Insurer Financial Results: 2005

Benefiting from sound risk management and strong investment results, the U.S. property/casualty industry's net income after taxes rose 11.7%, or $4.5 billion, in 2005 to $43.0 billion. [1]1. This study defines the U.S. property/casualty insurance industry as all private property/casualty insurers domiciled in the United States, including excess and surplus insurers and domestic insurers owned by foreign parents. The data in this report is based mainly on insurers' statutory financial statements as supplied to ISO by April 17, 2006, and excludes foreign subsidiaries of U.S. insurance groups. All figures are represented net of reinsurance, unless otherwise noted. Reflecting the industry's income, its consolidated surplus (statutory net worth) increased 9.2%, or $35.8 billion, to a record $427.1 billion at year-end 2005.

Net income and surplus both increased in 2005 even though catastrophe losses rose to a record high on a direct basis before reinsurance recoveries. According to ISO's Property Claim Services® unit, direct insured property losses from catastrophes in 2005 rose to $61.2 billion — more than double the $27.5 billion in direct insured property losses from catastrophes in 2004. [2]2. The PCS data for direct insured property losses from catastrophes cited in this study is based on information available through June 19, 2006, and is subject to change as more information about the cost of settling claims from the 2005 hurricanes becomes available.

The industry's financial results for 2005 are a testament to insurers' risk management and to the scale and efficiency of global mechanisms for spreading risk. On a net basis excluding catastrophe losses covered by foreign reinsurers, residual market mechanisms, and the Florida Hurricane Catastrophe Fund, ISO estimates that U.S. insurers' financial results for 2005 included between $31 billion and $36 billion in catastrophe losses. ISO also estimates that U.S. insurers' net losses from last year's catastrophes will ultimately total between $32 billion and $38 billion after upward revisions to direct losses since insurers closed their books for 2005. And ISO's analysis suggests that foreign insurers and reinsurers will ultimately cover between $15 billion and $20 billion of the $61.2 billion in catastrophe losses on a direct basis last year.

Managing and spreading catastrophe risk helped insurers maintain their GAAP rate of return on average net worth (RONW) last year. [3]3. 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 Principles (SAP), the accounting basis used by insurers when preparing the Annual Statements they submit to state regulators. See Appendix C on page 68 for a discussion of the major differences between GAAP and SAP. But at 9.4% in both 2005 and 2004, insurers' GAAP RONW remained low compared with both long-term norms and the rates of return earned by firms in other industries.

Moreover, countrywide data for all lines mask significant problems in some specific markets and locations. For example, before reinsurance recoveries and excluding losses covered by residual market mechanisms, the hurricanes of 2005 caused $25.7 billion in insured losses to structures and their contents in Louisiana — $4.1 billion more than all the premiums insurers charged for property insurance in the state during the twenty-three years from 1982 to 2004.

Net Income and Return on Net Worth
At $43.0 billion in 2005, net income after taxes had risen 16.8% above its previous peak of $36.8 billion in 1997. However, adjusted for inflation, the industry's net income last year was 4.0% less than it was in 1997.

Up from a record-low –$7.0 billion in 2001, the industry's 2005 net income consisted of $5.9 billion in net losses on underwriting, $49.5 billion in net investment income, $9.7 billion in realized capital gains on investments, and $0.9 billion in miscellaneous other income, less $11.2 billion in income taxes. [4]4. Throughout this report, figures may not balance because of rounding. Unless otherwise stated, the phrase “income taxes” and the phrase “federal income taxes” both refer to federal and foreign income taxes as shown in insurers' statutory Annual Statements. (See Table 1.)

Image

The property/casualty insurance industry's net income after taxes rose for the fourth consecutive year despite deterioration in underwriting results. The $5.9 billion net loss on underwriting in 2005 constitutes a $10.2 billion adverse swing from the $4.3 billion net gain on underwriting in 2004. But net investment income increased $9.5 billion in 2005, as realized capital gains rose $0.6 billion, miscellaneous other income increased $1.2 billion, and federal income taxes fell $3.4 billion.

