2009 - Year End Results

April 15, 2010

The property/casualty (P/C) insurance industry reported an annualized statutory rate of return on average surplus of 5.8 percent in 2009, up sharply from 0.6 percent in 2008. The results provide solid evidence of a substantial and sustained rebound in profitability for P/C insurers in the wake of the financial crisis that began in mid-2007. The magnitude and speed of the turnaround is truly remarkable given the length and depth of the crisis. As recently as the first quarter of 2009 the industry recorded a negative rate of return. Key factors driving 2009’s recovery include vastly improved investment market conditions in the final three quarters of the year, a 61 percent decline in catastrophe losses and significant releases of prior year reserves. It is notable that the recovery occurred despite the fact that 2009 was the sixth consecutive year of declining premiums, which fell 3.7 percent last year, and amid recessionary economic conditions that continued to destroy insurance exposure. The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).

Perhaps the most extraordinary sign of recovery was the industry’s rebound in claims paying capacity (as measured by policyholders’ surplus). Policyholders’ surplus increased by $54.2 billion to $511.5 billion or 11.8 percent during the year, up from $457.3 billion at the end of 2008. The reversal is notable and important. Property/casualty insurance industry capacity had plunged by $84.7 billion or 16.2 percent from the pre-crisis peak of $521.8 billion at the end of the second quarter of 2007 to the crisis trough of $437.1 billion. The bottom line is that P/C insurance industry capacity came within 2 percent of its all time record high just nine months after reaching its crisis low. Given continued favorable market conditions in the first quarter of 2010, it is quite likely that industry capacity reached a new record high, despite lingering difficulties in the overall economy. Indeed, one commonly used measure of capital adequacy—the ratio of net premiums written to surplus—is at its strongest level in modern history.

Why the Industry’s Resilience Should Influence Pending Regulation

The resilience of the property/casualty insurance industry even during times of extreme distress and volatility in the global economy and financial markets truly sets property/casualty insurers and reinsurers apart from the rest of the financial services industry. At its zenith the crisis consumed approximately 16 percent of the industry’s policyholders’ surplus—more than any other “capital” event in history including Hurricane Katrina (13.8 percent) or the September 11 terrorist attacks (10.9 percent). Unlike most banks, insurers and reinsurers continued to operate normally without any disruption to their operation.
From a public policy perspective, the rapid and effectively complete recovery in capacity could not come at a more propitious moment. As Congress considers financial industry reform, which could include the imposition of taxes on large financial firms (including insurers) in order to create a fund to resolve those that fail in the future, P/C insurers have been arguing vociferously that they were not the cause of the crisis and that the industry does not pose a systemic risk to the financial system. No P/C insurer failed because of the financial crisis (compared to more than 200 bank failures to date), no claim went unpaid and no policy was cancelled. Insurers continued to compete vigorously and introduce new products throughout the crisis whereas most banks radically scaled back their operations and product offerings.
The fact that P/C insurers recovered more quickly and completely than virtually any other segment of the financial industry is concrete proof that subjecting insurers to bank-style regulation would constitute a significant policy error, would needlessly raise insurance costs for hundreds of millions of insurance consumers and would unfairly require insurers to subsidize the reckless lending practices and speculative activities of failed banks. Indeed, the subsidy that banks would receive from insurers would contribute to an already significant moral hazard problem, encouraging those institutions to take even greater risks, secure in the knowledge that insurers (among others) would be obliged to bail them out.


