2009 - First Quarter Results

The property/casualty (P/C) insurance industry reported an annualized statutory rate of return on average surplus of negative 1.2 percent during the first quarter of 2009, down from positive 6.6 percent during the first quarter of 2008 and positive 0.5 percent for all of 2008.  The industry’s profitability was dragged into negative territory during the first three months of the year by a continuation during the quarter of 2008’s broad, rapid and steep deterioration in financial markets which last year contributed to a 96.2 percent plunge in property/casualty insurance industry profits and a 12 percent decrease in capacity (policyholder surplus).  Surplus fell an additional 4.2 percent ($19 billion) during the first quarter from year-end 2008.  Secondary factors contributing to the quarter’s poor results include the profit and premium-sapping impact of a soft market that has now entered its fifth year as well as a significant reduction in demand for insurance driven by a deepening global recession.  The weak pricing environment and the sharpest contraction in the economy since 1982 sent net written premiums tumbling by 3.6 percent.  Although the industry’s capitalization remains strong by historical standards, the 16.2 percent ($84.7 billion) erosion in policyholder surplus since the beginning of the crisis affirms the need to quickly improve underwriting performance in order to generate risk appropriate rates of return sufficient to attract and retain capital in the industry.  The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).

The Financial Crisis: A “Perfect Storm” Thunders into 2009

Sources of Decline in Profitability

Insurers have two sources of income: premiums and investment earnings.  All else being equal, if one source declines and is not offset by an increase in the other, profits and profitability will slide.  Both were under assault during the first quarter.  On occasions when both decline significantly, the bottom line is usually hit hard, as it was during the first quarter with net income (profits) suffering a net swing of $9.8 billion from positive $8.5 billion in first quarter 2008 to negative $1.3 billion this year (yielding a -1.2 percent return on average net worth).

The first quarter is best characterized as an extension of the “perfect storm” of 2008 when net income plunged 96.2 percent from $62.5 billion in 2007 to just $2.4 billion in 2008.  At the same time, growing weakness in premiums written reveals not only the strain of a five-year long soft market but also the fact that demand for insurance is finally beginning to succumb to the long, deep recession, which was 16 months old by the end of the quarter.  Net written premiums during the quarter fell 3.6 percent ($4.0 billion), following declines of 1.4 percent and 1.0 percent in 2008 and 2007, respectively.

Investment Performance: The Principal Cause of Decline in 2009: Q1 Profits and Capacity

The economic crisis has so far affected P/C insurer profitability primarily through reduced investment earnings—one of only two sources of revenue for insurers (the other being premium income).  Insurers are among the largest institutional investors in the world, with P/C insurers managing assets totaling some $1.2 trillion as of year-end 2008.  Earnings on investments fall into several categories, the largest being investment income (primarily interest generated from bond holdings and dividends from stocks).  Capital gains are the second most important source of investment earnings.  Both were down significantly during the first quarter of 2009.  Given the 11.7 percent drop in the Standard & Poor’s (S&P) 500 Index during the first quarter (coming on the heels of a 38.5 percent plunge during calendar year 2008), it is no surprise that the opportunity to realize net capital gains on stock holdings has effectively vanished.  As noted by ISO and PCI, realized capital gains were nonexistent in the first quarter—with the industry instead turning in a record first-quarter realized capital loss of $8.0 billion, compared with a comparatively small $412 million loss during the same quarter in 2008.  For all of 2008, the P/C insurance industry recorded a $19.8 billion realized loss on investments.  The $27.8 billion in realized capital losses since the beginning of 2008 is by far the largest in the industry’s history, dwarfing the $1.2 billion loss in 2002 in the wake of the tech bubble collapse and the market crash following the September 11, 2001 terrorist attack.

There are several reasons to believe that the worst might be behind the industry in terms of realized investment losses.  First, major stock market indices are well off their March 2009 lows.  The S&P 500 Index, for example, was up 35.8 percent through June 26 from its March 9 low (and up 1.7 percent for the year), leading the markets to their first positive quarter since the third quarter of 2007. Moreover, any future plunge in stock markets or loss of value in troubled credit instruments will have a much more muted impact on investment earnings because insurer portfolios have been substantially “derisked” over the past two years.  That is because plunging share prices since late 2007 have reduced equity exposure.  The share of the industry’s portfolio invested in common stock shrank from 17.7 percent at year-end 2007 to approximately 14.9 percent as of year-end 2008.  In addition, insurers have shifted assets into more conservative investments including US Treasury securities and cash.

