P/C Insurer Profits Rose in 2012, Despite Sandy Losses and Investment Gains Drop

Despite the impact of Superstorm Sandy and smaller investment gains, private U.S. property/casualty insurers’ net income after taxes grew to $33.5 billion in 2012 from $19.5 billion in 2011, with insurers’ overall profitability as measured by their rate of return on average policyholders’ surplus climbing to 5.9 percent from 3.5 percent. At 5.9 percent, insurers’ overall rate of return lagged their 8.9 percent average rate of return for the 54 years since the start of ISO’s annual data in 1959.

Insurers’ pretax operating income – the sum of net gains or losses on underwriting, net investment income, and miscellaneous other income – rose to $33.3 billion in 2012 from $15.4 billion in 2011.

Improvement in underwriting results drove the increases in insurers’ pretax operating income, net income after taxes, and overall rate of return, with net losses on underwriting dropping to $16.7 billion in 2012 from $36.2 billion in 2011. The combined ratio – a key measure of losses and other underwriting expenses per dollar of premium – improved to 103.2 percent for 2012 from 108.1 percent for 2011, according to ISO, a Verisk Analytics company (Nasdaq:VRSK), and the Property Casualty Insurers Association of America (PCI).

The decline in net losses on underwriting is attributable to premium growth and a drop in net losses and loss adjustment expenses (LLAE). Net written premiums climbed 4.3 percent in 2012 to $457 billion, and net earned premiums grew 3.4 percent to $449.4 billion. Conversely, net LLAE fell 2.8 percent in 2012 to $335 billion. The decline in net losses on underwriting would have been bigger if not for increases in underwriting expenses and dividends to policyholders, which both rose last year.

The improvement in underwriting results was partially offset by a drop in net investment gains, a decline in miscellaneous other income, and higher taxes. Net investment gains – the sum of net investment income and realized capital gains (or losses) on investments – fell $2.3 billion to $53.9 billion in 2012 from $56.2 billion in 2011 as miscellaneous other income dropped $0.2 billion to $2.3 billion from $2.5 billion and insurers’ federal and foreign income taxes rose $3 billion to $6 billion from $3 billion.

Policyholders’ surplus – insurers’ net worth measured according to Statutory Accounting Principles – grew $33.1 billion to a record $586.9 billion at year-end 2012 from $553.8 billion at year-end 2011 as a result of insurers’ $33.5 billion in net income after taxes.

The figures are consolidated estimates for all private property/casualty insurers based on reports accounting for at least 96 percent of all business written by private U.S. property/casualty insurers.

“While families and local communities continue to recover from Superstorm Sandy, the experts are already predicting that this year’s hurricane season will be very active,” said Robert Gordon, PCI’s senior vice president for policy development and research. “The horrific damage and suffering caused by Sandy serve as vivid reminders that now is the time for all of us – insurers, businesses, government officials, private citizens, and their elected representatives – to take the steps needed to minimize the economic damage and human tragedy that will occur when catastrophes strike. There is no substitute for preparation, and there is no excuse for not being prepared. Insurers’ record-high $586.9 billion in policyholders’ surplus as of December 31 attests to both insurers’ resilience in the wake of Superstorm Sandy and their ability to meet their obligations to policyholders if we’re hit again this year.”

“As good as insurers’ results for 2012 were compared with their results for 2011, they pale in comparison with long-term norms. For example, insurers’ 5.9 percent overall rate of return for 2012 fell far short of their 8.9 percent average rate of return for the 54 years from the start of ISO’s annual data in 1959 to 2012, ” said Michael R. Murray, ISO assistant vice president for financial analysis. “Moreover, with today’s investment yields, financial leverage, and tax rates, ISO estimates underwriting profitability as measured by the combined ratio would have to improve by an additional 4.6 percentage points to 98.6 percent for insurers to earn their long-term average rate of return. Lest this seem merely academic, insurance is an essential cornerstone of commerce; and over the long term, insurers’ ability to attract the capital necessary to meet the coverage needs of an expanding economy is a function of their profitability. That is, our economic future depends on insurers being able to earn rates of return commensurate with the risks they assume.”

