2011 - First Nine Months Results

The first nine months of 2011 have been remarkably violent in terms of catastrophes on a global scale. Megacastastrophes worldwide caused an estimated $350 billion in economic losses, shattering the previous record of $230 billion set in 2005. Approximately one-third of that total or $108 billion was insured, second only to the $123 billionrecorded in 2005. The Insurance Information Institutes estimates that catastrophe losses around the world shaved 0.5 percent off global gross domestic product (GDP) in 2011. In the United States, ISO’s PCS unit reported that insured catastrophe losses came to $32.6 billion through September 30, implying economic losses far in excess of $75 billion. High catastrophe losses, along with high underwriting losses in key non-catastrophe exposed lines such as workers compensation helped depress the property/casualty (P/C) insurance industry annualized statutory rate of return on average surplus to 1.9 percent during the first nine months of 2011, down from 6.8 percent through the first nine months of 2010 and 6.5 percent for all of last year. Moreover, with underwriting losses already reaching $34.9 billion through nine months, the industry is likely to suffer its second largest annual underwriting loss ever, behind the $52.3 billion underwriting loss in 2001. Profitability receded despite a surprising $2.1 billion, or 5.4 percent, improvement in investment earnings during the first nine months of the year and a respectable 3.1 percent increase in net premiums written, the strongest growth since 2006. Of little surprise is the fact that that capacity in the U.S. P/C insurance industry ended the catastrophe-wracked, bearish third quarter down $26.1 billion, or 4.6 percent, from the record set just six months earlier. Overall net income after taxes (profits) through the first nine months plunged by 70.5 percent to $8.0 billion from $27.1 billion in first nine months of 2010.
In one of the more positive developments for the industry since the end of the financial crisis, premium growth now appears to be on a sustained—and potentially accelerating—upward trajectory, rising for six consecutive quarters. Although growth remains modest at just 3.1 percent during the first nine months (4.1 percent in the third quarter), the very fact that the growth is sustained confirms not only that the era of mass exposure destruction in the property/casualty insurance industry is now over, with demand for insurance having stabilized and, in fact, growing (albeit slowly) in the aftermath of the “Great Recession.” Underwriting losses, however, skyrocketed during the first nine months, with the combined ratio climbing to 108.2, after excluding mortgage and financial guaranty insurers (109.9 including them), compared with 99.7 in the year-earlier period.

The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).


Policyholders’ Surplus (Capital/Capacity): Dented by Catastrophes, Markets

Policyholders’ surplus totaled $538.6 billion as of September 30, 2011, high by historical standards but down 4.6 percent, or $26.1 billion, from the all-time record of $564.7 as of March 31, 2011. The September 30 figure is also 3.3 percent, or $18.3 billion, below the $556.9 billion in surplus at year-end 2010 (itself a record at the time). 


One outstanding question is whether the decline in surplus during the second and third quarters are a transient occurrence, caused chiefly by surging catastrophe losses, or whether it is the beginning of a sequence of declines whereby excess capital is expunged from property/casualty insurer balance sheets as core (non-cat) underwriting losses mount and the ability to release prior-year reserves into the earnings stream diminishes. Historically, the latter has presaged a firming of markets whereas the former would suggest that weak market conditions could potentially linger into and possibly through 2012. Apart from the highest underwriting losses in a decade, surplus was also adversely affected by $13.1 billion in unrealized investment losses through the first nine months of 2011, compared with a $3.4 billion gain in the same period of 2010.
Given imbedded high catastrophe losses and poor overall equity market performance for the year, it is already clear that 2011 will be the first year since 2008 in which the industry posts a decline in capacity on an annual basis.
Despite the recent decline, the $538.6 billion in surplus as of September 30, 2011, exceeds the pre-crisis high of $521.8 billion set during the third quarter of 2007 by 3.2 percent—a difference of $16.8 billion. Irrespective of the prospect of further shrinkage in policyholders’ surplus at year-end 2011 following a first-quarter peak, the bottom line is that the industry is and will remain extremely well capitalized and financially prepared to pay very large scale losses again in 2012, as necessary. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.83, close to its strongest level in modern history.


Profit Recovery: Shifting into Reverse?