Declining stock prices were not the only reason for the plunge in realized capital gains.  Beyond the market swoon is the fact that insurers had to write off or write down billions of dollars in assets.  Assets in this case include not only stocks but credit instruments such as bonds and collateralized debt obligations that have lost value.  Barring another catastrophic deterioration in the financial markets, the magnitude of write downs on credit instruments should begin to diminish.  In some cases, insurers may be able to take favorable “marks” (record increases in value) on some securities.

Interest rates on the safest of assets plunged in late 2008 and remained low during the first quarter, reducing the ability to generate investment income in the future.  The Federal Reserve had cut its key federal funds rate on multiple occasions last year.  At the beginning of 2008, the federal funds rate was 4.25 percent.  On December 16, 2008 the Fed cut rates below 1.00 percent for the first time ever, targeting a range between zero and 0.25 percent, where they remained throughout the first (and second) quarter of 2009.  Because the Fed has now lowered the interest rates it controls effectively to zero, it has essentially reached the limits of what it can do to stimulate the economy by reducing borrowing costs, the traditional anti-recessionary policy prescription administered by the Fed for decades.  The Fed has not been rendered impotent, however.  Chairman Bernanke has engaged the Fed in a strategy known as “quantitative easing,” which means that it is purchasing agency debt (such as debt issued by Fannie Mae and Freddie Mac) as well as longer-dated Treasury securities.  Both efforts had the effect of pushing down longer-term interest rates during the first quarter in an effort to stimulate mortgage lending and capital investment, thereby adding to the economic stimulus of traditional interest rate policy.  By late in the first quarter of 2009 there was clear evidence that the Fed’s new strategy was meeting with at least some success. 

Lower interest rates are an important consideration for insurers.  As large as the realized capital losses are, capital gains (losses) generally constitute a smaller proportion of investment earnings than investment income, which decreased by 8.7 percent ($1.1 billion) during the first quarter.  The decline continues a trend that began in 2008 when investment income fell 7 percent to $51.2 billion from $55.1 billion in 2007.  Although net investment income—at $11.7 billion during the first quarter—remains a substantial source of earnings—it is no longer sufficient to propel the industry to a profit in light of rising realized capital losses and continued losses from underwriting.  The decline in investment income during the first quarter is largely attributable to lower interest rates as well as lower cash flows.

Stock Dividends: The Most Recent Casualty of the Financial Crisis

One often overlooked component of investment income that is also taking a nosedive is stock dividends.  Many dividend paying blue chip companies reported poor earnings in 2008 and expect to do the same in 2009.  Consequently, a record 367 companies announced dividend cuts during the first quarter of this year, according to Standard & Poor’s.  It was the first time that dividend cuts outpaced dividend increases since the S&P began tracking dividend payouts in 1955.  Altogether, the S&P said that dividend payouts during the first quarter fell by $77 billion.  Because insurers are among the largest institutional investors in the United States, the loss of so much dividend income will have a meaningful impact on investment earnings on an industrywide basis (though the effects will vary from insurer to insurer).  Among those recently cutting dividends: General Electric (down 68 percent), J.P. Morgan Chase (down 87 percent), Pfizer (down 50 percent) and Harley Davidson (down 70 percent).  Standard and Poor’s predicted in February that dividends paid by S&P 500 companies would fall 22.6 percent in 2009, second only to 1938 when dividends plunged 36.3 percent.

What Do Reduced Investment Earnings Mean for P/C Insurers?

The combination of low interest rates, depressed asset prices and smaller dividends means that P/C insurers are earning less from their investment portfolios than in the past. The implications are both profound and immediate because there can be no guarantee of a reversal in these trends.  The only guarantee is that insurers will continue to face losses from claims that are as large or larger than in the past.  The bottom line, therefore, is that insurers will need to earn more in premium through higher rates to compensate for lower investment earnings.  All else equal, robust investment returns allow insurers to charge less than they would otherwise need to charge.  Investment earnings are factored into rate need expectations.  Buyers of insurance and regulators will need to accept the fact that insurers will need to charge higher rates in order to meet expected losses that are little changed despite the recession and depressed investment environment.  A major hurricane striking the coast of Florida during the 2009 hurricane season would cost no less and probably more than the same storm before the crisis.  In the future, more of those losses will necessarily be paid through premiums and less from investment earnings. 

