Insurer Financial Results: 2003

Executive Summary
Analysis of property/casualty insurer financial results for 2003 reveals that the industry made substantial progress in its ongoing recovery from its first-ever net loss after taxes in 2001 and declines in surplus during the three years ending 2002. But insurers' overall rate of return remained low compared with long-term historical norms and the rates of return of firms in other industries. And written premium growth slowed in 2003 as a result of changing conditions in insurance markets, raising questions about the sustainability of improvement in insurers' financial results going forward.

Net Income and Return on Net Worth
The property/casualty insurance industry's net income after taxes rose to $29.9 billion in 2003 from $3.0 billion in 2002 and $7.0 billion in 2001. [1]1. This study defines the U.S. property/casualty industry as all private 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 GAAP rate of return on average net worth (RONW) rose to 8.9% in 2003 from 2.2% the year before and 1.2% in 2001. [2]2. GAAP stands for Generally Accepted Accounting Principles, the accounting basis most industries use. Unless otherwise stated, the figures in this report are based on Statutory Accounting Principles (SAP), the accounting basis insurers use when preparing the Annual Statements they submit to regulators. See Appendix C beginning on page 80 for a discussion of the major differences between GAAP and SAP. (See Table 1.)

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Improvement in underwriting results drove the increases in the industry's net income and its GAAP RONW. Net losses on underwriting fell to $4.6 billion last year from $30.8 billion in 2002 and a record $52.6 billion in 2001.

Improvement in investment results also contributed to the increases in the industry's net income and profitability in 2003. Net investment income increased 3.9% last year to $38.7 billion, and insurers realized $6.9 billion in capital gains on investments — an $8.1 billion positive swing from the $1.2 billion in capital losses on investments insurers realized in 2002. In addition, insurers' miscellaneous other income rose to ­$0.3 billion last year from $0.8 billion in 2002.

Combining insurers' net losses on underwriting with their investment income, realized capital gains, and other miscellaneous income, their net income before taxes increased $36.3 billion in 2003 to $40.6 billion from $4.4 billion in 2002. [3]3. Throughout this report, figures may not balance because of rounding. But, partially offsetting the increase in insurers' net income before taxes, insurers' federal income taxes climbed to $10.8 billion in 2003 from $1.3 billion the year before.

Though insurers' net income after taxes rose $26.8 billion, or 880.7%, in 2003, it remained 18.9% below its peak of $36.8 billion in 1997. Adjusting for inflation since 1997, the industry's net income last year was 29.2% less than it was six years earlier.

Rising to 8.9% in 2003, the industry's GAAP RONW reached its highest level since 1997, when it was 11.6%. But the industry's GAAP RONW for 2003 was 1.0 percentage point less than its 9.9% average RONW from 1971 to 2002. [4]4. Data for insurers' GAAP rate of return on average net worth for years before 1971 is not available. Analysis of data by decade shows that, despite the improvement in insurers' GAAP RONW last year, the industry's profitability has been trending downward. The industry's average RONW fell from 12.2% during the ten years ending 1983 to 9.7% during the ten years ending 1993 and 6.6% during the ten years ending 2003.

Underwriting Results
In 2003, the industry's net loss on underwriting after dividends to policyholders declined by $26.2 billion, or 85.0%. Including the improvement in underwriting results in 2002, the industry's net loss on underwriting has declined a total of $48.0 billion, or 91.2%, from the record $52.6 billion in losses on underwriting in 2001. The industry's statutory combined ratio — a key measure of losses and expenses per dollar of premium — improved to 100.1% last year from 107.3% in 2002 and 115.9% in 2001.

At 100.1% last year, the combined ratio had declined to its lowest level since 1978, when it was 97.4%. But, even with the improvement in combined ratios since 2001, the combined ratio has averaged 108.3% so far this decade — up from an average of 107.7% during the 1990s.

The improvement in underwriting results during the past two years reflects the excess of growth in premiums over growth in losses and other expenses. Although written premium growth slowed to 9.8% last year from 14.3% in 2002, written premium growth remained faster than it was in any other year since 1986, when written premiums grew 22.2%. Similarly, earned premium growth slowed to 11.4% in 2003 from 11.9% the year before, but remained faster than it was in any other year since 1987, when earned premiums rose 13.6%.

