2011 - Year End Results

In 2011 insurers endured one of the most extraordinarily violent years ever in terms of catastrophes on a global scale. Mega-catastrophes 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 billion recorded 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 totaled $33.6 billion, implying economic losses in excess of $75 billion. On an inflation adjusted basis, 2011 ranks as the fifth most expensive year on record for insured catastrophe losses. High catastrophe losses, along with high underwriting losses in key non-catastrophe exposed lines such as workers compensation, helped push the industry’s combined ratio to 108.2—its highest level since 2001—and depress the property/casualty (P/C) insurance industry annualized statutory rate of return on average surplus to 3.5 percent last year, down from 6.6 percent in 2010. Notably, underwriting losses more than tripled to $36.5 billion last year, up from $10.5 billion in 2010, resulting in the second largest annual underwriting loss ever, behind the $52.3 billion underwriting loss in 2001. Profitability receded despite a surprising $2.8 billion, or 5.2 percent, improvement in investment earnings and a respectable 3.3 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 year lower than it began. More surprising, however, is how small the decline was—just 1.6 percent or $8.9 billion. Overall net income after taxes (profits) in 2011 was nearly halved—plunging 46 percent to $19.2 billion from $35.2 billion in 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 seven consecutive quarters. Although growth remained modest at just 3.3 percent last year (3.8 percent in the fourth 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 106.4, after excluding mortgage and financial guaranty insurers (108.2 when they are included), compared to 100.9 in 2010.
The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).

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

Policyholders’ surplus totaled $550.3 billion at year-end 2011, high by historical standards and down just 2.5 percent, or $14.4 billion, from the all-time record of $564.7 as of March 31, 2011. The year-end figure is also just 1.6 percent, or $8.9 billion, below the $556.9 billion in surplus at year-end 2010 (itself a record at the time). The decline in surplus on an annual basis was the first since the onset of the financial crisis in 2008.
One outstanding question is whether the decline in surplus last year was 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. The former seems to be the more likely case. Indeed, while surplus was down by as much as 4.6 percent at the end of the third quarter, by year’s end the industry had recouped more than 60 percent of that decline. Apart from the highest underwriting losses in a decade, surplus was also adversely affected by $5.1 billion in unrealized investment losses in 2011, compared with a $16 billion gain in 2010.
Despite the recent decline, the $550.3 billion in surplus as of December 31, 2011, exceeds the pre-crisis high of $521.8 billion set during the third quarter of 2007 by 5.5 percent—a difference of $28.5 billion. Despite the modest shrinkage in policyholders’ surplus at year-end 2011, 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 and beyond. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.80, close to its strongest level in modern history. Indeed, barring a mega-catastrophe or significant investment market turmoil, it is quite likely that capacity in the P/C insurance industry will achieve a new all-time record high by year-end 2012.


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.
As noted earlier, the P/C insurance industry reported an annualized statutory rate of return on average surplus of 3.5 percent last year (4.6 percent after excluding mortgage and financial guaranty insurers), down from 6.6 percent in 2010. Overall net income after taxes (profits) for the year plummeted by 45.6 percent, or $16 billion, to $19.2 billion from $35.2 billion in 2010.
While catastrophe losses were the dominant factor adversely impacting earnings in 2011, the year’s profits would have been much lower were it not for a surprising degree of support from the continued and substantial release of prior-year reserves. 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 2011, prior-year reserve releases actually increased to $11.0 billion from $9.7 billion in 2010, a gain of 13.4 percent. Despite last year’s increase, the contribution to the bottom line from prior-year reserve releases is expected to resume its 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 through 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 finally turned positive for the first time in 30 quarters during the third quarter of last year (ticking up 0.9 percent), accelerating to 2.8 percent in the fourth quarter. This is a marked improvement over the average 5.6 percent decline recorded in 2010. Despite recent gains, the overall commercial lines price level today is equivalent that 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 Accelerates But Remains Quite Modest