Underwriting Performance:  The Secondary Cause of Decline in 2008 Profits and Capacity

Profits and profitability were also negatively impacted by a substantial deterioration in underwriting performance, driven first and foremost by continued cyclical deterioration as soft market conditions ground into their fifth consecutive year.  Notably, however, the weakness in pricing that gave rise to the underwriting losses derives primarily from commercial lines. One of the few breaks insurers caught during the quarter came from notably lower catastrophe losses, which fell by 17.1 percent to $2.9 billion from $3.5 billion in the year earlier period, according to ISO’s PCS unit (details below).  The combination of a cyclical deterioration in underwriting performance and severe stress in the mortgage and financial guaranty segments pushed the first quarter’s combined ratio up to 102.2 compared to 99.9 during the same quarter in 2008 and 105.1 for all of last year.

Mortgage and Financial Guaranty Insurers Distort Results

It is important to bear in mind that the 2008 results are somewhat skewed by the disastrous performance of many mortgage and financial guaranty insurers.  This segment accounts for just 2 percent of industry premiums written but ran a combined ratio of 299.6 percent during the first quarter—up from the already poor 268.2 combined ratio recorded in the first quarter of 2008.  According to ISO, exclusion of the mortgage and financial guaranty segment knocks 3.8 points off the combined ratio, leaving it at 98.4 during the first quarter, compared with 96.8 during the first quarter of 2008. Because the mortgage and financial guaranty segment so profoundly distorted the first quarter 2009 underwriting results, the combined ratio of 98.4 (rather than 102.2) is probably the best to use for comparative purposes as most insurers are not involved in this specialized business.  ISO also reports that the exclusion of mortgage and financial guaranty insurers raises the industry’s rate of return to +2.2 percent, compared with -1.2 percent when this segment is included.

Catastrophe Losses: A Bit of a Respite

As noted by ISO, insured catastrophe losses totaled $2.9 billion during the first quarter of 2009, down $600 million or 17.1 percent from $3.5 billion in the first quarter of 2008.  Lower catastrophe losses represent one of the few bright spots in the first quarter results, especially after last year’s $26.0 billion in losses which secured 2008’s place as the fourth-most expensive year ever for catastrophe losses (behind 2005, 2004 and 2001).  Catastrophe losses have remained tame during the second quarter of 2009 as well.  Looking ahead, it is the third quarter that causes insurers the most concern, with the peak of hurricane season occurring in September.  Fortunately, forecasters expect the 2009 hurricane activity to be only average or even below average compared to historical norms.

Premium Growth Declines Accelerate as Insurance Demand Succumbs to Deep Recession

Net written premiums declined by 3.6 percent during the first quarter of 2009, the biggest drop in first quarter premium since ISO began recording quarterly changes in premium, breaking the previous record decline of 0.8 percent in 2008.  Excluding mortgage and financial guaranty insurers produced a net decline of 3.1 percent.  If negative premium growth is sustained through the end of 2009, it would mark the first three-year sequential decline in premiums written since the Great Depression, when industry premiums fell for four consecutive years (1930 through 1933, inclusive) after peaking in 1929.  Premiums were held back in part by continued soft market conditions, primarily in commercial lines, which entered its fifth consecutive year in 2009. 

By late in 2008 and early 2009, the magnitude of rate decreases in most key commercial lines had begun to diminish, but remained in negative territory.  Personal lines (auto and home) were seeing small increases on net.  Nevertheless, whatever modest gains the industry earned from higher rates were more than offset by economic weakness cutting into the demand for most types of insurance.  The weak economy is having a disproportionately large impact on commercial insurers due to rising unemployment (slicing payrolls and eroding the exposure base for workers compensation premiums) and reduced construction and manufacturing activity.