Including the relatively rapid growth in written premiums during the past two years, written premiums have risen an average of 5.3% per year for the past ten years — down from an average of 8.3% per year during the ten years ending 1993.

U.S. government Consumer Price Indexes for personal insurance and ISO MarketWatch® data about rates on renewals for commercial insurance policies indicate that changing conditions in insurance markets contributed to both the acceleration in written premium growth from a record-low 1.8% in 1998 to 14.3% in 2002 and the subsequent deceleration in written premium growth to 9.8% last year. [5]5. ISO MarketWatch® 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 statistical territory. For example, countrywide data for the ISO MarketWatch lines shows that rate changes on renewals for commercial lines policies first turned positive in July 1999 and subsequently peaked at 12.9% in July 2002. But, by December 2003, rate changes on renewals for the ISO MarketWatch lines had dwindled to 4.6%. The slowing in rate increases is consistent with the cyclical pattern that would emerge before insurance markets start to soften, raising questions about the sustainability of recent improvement in insurers' financial results.

Estimates from ISO Market ProfilerTM show that commercial lines premium growth during the past five years has varied significantly by location. [6]6. For eleven commercial lines of insurance, 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 levels. For example, from 1999 to 2003, commercial lines premiums rose 15.9% per year in Delaware and 14.0% per year in California. Those average annual rates of growth contrast with increases in premiums averaging 7.4% per year in North Dakota and 7.0% per year in Idaho.

Premium growth has also varied significantly by standard industrial classification (SIC) code. For example, from 1999 to 2003, commercial lines premiums for financial holding companies and other investment offices increased 15.6% per year, and premiums for forestry businesses increased 14.7% per year. Commercial lines premiums for leather and leather products businesses and metal mining businesses grew less, increasing 1.5% per year and 0.2% per year, respectively. Differences in experience by location and class of business likely contributed to differences in the results of individual insurers.

In 2003, as premiums grew at the second fastest rate since the mid-1980s, growth in overall loss and loss adjustment expenses (LLAE) decelerated to its slowest pace in six years. Growth in overall LLAE slowed from 15.3% in 2001 to 3.0% in 2002 and 2.2% in 2003 — the slowest rate of growth in LLAE since 1997, when LLAE declined 4.2%.

Growth in overall LLAE slowed last year despite an increase in accident-year catastrophe losses, as reported by ISO's Property Claim Services® unit (PCS®). Catastrophe losses more than doubled to $12.9 billion in 2003 from $5.9 billion in 2002. Adjusting for inflation, the catastrophe losses in 2003 were the fourth highest on record since the start of ISO's data in 1949.

Catastrophe-adjusted loss and loss adjustment expenses fell 0.3% in 2003 to $283.6 billion from $284.5 billion in 2002. [7]7. ISO used the long-term average relationship between the catastrophe losses included in insurers' financial results and other loss and loss adjustment expenses to determine "normal" catastrophe losses for each year and then adjusted reported loss and loss adjustment expenses by substituting normal catastrophe losses for the actual catastrophe losses included in insurers' financial results. Other analyses in this report indicate that a decline in newly recognized environmental and asbestos (E&A) losses on policies written long ago contributed to the decline in noncatastrophe losses last year. Based on the data in the Notes to Financial Statements included in insurers' statutory Annual Statements for 2003, ISO estimates that insurers incurred $7.4 billion in E&A losses on old policies last year, down from $7.9 billion in 2002. Of that $7.4 billion, $6.5 billion was included in the LLAE reported in insurers' 2003 income statements. [8]8. The difference between the $7.4 billion and the $6.5 billion is attributable to one insurer that reported incurred E&A losses in the notes to its financial statements as a consequence of commuting a reinsurance arrangement. That insurer opted not to have those losses flow through its income statement. Instead, that insurer added to its loss reserves by posting negative paid losses.

