Property/Casualty Insurers' Full-Year 2007 Net Income and Overall Profitability Dip Due to Slippage in Underwriting Results

January 1, 2011 / 16 min read

JERSEY CITY, N.J., April 9, 2008 — The U.S. property/casualty insurance industry’s net income after taxes slipped 5.8 percent to $61.9 billion in 2007 from $65.8 billion in 2006. The insurance industry’s overall profitability as measured by its rate of return on average policyholders’ surplus dipped to 12.3 percent in 2007 from 14.4 percent in 2006.

Driving the erosion in net income and overall profitability, the property/casualty insurance industry’s net gains on underwriting fell 38.9 percent to $19 billion in 2007 from $31.1 billion the year before. The combined ratio — a key measure of losses and other underwriting expenses per dollar of premium — edged up to 95.6 percent in 2007 from 92.4 percent in 2006, according to ISO and the Property Casualty Insurers Association of America (PCI).

Partially offsetting the decline in net gains on underwriting, insurers’ net investment gains — the sum of net investment income and realized capital gains — climbed 13.9 percent to $63.6 billion in 2007 from $55.8 billion in 2006.

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

Underwriting Results
“Despite the deterioration in underwriting results, the 95.6 percent combined ratio for 2007 is the second best for any year since 1959, when ISO’s annual records begin. Even so, underwriting results weren’t good enough for insurers to achieve the rate of return typically earned by firms in other industries,” said Michael R. Murray, ISO assistant vice president for financial analysis. “With full-year 2007 investment results, financial leverage, and tax rates, ISO estimates that the combined ratio would have had to be more than 2 percentage points better — 93.3 percent — for insurers to have earned the same 13.9 percent long-term average rate of return as the Fortune 500.”

“Moreover, with today’s low interest rates and investment yields, insurers must now post significantly better underwriting results just to be as profitable as they once were,” said Dr. David Sampson, PCI president and chief executive officer. “Insurers’ combined ratio for 2007 was 12.5 percentage points better than their combined ratio for 1986. But even with improved underwriting results, insurers’ rate of return for 2007 was 2.7 percentage points below insurers’ rate of return for 1986.”

The deterioration in underwriting results is the result of weakness in premiums and an increase in loss and loss adjustment expenses. Reflecting escalating competition in insurance markets, net written premiums dropped to $440.8 billion in 2007 from $443.5 billion in 2006, with written premium growth falling to negative 0.6 percent last year from positive 4.2 percent in 2006. Net earned premiums edged up to $439.1 billion last year from $435.5 billion in 2006, but earned premium growth slipped to 0.8 percent in 2007 from 4.3 percent a year earlier.

“Based on data extending back almost five decades, the decline in written premiums in 2007 is the first on record. Despite ongoing problems in some coastal property insurance markets, government data suggests that escalating competition is cutting into premiums,” said Sampson. “All else being equal, one would expect premiums to rise as the economy grows and inflation increases the amount of insurance people need. However, written premiums fell 0.6 percent in 2007, even though the nation’s gross domestic product [GDP] increased 4.9 percent.”

In fourth-quarter 2007, the consumer price index (CPI) for tenants’ and household insurance fell 0.3 percent compared with its level a year earlier, as the CPI for all items increased 4 percent and the CPI for repair of household items climbed 4.2 percent. Though the CPI for motor vehicle insurance did increase 0.3 percent in fourth-quarter 2007, the CPI for motor vehicle repairs rose 3.3 percent, and the CPI for medical care rose 5 percent.

“Escalating competition is also taking a bite out of commercial lines premiums. ISO MarketWatch® data shows that commercial lines premiums on renewals fell 3.4 percent in third-quarter 2007, with the latest reports from agents, brokers, and risk managers all indicating that commercial insurance markets have continued softening since then,” said Murray. “Looking at the bigger picture, ISO’s analysis indicates that insurers’ recent results have led to an increase in the supply of insurance, which is contributing to widespread downward pressure on the price of insurance in competitive markets that is benefitting both consumers and businesses alike.”

“The million- or billion-dollar question at this juncture is whether there has been a fundamental change in the dynamics of insurance cycles that will lead to a soft landing or whether competitive pressures will continue escalating as they have in the past,” said Sampson. “Quite frankly, it is just too soon to tell. One factor suggesting the possibility of a soft landing is that many insurers now have more sophisticated tools and systems, enabling each of them to monitor its own pricing and underwriting more carefully and to make adjustments more quickly. But in the final analysis, people still make all the critical decisions, such as how to set the parameters in decision-making tools.”

Though net written premiums declined, overall net loss and loss adjustment expenses (after reinsurance recoveries) increased $14.8 billion, or 5.2 percent, to $298.6 billion in 2007 from $283.8 billion in 2006. Excluding catastrophe losses, ISO estimates that net loss and loss adjustment expenses increased $19.6 billion, or 7.2 percent, to $291.7 billion in 2007 from $272.1 billion a year earlier.