While negative premium growth since 2007 primarily reflects soft market (pricing) conditions, the recent acceleration in the decline clearly reflects the corrosive effect of the recession on exposure growth and the demand for insurance.  During the first quarter of 2009, the economy shrank by 5.5 percent following a 6.3 percent drop in the fourth quarter of 2008—the most severe plunge since the first quarter of 1982.  The economic slowdown is taking its toll in a variety of ways in 2009:

  • New Housing Starts: Estimated to drop to 550,000 units in 2009, down 73 percent from 2.07 million units in 2005.  The drop affects home insurers and insurers with books of business serving the construction, contracting and home supply industries.
  • New Car/Light Truck Sales: Expected to drop to 10.0 million vehicles in 2009, down 41 percent from 16.9 million vehicles in 2005;
  • Employment: The average unemployment rate during the first quarter of 2009 was 8.1 percent, up from 4.9 percent a year earlier.  By May the unemployment rate had reached 9.4 percent, the highest reading since August 1983.  Increases in unemployment sap payrolls, the exposure base for workers compensation.
  • Industrial Production and Capacity Utilization: Industrial production slumped 19.2 percent during the first quarter of 2009 while just 70.4 percent of industrial capacity was utilized.  Weakness in both of these metrics indicates less demand for insurance needed in the production process as well on the goods produced.

The Obama Economic Stimulus Plan: Modest Impact on P/C Insurance Premiums Written

As 2008 came to an end, the United States and most major world economies (with the sole exceptions of China and Brazil) were sinking deeper into recession.  To counter the effects of economic weakness—especially rising unemployment—most of these countries (including China) in early 2009 announced economic stimulus programs designed to ease the economic suffering of their citizens.  The combined spending associated with these program totals was approximately $2.75 trillion as of March 31, 2009.  In the United States, President Barack Obama successfully pushed through a $787 billion stimulus program with the stated objective of creating or preserving 3.5 million jobs.  However, because only about 25 percent of the package is allocated toward “traditional” stimulus spending on infrastructure (the remainder going to tax cuts, aid to states, etc.) the impact on the demand for insurance will be muted.  The Insurance Information Institute estimates that the U.S. stimulus package is unlikely to increase property/casualty insurance premiums written by more than 1 percent or about $4.3 billion by year-end 2010.  Nevertheless, there will be some modest benefit that accrues to the industry and to commercial insurers in particular.  Workers compensation is the line most likely to benefit from stimulus spending, again because the stated objective of the program is to create or preserve 3.5 million jobs.  Other lines that will likely benefit include commercial auto, commercial property and liability, inland marine, commercial auto and surety.  Existing P/C insurers will have no problem meeting any and all additional demand for insurance from the stimulus package.

Is Inflation a Concern for the P/C Insurance Industry?

There is mounting concern that the Obama Administration’s $787 billion stimulus package combined with the hundreds of billions of dollars the Federal Reserve has pumped into the financial system could ignite inflation.  The theory at work here is that with government ramping up spending to such an extraordinary degree that there is simply “too much money chasing too few goods” hence driving up prices as the money is spent.  Indeed, the Congressional Budget Office estimates that the US budget deficit will soar to $1.8 trillion this year, equivalent to 13 percent of gross domestic product (GDP)—the federal government’s highest share of economic activity since World War II.

Were government spending to cause sustained or accelerating inflation it could quickly become problematic for property/casualty insurers for the following reasons:

Five Key Risks from Sustained/Accelerating Inflation

  1. Rising Claim Severities: Inflation increases claims settlement costs, initially for property and eventually for liability coverages;
  2. Rate Inadequacy: Unanticipated inflation would render actuarial projections of rate need inadequate.  Specifically, because actuarial projections of severity embed historical trend (inflation) assumptions, rates based on those assumptions will be deficient;
  3. Adverse Reserve Development/Reserve Inadequacy: Reserves established to meet the obligations of past claims could prove to be inadequate if inflation pushes the cost of those claims up farther and/or faster than expected;
  4. Retention Burn-Through: Inflation will push the cost of claims settlement upwards, including costs below a policyholder’s retention (deductible).  Because claims costs will exceed deductibles more quickly, insurers could see increased claim frequency in addition to increased claim severity;
  5. Reinsurance Penetration/Exhaustion: Higher claim costs would cause primary insurers to burn through their retentions more quickly, tapping into their reinsurance more quickly (and more frequently) and potentially exhausting their reinsurance program limits. 

