2012 - Year End Results
April 25, 2013
Profitability in the property/casualty insurance industry rebounded sharply in 2012, despite $35 billion in insured losses from catastrophes, the majority of those from superstorm Sandy. The improvement was propelled chiefly by a growth in premiums and a reduction in both private insurer catastrophe and noncatastrophe related loss and loss adjustment expenses. The effect: the industry combined ratio fell to 103.2 in 2012 from 108.1 in 2011 on underwriting losses that shrank by 54 percent to $16.7 billion from $36.2 billion the year before. The industry’s bottom line benefited commensurately as overall net income after taxes (profits) surged by 72.3 percent in 2012 to $33.5 billion from $19.5 billion in 2011, pushing the industry’s return on average surplus up to 5.9 percent for the year, up from 3.5 percent in 2011. Stronger top line growth is also now a consistent and meaningful contributor to improved profitability. Net written premiums were up 4.3 percent in 2012, nearly a full point above the 3.4 percent gain recorded in 2011—the strongest growth so far recorded in the post-crisis era—while also exceeding the 4.0 percent nominal rate of growth in the overall economy last year. Indeed, net written premiums in 2012 expanded at their fastest pace in nearly a decade. Persistently low interest rates, of course, remain a challenge for the industry, with net investment income slipping by $2.3 billion or 4.1 percent in 2012. Overall industry capacity rose to a record $586.9 billion as of December 31, 2012—up $33.1 billion or 6.0 percent from $573.0 billion as of year-end 2011.
The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).
Profitability Improves: Looking Beyond Catastrophe Losses
The focus on property/casualty insurance industry financials over the past few months has been confined almost entirely to Sandy, causing the event to obscure what has otherwise been a broad based improvement in P/C insurance industry performance in 2012. In particular, pricing and exposure trends have been moving in a favorable direction, contributing to the strongest top line growth in years.
As noted earlier, the P/C insurance industry reported an annualized statutory rate of return on average surplus of 5.9 percent during in 2012 (6.2 percent after excluding mortgage and financial guaranty insurers), up from 3.5 percent in 2011 (4.7 percent after excluding mortgage and financial guaranty insurers). A discussion of the key drivers of last year’s performance follows.
Catastrophe Losses and Underwriting Performance: The Top and Bottom Line
Despite one of the worst years on record for catastrophe losses, underwriting losses through in 2012 tumbled by 54 percent to $16.7 billion from $36.2 billion in the year earlier period, providing a big lift to the industry’s bottom line. Normally it is the case that sharply lower underwriting losses are primarily the result of lower catastrophe losses, but not in 2012. Losses associated with tornadoes, tropical systems, derechos, hail and high winds, wildfires, winter storms and other major natural disasters totaled $35.0 billion—the fourth highest year on record on an inflation adjusted basis. Indeed catastrophe losses actually increased from a historically high $33.6 billion 2011. In particular, losses from tornados and winter storms were well below those experienced in 2011, though losses from tropical events were much higher, with insured losses from Sandy hitting $18.8 billion (not including losses insured through the National Flood Insurance Program).
Favorable Reserve Development Continues
In addition to accelerating premium growth, favorable development of prior-year claims reserves totaled $10.2 billion in 2012, down modestly from $11.0 billion in 2011, according to ISO/PCI. Removing the effects of unfavorable reserve development for mortgage and financial guaranty insurers produces a still larger net favorable prior-year development (release of reserves) of $12.1 billion in 2012, down from $14.3 billion in 2011.
Combined Ratio Improves
Higher catastrophe losses notwithstanding, the overall improvement in underwriting in 2012 was material, with the industry’s combined falling to 103.2 compared with 108.1 a year earlier (excluding mortgage and financial guaranty insurers the combined ratios for the same periods were 102.4 and 106.3, respectively).
Premium Growth: Top Line Records its Best Growth Performance in the Post-Recession Era
Also contributing to improved underwriting performance was a notable acceleration in premium growth, which rose 4.3 percent in, nearly a full percentage point above the 3.4 percent year earlier reading. During the fourth quarter itself, net premiums written rose by 4.8 percent, the second highest quarterly gain over the past six years.
There are two principal drivers of growth in the property/casualty insurance industry: exposure growth and rate. Exposure growth—basically an increase the number and/or value of insurable interests (such as property and liability risks)—is being fueled primarily by the rebounding economy. Nominal (current dollar) GDP increased by 4.0 percent in 2012 relative, approximating the 4.3 percent growth in net written premiums during the year.
Not all economic growth, however, leads directly to the formation of insurable exposures. Indeed, historically, the most important determinant in industry growth is rate activity. With auto, home and major commercial lines all trending positively, overall industry growth is poised to outpace overall economic growth once again in 2013.
Improving labor market conditions in 2012 are also critical to top line growth in the P/C insurance industry. Job growth benefits the entire economy, of course, but the associated expansion of payrolls benefits workers compensation insurers in particular. The United States economy added 2.25 million private sector jobs in 2012. Combined with modest increases in the hourly earnings of employees, payrolls expanded by $267 billion over the same period, leading to billions of dollars in new premiums written for workers compensation insurers. Indeed, workers compensation, hit hard during the recession by a soft market and a precipitous drop in payrolls, has within the span of just a few years transformed itself from the fastest contracting major property/casualty line to the fastest growing, with direct premium growth in 2012 up by approximately 10 percent.