The property/casualty industry’s 5.9 percent rate of return for 2012 was the net result of negative rates of return for mortgage and financial guaranty (M&FG) insurers and single-digit rates of return for other insurers. ISO estimates that M&FG insurers’ rate of return on average surplus improved to negative 9.3 percent for 2012 from negative 48 percent for 2011. Excluding M&FG insurers, the industry’s rate of return rose to 6.2 percent in 2012 from 4.7 percent in 2011.

Underwriting Results

Underwriting gains (or losses) equal earned premiums minus LLAE, other underwriting expenses, and dividends to policyholders.

Net losses on underwriting fell $19.6 billion to $16.7 billion in 2012 from $36.2 billion in 2011 as premiums rose and LLAE declined.

Net written premiums rose $19 billion, or 4.3 percent, to $457 billion for 2012 from $438 billion for 2011. At 4.3 percent, written premiums grew at their fastest pace since 2004, when written premiums rose 4.9 percent.

Net earned premiums rose $14.9 billion, or 3.4 percent, to $449.4 billion from $434.4 billion. Earned premiums last increased this rapidly in 2006, when they rose 4.3 percent.

Net LLAE (after reinsurance recoveries) dropped $9.7 billion, or 2.8 percent, to $335 billion in 2012 from $344.6 billion in 2011.

Partially negating the effects of the growth in premiums and decline in LLAE, other underwriting expenses – primarily acquisition expenses; expenses associated with underwriting, pricing, and servicing insurance policies; and premium taxes – increased $4.8 billion, or 3.8 percent, to $129 billion in 2012 from $124.2 billion in 2011.

Dividends to policyholders totaled $2.1 billion in 2012, up $0.3 billion from the $1.9 billion in dividends to policyholders in 2011.

The decrease in overall LLAE was largely driven by a decline in catastrophe losses, with ISO estimating that private insurers’ net LLAE from catastrophes fell $5.9 billion to $32.1 billion in 2012 from $38 billion in 2011. But other net LLAE also dropped, falling $3.7 billion, or 1.2 percent, to $302.9 billion in 2012 from $306.6 billion in 2011.

U.S. insurers’ $32.1 billion in net LLAE from catastrophes in 2012 is primarily attributable to catastrophes that struck the United States. Though estimating U.S. insurers’ LLAE from catastrophes elsewhere around the globe is difficult, the available information suggests that U.S. insurers’ net LLAE from catastrophes overseas dropped to near nil in 2012 from between $4.5 billion and $6.5 billion in 2011.

According to ISO’s Property Claim Services (PCS) unit, based on the information available as of April 23, 2013, catastrophes striking the United States in 2012 caused $35 billion in direct insured property losses (before reinsurance recoveries) for all insurers (including residual market insurers, foreign insurers, and reinsurers, but excluding the National Flood Insurance Program and ocean marine losses) – up $1.3 billion compared with the $33.6 billion in direct insured losses caused by catastrophes striking the United States in 2011 and $11 billion more than the $23.9 billion average for direct catastrophe losses during the past ten years.

Reflecting the growth in premiums and the decline in LLAE, the combined ratio improved by 4.9 percentage points to 103.2 percent in 2012 from 108.1 percent in 2011.

“Much of the improvement in underwriting results last year reflects improvement in the underlying fundamentals of the property/casualty business as opposed to lower weather-related catastrophe losses,” said Gordon. “The drop in net LLAE from catastrophes accounts for just $5.9 billion of the $19.6 billion decline in net losses on underwriting. Even if net LLAE from catastrophes had remained flat, the combined ratio would have improved by 3.6 percentage points to 104.6 percent in 2012.”

Underwriting results for 2012 benefited from $10.2 billion in favorable development of LLAE reserves based on new information and updated estimates for the ultimate cost of old claims from prior accident years. The $10.2 billion in favorable reserve development in 2012 follows $11 billion of favorable development in 2011.

The $10.2 billion in favorable reserve development for the industry overall in 2012 reflects $2 billion in unfavorable reserve development for M&FG insurers and $12.1 billion in favorable reserve development for other insurers.