At 9.4% in 2004 and 2005, the industry's GAAP rates of return were the highest since the 11.6% GAAP RONW for 1997. Nonetheless, the industry's GAAP RONW for 2005 was 0.5 percentage points less than its 9.9% average GAAP RONW from 1971 to 2004. [5]5. 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 the industry's profitability has been trending downward.  Despite the increase in GAAP RONW since the record-low –1.2% for 2001, the industry's average RONW fell to 7.0% in the decade ending 2005 from 10.5% in the decade ending 1995 and 11.9% in the decade ending 1985.

The industry's investment income, net income after taxes and its GAAP RONW for 2005 all benefited from $3.2 billion in nonrecurring special dividends one insurer received from an investment subsidiary. Excluding those special dividends and associated taxes, net investment income rose 15.8% last year to $46.3 billion, net income after taxes increased 4.3% to $40.2 billion, and the industry's GAAP RONW fell 0.6 percentage points to 8.8%.

Underwriting Results
The industry's statutory combined ratio — a key measure of losses and expenses per dollar of premium — deteriorated to 100.9% in 2005 from 98.3% in 2004. The deterioration of underwriting results last year reflects the excess of growth in losses and other expenses over growth in premiums. In 2005, written premiums increased $1.6 billion to $425.7 billion, and earned premiums rose $3.9 billion to $417.7 billion. Loss and loss adjustment expenses (LLAE) grew $10.4 billion to $311.4 billion, other underwriting expenses increased $3.5 billion to $110.3 billion, and dividends to policyholders rose $0.2 billion to $1.9 billion.

In 2005, written premium growth slowed to a record-low 0.4% from 4.9% in 2004, 9.4% in 2003, and 14.3% in 2002. 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 the slowing in premium growth. For example, countrywide data for the ISO MarketWatch lines [6]6. ISO MarketWatch® tracks rates 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. shows that rate changes on renewals for commercial lines policies peaked in July 2002 at 12.9%. But rate increases have since become rate decreases. Rates on commercial renewals in December 2005 were 1.5% below year-ago levels.

As premiums rose 0.4% in 2005, LLAE rose 3.5%. The growth in LLAE is attributable to an increase in catastrophe losses. ISO estimates that, on a net basis after reinsurance recoveries, U.S. insurers' net underwriting results for 2005 included between $31 billion and $36 billion in catastrophe losses — more than twice the $15 billion in catastrophe losses included in net underwriting results for 2004. [7]7. ISO's estimates for the net catastrophe losses in insurers' calendar-year 2005 results include revisions to U.S. insurers' estimates of their net losses at ultimate from the hurricanes of 2004 and the terrorist attack on September 11, 2001. ISO's analysis indicates that insurers increased their estimates of net losses at ultimate from the 2004 hurricanes by $0.4 billion in 2005, as they reduced their estimates of net losses at ultimate from the terrorist attack by $0.3 billion.

Comparing the growth rate in reported LLAE with the growth rate in LLAE adjusted for catastrophe losses sheds light on the extent to which swings in catastrophe losses affected growth in reported LLAE. Though reported LLAE increased 3.5% in 2005, catastrophe adjusted LLAE declined 2.8% to $285.1 billion from $293.3 billion in 2004. [8]8. ISO used the long-term average relationship between the catastrophe losses included in insurers' financial results and other LLAE to determine “normal” catastrophe losses for each year and then adjusted reported LLAE by substituting normal catastrophe losses for the actual catastrophe losses included in insurers' financial results.