Profit Recovery Is Impressive But Incomplete

Net income after taxes (profit) in 2009 totaled $28.3 billion, nearly ten times the $3.0 billion earned in 2008. The profit was earned entirely in the final three quarters of the year, more than offsetting the $1.3 billion loss recorded during the first quarter. As mentioned earlier, the impact was to push the industry’s return on average surplus in 2009 to 5.8 percent, up from 0.6 percent in 2008. Last year’s stock market rally and improved credit market conditions, along with low catastrophe losses, favorable claim cost trends and reserve releases all worked to the benefit of property/casualty insurers and reinsurers in 2009.
It is worth noting that mortgage and financial guaranty insurers, which account for just 2 percent of industry premiums but ran a negative 51.4 percent return on average surplus in 2009, again had a disproportionate impact on industry profitability. Excluding these classes of business (which are written by only a small minority of insurers) provides a truer picture of performance—with the resulting return on average surplus rising to 7.3 percent last year from 4.4 in 2008, according to ISO/PCI.
Still, current profit recovery must be kept in perspective. While net income is once again growing, a 7.3 percent rate of return is inadequate for many insurers. The U.S. property/casualty insurance industry’s equity cost of capital stood at approximately 10.5 percent in 2009. This means that there is about a 3 percent gap between the actual rate of return and the rate of return that investors in the industry expect to earn given the risks they are being asked to assume. Failure to earn the cost of capital over an extended period of time could result in the exit of capital and, more importantly, difficulty in raising capital after a major “capital event.” In dollar terms, insurers are earning far less than they did immediately before the crisis. The industry’s net income exceeded $60 billion in both 2006 and 2007, compared to a combined total of $31.3 billion over the past two years. The accumulated profits in the years immediately prior to the financial crisis helped cushion the impact on P/C insurers. It is abundantly clear today that widespread criticism of insurer profits in those years was misguided.

Top Line Shrinks Even as the Bottom Line Grows: Insurance Exposure and Demand Succumb to the “Great Recession”

Despite the significant improvement of the bottom line, net written premiums tumbled by 3.7 percent in 2009 (3.2 percent excluding mortgage and financial guaranty insurers, according to ISO). The decline represents an acceleration in a trend that began in 2007, when premiums written fell 0.6 percent and then fell again—by 1.3 percent—in 2008.
Last year’s 3.7 percent decline in net written premium growth in 2009 is auspicious in that it marks the first three-year sequential decline in premiums written since the Great Depression, when industry premiums fell for four consecutive years (1930 through 1933) after peaking in 1929, though the declines then were much larger. Premiums in 2009 were held back in part by continued soft market conditions, primarily in commercial lines, which continued to grip the industry for a fifth consecutive year in 2009. The economy was also a major factor (details below). The nation’s real (i.e., inflation adjusted) gross domestic product (GDP) shrank by 2.4 percent in 2009, despite growth in the second half of the year. Even before 2009 began, the economy had already contracted in four of the previous five quarters going all the way back to 2007. Fortunately, the economy is now on a sustained growth trajectory. The odds of a so-called “double-dip” recession have greatly receded in recent months and real GDP growth of between 2.5 and 3.5 percent is expected in 2010 and 2011, according to Blue Chip Economic Indicators.
Softness in commercial insurance pricing remains a persistent problem for insurers. Although the magnitude of price decreases gradually diminished from the 13.8 percent drop recorded in the first quarter of 2008 to a decline of 6.0 percent in the fourth quarter of 2009, that drop was actually larger than the second and third quarter declines of 4.9 percent and 5.8 percent, respectively, according to Council of Insurance Agent and Broker data. Auto insurance premiums were up approximately 4.5 percent in 2009 compared with the same period a year earlier, according to Consumer Price Index data. Home insurance prices were up about 2.5 to 3 percent. 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 has had a disproportionately large impact on commercial insurers due to rising unemployment (slicing payrolls and eroding the exposure base for workers compensation premiums), reduced construction and manufacturing activity, a surge in business bankruptcies and weakness in new business formation and expansions. The latter is in part due to lingering problems in credit markets and at financial institutions servicing small and medium sized businesses. These so-called “middle-market” customers are essential to any recovery in commercial insurance exposure and are core to the operating model of many commercial insurers.
Given continued soft market conditions in most key commercial lines and an economy that while growing has yet to do much to stimulate insurance demand or restore lost exposure, it is quite likely that net premiums written will fall in 2010 as well. A.M. Best estimates that net premiums written will decline by 1.6 percent in 2010.
While negative premium growth since 2007 primarily reflects soft market (pricing) conditions, the acceleration in the decline in 2008 and especially 2009 clearly reflects the corrosive effect of the recession on exposure growth and the demand for insurance. The economic slowdown took a heavy toll in a variety of ways in 2009:
  • New Housing Starts: Fell to 560,000 units in 2009, down 72 percent from 2.07 million units in 2007. The drop affects home insurers and insurers with books of business serving the construction, contracting and home supply industries. 
  • New Car/Light Truck Sales: Fell to 10.3 million vehicles in 2009, down 39 percent from 16.9 million vehicles in 2005. The decline occurred despite the wildly successful “cash for clunkers” program, which sparked the sale of nearly 700,000 vehicles. (Note: the Insurance Information Institute estimated that the program netted auto insurers about $300 million in net new auto premiums).
  • Employment/Underemployment: The average unemployment rate during 2009 was 9.3 percent, up from 5.9 percent in 2008. By October the unemployment rate had reached 10.1 percent, the highest since August 1983. Some 5.5 million jobs were lost in 2009 for a total of 8.4 million since the beginning of the recession in December 2007. Increases in unemployment sap payrolls, the exposure base for workers compensation. Underemployment is also a problem. Many people who would like to work full time are working part time. Adding those individuals to the unemployed plus so-called “discouraged workers” (people who have looked for work so long they have stopped searching) reached 16.3 percent in 2009, up from 10.6 in 2008. In other words, nearly one in six workers was either unemployed or underemployed last year, compared to fewer than one in ten in 2008.
  • Industrial Production and Capacity Utilization: Industrial production increased by 6.4 percent and 6.6 percent during the third and fourth quarters of 2009, respectively, after plunging 19.0 percent and 10.4 percent during the first and second quarters of the year, respectively. Just 69.9 percent of industrial capacity was utilized during the third quarter, according to the Federal Reserve, but recent trends are favorable. Capacity utilization rose from 68.3 percent in June to 71.9 percent in December (though still well below the long-run 80.9 percent average from 1972 to 2008). Weakness in both of these metrics indicates less demand for insurance needed in the production process as well on the goods produced. Nevertheless, continued improvements in these figures should help to increase demand for many types of insurance. 