Inflation would clearly pose a variety of operational challenges for P/C insurers.  The question remains, however, as to how much of a threat inflation actually is going forward.  The most recent forecast from Blue Chip Economic Indicators puts inflation in 2009 at negative 0.6 percent (implying deflation in 2009, largely due to lower energy and commodity prices relative to 2008) and positive 1.8 percent in 2010. Also keeping inflation in check is the weakened state of the economy.  There is ample slack to absorb the stimulus spending and any additional lending that might result from cash pumped into the banking system. There is certainly plenty of available labor.  The unemployment stood at 9.4 percent in May 2009 and is expected to crest at about 10 percent later this year and into 2010.  At the same time, industrial output plunged nearly 20 percent during the first quarter, suggesting significant unused capacity at American factories.  It is true that  yields on longer-term Treasury securities have risen in recent months, potentially indicating concern about inflation further down the road, but those increases also reflect the return of risk appetite to the credit markets, causing the price of Treasurys to fall (and the yield to rise) as investors seek higher returns elsewhere.  Nevertheless, P/C insurers need to at least consider the possibility of higher inflation going forward (beyond 2010) and must begin to plan accordingly in terms of rates, reserving and reinsurance.

Industry Experience in 2008: No Comparison to the Great Depression

As mentioned previously, net written premium growth remained negative in 2009’s first quarter, falling by 3.6 percent following declines of 1.4 percent and 1.0 in calendar years 2008 and 2007, respectively—the first consecutive three-year period of negative premium growth since 1930 to 1933 during the Great Depression.  During the Great Depression, however, estimates from the Insurance Information Institute indicate that premiums written fell by a staggering 35 percent over a four-year span from their 1929 peak through their 1933 trough.  Policyholders’ surplus, a measure of capacity, decreased by 12 percent in 2008, the first decline since 2002, and fell an additional 4.2 percent during the first quarter of 2009.  Yet during the Great Depression policyholders’ surplus fell by an estimated 37 percent.  Invested assets also took a modest hit in 2008 but plunged an estimated 28 percent during the Great Depression.  The bottom line is that the impact of the current financial crisis on P/C insurance, as bad as it is, is not even remotely close to the impacts experienced during the Great Depression.  Indeed, premiums, surplus and assets will likely return to their pre-crisis levels within a few years.  It took 10 to 12 years (i.e., until 1939, 1940 or 1941) for these same financials to recover in the wake of the Depression.

Impacts of the Economic Crisis on P/C Insurer Policyholders’ Surplus (Capacity/Capital)

Property/casualty insurance is a highly cyclical business.  Because the industry’s peak profits in the most recent cycle were achieved in 2006 and 2007, insurers entered the credit crisis and recession from a position of financial strength.  Insurers routinely plow back most of their earnings into the business in order to build up their capital positions.  The expanded capital cushion not only provides insurers with the necessary resources to pay large-scale catastrophe losses such as Hurricane Katrina ($41.1 billion) or the September 11 terrorist attacks ($32.5 billion), but also helps insurers ride out stock market crashes, credit market turmoil, recessions, inflations and every other sort of economic and financial market disruption. 

That being said, no investor will emerge from the current economic crisis unscathed and in the end there will be a significant impact on insurance industry capacity.  As noted by ISO and PCI, industry policyholders’ surplus (the industry’s primary measure of capacity—akin to net worth in other industries) fell by $19 billion or 4.2 percent to $437.1 billion from $456.1 billion at year-end 2008.  In 2008, surplus fell by a record $62.3 billion, or 12.0 percent.  The first quarter’s decline is the sixth-consecutive quarterly drop in policyholders’ surplus, which peaked a year earlier at $521.8 billion during the third quarter of 2007.  The net $84.7 billion decline in surplus represents a reduction of 16.2 percent in the industry’s capital base.  In contrast, surplus increased by 6.2 percent in 2007, 14.3 percent in 2006, 8.2 percent in 2005, 13.4 percent in 2004 and 21.6 percent in 2003, following declines in 2000, 2001 and 2002.  The return to negative capital accumulation is attributable to several factors, the largest and most obvious being declining prices for financial assets.  From the start of 2008 through the first quarter of 2009, P/C insurers have recorded unrealized capital losses totaling $69.3 billion in addition to $27.8 billion in realized capital losses and $23.7 billion in underwriting losses. The reduction in capital has led many (though not all) insurers to scale back, suspend or discontinue the return of capital to shareholders through share buybacks.  Share buybacks reached a record $23.2 billion in 2007.

