Insurer Financial Results: 2000

Insurer Financial Results: 2000

Executive Summary

Net Income and Return on Net Worth

Despite increases in net investment income and realized capital gains, sharply higher net losses on underwriting led to deterioration in the industry's overall results in 2000.[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 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 7.3% to $20.3 billion last year from $21.9 billion in 1999. 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 5.8% in 2000 from 6.0% the year before. (See Table 1.)

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Underwriting Results
In 2000, the industry's combined ratio — a key measure of losses and expenses per dollar of premium — worsened, climbing 2.7 percentage points to 110.4% from 107.8% in 1999.[3]3. Throughout this report, figures may not balance due to rounding.The industry's net underwriting loss after dividends to policyholders ballooned by 39.8%, growing to $32.3 billion in 2000 from $23.1 billion in 1999.

Underwriting results deteriorated even though premium growth accelerated. Industry net written premium climbed 4.9% to $301.0 billion in 2000, after rising just 1.9% in 1999 and a record-low 1.8% in 1998. Data about rates on renewals from ISO MarketWatchTM indicates that broad-based firming in commercial insurance markets contributed to the acceleration in premium growth last year. Rates on renewals for the ISO MarketWatch basket of commercial lines[4]4. ISO MarketWatchTM tracks rate changes on renewals for commercial auto liability, commercial auto physical damage, products liability, premises/operations liability, businessowners, commercial fire, and commercial allied lines by class and geographic location.rose an average of 5.2% in 2000 and 0.1% in 1999, after falling 2.3% in 1998, 1.7% in 1997, and 1.1% in 1996. But these countrywide composite numbers mask significant differences in experience by location, line of insurance, and class of business.

Data from ISO Market ProfilerTM shows that commercial lines premium growth over the past five years has varied significantly by location and standard industrial classification (SIC) code group.[5]5. ISO Market ProfilerTM provides market segmentation information, including insurance premium and loss statistics and business demographics for more than 900 industries at the county, state, and countrywide level.For example, from 1996 to 2000, commercial lines premiums in Hawaii decreased an estimated 8.4% per year, while commercial lines premiums in Florida rose an estimated 4.5%. During the same period, commercial lines premiums for the SIC codes for apparel manufacturing and energy production decreased between 2.8% and 4.7% per year. Premiums for the SIC code for securities and commodities brokers rose 7.8% per year. Differences in experience by location and SIC code likely contributed to differences in the results of individual insurers.

Catastrophe losses fell to $4.6 billion in 2000 from $8.3 billion in 1999 and $10.1 billion in 1998. Growth in noncatastrophe loss and loss adjustment expenses (LLAE) drove the deterioration in underwriting profitability last year. Noncatastrophe LLAE climbed $22.5 billion, or 10.5%, to $236.4 billion in 2000. Reflecting this increase, overall LLAE including catastrophes rose $18.7 billion, or 8.4%, to $241.0 billion last year.

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). ISO's preliminary analysis of LLAE reserves as of year-end 2000 suggests that the adequacy of reserves for losses other than E&A deteriorated by between $7 billion and $17 billion in 2000, after deteriorating by a similar amount in 1999.

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 notably worse. In 2000, the industry's adjusted combined ratio rose 5.2 percentage points to 114.2% from 109.0% the year before. The industry's adjusted GAAP RONW fell 1.9 percentage points to 3.4% last year from 5.3% in 1999. The industry's adjusted RONW has been trending downward since 1992, the first year for which data is available on this basis. The 3.4% adjusted RONW for 2000 is less than one-quarter of the 16.6% adjusted RONW for 1992.

Investment Income and Capital Gains
Increases in investment income and realized capital gains partially offset the effects of deterioration in underwriting results. The industry's reported net investment income rose 4.4% to $40.6 billion in 2000, after declining by 2.7% in 1999 and a record 3.8% in 1998. The increase in investment income last year is the net effect of two developments: an increase in the yield on average holdings of cash and invested assets to 5.1% in 2000 from 4.9% in 1999, and a $0.5-billion decrease in average holdings of cash and invested assets to $797.4 billion from $797.9 billion.

The industry's realized capital gains climbed 30.3% to $17.0 billion in 2000 from $13.0 billion in 1999. The industry's realized capital gains in 2000 and 1999 were the second and third largest on record, exceeded only by the industry's $18.0 billion in realized capital gains in 1998. The industry's large realized capital gains in recent years may reflect decisions by some insurers to sell assets at a gain to raise cash and bolster income in the wake of otherwise poor results.