Noncatastrophe LLAE declined last year despite strengthening of the industry's LLAE reserves. ISO's preliminary analysis of reserves as of year-end 2003 suggests that insurers strengthened reserves for losses not associated with catastrophe or E&A claims by between $4 billion and $10 billion in 2003, after strengthening such reserves by between $2 billion and $8 billion in 2002. [9]9. ISO's estimates for reserve strengthening include both additions to loss reserves for prior accident years and an assessment of the adequacy of reserves for losses occurring in the current accident year.

In recent years, swings in catastrophe losses, E&A losses, and possible changes in the adequacy of reserves for other claims have all had a significant effect on insurers' reported financial results. Adjusted for catastrophes, E&A losses, and changes in reserve adequacy, the combined ratio improved to 95.0% in 2003 from 104.0% the year before, and the industry's GAAP RONW improved to 12.5% from 4.5%.

The 100.1% combined ratio for 2003 based on reported data was 5.1 percentage points above the adjusted combined ratio for the year. The 8.9% GAAP RONW for 2003 was 3.6 percentage points below the adjusted rate of return for the year. That is, abnormal catastrophes, E&A losses, and changes in reserve adequacy together added 5.1 percentage points to the combined ratio for 2003 and reduced the industry's GAAP RONW by 3.6 percentage points, compared with what they would have been in the absence of abnormal catastrophes, E&A losses, and changes in reserve adequacy.

Investment Income and Capital Gains
Net investment income rose 3.9% in 2003 after declining 1.4% in 2002 and a record 7.3% in 2001. Even with the increase in investment income last year to $38.7 billion, investment income remained 5.0% below insurers' $40.7 billion in investment income in 2000.

The growth in investment income last year is the net result of increases in insurers' average holdings of cash and invested assets and a decline in the yield on cash and invested assets. Insurers' average holdings of cash and invested assets grew 9.9% in 2003 to $882.5 billion. But the yield on cash and invested assets fell to 4.4% in 2003 from 4.6% the year before.

Despite the increase in investment income last year, growth in investment income has been slowing over time. Based on records back to 1959, the industry's investment income has declined in just six years, and all six declines have occurred in the last twelve years. The average rate of growth in investment income has fallen from 18.7% per year in the 1970s to 12.8% per year in the 1980s, 2.2% per year in the 1990s, and 0.1% per year so far this decade.

The decline in the average rate of growth in investment income since the 1980s reflects trends in interest rates and the yield insurers earn on their cash and invested assets. The average yield on ten-year Treasury notes fell from 10.59% in the 1980s to 6.67% in the 1990s and to 4.92% so far this decade. Reflecting the trends in interest rates, the average yield on insurers' cash and invested assets dropped from 7.6% in the 1980s to 5.9% in the 1990s and to 4.7% during the past four years. The decline in interest rates and insurers' yield on cash and invested assets has cut into insurers' ability to use investment income to offset underwriting losses. That is, combined ratios must now be lower than they were in the past for insurers to achieve the same level of overall profitability.

Combining insurers' $6.9 billion in realized capital gains last year with their $25.2 billion in unrealized capital gains, insurers posted $32.1 billion in total capital gains for the year, as the S&P 500 index of common stock prices rose 26.4%. But those capital gains were not enough to offset the $35.7 billion in capital losses that insurers suffered during the preceding three years, as the S&P 500 declined an average of 15.7% per year. On balance, during the first four years of this decade, insurers experienced a total of $3.6 billion in overall capital losses, as the S&P 500 declined 6.7% per year. The capital losses of the past four years contrast with the industry's $105.5 billion in capital gains during the four years from 1996 to 1999. During those four years, the S&P 500 increased at a compound average annual rate of 24.3%.

Surplus and Leverage
The property/casualty industry's surplus increased 21.6% to $347.0 billion at year-end 2003 from $285.4 billion at year-end 2002. If not for inflation, the industry's $347.0 billion in surplus at year-end 2003 would have been a record. But, taking inflation into account, surplus at year-end 2003 was 6.0% below surplus at year-end 1999 and 7.8% below surplus at year-end 1998.