The amount of unfavorable reserve development suffered by M&FG insurers dropped $1.3 billion to $2 billion last year from $3.3 billion in 2011.

The amount of favorable reserve development for the industry excluding M&FG insurers fell $2.2 billion to $12.1 in 2012 billion from $14.3 billion the year before.

Excluding development of LLAE reserves, total industry net LLAE fell $10.5 billion, or 3 percent, to $345.1 billion in 2012 from $355.7 billion in 2011, and the combined ratio improved by 5.1 percentage points to 105.5 percent from 110.6 percent.

The $16.7 billion in net losses on underwriting in 2012 amounted to 3.7 percent of the $449.4 billion in net premiums earned during the period, whereas the $36.2 billion in net losses on underwriting in 2011 amounted to 8.3 percent of the $434.4 billion in net premiums earned during that period.

“Once again, mortgage and financial guaranty insurers suffered disproportionate losses on underwriting,” said Murray. “Though mortgage and financial guaranty insurers’ combined ratio dropped 67.3 percentage points to 164.9 percent for 2012 from 232.3 percent for 2011, their combined ratio for 2012 was 62.6 percentage points worse than the 102.4 percent combined ratio for the industry excluding mortgage and financial guaranty insurers.”

M&FG insurers’ net written premiums dropped 6.8 percent to $5 billion for 2012 from $5.3 billion for 2011, and their net earned premiums fell 5.1 percent to $6 billion from $6.3 billion. The adverse effects of these declines in premiums were more than offset by declines in LLAE and other underwriting expenses. M&FG insurers’ LLAE fell 23.8 percent to $8.8 billion in 2012 from $11.5 billion in 2011, and their other underwriting expenses dropped 64.7 percent to $1 billion from $2.7 billion.

Excluding M&FG insurers, industry net written premiums rose 4.5 percent in 2012 to $452 billion, net earned premiums increased 3.6 percent to $443.3 billion, LLAE fell 2.1 percent to $326.2 billion, other underwriting expenses increased 5.4 percent to $128 billion, and dividends to policyholders increased 14.3 percent to $2.1 billion. As a result, the combined ratio for the industry excluding M&FG insurers improved to 102.4 percent for 2012 from 106.3 percent for 2011.

“Growth in overall net written premiums accelerated to 4.3 percent in 2012 from 3.4 percent in 2011 and 1.3 percent in 2010. Moreover, premium growth accelerated for all major segments of the industry,” said Murray. “But growth varied by segment. Excluding mortgage and financial guaranty insurers, net written premiums for insurers writing predominantly commercial lines climbed 5.7 percent in 2012. Premiums for other segments rose less, with premiums for insurers writing more balanced books of business increasing 4.2 percent last year as premiums for insurers writing predominantly personal lines rose 3.6 percent. Differences in market conditions likely contributed to differences in growth by segment, with reports from various sources indicating commercial insurance rates rose between 4 percent and 6 percent last year as the CPI for tenants and household insurance increased 3.1 percent and the CPI for motor vehicle insurance increased 3.6 percent. In addition, commercial lines premiums tend to be more sensitive than personal lines premiums to changes in the economy, and the economy grew last year.”

“Underwriting profitability improved for all three major sectors of the industry, reflecting the effects of premium growth and the drop in LLAE,” said Gordon. “Excluding mortgage and financial guaranty insurers, commercial lines insurers’ combined ratio dropped 2.4 percentage points in 2012 to 102.3 percent as balanced insurers’ combined ratio improved by 4.7 percentage points to 104.6 percent and personal lines insurers’ combined ratio fell 4.8 percentage points to 101.1 percent.”

Investment Results

Insurers’ net investment income – primarily dividends from stocks and interest on bonds – fell 3 percent to $47.7 billion in 2012 from $49.2 billion in 2011. Insurers’ realized capital gains on investments dropped $0.8 billion to $6.2 billion in 2012 from $7 billion a year earlier. Combining net investment income and realized capital gains, overall net investment gains declined $2.3 billion, or 4.1 percent, to $53.9 billion for 2012 from $56.2 billion for 2011.