Overall loss and loss adjustment expenses rose despite a decline in catastrophe losses. According to ISO’s Property Claim Services® (PCS®) unit, catastrophes occurring in 2007 caused $6.7 billion in direct insured losses to property (before reinsurance recoveries), down from the $9.2 billion in direct insured losses to property caused by catastrophes occurring in 2006. Including additional development of losses from the catastrophic hurricanes of 2005, ISO estimates that the net catastrophe losses included in insurers’ financial results fell to $6.9 billion in 2007 from $11.8 billion in 2006.

“Fast Track data compiled by ISO, the PCI, and other statistical agents indicates that continuing increases in claim severity contributed to the growth in overall loss and loss adjustment expenses, at least for the personal lines,” said Murray. “For example, private passenger auto liability bodily injury paid claim severity rose 6 percent in 2007, and homeowners paid claim severity [excluding catastrophe losses] jumped 9.8 percent. But the Fast Track data also shows that, for some lines and coverages, previously favorable frequency trends have become unfavorable. In particular, private passenger auto liability property damage paid claim frequency rose 0.6 percent in 2007, as private passenger auto collision paid claim frequency increased 2.3 percent and homeowners paid claim frequency [excluding catastrophe losses] climbed 3.2 percent.”

The decline in written premiums also contrasts with growth in other underwriting expenses — primarily acquisition expenses, expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes. Other underwriting expenses rose $1.9 billion, or 1.6 percent, to $119 billion in 2007 from $117.1 billion in 2006.

Dividends to policyholders fell $1 billion, or 28.6 percent, to $2.4 billion in 2007 from $3.4 billion in 2006.

The $19 billion net gain on underwriting in 2007 amounts to 4.3 percent of the $439.1 billion in net premiums earned during the period, whereas the $31.1 billion net gain on underwriting in 2006 amounted to 7.1 percent of the $435.5 billion in net premiums earned during that period.

Investment Results
The industry’s net investment income — primarily dividends from stocks and interest on bonds — grew $2.3 billion, or 4.5 percent, to $54.6 billion in 2007 from $52.3 billion in 2006. Realized capital gains on investments (not included in net investment income) almost tripled, rising to $9 billion in 2007 from $3.5 billion in 2006. Combining net investment income and realized capital gains, overall net investment gains climbed 13.9 percent to $63.6 billion in 2007 from $55.8 billion in 2006.

Combining the $9 billion in realized capital gains in 2007 with $0.5 billion in unrealized capital losses during the year, insurers posted $8.4 billion in overall capital gains in 2007 — down $15.7 billion, or 65 percent, from the $24.1 billion in overall capital gains in 2006.

The 4.5 percent increase in property/casualty insurers’ net investment income in 2007 is the result of two partially offsetting developments. Insurers’ average holding of cash and invested assets rose 6.3 percent. But the yield on insurers’ cash and invested assets edged down to 4.4 percent in 2007 from 4.5 percent in 2006, as the average yield on ten-year Treasury notes dropped to 4.63 percent from 4.80 percent.

“Looking forward, we may see slowing in the growth of investment income as softening prices in insurance markets cut into premiums and the cash available to fund new investments,” said Sampson. “In addition, the Federal Reserve has lowered its target for a key benchmark interest rate — the federal funds rate — six times since it started cutting rates on September 18, 2007, with the most recent cut coming on March 18, 2008. Together, the six cuts reduced the federal funds rate from 5.25 percent to 2.25 percent. If continuing problems in subprime credit markets and weakness in the economy lead to further declines in interest rates, lower yields will likely take a bite out of insurers’ investment earnings.”

“The 65 percent decrease in insurers’ total capital gains in 2007 reflects developments in financial markets,” said Murray. “Stock prices as measured by the S&P 500 increased just 3.5 percent in 2007 — down substantially from the 13.6 percent increase in the S&P 500 in 2006. Going forward, the S&P 500 fell 9.9 percent from year-end 2007 through March 31 of this year, and other major stock indexes — such as the New York Stock Exchange, NASDAQ composites, and the Dow Jones Industrial Average — also fell during that period. This suggests insurers’ results for first-quarter 2008 won’t benefit from capital gains on stocks. Beyond this, any forecast for insurers’ capital gains on stocks is only as good as the underlying forecasts 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 — fell 14.1 percent to $72.7 billion in 2007 from $84.6 billion in 2006. The $11.9 billion decline in operating income is the net result of a $12.1 billion decline in net gains on underwriting, a $2.3 billion increase in net investment income, and a $2.2 billion decline in miscellaneous other income to negative $1 billion in 2007 from positive $1.2 billion in 2006. The decline in miscellaneous other income reflects a special transaction in which one U.S. insurer assumed $9.3 billion in liabilities from a foreign entity in exchange for considerations valued at $7.1 billion, some tax benefits, and the opportunity to earn investment income on the funds held to pay down the liabilities.