Combining the industry's $17.0 billion in realized capital gains in 2000 with its $17.5 billion in unrealized capital losses, the industry suffered $0.5 billion in overall capital losses last year. In contrast, in 1999, the industry enjoyed $14.9 billion in overall capital gains.

Despite recent capital losses, the industry posted a cumulative total of $132.7 billion in total capital gains during the six years from 1995 to 2000. These gains reflect the strength in financial markets during much of that period. The Standard & Poor's 500 index of common stock prices has risen at a compound average annual rate of 19.2% for the past six years, despite having fallen 10.1% in 2000. During the same six years, the industry's holdings of common stock appreciated at a compound average annual rate of 14.5%.

Surplus and Leverage
The property/casualty industry's surplus declined $15.7 billion, or 4.7%, to $318.7 billion at year-end 2000 from $334.3 billion at year-end 1999. The decline in surplus last year reflects the excess of $17.5 billion in unrealized capital losses, $16.5 billion in dividends to shareholders, and $6.5 billion in miscellaneous charges against surplus over the industry's $20.3 billion in net income after taxes and $4.5 billion in new funds paid in. (See Table 2.)

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The 4.7% decline in surplus in 2000 was the first decline since 1984, when surplus declined 3.1%, and the largest since 1974, when surplus declined by 23.9%.

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 edged up to 0.94 from 0.86 in 1999 and a record-low 0.84 in 1998. The industry's LLAE-reserves-to-surplus ratio also rose a bit in 2000, increasing to 1.13 from 1.08 the year before.

Despite recent increases, the 0.94 premium-to-surplus ratio for 2000 is the fourth-lowest on record. Data going back to 1959 indicates a downward trend in the industry's premium-to-surplus ratio from a peak of 2.75 in 1974. The data also indicates a long-term downward trend in the industry's LLAE-reserves-to-surplus ratio since 1974. The LLAE-reserves-to-surplus ratio of 1.13 in 2000 is about half of the 2.13 that the LLAE-reserves-to-surplus ratio was 26 years earlier.

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 downward trends in the premium-to-surplus ratio and LLAE-reserves-to-surplus ratio 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 49.1% in 1999, the latest year for which complete data is available.[6]6. 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.

Operating Cash Flow
Operating cash flow[7]7. Operating cash flow is the sum of premiums collected (net of reinsurance), net investment income received, other underwriting 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 $5.7 billion in 2000 from $7.8 billion in 1999 and a cyclical peak of $31.0 billion in 1997.[8]8. ISO estimated industry operating cash flow for 2000 based on the historical relationships between items on insurers' income and cash-flow statement9. 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 2000, thirty-seven large insurers each wrote more than $1.5 billion in premiums.In 1984, the bottom of the worst underwriting cycle in the industry's history, the industry's OCF was $8.5 billion. The drop in OCF during the last three years reduced the industry's OCF to its lowest level since before 1980, the earliest year for which ISO has OCF data.

In 1999, insurers accounting for 35.0% of industry premium had negative operating cash flows. The widespread deterioration in results in 2000 suggests that the market share of insurers with negative operating cash flows increased last year. In 1984, insurers with negative operating cash flows accounted for 22.5% of industry premium.

When measured relative to net written premium, the industry's OCF looks even worse. In 2000, the industry's OCF fell to a record-low 1.9% of net written premium — less than one-third of the industry's 7.1% OCF ratio in 1984.

With the industry's OCF ratio having fallen to its lowest level in more than twenty years, the acceleration in premium growth last year and the ISO MarketWatchTM data about rate changes on renewals for commercial insurance coverage suggest that some insurers who need to raise cash may be repricing their books of business.

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 2000 was 15.7% — more than double the 6.1% RONW earned by large property/casualty insurers[9]9. 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 2000, thirty-seven large insurers each wrote more than $1.5 billion in premiums. and the 5.8% 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 between insurers' rate of return and the Fortune 500's was much larger than normal in 2000. From 1983 to 2000, the median RONW for the Fortune 500 averaged an estimated 13.9% — 4.7 percentage points more than the 9.2% average RONW for large insurers and 5.0 percentage points greater than the 8.9% average RONW for the entire property/casualty industry.