“The 3 percent decline in insurers’ investment income in 2012 was driven by a drop in the yield on insurers’ cash and invested assets,” said Gordon. “The average yield on ten-year Treasury notes fell from 2.8 percent in 2011 to a record-low 1.8 percent last year. And as market interest rates dropped, the yield on insurers’ average cash and invested assets receded from 3.8 percent in 2011 to 3.6 percent in 2012. Conversely, insurers’ average holdings of cash and invested assets – the funds on which insurers earn investment income – rose 1.9 percent from 2011 to 2012.”

Combining the $6.2 billion in realized capital gains in 2012 with $18.8 billion in unrealized capital gains during the same period, insurers posted $25 billion in overall capital gains for 2012 – up $22.4 billion from the $2.6 billion in overall capital gains for 2011. Since the start of ISO’s data in 1959, insurers’ total capital gains have ranged from as high as $39.8 billion in 1997 to as low as negative $72.7 billion in 2008 during the financial crisis.

“Insurers’ overall capital gains for 2012 reflect developments in financial markets. The Dow Jones Industrial Average increased 7.3 percent in 2012 as the New York Stock Exchange Composite rose 12.9 percent, the S&P 500 rose 13.4 percent, and the NASDAQ Composite climbed 15.9 percent,” said Murray. “With the financial crisis and Great Recession fading into history, insurers’ realized capital losses on impaired investments dropped from $16.1 billion in 2009 to $5.9 billion in 2010 to $4 billion in 2011 and $3.1 billion in 2012. Prospectively, the Dow, the NYSE Composite, the S&P 500, and the NASDAQ Composite all rose in first-quarter 2013, meaning we have good reason to believe insurers will post additional capital gains when reporting their results for the period. Beyond that, any forecast for capital gains is only as good as the underlying forecast for stock prices.”

Pretax Operating Income

Pretax operating income – the sum of net gains or losses on underwriting, net investment income, and miscellaneous other income – jumped $17.9 billion to $33.3 billion for 2012 from $15.4 billion for 2011. The $17.9 billion increase in operating income reflects the $19.6 billion decrease in losses on underwriting, with that development partially offset by the $1.5 billion decline in net investment income and the $0.2 billion drop in miscellaneous other income.

M&FG insurers’ operating income improved to negative $1.6 billion in 2012 from negative $6.6 billion in 2011. Excluding M&FG insurers, the insurance industry’s operating income climbed $13 billion to $35 billion for 2012 from $22 billion for 2011.

Net Income after Taxes

Combining operating income, realized capital gains (losses), and federal and foreign income taxes, the insurance industry’s net income after taxes increased $14.1 billion to $33.5 billion for 2012 from $19.5 billion for 2011. The increase in net income was the net result of the $17.9 billion increase in operating income, the $0.8 billion decrease in realized capital gains, and the $3 billion increase in federal and foreign income taxes.

M&FG insurers’ net income after taxes rose to negative $1.1 billion for 2012 from negative $6 billion for 2011. Excluding M&FG insurers, the insurance industry’s net income after taxes grew $9.3 billion to $34.7 billion for the 12 months ending December 31, 2012, from $25.4 billion for the 12 months ending December 31, 2011.

Policyholders’ Surplus

Policyholders’ surplus climbed $33.1 billion to a record-high $586.9 billion as of December 31, 2012, from $553.8 billion at year-end 2011. Additions to surplus in 2012 included insurers’ $33.5 billion in net income after taxes, $18.8 billion in unrealized capital gains on investments (not included in net income), $4.4 billion in new funds paid in, and $0.2 billion in miscellaneous other additions to surplus. Those additions were partially offset by $23.7 billion in dividends to shareholders.

Insurers’ $18.8 billion in unrealized capital gains on investments in 2012 constituted a $23.2 billion positive swing from their $4.4 billion in unrealized capital losses in 2011.

New funds paid in rose to $4.4 billion in 2012 from $2.3 billion in 2011.