Net Income after Taxes
The insurance industry’s net income after taxes fell $3.8 billion to $61.9 billion in 2007 from $65.8 billion in 2006, as a $5.4 billion increase in realized capital gains on investments partially offset the $11.9 billion decline in pretax operating income. The industry’s net income after taxes also benefited from a decline in income taxes. Federal and foreign income taxes declined $2.7 billion, or 11.9 percent, to $19.7 billion in 2007 from $22.4 billion in 2006.

Policyholders’ Surplus
Fueled primarily by the industry’s net income, policyholders’ surplus — insurers’ net worth measured according to Statutory Accounting Principles — increased $31.6 billion, or 6.5 percent, to $517.9 billion at year-end 2007 from $486.2 billion at year-end 2006. Other additions to surplus in 2007 included $3.2 billion in new funds paid in (new capital raised by insurers). The additions to surplus last year were partially offset by deductions from surplus, including $0.5 billion in unrealized capital losses on investments (not included in net income), $32 billion in dividends to shareholders, and $0.9 billion in miscellaneous charges against surplus.

The $3.2 billion in new funds paid in during 2007 is down $0.6 billion, or 15.7 percent, from $3.8 billion in 2006.

The $0.5 billion in unrealized capital losses in 2007 contrasts with $20.6 billion in unrealized capital gains in 2006.

The $32 billion in dividends to shareholders in 2007 is up $7.3 billion, or 29.3 percent, from $24.7 billion in 2006.

The $0.9 billion in miscellaneous charges against surplus in 2007 compares with $4.9 billion in miscellaneous charges against surplus in 2006.

“Though insurers’ results slipped in 2007, they remained exceptionally strong. But insurers can’t claim full credit for their results, with insurers and consumers both having benefited from old-fashioned good luck last year,” said Murray. “In 2007, despite dire predictions from all the experts, the U.S. was struck by just one hurricane — Hurricane Humberto — and it caused relatively little damage when it hit. Though we’d all like our run of good luck to continue, there’s no escaping the fact that millions of people live in areas exposed to hurricanes and earthquakes and that, consequently, there are trillions of dollars of property in areas subject to natural catastrophes. With state-of-the-art catastrophe models indicating that we’ll one day face a storm or earthquake that causes twice the damage done by Hurricane Katrina or more, all of us — insurers, regulators, politicians, businesses, and consumers — need to continue working on loss mitigation and risk management.”

Fourth-Quarter Results
The industry’s consolidated net income after taxes for fourth-quarter 2007 amounted to $12.5 billion, down 36.2 percent from the $19.6 billion in net income for fourth-quarter 2006. The industry’s net income for fourth-quarter 2007 consisted of $16 billion in pretax operating income and $0.8 billion in realized capital gains on investments, less $4.3 billion in federal and foreign income taxes.

The industry’s fourth-quarter 2007 pretax operating income of $16 billion was down 29 percent from $22.6 billion in fourth-quarter 2006. Fourth-quarter 2007 operating income consisted of $0.9 billion in net gains on underwriting and $15.1 billion in net investment income.

The $0.9 billion in net gains on underwriting in fourth-quarter 2007 was down 87.1 percent from $6.8 billion in fourth-quarter 2006. The decline in net gains on underwriting reflects weakness in premiums and increases in the cost of providing insurance.

Written premiums fell $2.7 billion to $103.2 billion in fourth-quarter 2007 from $105.9 billion in fourth-quarter 2006, with fourth-quarter written premium growth dropping to negative 2.5 percent in 2007 from positive 1.7 percent in 2006 and a cyclical peak of 15.8 percent in fourth-quarter 2002.

Earned premiums fell $0.5 billion to $109.8 billion in fourth-quarter 2007 from $110.3 billion in fourth-quarter 2006, with fourth-quarter earned premium growth slowing to negative 0.5 percent in 2007 from positive 3 percent in 2006 and a cyclical peak of 13.4 percent in 2002.

Overall loss and loss adjustment expenses climbed $7.5 billion, or 10.5 percent, to $79.1 billion in fourth-quarter 2007 from $71.6 billion in fourth-quarter 2006. Excluding catastrophe losses, loss and loss adjustment expenses rose $7.1 billion, or 10.1 percent, to $77.2 billion in fourth-quarter 2007 from $70.1 billion in fourth-quarter 2006.

Direct insured losses from catastrophes rose to $1.9 billion in fourth-quarter 2007 from $1.5 billion in fourth-quarter 2006, according to ISO’s PCS unit.

Other underwriting expenses dropped $1.1 billion, or 3.6 percent, to $28.6 billion in fourth-quarter 2007 from $29.6 billion in fourth-quarter 2006.