The decline in catastrophe-adjusted LLAE reflects a decline in newly recognized environmental and asbestos (E&A) losses on policies written long ago and a slowing in the rate at which insurers strengthened LLAE reserves for other losses. ISO estimates that insurers' overall LLAE last year included $4.2 billion in E&A losses on old policies — down from $5.9 billion in 2004. And ISO's preliminary analysis of LLAE reserves as of year-end 2005 suggests that insurers strengthened reserves for losses not associated with catastrophes or E&A claims by between $8 billion and $14 billion in 2005, after strengthening such reserves by between $20 billion and $26 billion in 2004. [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. Despite the reserve strengthening in recent years, a preliminary ISO analysis of the available data indicates insurers' reserves for LLAE other than those associated with catastrophe and E&A claims were between roughly adequate and deficient by about $20 billion at year-end 2005.

The decline in catastrophe-adjusted LLAE in 2005 also reflects a transaction in which one reinsurer ceded $6.0 billion in LLAE and the same amount of premiums to its foreign parent. [10]10. The $6.0 billion in LLAE one insurer ceded to its foreign parent in 2005 included an estimated $1.1 billion in E&A losses. If not for that transaction, E&A LLAE incurred would have dropped to $5.3 billion in 2005 instead of dropping to $4.2 billion. If not for that transaction, overall LLAE would have increased 5.5% last year instead of 3.5%. Similarly, written premiums would have risen 1.8% instead of 0.4%.

In recent years, catastrophe losses, E&A losses, and changes in the adequacy of reserves for other claims have all had a significant effect on insurers' reported financial results. If not for abnormal catastrophe losses, E&A losses, and changes in reserve adequacy, the industry's combined ratio for 2005 would have been 90.6% instead of 100.9%, and the industry's GAAP RONW would have been 16.0% instead of 9.4%. [11]11. When calculating adjusted combined ratios and GAAP rates of return, ISO smoothed catastrophe losses, excluded environmental and asbestos losses as defined for purposes of the Notes to Financial Statements included in the statutory Annual Statements insurers file with state regulators, and restated other losses to eliminate changes in reserve adequacy.

Analyses of long-term data reveal downward trends in premium growth and deterioration in underwriting results. Premium growth fell to an average of 5.1% per year in the decade ending 2005 from 6.0% per year in the decade ending 1995 and 11.3% per year in the decade ending 1985. The combined ratio improved to below 100.0% only once in the twenty-seven years from 1979 to 2005. But the combined ratio was below 100.0% in ten of the twenty years from the start of ISO's records in 1959 to 1978.

The long-term downward trend in premium growth reflects moderation in inflation and intensifying competition in insurance markets. The latter has contributed to deterioration in underwriting results over time.

Investment Income and Capital Gains
Growth in reported net investment income accelerated to 23.7% in 2005 from 3.4% in 2004 as a consequence of $3.2 billion in nonrecurring special dividends one insurer received from an investment subsidiary, growth in insurers' holdings of cash and invested assets, and an increase in the yield on those assets. Excluding those special dividends, investment income increased 15.8% in 2005, as insurers´ average holdings of cash and invested assets increased 9.2% and the yield on cash and invested assets increased to 4.3% from 4.0% in 2004.

Nonetheless, the average rate of growth in investment income slowed to 3.0% in the decade ending 2005 from 6.6% per year in the decade ending 1995 and 17.5% per year in the decade ending 1985. The long-term slowing in the growth of investment income reflects trends in interest rates and the yield on insurers' cash and invested assets. The average yield on ten-year Treasury notes fell to 5.2% in the ten years ending 2005 from 7.6% in the ten years ending 1995 and 10.5% in the ten years ending 1985, as the average yield on insurers' cash and invested assets dropped to 4.9% from 6.7% and 7.1%. [12]12. The average yield on insurers' cash and invested assets in the ten years ending 2005 is 4.9% regardless of whether the $3.2 billion in special dividends one insurer received in 2005 is included in the calculation of the average.

The long-term slowing in the growth of investment income also reflects trends in insurers' holdings of cash and invested assets. The average rate of growth in insurers' average holdings of cash and invested assets slowed to 5.4% per year in the decade ending 2005 from 10.3% per year in the decade ending 1995 and 12.3% per year in the decade ending 1985.