Miscellaneous additions to surplus fell to $0.2 billion in 2012 from $3.1 billion in 2011.

Dividends to shareholders dropped $2.1 billion, or 8.2 percent, to $23.7 billion in 2012 from $25.9 billion in 2011.

M&FG insurers’ surplus rose to $12.4 billion as of December 31, 2012, from $12.3 billion at year-end 2011. Excluding M&FG insurers, industry surplus rose $33 billion to $574.5 billion as of December 31 last year from $541.5 billion as of December 31, 2011.

“As of year-end 2012, the premium-to-surplus ratio was 0.78 – little changed from the 0.79 for 2011 and the record-low 0.76 for 2010, and only about half the 1.46 average premium-to-surplus ratio for the 54 years from the start of ISO’s data in 1959 to 2012. Similarly, the ratio of loss and loss adjustment expense reserves to surplus as of year-end 2012 was 0.99 – far below the 1.40 average LLAE-reserves-to-surplus ratio for the past 54 years,” said Murray. “To the extent that these leverage ratios shed light on the amount of risk supported by each dollar of surplus, insurers are extremely well capitalized at this point. To the extent that these same leverage ratios shed light on insurers’ capacity utilization, the law of supply and demand suggests excess capacity is the reason recent firming in insurance markets has been so modest compared with previous cycles.”

Fourth-Quarter Results

The property/casualty insurance industry’s consolidated net income after taxes fell to $6.4 billion in fourth-quarter 2012, down $4.7 billion from $11.1 billion in fourth-quarter 2011. Property/casualty insurers’ annualized rate of return on average surplus dropped to 4.4 percent in fourth-quarter 2012 from 8.1 percent a year earlier.

M&FG insurers’ annualized rate of return climbed to negative 14.4 percent in fourth-quarter 2012 from negative 62.4 percent in fourth-quarter 2011 as their net income after taxes rose to negative $0.4 billion from negative $1.8 billion. Excluding M&FG insurers, the insurance industry’s annualized rate of return decreased to 4.8 percent in fourth-quarter 2012 from 9.6 percent in fourth-quarter 2011 as net income after taxes fell to $6.8 billion from $12.9 billion.

The $6.4 billion in net income after taxes for the entire insurance industry in fourth-quarter 2012 was a result of $2.7 billion in pretax operating income, $3.3 billion in realized capital gains on investments, and $0.4 billion in federal and foreign income tax recoveries.

The industry’s $2.7 billion in pretax operating income for fourth-quarter 2012 was down $9 billion from $11.7 billion for fourth-quarter 2011. The industry’s fourth-quarter 2012 pretax operating income was the net result of $10 billion in net losses on underwriting, $12.6 billion in net investment income, and $0.2 billion in miscellaneous other income. Excluding M&FG insurers, pretax operating income for fourth-quarter 2012 amounted to $3.2 billion – a $10.6 billion decrease from the $13.8 billion in pretax operating income for fourth-quarter 2011.

For the entire industry, net losses on underwriting grew $8.5 billion to $10 billion in fourth-quarter 2012 from $1.5 billion in fourth-quarter 2011.

ISO estimates that the net LLAE from catastrophes included in private U.S. insurers’ financial results jumped to $15.3 billion in fourth-quarter 2012 from $2.9 billion a year earlier. Those amounts exclude LLAE that emerged after insurers closed their books for each period but do include late-emerging LLAE from events in prior periods.

Excluding loss adjustment expenses, direct insured losses from catastrophes striking the United States in fourth-quarter 2012 totaled $18.8 billion – up $17.9 billion from the $0.9 billion in direct insured losses caused by catastrophes that struck the United States in fourth-quarter 2011, according to ISO’s PCS unit. Superstorm Sandy was the only event in fourth-quarter 2012 officially designated a catastrophe by PCS.

Fourth-quarter 2012 net losses on underwriting amounted to 8.8 percent of the $114.2 billion in premiums earned during the period, whereas fourth-quarter 2011 net losses on underwriting amounted to 1.4 percent of the $110.3 billion in premiums earned during that period. Fourth-quarter net losses on underwriting last exceeded 8.8 percent of premiums earned in 2002, when net losses on underwriting amounted to 14 percent of fourth-quarter premiums earned.