Dividends to policyholders fell $1 billion, or 45.4 percent, to $1.3 billion in the last quarter of 2007 from $2.3 billion in the last quarter of 2006.

Net gains on underwriting dropped to 0.8 percent of the $109.8 billion in premiums earned during fourth-quarter 2007, down from 6.2 percent of the $110.3 billion in premiums earned during fourth-quarter 2006. The industry’s combined ratio deteriorated to 100.9 percent in fourth-quarter 2007 from 95 percent in fourth-quarter 2006. Nonetheless, the industry’s combined ratio for fourth-quarter 2007 was the fourth best for any fourth quarter since 1986, when ISO’s quarterly data begins.

The $15.1 billion of net investment income in fourth-quarter 2007 is up $0.3 billion, or 2.1 percent, compared with investment income in fourth-quarter 2006.

Miscellaneous other income dropped to near zero in fourth-quarter 2007 from $1 billion in fourth-quarter 2006.

The $0.8 billion in realized capital gains in fourth-quarter 2007 is down $1.3 billion from $2.1 billion in fourth-quarter 2006.

Combining net investment income and realized capital gains, the industry posted $15.9 billion in net investment gains in fourth-quarter 2007, down 5.8 percent from $16.9 billion a year earlier.

The $6.8 billion in unrealized capital losses in fourth-quarter 2007 contrasts with $8.6 billion in unrealized capital gains on investments in fourth-quarter 2006. Combining realized capital gains and unrealized capital losses, the insurance industry posted $6 billion in overall capital losses in fourth-quarter 2007 — a $16.6 billion adverse swing from $10.6 billion in overall capital gains in fourth-quarter 2006.

“Versus year-ago levels, net written premiums declined 2.5 percent in fourth-quarter 2007, 0.2 percent in third-quarter 2007, and 0.6 percent in second-quarter 2007, making this the first time in more than 20 years that written premiums have declined for three consecutive quarters,” noted Murray.

“The recent declines in written premiums and the continued softening in insurance markets set the stage for further deterioration in underwriting profitability,” said Sampson. “But the wild card in any forecast for underwriting results is catastrophe losses, and the experts are again predicting an unusually active hurricane season.”

OPERATING RESULTS FOR 2007 and 2006 ($ Millions)

TWELVE MONTHS	2007	2006

NET WRITTEN PREMIUMS	440,815	443,460
NET EARNED PREMIUMS	439,083	435,484
INCURRED LOSS & LOSS ADJUSTMENT EXPENSES	298,626	283,846
STATUTORY UNDERWRITING GAINS (LOSSES)	21,454	34,518
POLICYHOLDERS’ DIVIDENDS	2,430	3,403
NET UNDERWRITING GAINS (LOSSES)	19,024	31,115
PRETAX OPERATING INCOME	72,672	84,607
NET INVESTMENT INCOME EARNED	54,641	52,309
NET REALIZED CAPITAL GAINS (LOSSES)	8,971	3,524
NET INVESTMENT GAINS	63,612	55,834
NET INCOME (LOSS) AFTER TAXES	61,940	65,777
SURPLUS (CONSOLIDATED)	517,869	486,231
LOSS & LOSS ADJUSTMENT EXPENSE RESERVES	533,409	513,482
COMBINED RATIO, POST-DIVIDENDS (%)	95.6	92.4

FOURTH QUARTER	2007	2006

NET WRITTEN PREMIUMS	103,244	105,904
NET EARNED PREMIUMS	109,795	110,339
INCURRED LOSS & LOSS ADJUSTMENT EXPENSES	79,070	71,580
STATUTORY UNDERWRITING GAINS (LOSSES)	2,140	9,120
POLICYHOLDERS’ DIVIDENDS	1,262	2,312
NET UNDERWRITING GAINS (LOSSES)	878	6,808
PRETAX OPERATING INCOME	16,033	22,593
NET INVESTMENT INCOME EARNED	15,126	14,816
NET REALIZED CAPITAL GAINS (LOSSES)	768	2,051
NET INVESTMENT GAINS	15,894	16,867
NET INCOME (LOSS) AFTER TAXES	12,541	19,648
SURPLUS (CONSOLIDATED)	517,869	486,231
LOSS & LOSS ADJUSTMENT EXPENSE RESERVES	533,409	513,482
COMBINED RATIO, POST-DIVIDENDS (%)	100.9	95.0

Release: Immediate

Contacts:
Jeffrey Brewer, PCI
847-553-3763

Michael R. Murray, ISO
201-469-2339

Loretta Worters, III
212-346-5500

Property/Casualty Insurers' Full-Year 2007 Net Income and Overall Profitability Dip Due to Slippage in Underwriting Results

OPERATING RESULTS FOR 2007 and 2006 ($ Millions)