Ever since plunging by 96 percent during the height of the global financial crisis, net income after taxes (profit) had been rebounding fairly steadily and robustly as asset prices recovered, underlying claim frequency and severity trends remained relatively subdued and the release of prior year reserves bolstered the bottom line.
Through the first nine months of 2011, however, these three factors seem less capable of turbocharging the bottom line than in the recent past. Higher catastrophe losses provided another stiff headwind. As noted earlier, the P/C insurance industry reported an annualized statutory rate of return on average surplus of 1.9 percent during the first nine months of 2011 (3.0 percent after excluding mortgage and financial guaranty insurers), down from 6.8 percent from the year earlier period and 6.5 percent for all of 2010. Overall net income after taxes (profits) for the half plummeted by 70.5 percent, or $19.1 billion, to $8.0 billion from $27.1 billion in first nine months of 2010.
While catastrophe losses were the dominant factor adversely impacting profits in the first nine months, the reduction in prior-year reserve releases also played a role. Indeed, billions in profits over the past several years were actually the result of downward revisions in the estimated ultimate cost of claims occurring in years past. During the first nine months, prior-year reserve releases fell to $7.7 billion from $11.5 in first nine months of 2010, a decline of 33 percent. The contribution to the bottom line from prior-year reserve releases is expected to continue to decline as the pool of redundant reserves diminishes over time, pushing the combined ratio up. This dynamic will contribute to higher underwriting losses in the future and eventually exert pressure on rates.
Of course, a firming in the pricing environment would help the bottom line on a sustained basis. While pricing in personal lines (which account for approximately half of all premiums written) has been trending positive for several years, and appears likely to continue that trend into 2012, commercial lineshad remained in negative territory since 2004. According to the Council of Insurance Agents and Brokers (CIAB), however, the average commercial rate change in the third quarter of 2011 registered an increase for the first time in more than seven years, ticking up by 0.9 percent. This is marked improvement over the 5.2 percent decline noted in the same period of 2010. The CIAB survey indicates that commercial renewals had been negative for an astonishing 30 consecutive quarters—dating all the way back to the first quarter of 2004. The overall commercial lines price level today is equivalent to where it was in late 2000. In other words, the cost of insurance sold to businesses today is basically the same as it was more than a decade ago.

Top Line Growth Surprises to the Upside

Net written premiums were up 3.1 percent though the first nine months of 2011. While the current tepid rate environment does not portend imminent hard market conditions, the improvement is evidence that commercial insurance renewals are no longer uniformly negative and that the property/casualty insurance industry is benefiting even from the miserably slow growth in the American economy, which is translating into an increasingly steady stream of additional insurable exposures. On a quarterly basis, premium growth has been positive since the second quarter of 2010, placing the industry on a favorable growth trajectory for 2012.
Deconstructing the nine-month premium growth of 3.1 percent reveals several interesting trends. Personal lines net premiums written were up 3.1 percent during the first nine months (down from +3.6 percent growth in same period in 2010). The deceleration was anticipated. According to monthly data compiled from the Bureau of Labor Statistics, the consumer price index component for auto insurance was up 3.8 percent, on average, through the first nine months of 2011, compared with 5.1 percent during the same period in 2010. Auto accounts for 72 percent of personal lines premiums written. Commercial lines insurers saw growth of 3.9 percent (up from a 1.9 percent decline a year earlier). Insurers with a more diversified book of business experienced growth of 2.3 percent during the first half of this year, down slightly from 2.5 percent in the first nine months of 2010.
While any growth is welcome after three years of decline (2007–2009) and anemic growth (+0.9 percent) in 2010, the figures through the first three quarters if 2011 are undeniably a welcome respite and increasingly seem to portend stronger growth in 2012. Premiums in 2010 and much of 2011 were held back in part by continued soft market conditions, primarily in commercial lines, which continued to grip the industry for a seventh consecutive year. The economy was also a factor (details below), though the massive exposure losses that plagued the industry in 2008 and 2009 are much less of a factor today. Indeed, the era of “mass exposure destruction” is over as the economy continues to recover—albeit weakly and unevenly. Although the nation’s real (i.e., inflation adjusted) gross domestic product (GDP) actually began to expand during the second half of 2009 and further expanded, by 2.9 percent, in 2010, the economy grew at a feeble annualized rate of just 1.2 percent through the first three quarters of the year. In general, P/C insurance exposure usually lags behind economic growth by a year or more. This is because the early stages of economic recoveries are always led by productivity gains rather than additions to fixed investment (e.g., plants, equipment) or hiring (which would add to payrolls).
Despite extreme economic pessimism through much of 2010 and much of 2011, the economy has so far avoided a much feared “double-dip” recession. Although real GDP growth came in at a disappointing 1.8 percent during the third quarter (on the heels of an even worse 0.4 percent and 1.3 percent figures in the first and second quarters, respectively), economic growth is expected to rise to about 3 percent in the fourth quarter before receding to the 2.0 percent to 2.5 percent range in 2012, according to Blue Chip Economic Indicators.
As discussed in the previous section, softness in commercial insurance pricing is a lingering, though somewhat less severe, problem for insurers. Lingering economic weakness also remains a problem, restraining the demand for many types of insurance. However, lines such as workers compensation have benefited from the fact that the economy added 3.1 million private sector workers from January 2010 through November 2011, adding tens of billions of dollars in payroll, which is the exposure base for this large and compulsory line of coverage.