Investment Performance: Significant Improvement, But Still a Drag on Profits

The financial crisis continues to affect P/C insurer profitability primarily through reduced investment earnings—one of only two sources of revenue for insurers (the other being premiums). Insurers are among the largest institutional investors in the world, with P/C insurers managing assets totaling nearly $1.3 trillion as of year-end 2009. 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. Net investment income fell 4.7 percent or $4.5 billion to $47.0 billion during in 2009 compared with $51.5 billion in 2008. Despite the recovery in the markets since their March 2009 lows (the S&P 500 index was up 23.5 percent in 2009), net realized capital losses remained very large for the year and were a significant obstacle to further improvements in profitability. That being said, the $8.0 billion in realized capital losses in 2009 was a vast improvement over the record $19.8 billion a year earlier. 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 attacks.
It is worth noting that the industry may have finally turned the corner when it comes to realized capital losses. The industry actually recorded realized capital gains of $1.7 billion in the final quarter of last year after losses in each of the three prior quarters.
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. The recovery in credit markets has allowed insurers 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 through 2009. The Federal Reserve 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 2009 (and where they remain as of this writing).  
Interest rates are also being held down by subdued inflationary expectations. While there has been concern that the Obama administration’s $787 billion economic stimulus program, combined with the Federal Reserve’s ballooning balance sheet would put inflationary pressure on the economy, there remains no inflation on the horizon. The combination of high unemployment, low factory utilization and the bursting of last year’s energy and commodity price bubble means that there is plenty of slack in the system to absorb growth without sparking inflation. One of the best measures of inflationary expectations is interest rates on intermediate and long-dated Treasury securities. In December, the average yield on 10-year U.S. Treasury securities stood at 3.26 percent while the yield on 30-year bonds was 4.49 percent. Neither suggests a great deal of concern on the part of investors about inflation. Moreover, the Federal Reserve is highly cognizant of the risk and is already looking at the timing dimensions for partial withdrawal of its monetary stimulus. It is worth noting, however, that longer-term Treasury yields have been creeping up recently as consensus builds for a more robust economic recovery than was anticipated just a few months ago. The yield on 10-year Treasurys had risen to 3.73 percent in March 2010 while the 30-year bond yield had risen to 4.64 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 as 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 being 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 have 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. Had a major hurricane struck the coast of Florida during the 2009 hurricane season it would have 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.
A concrete way to see that disciplined underwriting and pricing will be important in the years ahead comes from an historical examination of periods of similar underwriting performance relative to profitability. The industry’s 2009 combined ratio of 101.0 resulted in a 5.8 percent return on average surplus. In 2005, the identical (full-year) combined ratio produced a 9.6 percent rate of return. Back in 1979, the industry’s combined ratio was 100.6 while the overall return was 15.9 percent. Given that the underwriting performance in each of these years was virtually identical, what explains the radically different profitability figures? The answer is the investment environment and the prevailing level of interest rates in particular. Lower interest rates, which are becoming embedded in insurer portfolios as higher yield bonds mature and are replaced with lower yielding securities, make it extremely difficult, if not impossible, for most insurers to earn a risk appropriate rate of return without improving their underwriting performance through increased rates, lower claims cost, lower expenses or some combination of the three.