The industry’s combined ratio deteriorated to 110.4 percent in fourth-quarter 2012 from 103.3 percent in fourth-quarter 2011. At 110.4 percent, the combined ratio for fourth-quarter 2012 was the highest fourth-quarter combined ratio since the 114.2 percent combined ratio for fourth-quarter 2002. Since the start of ISO’s quarterly data in 1986, the fourth-quarter combined ratio has averaged 107.3 percent but has ranged from as high as 123.3 percent in 1992 to as low as 95 percent in 2006.

The $10 billion in net losses on underwriting in fourth-quarter 2012 was after deducting $1 billion in premiums returned to policyholders as dividends, with dividends to policyholders up $0.2 billion from $0.8 billion in fourth-quarter 2011.

Net written premiums rose $4.9 billion, or 4.8 percent, to $108.1 billion in fourth-quarter 2012 from $103.2 billion in fourth-quarter 2011, with fourth-quarter net written premiums growing at their fastest rate since 2004, when written premiums grew 5.4 percent.

Net earned premiums grew $3.9 billion, or 3.6 percent, to $114.2 billion in fourth-quarter 2012 from $110.3 billion in fourth-quarter 2011. Net earned premiums also rose 3.6 percent in fourth-quarter 2011, with fourth-quarter earned premiums rising at their fastest pace since 2004, when earned premiums rose 6.9 percent.

LLAE jumped 13.4 percent to $91.2 billion in the last quarter of 2012 from $80.5 billion in the last quarter of 2011. At 13.4 percent, fourth-quarter LLAE growth had risen to its highest level since the 19 percent for fourth-quarter 1992.

Excluding M&FG insurers, net written premiums rose 4.8 percent in fourth-quarter 2012, net earned premiums rose 3.5 percent, LLAE rose 15.2 percent, and the combined ratio rose to 109.8 percent from 101 percent in fourth-quarter 2011.

“Insurers’ results for fourth-quarter 2012 were severely affected by Superstorm Sandy,” said Gordon. “If catastrophe losses in fourth-quarter 2012 had been the same as they were in fourth-quarter 2011, insurers would have posted $2.4 billion in net gains on underwriting, instead of $10 billion in net losses. Similarly, the combined ratio would have improved to 99.5 percent in fourth-quarter 2012, instead of deteriorating to 110.4 percent. Nonetheless, there were some positives in insurers’ results for fourth-quarter 2012. Excluding catastrophes, net LLAE declined 2.1 percent to $75.9 billion in fourth-quarter 2012 from $77.6 billion in fourth-quarter 2011. Moreover, the insurance industry achieved its eleventh successive quarter of growth in written premiums, following 12 quarters of declines.”

The $12.6 billion in net investment income in fourth-quarter 2012 was up 0.3 percent compared with $12.5 billion in fourth-quarter 2011.

Miscellaneous other income dropped $0.5 billion to $0.2 billion in fourth-quarter 2012 from $0.7 billion in fourth-quarter 2011.

Realized capital gains on investments rose to $3.3 billion in fourth-quarter 2012 from $1.5 billion in fourth-quarter 2011.

Combining net investment income and realized capital gains, net investment gains grew $1.8 billion, or 12.6 percent, to $15.8 billion in fourth-quarter 2012 from $14.1 billion a year earlier.

Insurers posted $1.6 billion in unrealized capital gains on investments in fourth-quarter 2012 – down $6.7 billion from insurers’ $8.3 billion in unrealized capital gains in fourth-quarter 2011. Combining realized and unrealized amounts, the insurance industry posted $4.8 billion in overall capital gains in fourth-quarter 2012 – down $5 billion from the $9.8 billion in overall capital gains on investments in fourth-quarter 2011.

The $4.8 billion in overall capital gains for fourth-quarter 2012 is net of $0.6 billion in realized write-downs on impaired investments, with realized write-downs on impaired securities dropping from $1.5 billion in fourth-quarter 2011.

Source: ISO/PCI