The $61.6-billion increase in surplus in 2003 is the largest dollar increase in surplus on record, both before and after adjusting for inflation. Additions to surplus last year included $29.9 billion in net income after taxes, $25.2 billion in unrealized capital gains on investments, $11.5 billion in new funds paid in, and $4.1 billion in miscellaneous surplus changes. These additions were partially offset by $9.1 billion in dividends to stockholders. (See Table 2.)

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The growth in surplus in 2003 follows an unprecedented three consecutive years of declines in surplus, with surplus dropping a total of 14.6% from year-end 1999 to year-end 2002. But the National Association of Insurance Commissioners Codification of Statutory Accounting Practices, effective January 1, 2001, has tempered changes in surplus since then. ISO estimates that surplus would have declined $4.0 billion more than it did in 2001 and $5.9 billion more than it did in 2002, if not for the Codification of Statutory Accounting Principles. Conversely, ISO estimates that surplus would have grown $1.5 billion more than it did in 2003, if not for the effects of Codification.

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. The industry's premium-to-surplus ratio fell to 1.17 last year from 1.30 in 2002, after rising for four consecutive years from a record-low 0.84 in 1998. The industry's LLAE-reserves-to-surplus ratio also fell in 2003, dropping to 1.22 from 1.38 in 2002, after rising for three consecutive years.

Despite year-to-year changes in premium-to-surplus and LLAE-reserves-to-surplus ratios, both have been trending downward. The average premium-to-surplus ratio fell from 2.22 in the 1970s to 1.78 in the 1980s, 1.18 in the 1990s, and 1.13 during the first four years of this decade. The average LLAE-reserves-to-surplus ratio increased from 1.69 in the 1970s to 1.97 in the 1980s but then declined to 1.60 in the 1990s and 1.25 so far this decade.

The declines in leverage ratios suggest that the industry's financial condition has improved over the years, but leverage ratios can be misleading. Low premium-to-surplus ratios can be an indication of inadequate premiums rather than financial strength. Similarly, low LLAE-reserves-to-surplus ratios can be a reflection of reserve deficiencies. And, to the extent that reserve deficiencies inflate surplus, they artificially reduce premium-to-surplus ratios.

ISO's preliminary analysis of loss reserves as of year-end 2003 indicates that industry reserves for losses other than those associated with E&A claims were deficient by between $39 billion and $55 billion as of the end of last year. Using an estimate near the middle of that range and assuming a tax rate of 30%, the premium-to-surplus ratio at year-end 2003 would have been 1.29 had reserves been adequate, instead of 1.17. The LLAE-reserves-to-surplus ratio would have been 1.50, instead of 1.22.

Operating Cash Flow
Operating cash flow [10]10. Operating cash flow is the sum of underwriting cash flow, net investment income received, and other income received, minus taxes paid. (OCF) indicates the rate at which basic underwriting and investment operations generate cash to fund new investments, dividend payments to stockholders, or other activities. When operating cash flow is low, an insurer may have to liquidate assets to meet its financial obligations, potentially reducing investment earnings and capital gains.

ISO estimates that the industry's OCF rose to $66.5 billion in 2003 from $50.0 billion in 2002 and a low of $7.8 billion in 1999. [11]11. ISO estimated the industry's operating cash flow for 2003 based on the historical relationships between items on insurers' income and cash flow statements. Improvement in underwriting cash flow drove the improvement in overall cash flow. Net underwriting cash flow increased from $25.0 billion in 1999 and $29.3 billion in 2000 to $8.0 billion in 2002 and an estimated $38.1 billion in 2003.

Reflecting the improvement in cash flow for the industry as a whole, the market share of insurers with negative or low operating cash flows dropped from 62.7% in 1999 to 11.8% in 2002, the latest year for which complete data was available. [12]12. ISO defined low operating cash flows as cash flows between 0.0% and 5.0% of net premiums written.

OCF ratios measure operating cash flow relative to net written premiums. The industry's operating cash flow increased to an estimated 16.4% of premium in 2003 from 13.5% in 2002 and 2.7% in 1999. Though complete data for 2003 was not yet available, data for 2002 shows that the OCF ratio for commercial lines insurers rose to 21.9% that year from 7.6% in 2001 and 0.0% in 1999. The OCF ratio for balanced insurers increased to 12.0% in 2002 from 5.6% in 2001 and 3.0% in 1999. And the OCF ratio for personal lines insurers rose to 8.7% in 2002, after falling to 1.5% in 2001 from 4.9% in 1999. The widespread improvement in underwriting results last year suggests that OCF ratios for all three segments of the industry improved in 2003.