Strong growth in the workers compensation line is one reason why growth among carriers writing predominantly commercial lines rose by 5.7 percent in 2012 (up from 4.3 percent in 2011) compared to 3.6 percent for insurers writing predominantly personal lines (up from 2.9 percent a year earlier) and 4.2 percent for those with a more balanced mix of business (up from 2.4 percent a year earlier). Taken as a whole, the P/C insurance industry last year recorded its strongest growth in the post-crisis era.
Investment Performance: Low Interest Rates Have Expected Effect
The industry’s cash and invested assets as of the end of 2012 totaled $1.54 trillion—up 1.9 percent versus year-end 2011.
For the full year 2012, net investment gains were $53.9 billion, compared to $56.2 billion for the full year 2011, a $2.3 billion drop (-4.1 percent). In measuring insurance company income, accounting rules recognize two components as net investment gains: (i) net investment income; and (ii) realized capital gains and losses. Unrealized capital gains and losses are not considered income and affect only surplus on the balance sheet.
Net Investment Income
Net investment income has two components: interest payments from bonds and stock dividends. The industry’s net investment income for the full year 2012 was $47.7 billion, compared to $49.2 billion in the full year 2011 (down 3.0 percent). The vast majority of this income comes from the industry’s bond investments, which are mainly high quality corporate and municipal bonds.
Driven by Federal Reserve actions, prevailing bond yields continued to decline in 2012. Moody’s AAA-rated seasoned bond index yields had, in 2011, drifted down from about 5 percent at the start of 2011 to 3.9 percent at its end, and they ranged between 3.8 percent and 4 percent during most of 2012’s first half. Yields ranged from 3.3 percent to 3.5 percent during most of the third quarter, then rose slightly back to the 3.6 percent to 3.9 percent range. Yields for municipal (state and local) bonds were very similar to U.S. Treasury yields. These yields were generally lower than those of older bonds being rolled over, constraining overall net investment income.
The forces that affected interest rates in 2012 are the same as those that have been at work for the past few years: unused capacity (in both capital resources and high unemployment); slack in the economy and low near-term future expectations for the economy, leading to a reluctance to lend, borrow and invest; and Federal Reserve actions to keep both short-term and longer-term interest rates low, all of which contributed to low inflation expectations.
Moreover, P/C carriers have been adjusting the mix of bond maturities in their portfolios, moving toward shorter terms. For example, at year-end 2007—just before the financial crisis and the “Great Recession”—the percentage of 5- to 10-year bonds was 33.8 percent of invested assets; that percentage shrank steadily so that at year-end 2011 the percentage was 26.8 (7 percentage points lower). In contrast, the percentage in 1- to 5-year bonds rose in that span from 30.0 percent to 41.4 percent. This shortening of maturities of invested bonds contributed to the drop in net investment earnings, which continued through year-end 2012.
The other significant source of net investment income is stock dividends. Contrary to the experience of bond yields, dividends grew strongly. Compared to the same quarter in 2011, net dividends in the first quarter of 2012 rose by 6.0 percent, in the second quarter by 8.8 percent, in the third quarter by 7.5 percent,and in the fourth quarter by 23.2 percent. But stock holdings in general represent roughly only one-sixth of the industry’s invested assets, and not all stock holdings are dividend-paying.
Realized Capital Gains/Losses
Realized capital gains from the full year 2012 were $6.2 billion compared to $7.0 billion for the full year 2011. As in the past, the downtrend in interest rates that constrains investment income pushed asset values of older bonds up, providing opportunities for capital gains on those bonds.
The broad stock market did quite well throughout the first quarter of 2012—the S&P 500 rose 12.00 percent—but it lost 3.29 percent in the second quarter, mostly in May (-6.27 percent). However, it rose by 3.96 percent in June and so ended the first half of 2012 up roughly 6 percent. In the third quarter the S&P 500 rose ended each month higher than the month before—up 1.26 percent in July, 1.98 percent in August, and 2.42 percent in September. October was a down month (-1.98 percent) but November and December were positive (+0.28 percent and 0.71 percent, respectively). Money invested in the broad index throughout the year returned 13.4 percent, providing opportunities for harvesting capital gains.
Policyholders’ Surplus (Capital/Capacity): New Record High Demonstrates Industry Strength and Resilience
Policyholders’ surplus as of December 31, 2012, stood at $586.9 billion, up 6.0 percent from $553.8 as of December 31, 2011. During 2011, policyholders’ surplus actually shrank by 4.6 percent as catastrophes took their toll. The fact that the industry was able to rapidly and fully recoup its losses from 2011 and reach a new record high in terms of capital strength in 2012 despite Sandy is further evidence of the P/C insurance industry’s remarkable resilience in the face of extreme adversity.
The bottom line is that the industry is, and will remain, extremely well capitalized and financially prepared to pay very large scale losses in 2013 and beyond despite the fact that insurers have paid catastrophe losses in each of the past two years that are more than 40 percent higher than the $23.9 billion average over the past decade. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.78, close to its strongest level in modern history.
The property/casualty insurance industry turned in an improved performance in 2012 in underwriting performance and overall return on average surplus (profitability). In addition, policyholders’ surplus reached a new all-time record high. Although profitability surged amid lower underwriting losses and strong prior-year reserve releases, overall investment gains were down, in large part to historically low yields on fixed income securities. Premium growth, while still modest, nevertheless accelerated to its fastest pace in the post-crisis era. It appears likely that the industry’s momentum will continue to build through 2013.
Fundamentally, the P/C insurance industry remains quite strong financially, with capital adequacy ratios remaining high relative to long-term historical averages.
A detailed industry income statement for 2012 follows.
Full-Year 2012 Financial Results*