The declines in insurers' yield on cash and invested assets and the slowing in the growth of cash and invested assets mean that combined ratios must now be lower than they were in the past for insurers to achieve the same level of overall profitability. Insurers' GAAP RONW last surpassed 15.0% in 1987, when it was 17.3% and the combined ratio was 104.6%. In 2005, the combined ratio was 100.9%, but insurers' GAAP RONW was just 9.4%.

Combining insurers' $9.7 billion in realized capital gains in 2005 with their $3.2 billion in unrealized capital losses, insurers posted $6.5 billion in total capital gains for the year — down from $19.7 billion in 2004 and $31.6 billion in 2003. Nonetheless, the $57.8 billion in capital gains during the past three years more than offsets the $35.7 billion in capital losses that insurers suffered from 2000 to 2002.

Insurers' capital gains during the past three years and insurers' capital losses during the preceding three years both reflect developments in financial markets. The S&P 500 index of common stock prices rose 3.0% in 2005 and an average of 12.4% per year from 2003 to 2005. The same index declined each year from 2000 to 2002, falling 15.7% per year.

Surplus and Leverage
The property/casualty industry's surplus increased 9.2% to $427.1 billion at year-end 2005 from $391.3 billion at year-end 2004. The industry's surplus at year-end 2005 was a record high, both before and after adjusting for inflation. On an inflation-adjusted basis, surplus at year-end 2005 was 5.6% more than surplus at year-end 2004, the previous record.

Additions to surplus last year included $43.0 billion in net income after taxes and $14.0 billion in new funds paid in.  These additions were partially offset by $15.2 billion in dividends to stockholders, $3.2 billion in unrealized capital losses on investments, and $2.8 billion in miscellaneous charges against surplus. (See Table 2.)

Image

Leverage ratios, such as the premium-to-surplus ratio and the LLAE-reserves-to-surplus ratio, provide simple measures of how much risk each dollar of surplus supports. The industry's premium-to-surplus ratio fell to 1.00 last year from 1.30 in 2002, after rising for four consecutive years from a record-low 0.84 in 1998. Similarly, the LLAE-reserves-to-surplus ratio dropped to 1.18 in 2005 from 1.38 in 2002, after rising for three consecutive years from 1.08 in 1999.

Analysis of data extending back several decades reveals that premium-to-surplus ratios and LLAE-reserves-to-surplus ratios have both been trending downward. The average premium-to-surplus ratio fell to 1.03 in the decade ending 2005 from 1.51 in the decade ending 1995 and 2.01 in the decade ending 1985. The average LLAE-reserves-to-surplus ratio fell to 1.22 in the past ten years from 1.94 in the ten years ending 1995 and 1.92 in the ten years ending 1985.

The downward trends in leverage ratios suggest that the industry's ability to meet its financial obligations has improved with the passage of time. But to the extent that the long-term declines in leverage ratios mean that insurers are holding more capital relative to the risks they have underwritten, insurers may be using capital less efficiently than they used to. And to the extent that the downward trends in leverage ratios reflect increasingly competitive pricing in insurance markets and changes in reserve adequacy, the trends in leverage ratios are imperfect indicators of changes in insurers' financial condition.

Operating Cash Flow
Operating cash flow [13]13. 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.

OCF decreased to an estimated $75.5 billion in 2005 from $89.9 billion in 2004, after increasing for five consecutive years from a record-low $7.8 billion in 1999. [14]14. ISO's OCF data extends back to 1979. Deterioration in underwriting cash flow led to the deterioration in overall cash flow last year, with net underwriting cash flow decreasing to an estimated $39.3 billion in 2005 from $62.3 billion in 2004.

OCF ratios measure operating cash flow relative to net written premiums. Reflecting the increase in catastrophe losses in 2005, the industry's OCF ratio dropped for the first time in six years, with OCF falling to an estimated 17.7% of premiums from 21.2% in 2004. Nonetheless, the industry's OCF ratio remained more than six times the record-low 2.7% for 1999.