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 Fortune 500 companies in 2003 was 13.4% — 4.6 percentage points above the 8.9% GAAP RONW for the insurance industry as a whole and 2.9 percentage points above the 10.5% GAAP RONW for large insurers. [13]13. 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 2003, thirty-four large insurers each wrote more than $2.2 billion in premiums.

From 1983 to 2003, the estimated RONW for the Fortune 500 averaged 13.6% — 5.1 percentage points more than the 8.5% average RONW for large insurers and 5.5 percentage points more than the 8.1% average RONW for the insurance 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 1993 to 2002 (the latest year for which complete COMPUSTAT data was available), the RONW for 291 noninsurance industries averaged 10.0% — 3.3 percentage points more than the insurance industry's 6.8% average RONW for the period. In a ranking from most to least profitable during that ten-year period, insurance ranked 205 out of 292 industries. The results were similar when ISO lengthened the analysis to also include the ten years from 1983 to 1992.

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 S&P Property & Casualty Insurance Index with the performance of the S&P Life & Health Insurance Index, the S&P Financials Index, and the S&P 500 — a widely used measure of the stock market overall — to assess how investors in property/casualty insurance stocks have fared. [14]14. As of year-end 2003, the S&P Property & Casualty Index was based on data for eleven insurers that collectively accounted for 19.7% of total industry net written premium in 2003 and 26.5% of total stock company net written premium in 2002 (the latest year for which separate data on stock company premiums was available). The S&P Life & Health Index was based on data for eight life/health insurers, and the S&P Financials Index was based on data for eighty-three companies in a diverse array of financial service industries, including property/casualty insurance, life/health insurance, banking, investment banking and brokerage, and consumer finance, among others. The S&P 500 consists of the largest publicly traded corporations in a broad spectrum of industries. 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 2003, investors in the S&P property/casualty index earned a total rate of return (capital gains plus dividends) of 26.4%. That is, the value of one hundred dollars invested in the stock of the insurers in the S&P property/casualty index on December 31, 2002, would have grown to about $126.40 on December 31, 2003. Investors in the S&P life/health index earned a total rate of return of 27.0% in 2003. Investors in the S&P financials index and the S&P 500 earned total rates of return of 31.0% and 28.6%, respectively. Hence, investors in the S&P property/casualty index made money in 2003, but not as much as investors in the other S&P indexes included in this analysis.

Based on the performance of the S&P property/casualty index over the past twenty years, investors in property/casualty stocks have earned total returns better than those earned by investors in life/health stocks but less robust than those enjoyed by investors in other stocks. From year-end 1983 to year-end 2003, investors in the S&P property/casualty index earned a compound average annual total rate of return of 12.6%. During the same period, investors in the S&P life/health index earned total rates of return averaging 11.3%, as investors in the S&P financials index and the S&P 500 earned total rates of return averaging 14.8% and 12.9%, respectively.

But many insurers are smaller than the companies in the S&P 500. And, as the S&P 500 increased 26.4% in 2003, the S&P MidCap 400 rose 34.0%, and the S&P SmallCap 600 climbed 37.5%. That is, investments in middle-capitalization and small-capitalization stocks outperformed investments in large-capitalization stocks.

The Goldman Sachs (GS) property/casualty index is based on data for thirty-eight insurers, including some in the S&P MidCap 400. In 2003, the GS property/casualty index and the S&P property/casualty index both rose 24.0%. But investors in some sectors of the property/casualty industry did better than investors in other sectors. In particular, Goldman Sachs subdivides its property/casualty index into a commercial property/casualty index, a personal property/casualty index, and a reinsurance index. In 2003, the GS commercial property/casualty index increased 27.9%, as the GS personal property/casualty index increased 19.8%, and the GS reinsurance index rose 13.2%.

