Profitability in the property/casualty insurance industry surged to its highest level in the post-crisis era in 2013 as sharply lower catastrophe losses, modestly higher premium growth, improved realized investment gains and favorable prior-year reserve loss development coalesced to push the industry’s return on average surplus to 10.3 percent, up from 6.1 percent in 2012 and just 3.5 percent in 2011. The effect: the industry combined ratio in 2013 fell to 96.1, down from 102.9 in 2012, leading to an underwriting profit of $15.5 billion—a necessity in an era of persistent, ultra-low interest rates (despite some increases in longer-term yields late in the year). The industry’s bottom line benefited commensurately as overall net income after taxes (profits) for the year surged by 81.9 percent to $63.8 billion from $35.1 billion a year earlier. Top line growth was also a consistent and meaningful contributor to improved profitability. Net written premiums were up 4.6 percent in 2013, up from a 4.3 percent gain recorded in 2012. Persistently low interest rates, of course, remain a challenge for the industry, with net investment income for the year the slipping by $0.6 billion or 1.4 percent. Overall industry capacity rose to a record $653.3 billion as of December 31, 2013—up $66.3 billion, or 11.3 percent, from $587.1 billion as of year-end 2012.
The industry results were released by ISO, a Verisk Analytics company, and the Property Casualty Insurers Association of America (PCI).
Profitability Improves: Catastrophes Much Less of a Drag on Earnings
The industry’s performance in 2013 is a welcome departure from the heavily catastrophe impacted results of 2011 and 2012. As noted earlier, the P/C insurance industry reported an annualized statutory rate of return on average surplus of 10.3 percent last year (9.8 percent after excluding mortgage and financial guaranty insurers), up from 6.1 percent in the year earlier period (6.3 percent after excluding mortgage and financial guaranty insurers).
A discussion of 2013’s key performance drivers follows:
Catastrophe Losses and Underwriting Performance
Much of the improvement in performance in 2013 can be attributed to materially lower catastrophe losses. While the prior two years (2011 and 2012) ranked among the costliest on record for catastrophe losses, direct insured losses from catastrophes in 2013 fell by $22.1 billion to $12.9 billion from $35.0 billion in 2012 (with superstorm Sandy accounting for $18.8 billion of those losses), providing a meaningful lift to the industry’s bottom line. Last year’s catastrophe losses were far below the 10-year average annual catastrophe losses of $23.9 billion, according to ISO’s PCS unit. The largest catastrophe event of 2013 was an EF-5 tornado that struck Moore, Oklahoma, on May 20, causing nearly $2 billion in insured damages. Wildfires in Colorado and several other states resulted in hundreds of millions of dollars in claims as did an outbreak of unusual late season (fourth quarter) tornadoes in the Midwest. According to PCS, Oklahoma led the country with $2.0 billion in insured catastrophe losses, followed by $1.5 billion in Texas, $1.2 billion in Illinois and $0.9 billion in both Colorado and Minnesota.
Favorable Reserve Development Strengthens
In addition to accelerating premium growth and lower catastrophe losses, favorable development of prior-year claims reserves in 2013 totaled $16.0, a material increase from $10.2 billion in 2012, according to ISO/PCI. Reserve releases are generally associated with lower-than-expected costs for claims occurring in past accident years. While early in 2013 some of the reserve releases were associated with Hurricane Sandy claims, much of the growth in reserve releases is attributable to favorable development within the mortgage and financial guaranty (MF&G) lines ($3.5 billion), which had been hit hard during the financial crisis but have now largely recovered. Excluding these insurers, favorable reserve development totaled $12.4 billion in 2013 compared with $12.1 billion in the year earlier period. Removing the effects of favorablereserve development altogether results in a combined ratio of 99.5 for 2013 (versus 96.1 when the effects are included).
Combined Ratio Improves: Rare Underwriting Profit Assured for 2013
The overall improvement in underwriting during 2013 was material and notable, with the industry’s combined ratio falling to 96.1 compared with 102.9 in 2012 (excluding mortgage and financial guaranty insurers the combined ratios for the same periods were 96.7 and 102.3, respectively).
Premium Growth: Top Line Growth Continues
Also contributing to improved underwriting performance was continued and steady premium growth, which accelerated slightly to 4.6 percent in 2013 from 4.3 percent in 2012.
There are two principal drivers of growth in the property/casualty insurance industry: exposure growth and rate. Exposure growth—basically an increase in the number and/or value of insurable interests (such as property and liability risks)—is being fueled primarily by the rebounding economy. Real (inflation adjusted) GDP in 2013 actually decelerated to 1.9 percent from 2.8 percent in 2012. That said, continued expansion in key areas of the economy such as new vehicle sales, residential construction and consistent employment and payroll growth clearly benefitted the P/C insurance industry. With the pace of GDP growth expected to quicken in 2014 to 2.7 percent, personal and commercial lines exposures should continue to expand modestly.