Underwriting Performance and Catastrophe Losses: Discipline, Good Fortune or Both?

Profits during the first half of 2009 were hurt by a modest underwriting loss of $3.1 billion after policyholder dividends on a combined ratio of 101.0. Yet the underwriting performance is much better than the 105.0 recorded in 2008, which was associated with an underwriting loss of $21.2 billion.
Weakness in commercial lines pricing now stands as the greatest challenge to industry underwriting performance. One break that insurers caught in 2009 came from notably lower catastrophe losses, which fell by 61 percent to $10.3 billion from $27.1 billion in the year earlier period, according to ISO’s PCS unit. It is highly unlikely that insurers will experience the same degree of low catastrophe losses in 2010.

Mortgage and Financial Guaranty Insurers Continue to Distort Results

It is important to bear in mind that the 2009 results remain somewhat skewed by the disastrous performance of many mortgage and financial guaranty insurers. This segment accounts for just 2.0 percent of industry premiums written but ran a combined ratio of 192.0 in 2009. As bad as that result is, it is much improved from 297.6 percent result recorded in 2008. According to ISO, exclusion of the mortgage and financial guaranty segment knocks 1.7 points off the combined ratio, leaving it at 99.3 in 2009. Because the mortgage and financial guaranty segment so profoundly distorted the 2009 results, the combined ratio of 99.3 (rather than 101.0) 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 increases the industry’s net income to $34.5 billion in 2009 (from $28.3 billion in 2008) and the associated average return on surplus to 7.3 percent from 5.8 percent in 2009 and 2008, respectively.

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 at the height of the crisis in early 2009 there was a significant impact on insurance industry capacity. Since March the turnaround in stock and bond markets has had a favorable impact on asset prices, bolstering policyholder surplus. As discussed above and noted by ISO and PCI, industry policyholders’ surplus increased by $54.2 billion to $511.5 billion or 11.8 percent in 2009—a notable and important reversal. Property/casualty insurance industry capacity had plunged by an alarming $84.7 billion or 16.2 percent over a span of five quarters from the pre-crisis peak of $521.8 at the end of the second quarter of 2007 through the first quarter of 2009. Industry capacity as of year-end 2009 is now just 2 per below its 2007 peak.


A volatile investment environment and shrinking economy had a significant impact on the financial and underwriting performance of the P/C insurance industry over the past several years. A return to profitability and rising capacity in 2009 are primarily attributable to improved investment market performance. At the same time, persistent soft market conditions and a deep recession severely impacted growth. While insurers remain cautious about the economy and financial market conditions, there is guarded optimism that both will continue to improve as the industry moves into 2010.
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 2009 follows.

Full-Year 2009 Financial Results*

($ Billions)

Net Earned Premiums $419.00
Incurred Losses 306.7
(Including loss adjustment expenses)  
Expenses 113.4
Policyholder Dividends 2
Net Underwriting Gain (Loss) -3.1
Investment Income 47
Other Items 0.8
Pre-Tax Operating Gain 44.7
Realized Capital Gains (Losses) -8
Pre-Tax Income 36.7
Taxes 8.4
Net After-Tax Income $28.30
Surplus (End of Period) $511.50
Combined Ratio 101.0**

*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 99.3.


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