Even though investors in the reinsurance sector may not have done as well as investors in other sectors of the property/casualty industry last year, they have fared relatively well over the past three years. From year-end 2000 to year-end 2003, the GS reinsurance index rose 10.4% per year. During the same period, the GS personal property/casualty and commercial property/casualty indexes rose 10.0% per year and 4.6% per year, respectively.

Mergers, Acquisitions, and Market Concentration
Based on data compiled by Conning & Company, the number of mergers and acquisitions in the property/casualty insurance industry rose to 51 in 2003 from 36 in 2002. The reported dollar value of property/casualty mergers and acquisitions rose to $20.4 billion last year from $0.5 billion in 2002.

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

  • increases in the price of stocks in general and property/casualty stocks in particular;
  • cyclical improvement in insurers' financial results;
  • sales of businesses by insurers refocusing on core operations;
  • the need for some insurers to restructure or seek stronger partners, because of poor financial results before 2003; and,
  • a shift toward nontraditional transactions, such as purchases of books of business or renewal rights, that can be less subject to legacy issues often associated with traditional transactions.

At 51 in 2003, the number of property/casualty mergers had reached its highest level since the 52 in 2000. Nonetheless, the 51 property/casualty mergers and acquisitions in 2003 was less than half of the 117 property/casualty mergers and acquisitions in 1998. Similarly, at $20.4 billion in 2003, the reported value of property/casualty mergers and acquisitions was less than half of the $55.8 billion in property/casualty mergers and acquisitions in 1998. [15]15. 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 51 mergers and acquisitions in 2003 compares with an average of 59 per year from 1988 to 2002. The $20.4-billion reported value of mergers and acquisitions last year compares with an average of $10.8 billion per year from 1988 to 2002.

Despite the 940 property/casualty mergers and acquisitions from 1988 to 2003, 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. This study defines the U.S. property/casualty industry as all private 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 most industries use. Unless otherwise stated, the figures in this report are based on Statutory Accounting Principles (SAP), the accounting basis insurers use when preparing the Annual Statements they submit to regulators. See Appendix C beginning on page 80 for a discussion of the major differences between GAAP and SAP.

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

4. Data for insurers' GAAP rate of return on average net worth for years before 1971 is not available.

5. ISO MarketWatch® 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 statistical territory.

6. For eleven commercial lines of insurance, 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 levels.

7. ISO used the long-term average relationship between the catastrophe losses included in insurers' financial results and other loss and loss adjustment expenses to determine "normal" catastrophe losses for each year and then adjusted reported loss and loss adjustment expenses by substituting normal catastrophe losses for the actual catastrophe losses included in insurers' financial results.

8. The difference between the $7.4 billion and the $6.5 billion is attributable to one insurer that reported incurred E&A losses in the notes to its financial statements as a consequence of commuting a reinsurance arrangement. That insurer opted not to have those losses flow through its income statement. Instead, that insurer added to its loss reserves by posting negative paid losses.

9. ISO's estimates for reserve strengthening include both additions to loss reserves for prior accident years and an assessment of the adequacy of reserves for losses occurring in the current accident year.

10. Operating cash flow is the sum of underwriting cash flow, net investment income received, and other income received, minus taxes paid.

11. ISO estimated the industry's operating cash flow for 2003 based on the historical relationships between items on insurers' income and cash flow statements.

12. ISO defined low operating cash flows as cash flows between 0.0% and 5.0% of net premiums written.

13. 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 2003, thirty-four large insurers each wrote more than $2.2 billion in premiums.

14. As of year-end 2003, the S&P Property & Casualty Index was based on data for eleven insurers that collectively accounted for 19.7% of total industry net written premium in 2003 and 26.5% of total stock company net written premium in 2002 (the latest year for which separate data on stock company premiums was available). The S&P Life & Health Index was based on data for eight life/health insurers, and the S&P Financials Index was based on data for eighty-three companies in a diverse array of financial service industries, including property/casualty insurance, life/health insurance, banking, investment banking and brokerage, and consumer finance, among others. The S&P 500 consists of the largest publicly traded corporations in a broad spectrum of industries.

15. 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.