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 could outpace overall economic growth in 2014, as was the case in the prior two years.
Improving labor market conditions in 2013 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 2.368 million private sector jobs in 2013. Combined with modest increases in the hourly earnings of employees, payrolls expanded by $142.8 billion last year, which contributed to billions of dollars in new premiums written being earned by workers compensation insurers in 2013. 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 2013 up by nearly 10 percent. Workers compensation is likely to remain the fastest growing major P/C line of insurance in 2014 if economic growth and hiring accelerate as projected.
Strong growth in the workers compensation line, recovery in the residential construction sector and stronger car sales are just a few of the reasons why moderate growth is likely to continue into 2014. Among carriers writing predominantly commercial lines, premiums written rose by 4.0 percent in 2013 (actually down from 5.5 percent in 2012) compared to 5.3 percent for insurers writing predominantly personal lines (up from 3.5 percent a year earlier) and 4.1 percent for those with a more balanced mix of business (down from 4.6 percent a year earlier).
Investment Performance: Improvement But Interest Rates Remain Low
For the full year 2013, net investment gains (which include net investment income plus realized capital gains and losses) rose by $4.6 billion (+8.5 percent) to $58.8 billion, compared with $54.2 billion in 2012. In measuring insurance company net investment gains, accounting rules recognize two components: (i) net investment income; and (ii) realized capital gains or losses. Unrealized capital gains or losses are not considered income and affect only surplus on the balance sheet.
Net Investment Income in 2013
Net investment income itself has basically two elements—interest payments from bonds and dividends from stock. The industry’s net investment income for the full year 2013 was $47.4 billion, compared to $48.0 billion in 2012 (down 1.4 percent). Most of this income comes from the industry’s bond investments, which are mainly high quality corporates and municipals.
Corporate bond market yields in the first five months of 2013, as captured by Moody’s AAA-rated seasoned bond index, averaged 3.85 percent. In June yields jumped to average 4.27 and averaged 4.55 percent for the last half of 2013. The January?May yields were roughly the same as in the first half of 2012.
Although the U.S. economy is improving—slowly (real GDP rose only 1.9 percent in 2013)—it remains beset by the same forces that have held interest rates down for the past few years: unused capacity (in both capital resources and still-high unemployment); cautious consumer and business spending, and low near-term future expectations for the economy; and Federal Reserve actions to keep both short-term and longer-term interest rates low, all of which contributed to low inflation expectations. The small spike in June appears to have been a response to belief that the Federal Reserve would soon begin to “taper off” its program of buying long-maturity Treasury and agency bonds, which it actually did begin in December. However, the Fed was clear that it intends to keep short-term rates low for a substantial time even after the bond-buying program ends.
The other significant source of net investment income (apart from bond yields) is stock dividends. In 2013 stock dividends were volatile. Seasonally adjusted, net dividends in the first quarter of 2013 ran at an annual rate of $763.8 billion, in the second quarter at a $1,037.3 billion annual rate, in 2013:Q3 at an $858.3 billion annual rate, and in 2013:Q4 at a $948.8 annual rate. (For comparison, net dividends for the full year 2012 were $770.3 billion vs. $902.0 billion in 2013.) But stock holdings in general represent roughly only about one-sixth of the industry’s invested assets.
Realized Capital Gains
Realized capital gains in 2013 were $11.4 billion, compared to $6.2 billion in 2012. The broad stock market did quite well throughout 2013—the S&P 500 rose 33 percent, providing opportunities for capital gains. Again, however, the industry’s overall stock allocation represents only about one-sixth of invested assets.
Policyholders’ Surplus (Capital/Capacity): New Record High Demonstrates Industry Strength and Resilience
Policyholders’ surplus as of December 31, 2013 stood at $653.3 billion, up 11.3 percent or $66.3 billion from year-end 2012. Policyholders’ surplus has generally continued to increase despite high catastrophe losses in two of the past three years (2011 and 2012). The fact that the industry was able to rapidly and fully recoup its losses to surplus even in the event of disasters like Sandy (which produced $18.8 billion in insured losses in 2012) is continued 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 2014 and beyond. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.73, close to its strongest level in modern history.
The property/casualty insurance industry turned in a sharply improved performance in of 2013 in terms of underwriting performance and overall return on average surplus (profitability). In addition, policyholders’ surplus reached a new all-time record high. Profitability surged amid lower catastrophe losses and strong prior-year reserve releases—even investment gains were up as strength in realized capital gains overcame weakness in investment income, in large part due to historically low yields on fixed income securities through much of the year. Premium growth, while still modest, is now experiencing its longest sustained period of gains in a decade.
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 2013 follows.