to-surplus ratio has fallen to its lowest level since 1968, when that ratio was 0.97. The downward trend in both leverage ratios suggests that the industry's financial condition has improved over the years. But interpretation of leverage ratios is not straightforward. The declines in the premium-to-surplus ratio and LLAE-reserves-to-surplus ratio in recent years may reflect declining prices in insurance markets and deteriorating reserve adequacy, rather than improvement in the industry's financial condition. 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 50.4% in 1998, the latest year for which complete data is available. [5]5. For purposes of this analysis, the long-tailed lines of insurance are 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.

Operating Cash Flow
Operating cash flow [6]6. Operating cash flow is the sum of premiums collected (net of reinsurance), other underwriting income received, net investment income received, and other income received, minus loss and loss adjustment expenses paid, other underwriting expenses paid, policyholder dividends paid, and taxes paid. (OCF) indicates the rate at which basic underwriting and investment operations generate cash to fund new investments, dividend payments to shareholders, or other activities. ISO estimates that the industry's OCF fell to $11.9 billion in 1999 from $16.0 billion in 1998 and $31.0 billion in 1997.[7]7. ISO estimated industry operating cash flow for 1999 based on the historical relationships between items on insurers' income and cash flow statements. The drop in OCF during 1999 and 1998 reduced the industry's OCF to its lowest level since 1984 — the bottom of the worst underwriting cycle in the industry's history. When measured relative to net written premium, the industry's OCF looks even worse. In 1999, the industry's OCF fell to 4.1% of net written premium, 3.0 percentage points less than the industry's 7.1% OCF ratio in 1984.

Data on net purchases of investments in 1999 is not yet available, [8]8. The techniques that ISO used to estimate industry operating cash flow cannot be used to estimate net cash from investments. but the deterioration in OCF in 1999 suggests that insurers may have tapped their investment portfolios to raise cash. When OCF declined in 1998, insurers raised $1.9 billion in cash by tapping their investment portfolios. Before 1998, insurers had used cash to add to their investment holdings every year since at least 1980.

With the industry's OCF ratio having fallen to its lowest level in at least twenty years, some insurers that need to raise cash may seek to reunderwrite or reprice their books of business. Others may compete more aggressively for premium dollars.

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 1999 was 16.5% — more than 10 percentage points higher than both the 6.1% RONW earned by large insurers [9]9. This study classifies an insurer as "large" if the insurer accounts for more than 0.5% of industry's net written premiums in a given year. In 1999, thirty-seven insurers qualified as large with each writing $1.44 billion in premiums. and the 6.4% RONW earned by the property/casualty industry overall.

Though longer-term data indicates that insurers have a history of being less profitable than the Fortune 500, the gap in 1999 between insurers' rate of return and the Fortune 500's was much larger than normal. From 1983 to 1999, the median RONW for the Fortune 500 averaged an estimated 13.8% — 4.3 percentage points higher than the 9.5% average RONW for large insurers and 4.7 percentage points greater than the 9.1% 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 COMPUSTAT data obtained from Standard & Poor's Institutional Market Services. During the ten years from 1989 to 1998 (the latest year for which complete COMPUSTAT data was available), the RONW for 152 noninsurance industries averaged 11.4% — 2.6 percentage points higher than the insurance industry's 8.8% average RONW for the period. In a ranking from most to least profitable during that ten-year period, insurance ranked 101 out of 153 industries. The results were similar when ISO lengthened the analysis to include the ten years from 1979 to 1988.

The Performance of Insurance Stocks
Insurers' capacity to provide financial protection to policyholders depends on 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 their ability to offer attractive rates of return to investors.

In this report, ISO compares the performance of the Standard & Poor's (S&P) property/casualty insurance index with the performance of the S&P life/health insurance and financial services indexes, as well as the S&P 500 — a widely used measure of the stock market overall — to assess how investors in property/casualty insurance stocks have fared. [10]10. As of March 31, 2000, the S&P property/casualty index was based on data for eight insurers accounting for 15.3% of total industry net written premium and 22.0% of total stock company net written premium. ISO also compares the recent performance of the Goldman Sachs (GS) index for the property/casualty industry overall and the GS indexes for various sectors of the property/casualty industry to assess how investors in different segments of the industry fared last year.

In 1999, investors in the S&P property/casualty index earned a total rate of return (capital gains plus dividends) of -25.4%. That is, one hundred dollars invested in the stock of the insurers in the S&P property/casualty index on December 31, 1998, would have shrunk to about $74.60 on December 31, 1999. Investors in the S&P life/health index earned a total rate of return of -13.9% in 1999.

The S&P financial services index includes the stocks in the S&P insurance indexes, as well as the stocks of companies in a broad array of other financial service industries. While investors in the S&P property/casualty index experienced a total rate of return of -25.4% in 1999, investors in the S&P financial services index experienced a total rate of return of 4.0%. The rate of return for property/casualty insurance stocks in 1999 looks worse when compared with the 21.0% rate of return for the S&P 500. The S&P 500 includes all the stocks in the S&P financial services index, as well as stocks in a wide array of nonfinancial industries, such as manufacturing and retail trade.