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 2005 was 16.1% — 6.7 percentage points more than the 9.4% GAAP RONW for the insurance industry as a whole and 5.7 percentage points more than the 10.4% GAAP RONW for large insurers. [15]15. 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 2005, thirty-seven large insurers each wrote more than $2.1 billion in premiums.

From the start of ISO's data for the Fortune 500 in 1983 to 2005, the estimated RONW for the Fortune 500 averaged 13.8% — 5.5 percentage points more than the 8.2% average RONW for the insurance industry and 5.1 percentage points more than the 8.6% average RONW for large insurers. And, in twenty one of those twenty-three years, the rate of return for the Fortune 500 exceeded the rates of returns earned by both the industry overall and large insurers.

Analyses in this study 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 1995 to 2004 (the latest year for which complete COMPUSTAT data was available), the RONW for 300 noninsurance industries averaged 10.3% — 3.3 percentage points more than the insurance industry's 6.9% average RONW for the period. In a ranking from most to least profitable during that ten-year period, insurance ranked 212 out of 301 industries. The results were similar when ISO lengthened the analysis to also include the ten years from 1985 to 1994.

1. This study defines the U.S. property/casualty insurance industry as all private property/casualty insurers domiciled in the United States, including excess and surplus insurers and domestic insurers owned by foreign parents. The data in this report is based mainly on insurers' statutory financial statements as supplied to ISO by April 17, 2006, and excludes foreign subsidiaries of U.S. insurance groups. All figures are represented net of reinsurance, unless otherwise noted.

2. The PCS data for direct insured property losses from catastrophes cited in this study is based on information available through June 19, 2006, and is subject to change as more information about the cost of settling claims from the 2005 hurricanes becomes available.

3. 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 Principles (SAP), the accounting basis used by insurers when preparing the Annual Statements they submit to state regulators. See Appendix C on page 68 for a discussion of the major differences between GAAP and SAP.

4. Throughout this report, figures may not balance because of rounding. Unless otherwise stated, the phrase “income taxes” and the phrase “federal income taxes” both refer to federal and foreign income taxes as shown in insurers' statutory Annual Statements.

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

6. ISO MarketWatch® tracks rates 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.

7. ISO's estimates for the net catastrophe losses in insurers' calendar-year 2005 results include revisions to U.S. insurers' estimates of their net losses at ultimate from the hurricanes of 2004 and the terrorist attack on September 11, 2001. ISO's analysis indicates that insurers increased their estimates of net losses at ultimate from the 2004 hurricanes by $0.4 billion in 2005, as they reduced their estimates of net losses at ultimate from the terrorist attack by $0.3 billion.

8. ISO used the long-term average relationship between the catastrophe losses included in insurers' financial results and other LLAE to determine “normal” catastrophe losses for each year and then adjusted reported LLAE by substituting normal catastrophe losses for the actual catastrophe losses included in insurers' financial results.

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. Despite the reserve strengthening in recent years, a preliminary ISO analysis of the available data indicates insurers' reserves for LLAE other than those associated with catastrophe and E&A claims were between roughly adequate and deficient by about $20 billion at year-end 2005.

10. The $6.0 billion in LLAE one insurer ceded to its foreign parent in 2005 included an estimated $1.1 billion in E&A losses. If not for that transaction, E&A LLAE incurred would have dropped to $5.3 billion in 2005 instead of dropping to $4.2 billion.

11. When calculating adjusted combined ratios and GAAP rates of return, ISO smoothed catastrophe losses, excluded environmental and asbestos losses as defined for purposes of the Notes to Financial Statements included in the statutory Annual Statements insurers file with state regulators, and restated other losses to eliminate changes in reserve adequacy.

12. The average yield on insurers' cash and invested assets in the ten years ending 2005 is 4.9% regardless of whether the $3.2 billion in special dividends one insurer received in 2005 is included in the calculation of the average.

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

14. ISO's OCF data extends back to 1979.

15. 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 2005, thirty-seven large insurers each wrote more than $2.1 billion in premiums.