Investment Performance: Resilient Amid Market Volatility, Low Interest Rates

The industry’s cash and invested assets for the first three quarters of 2011 totaled $1.3 trillion—essentially flat (actually, up about $4.4 billion, or 0.3 percent) from the comparable period in 2010. Since the amount of invested funds did not change much from 2010 to 2011, changes in investment gains are attributable to prevailing investment conditions.

The industry’s total investment gains (which include net investment income plus realized capital gains and realized losses) in the first nine months of 2011 rose by $2.1 billion (+5.4 percent) to $42.0 billion, from $39.8 billion in the comparable period of 2010. Thus $2.1 billion growth is a half billion less than the $2.6 billion growth reported last quarter, when comparing the first half of 2011’s net investment gains with the gains from the comparable 2010 period.

Net Investment Income

The largest component of total investment gains is net investment income (NII)—primarily interest earned on the industry’s bond portfolio plus stock dividends. NII increased by $1.2 billion, or 3.5 percent, to $36.5 billion through September 30, 2011. For comparison, NII in 2010’s first nine months was $35.2 billion.

Corporate profits after taxes were also fairly weak in the first three quarters of 2011, following a strong 2010. For the first three quarters of 2011, corporate profits rose by 0.1 percent, 4.3 percent and 2.7 percent (seasonally adjusted at annual rates) respectively (for a cumulative growth of 7.3 percent). This compares to a 27.5 percent spurt for all of 2010. Weakness in profit growth led to little growth in stock dividends, reinforcing the effect of lower interest rates.

Realized Gains/Losses

Realized capital gains for the P/C industry totaled $5.5 billion during the first nine months of 2011, compared with $4.6 billion in the comparable year-earlier period. Lower interest rates raised bond prices, providing insurers with limited opportunities to realize capital gains from the sale of appreciated bonds.

Stock investments constitute about one-sixth of the P/C industry’s invested assets. The U.S. stock market was disappointing in the third quarter. The S&P 500 Index dropped by 2.15 percent in July, by another 5.68 percent in August and by another 7.18 percent in September. This wiped out all prior market value gains for the year and dropped the index into negative territory. However, a bounce-back in October brought the index to near-zero growth for the year. 

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

Investment earnings are factored into rate need expectations. All else being equal, robust investment returns allow insurers to charge less than they would otherwise need to charge. 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 for most insurers to earn a risk-appropriate rate of return without improving their underwriting performance through increased rates, lower claims costs, lower expenses or some combination of the three.
Insurers will need to earn more in premium through higher rates to compensate for lower investment earnings. 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 continue to grow despite the weak economy and depressed investment environment.


The property/casualty insurance industry turned in a relatively weak performance during the first nine months of 2011. Although profitability slumped amid high catastrophe losses, premium growth is accelerating, investment earnings were more robust than anticipated and policyholders’ surplus declined only modestly from its all-time record high. The outlook for the fourth quarter is a cautious one given continued high catastrophe losses, the prospect of high underwriting losses associated with non-cat losses and more uncertainty in the investment markets.
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 nine months of 2011 follows.


($ Billions)

Net Earned Premiums $323.8
Incurred Losses (Including loss adjustment expenses) 264
Expenses 93.6
Policyholder Dividends 1.1
Net Underwriting Gain (Loss) -34.9
Investment Income 36.5
Other Items 1.7
Pre-Tax Operating Gain 3.3
Realized Capital Gains (Losses) 5.5
Pre-Tax Income 8.8
Taxes 0.8
Net After-Tax Income $8.0
Surplus (End of Period) $538.6
Combined Ratio 109.9**

*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 108.2.

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ISO: P/C Insurers Underwriting And Overall Financial Results For Nine-Months 2011 Show Deterioration Driven By Spike In Catastrophe Losses