Based on the performance of the S&P property/casualty index over the past twenty years, investors in pure property/casualty stocks have failed to earn total returns comparable to those enjoyed by other investors. From year-end 1979 to year-end 1999, investors in the S&P property/casualty index earned a compound average annual total rate of return of 13.5%. During the same period, investors in the other S&P indexes cited in this report earned average total rates of return that ranged from 16.0% per year for the S&P life/health index to 17.8% per year for the S&P 500. [11]11. ISO also analyzed data for the S&P multiline insurance index, which was based on data for just four insurers as of March 31, 2000. ISO's research indicates that the exceptionally strong performance of the stock of one company has greatly affected the recent performance of that index. For these reasons, the performance of that index may not be indicative of the performance of a typical publicly traded multiline insurer. Nonetheless, investors in the S&P multiline insurance index earned a total rate of return of 27.4% in 1999 and total rates of return that averaged 17.5% per year during the twenty years from year-end 1979 to year-end 1999.

The relatively low returns earned by investors in property/casualty stocks may reflect property/casualty insurers' relatively low GAAP rates of return compared with those of firms in other industries.

Data provided by Goldman Sachs (GS) sheds light on the recent performance of the stocks of companies in various sectors of the property/casualty industry. From year-end 1998 to year-end 1999, the GS overall property/casualty index fell 23.0%, the GS commercial property/casualty index declined 18.1%, and the GS personal property/casualty index dropped 30.1%. The GS reinsurance index fell 26.3% — an amount roughly midway between the declines in the GS commercial and personal property/casualty indexes.

Mergers, Acquisitions, and Market Concentration
Based on data compiled by Conning & Company, the number of mergers and acquisitions in the property/casualty insurance industry declined to 64 in 1999 from a record 117 in 1998. The reported dollar value of property/casualty mergers and acquisitions fell to $19.2 billion in 1999 from a record $55.8 billion in 1998. [12]12. The number and value of property/casualty mergers and acquisitions in 1998 exclude the merger of Travelers Group Inc. with Citicorp, a noninsurer. Nonetheless, the 64 mergers and acquisitions in 1999 exceeded the average of 58 per year during the ten years from 1988 to 1997. And the $19.2 billion in mergers and acquisitions in 1999 was more than twice the average of $7.7 billion per year from 1988 to 1997.

Factors that may have contributed to the decline in merger and acquisition activity last year include:

  • volatility in financial markets
  • weakness in the prices of property/casualty insurance stocks
  • increases in interest rates, which may have affected the cost of financing acquisitions
  • concerns about potential Y2K computer problems
  • uncertainty about repeal of Glass-Steagall barriers between the banking, insurance, and securities industries and the possible aftereffects

Despite the unusually rapid pace of merger and acquisition activity in the property/casualty industry in recent years, quantitative measures based on long-term data show that the industry has been consolidating slowly over time. 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 multiperil and medical malpractice were less concentrated in 1998, the latest year for which complete data is available, than those markets were in 1980. Concentration in the markets for other major lines of insurance did increase, but not enough for those markets to be deemed concentrated, based on U.S. Department of Justice criteria.

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 regulators.

3. Throughout this report, figures may not balance because of rounding.

4. For purposes of this analysis, miscellaneous surplus changes are the net result of all things affecting surplus other than operating income, capital gains, federal income taxes, dividends to stockholders, and new funds paid in. As such, miscellaneous surplus changes include changes in statutory penalties to surplus, aggregate write-ins for gains and losses in surplus, extraordinary taxes for prior years, and changes in non-admitted assets, as well as a variety of other items that affect surplus but do not flow through insurers' income statements.

5. For purposes of this analysis, the long-tailed lines of insurance are 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.

6. Operating cash flow is the sum of premiums collected (net of reinsurance), other underwriting income received, net investment income received, and other income received, minus loss and loss adjustment expenses paid, other underwriting expenses paid, policyholder dividends paid, and taxes paid.

7. ISO estimated industry operating cash flow for 1999 based on the historical relationships between items on insurers' income and cash flow statements.

8. The techniques that ISO used to estimate industry operating cash flow cannot be used to estimate net cash from investments.

9. This study classifies an insurer as "large" if the insurer accounts for more than 0.5% of industry's net written premiums in a given year. In 1999, thirty-seven insurers qualified as large with each writing $1.44 billion in premiums.

10. As of March 31, 2000, the S&P property/casualty index was based on data for eight insurers accounting for 15.3% of total industry net written premium and 22.0% of total stock company net written premium.

11. ISO also analyzed data for the S&P multiline insurance index, which was based on data for just four insurers as of March 31, 2000. ISO's research indicates that the exceptionally strong performance of the stock of one company has greatly affected the recent performance of that index. For these reasons, the performance of that index may not be indicative of the performance of a typical publicly traded multiline insurer. Nonetheless, investors in the S&P multiline insurance index earned a total rate of return of 27.4% in 1999 and total rates of return that averaged 17.5% per year during the twenty years from year-end 1979 to year-end 1999.

12. The number and value of property/casualty mergers and acquisitions in 1998 exclude the merger of Travelers Group Inc. with Citicorp, a noninsurer.