The diminution of capital, combined with reduced investment earnings, implies that insurers will need to be very disciplined in their underwriting if they hope to earn risk appropriate rates of return. In effect, this involves a return to the way property/casualty insurance companies were managed for many decades before the era of high interest rates began in the mid-1970s.  Prior to that time insurers managed their operations with the intent of earning underwriting profits every year and were generally successful at doing so in most.  Investment earnings were considered helpful but were certainly not viewed as a reliable source of significant earnings.

Despite the erosion of capital, the property/casualty insurance industry ended the first quarter well capitalized by historical standards.  According to ISO and PCS, the ratio of 12-month premiums written to available surplus (a simple measure of financial leverage) stood at 0.98 as of March 31.  This means that insurers had $1 in capital (surplus) on hand for every $0.98 in premium written.  This compares to an average ratio of 1.52 during the past 50 years.

Although current levels of capitalization suggest industry strength remains intact, the ability of (re)insurers to raise capital following a “capital event” (e.g., major catastrophe) is something worth considering in light of the global financial crisis which has dramatically reduced access to capital.  In the wake of both the September 11 terrorist attacks in 2001 and hurricanes Katrina, Rita and Wilma in 2005, insurers and reinsurers were able to raise tens of billions of dollars in new funds quickly and relatively easily.  Today, there is far less available capital in the world, and the cost of that available capital is much higher.  This changes the economics of catastrophe risk financing.  Already the cost of reinsurance is rising as demand increases and insurers seek to protect the capital they have on hand.  Fortunately, during the second quarter capital market conditions improved considerably with a wide variety of financial institutions (including insurers) able to raise tens of billion of dollars from investors.

Financial Strength: P/C Insurer Impairments Were Near Record Lows in 2008

Additional evidence of strength and resilience in the property/casualty insurance industry comes from recent data on financial impairments of insurers.  According to A.M. Best, seven P/C insurers became impaired in 2008.  The corresponding impairment rate is 0.23 percent, the second lowest on record—second only to the record low of 0.17 percent set in 2007.  All of the impairments in 2008 were of tiny companies, whose business mix bears little resemblance to that of the industry overall.  Among the impaired insurers were three title insurance companies, a Texas-only auto and home insurer pushed over the edge by Hurricane Ike and a risk retention group established to handle liability risks of a trucking company.


A hostile investment environment and shrinking economy had a significant impact on the financial and underwriting performance of the P/C insurance industry during the first quarter of 2009.  The quarter’s sharp decline in profitability and shrinking capacity was primarily attributable to poor investment market performance, persistent soft market conditions, modest catastrophe losses, and a spillover of the housing and credit bubble collapse into the mortgage and financial guaranty segments of the P/C insurance industry.  Excluding this segment and normalizing catastrophe losses reveals a much more modest decline in profitability, more in keeping with the pace normally associated with cyclical downturns.  While insurers remain cautious about the economy and financial market conditions, there is guarded optimism that both will continue to improve as we move into the second half of 2009.

Fundamentally, the property/casualty insurance industry remains quite strong financially, with capital adequacy ratios remaining high relative to long-term historical averages.

A detailed industry income statement for the first quarter of 2009 follows:



($ Billions)

Net Earned Premiums $105.6
Incurred Losses 78.7
(Including loss adjustment expenses)   
Expenses 29.1
Policyholder Dividends 0.3
Net Underwriting Gain (Loss) -2.5
Investment Income 11.7
Other Items 0.3
Pre-Tax Operating Gain 9.5
Realized Capital Gains (Losses) -8
Pre-Tax Income 1.5
Taxes 2.9
Net After-Tax Income ($1.3)
Surplus (End of Period) $437.1
Combined Ratio 102.2**

*Figures may not add to totals due to rounding. Calculations in text based on unrounded figures.
**Includes mortgage and financial guaranty insurers. Excluding these insurers the combined ratio was 98.4.

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