Analyses in this report also compare property/casualty 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 1990 to 1999 (the latest year for which complete COMPUSTAT data was available), the RONW for 145 noninsurance industries averaged 11.1% — 2.7 percentage points higher than the property/casualty insurance industry's 8.4% average RONW for the period. In a ranking from most to least profitable during that ten-year period, property/casualty insurance ranked 101 out of 146 industries. The results were similar when ISO lengthened the analysis to include the ten years from 1980 to 1989.

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 to that 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 April 2001, the S&P property/casualty index was based on data for eight insurers that collectively accounted for 15.3% of total industry net written premium in 2000 and 22.1% of total stock company net written premium in 1999 (the latest year for which separate data on stock company premiums is available) 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 2000, investors in the S&P property/casualty index earned a total rate of return (capital gains plus dividends) of 55.6%. That is, $100 invested in the stock of insurers in the S&P property/casualty index on December 31, 1999, would have grown to about $155.60 on December 31, 2000. Investors in the S&P life/health index earned a total rate of return of 13.7% in 2000.

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 55.6% in 2000, investors in the S&P financial services index experienced a total rate of return of 26.0%. The rate of return for property/casualty insurance stocks in 2000 looks even better when compared with the -9.1% 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 spectrum of nonfinancial industries, such as manufacturing and retail trade.

However, based on the performance of the S&P property/casualty index over the past twenty years, investors in property/casualty stocks did not earn total returns as high as those enjoyed by other investors. From year-end 1980 to year-end 2000, investors in the S&P property/casualty index earned a compound average annual total rate of return of 15.4%. During the same period, investors in the other S&P indexes discussed in this report earned average total rates of return that ranged from 15.6% per year for the S&P 500 to 17.2% per year for the S&P financial services index.[11]11. Investors in the S&P life/health insurance index earned an average total rate of return of 16.1% per year from year-end 1980 to year-end 2000. The lower 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 1999 to year-end 2000, the GS overall property/casualty index climbed 43.0%. The GS personal property/casualty index rose 24.2%, while the GS commercial property/casualty index increased 42.2%, and the GS reinsurance index soared 83.2%.

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 52 in 2000 from 64 in 1999 and a record 117 in 1998. The reported dollar value of property/casualty mergers and acquisitions fell to $8.9 billion last year from $19.1 billion in 1999 and a record $55.8 billion in 1998.[12]12. The number and value of the property/casualty mergers and acquisitions exclude the 1998 merger of Travelers Group Inc., with Citicorp Inc., a noninsurer, and Citigroup Inc.'s acquisition of Associates First Capital Corporation in 2000. The 52 mergers and acquisitions in 2000 compares with an average of 62 per year from 1988 to 2000. The reported $8.9-billion value of mergers and acquisitions last year compares with an average of $12.4 billion per year from 1988 to 2000.

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

  • weakness in financial markets
  • concern about the outlook for the economy and the property/casualty industry
  • increases in the prices of insurance stocks, raising the cost of acquisitions
  • questions about the success of past transactions

Despite mergers and acquisitions, 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.

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. Throughout this report, figures may not balance due to rounding.

4. ISO MarketWatchTM tracks rate changes on renewals for commercial auto liability, commercial auto physical damage, products liability, premises/operations liability, businessowners, commercial fire, and commercial allied lines by class and geographic location.

5. ISO Market ProfilerTM provides market segmentation information, including insurance premium and loss statistics and business demographics for more than 900 industries at the county, state, and countrywide level.

6. 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.

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

8. ISO estimated industry operating cash flow for 2000 based on the historical relationships between items on insurers' income and cash-flow statement9. 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 2000, thirty-seven large insurers each wrote more than $1.5 billion in premiums.

9. 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 2000, thirty-seven large insurers each wrote more than $1.5 billion in premiums.

10. As of April 2001, the S&P property/casualty index was based on data for eight insurers that collectively accounted for 15.3% of total industry net written premium in 2000 and 22.1% of total stock company net written premium in 1999 (the latest year for which separate data on stock company premiums is available)

11. Investors in the S&P life/health insurance index earned an average total rate of return of 16.1% per year from year-end 1980 to year-end 2000.

12. The number and value of the property/casualty mergers and acquisitions exclude the 1998 merger of Travelers Group Inc., with Citicorp Inc., a noninsurer, and Citigroup Inc.'s acquisition of Associates First Capital Corporation in 2000.