2012 - First Nine Months Results

Profitability in the property/casualty insurance industry rebounded sharply during the first nine months of 2012, propelled chiefly by a sharp drop in catastrophe losses and a marked acceleration in premium growth. According to ISO’s PCS unit, catastrophe losses plunged by more than half (51 percent or $16.6 billion) to $16.2 billion in the first nine months of 2012 from $32.8 billion in the first nine months of 2011—largely the result of diminished tornado activity, lower winter storm losses and mild hurricane losses through September 30 (Hurricane Sandy made landfall in the Northeast United States in late October). The effect: the industry combined ratio fell to 100.9 in the first nine months, down significantly from 109.8 a year earlier (and from 108.2 for full-year 2011) on underwriting losses that shrank by 81 percent to $6.7 billion from $34.7 billion in the first nine months of 2011. The industry’s bottom line benefited commensurately as overall net income after taxes (profits) surged in the first three quarters of 2012 by 221.7 percent to $27.0 billion from $8.4 billion in the year earlier period, pushing the industry’s return on average surplus up to 6.3 percent during the first nine months, from 2.0 percent in the first nine months of 2011 (and from just 3.5 percent for full-year 2011). Stronger top line growth also contributed to improved profitability. Net written premiums were up 4.2 percent in the first nine months, a full point above the 3.2 percent gain recorded in the year-earlier period and double the 2.1 percent annualized growth rate in GDP in the first nine months of the year. Indeed, net written premiums for full-year 2012 will likely expand 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 $1.5 billion or 4.1 percent during the first nine months. Overall industry capacity rose to a record $583.5 as of September 30, up $12.8 billion or 2.2 percent from the previous record high of $570.7 billion as of March 31, 2012.
Again, it is important to note that the results for the first nine months of 2012 do not include the impacts of Hurricane Sandy, which slammed into the Northeast coast of the United States during the final week of October. Although current insured loss estimates suggest claim payouts in the $19 billion range (averaging the midpoints of current insured loss estimates from the three major catastrophe modeling firms), making Hurricane Sandy the fourth most expensive natural disaster in U.S. insurance history, the bottom line is that the property/casualty insurance industry ended the third quarter of 2012 in extremely strong financial condition, fully prepared for the storm’s enormous costs.
The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).

Profitability Improves: Looking Beyond Catastrophe Losses

Although the focus on property/casualty insurance industry financials over the past few months has been confined almost entirely to Hurricane Sandy, the event has obscured what has otherwise been a broad based improvement in property/casualty 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 6.3 percent during the first nine months of 2012 (6.6 percent after excluding mortgage and financial guaranty insurers), up from 2.0 percent in the first nine months of 2011 (3.1 percent after excluding mortgage and financial guaranty insurers). A discussion of the key drivers of the nine-month improvement in performance follows.
Catastrophe Losses and Underwriting Performance: The Top and Bottom Line
Underwriting losses through the first nine months of 2012 tumbled by 81 percent to $6.7 billion from $34.7 billion in the year earlier period. It is certainly true that sharply lower catastrophe losses through the first nine months of 2012 were the dominant factor favorably influencing insurer performance. Losses associated with tornadoes, tropical systems, derechos, hail and high winds, wildfires, winter storms and other major natural disasters through September 30 were down 51 percent ($16.6 billion), to $16.2 billion from $32.8 billion a year earlier—a very welcome improvement. In particular, losses from tornados and winter storms were well below those experienced in 2011 (which by year-end 2011 turned out to be the fifth costliest year ever for insured catastrophe losses in the United States).
Fewer and less costly disasters benefited the industry’s underwriting performance, contributing to a sharp drop in the combined ratio of nearly nine full points, to 100.9 through September 30 compared with 109.8 a year earlier (excluding mortgage and financial guaranty insurers the combined ratios for the same periods were 100.0 and 108.1, respectively). Several other factors also played important roles, including premium growth and prior year reserve releases.
Premium Growth: The Top Line Continues to Accelerate and Is on Track for Best Growth Performance in the Post-Recession Era
Also contributing to improved underwriting performance was a notable acceleration in premium growth, which rose 4.2 percent in the first nine months of 2012, a full percentage point above the year earlier reading. During the third quarter itself, net premiums written rose by 5.1 percent, the sharpest quarterly gain in nearly six years (i.e., since the 6.6 percent gain recorded in the fourth quarter of 2006).
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 4.3 percent in the third quarter of 2012 relative to the third quarter of 2011, approximating the 4.2 percent growth in net written premiums during the first nine months of 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. With third quarter 2012 net written premiums up 5.1 percent year-over-year, this trend may already be underway.
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 1.36 million jobs in the first nine months of 2012. Combined with modest increases in the hourly earnings of employees, payrolls expanded by $87.8 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 is up 6.1 percent through the first nine months (up from 4.0 percent in the year earlier period) compared to 3.3 percent for insurers writing predominantly personal lines (up from 3.2 percent a year earlier) and 3.8 percent for those with a more balanced mix of business (up from 2.4 percent a year earlier). Taken as a whole, the property/casualty insurance industry is on track to record its strongest growth in the post-crisis era.
Favorable Reserve Development
Favorable reserve development continued to bolster the industry’s underwriting performance and bottom line through the first nine months of 2012. According to ISO/PCI, favorable prior-year reserve development (excluding mortgage and financial guaranty insurers) totaled $10.2 billion through September 30, down slightly (5.4 percent) from $10.6 billion through the same period in 2011. Favorable reserve development—essentially downward revisions in the estimated ultimate cost of claims occurring in years past—has been an important contributor to industry underwriting performance and profitability in recent years.