Net written premiums were up 3.3 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 in fact are generally trending positive—and that the property/casualty insurance industry is benefiting even from the frustratingly 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 2.9 percent last year (down from +3.8 percent growth in 2010). The deceleration was anticipated. According to data compiled from the Bureau of Labor Statistics, the consumer price index component for auto insurance was up 3.6 percent in 2011, compared with 5.2 percent in 2010. Auto accounts for approximately 70 percent of personal lines premiums written. Commercial lines insurers saw growth of 4.3 percent (up from a 2.3 percent decline a year earlier). Insurers with a more diversified book of business experienced growth of 2.4 percent last year, up slightly from 2.3 percent in 2010.
While any growth is welcome after three years of decline (2007–2009) and anemic growth (+0.9 percent) in 2010, and the figures for 2011 demonstrate that growth is likely sustainable through 2012 and possibly several years beyond, the trajectory of growth remains quite modest. Premiums in 2010 and much of 2011 were held back in part by continued soft market conditions, primarily in commercial lines, which gripped the industry through the first half of last 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 3.0 percent, in 2010, the economy grew at a feeble rate of just 1.7 percent in 2011. 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).
P/C insurers in 2012 should begin to see the benefits of the accelerating exposure growth that began in earnest last year. For example, the value of manufacturing shipments in December 2011 was just 4.5 percent below its pre-crisis peak. Indexes of manufacturing and non-manufacturing activity ended 2011 indicating that expansion was continuing. Such activity fuels premium growth across many commercial coverages including commercial property, liability, commercial auto and workers compensation. Perhaps most importantly, the private sector created 2.105 million jobs last year, up from 1.423 million in 2010. Through the first three months of 2012, private sector employers added an additional 631,000 workers. Overall payroll, the exposure base for workers compensation insurance, now exceeds its pre-crisis peak. During 2011, the unemployment rate ranged from a high of 9.2 percent in June to a low of 8.5 percent at year’s end. By March 2012, the unemployment had dropped still further to 8.2 percent.
Despite extreme economic pessimism throughout much of the past two years, the economy appears to have successfully avoided a much feared and often discussed “double-dip” recession. Although real GDP growth came in at a disappointing 1.7 last year, economic growth is expected to rise to 2.3 percent in 2012 and 2.6 percent in 2013, according to Blue Chip Economic Indicators.

Investment Performance: Investment Gains Continue

Total investment gains (which include net investment income plus realized capital gains net of realized capital losses) rose in 2011, to $56.2 billion from $53.4 billion in 2010, up $2.8 billion (5.2 percent).
Net Investment Income
Net investment income (primarily interest earned on the industry’s bond portfolio plus stock dividends) rose slightly in 2011 vs. 2010, increasing from $47.6 billion in 2010 to $49.0 billion. Roughly 70 percent of the industry’s invested assets are in bonds—virtually all of which are considered investment grade.
Yields on Moody’s AAA-rated seasoned bonds started 2011 close to 5 percent and stayed at that level—plus or minus 20 basis points—until August. In August yields dropped to 4.3 percent—plus or minus 15 basis points—and in September and October dropped again to about 4.0 percent—plus or minus 15 basis points. In November and December yields dropped again to about 3.8 percent—plus or minus 20 basis points—and ended 2011 at 3.77 percent. As a result of this drop, bonds bought in prior years that matured and were reinvested in 2011, particularly in the second half of the year, commanded much lower yields than previously. Similarly, new bond investments locked in these low yields for several future years and, if interest rates rise and the bonds are sold before maturity, might generate capital losses as well.
The conventional wisdom throughout 2011 was that interest rates would remain low for several more years. The Federal Reserve not only kept its key federal funds rate between zero and 0.25 percent and signaled multiple times that it expected the rate to remain there until perhaps late 2014. Although annualized inflation reached (and, by some measures, passed) the Fed’s 2 percent target, the high continuing unemployment rate, remaining underutilized industrial capacity and generally depressed consumer demand all pointed to inflation (and, therefore, interest rates) remaining low for the foreseeable future.
As for stock dividends, net dividends for the first three quarters of 2011 (the latest data available at this writing) were running at a seasonally adjusted annual rate of over $810 billion compared to $737 billion for 2010. Although this is roughly a 10 percent increase, its effect is small because dividend-paying stocks are only a small component of P/C insurer invested assets.
Realized Capital Gains and Losses
Stock market conditions through much of 2011 did not offer much opportunity for realized capital gains. Like bonds, the stock market was generally flat for the first half of the year, sank during the summer and recovered somewhat in the fourth quarter. Falling interest rates into late 2011 helped push bond prices higher, providing insurers with some opportunities to realize capital gains on bond holdings. Realized capital gains of $7.2 billion in 2011 slightly exceeded the 2010 total of $5.9 billion.


The property/casualty insurance industry turned in a relatively weak performance during in 2011 in terms of underwriting performance and overall return on average surplus. Although profitability slumped amid high catastrophe losses, premium growth accelerated, investment earnings were more robust than anticipated and policyholders’ surplus declined only modestly from its all-time record high. The outlook for 2012, given the continued potential for high catastrophe losses, the prospect of high underwriting losses associated with non-cat losses and more uncertainty in the investment markets, is for a challenging year for insurers.
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 2011 follows.

Full-Year 2011 Financial Results*

--($ Billions)--

Net Earned Premiums $433.9
Incurred Losses 344.5
(Including loss adjustment expenses)  
Expenses 124.0
Policyholder Dividends 1.9
Net Underwriting Gain (Loss) -36.5
Investment Income 49.0
Other Items 1.2
Pre-Tax Operating Gain 14.8
Realized Capital Gains (Losses) 7.2
Pre-Tax Income 22.0
Taxes 2.9
Net After-Tax Income -$19.2
Surplus (End of Period) $550.3
Combined Ratio 108.2**

*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 106.4.

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ISO: P/C Insurers Full-Year Results Deteriorated In 2011 as Catastrophe Losses Spiked, But Fourth-Quarter Results Tell a Different Story