Investment Performance: Low Interest Rates Have their Expected Effect

For the first three quarters of 2012, net investment gains totaled $38.1 billion, compared to $42.2 billion in the first three quarters of 2011, a $4.1 billion drop (-9.7 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 first three quarters of 2012 was $35.1 billion, compared to $36.6 billion in the first three quarters of 2011 (down 4.1 percent). The vast majority of this income comes from the industry’s bond investments, which are mainly high quality corporate and municipal bonds. Corporate bond market yields in the first three quarters of 2012 remained at unusually low levels. Moody’s AAA-rated seasoned bond index yields ranged between 3.8 percent and 4 percent during most of the year’s first half. Yields ranged from 3.3 percent to 3.5 percent during most of the third quarter. Yields for municipal (state and local) bonds were very similar to corporate AAA 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 the first three quarters of 2012 are the same forces 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 an unwillingness 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.
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, and in the third quarter by 7.5 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 first three quarters of 2012 were $3.0 billion compared to $5.5 billion for the first three quarters of 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.

Policyholders’ Surplus (Capital/Capacity): New Record High Demonstrates Industry Strength and Resilience

Policyholders’ surplus as of September 30, 2012, stood at $583.5 billion, up 2.2 percent from a record $570.7 as of March 31, 2012, and up $33.2 billion or 6.0 percent from $550.3 billion at year-end 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 recoup those losses and maintain such a strong capital position through the first nine months of 2012 ahead of Hurricane 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 fourth quarter impact of Hurricane Sandy. 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.


The property/casualty insurance industry turned in a relatively strong performance during the first nine months of 2012 in terms of underwriting performance and overall return on average surplus (profitability) compared with the first nine months of 2011. In addition, policyholders’ surplus reached a new all-time record high as catastrophe losses through first nine months remained well below those experienced in the year-earlier period and asset prices rose. Although profitability surged amid much lower catastrophe losses this year, 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 recent momentum will carry through into 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 first nine months of 2012 follows.

First Nine Months 2012 Financial Results*

--($ Billions)--

Net Earned Premiums $335.3
Incurred Losses 243.9
     (Including loss adjustment expenses)  
Expenses 97
Policyholder Dividends 1.1
Net Underwriting Gain (Loss) -6.7
Investment Income 35.1
Other Items 2.1
Pre-Tax Operating Gain 30.6
Realized Capital Gains (Losses) 3
Pre-Tax Income 33.6
Taxes 6.6
Net After-Tax Income $27.0
Surplus (End of Period) $583.5
Combined Ratio 100.9**

*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 100.0.


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