The third quarter of 2015 capped a strong first nine months for the property/casualty (P/C) insurance industry. In that period, overall net income after taxes (profits) in the P/C industry was $44.0 billion. This was up by $6.2 billion (+16.4 percent) from $37.8 billion in the first nine months of 2014. For perspective, note that profits for the first three quarters of 2013 were $42.7 billion (an unusually strong year), and for the comparable period in 2012 were $27.8 billion. Indeed, the $44.0 billion profit was the highest nine-month total since 2007.
At the end of the first three quarters of 2015, overall industry capacity (as measured by policyholders’ surplus—what in other industries would be called net worth) slipped by 1.6 percent as compared to 2014, to $663.9 billion. The combined effect of somewhat higher profits and a slightly lower capital base produced an overall 8.8 percent rate of return on capital (profitability) in the first three quarters of 2015, up from 7.6 percent in the first three quarters of 2014.
Net written premiums continued steady “top line” growth, rising 4.1 percent in the first nine months of 2015 over the comparable period in 2014. But claims related outlays did not rise as much (+2.7 percent), so the industry’s combined ratio fell by 0.8 points to 96.9 during the first three quarters of 2015 compared to 97.7 in the comparable 2014 period. The improvement is welcome, but it is not enough: P/C companies generally need to maintain combined ratios below 95 in order to earn their cost of capital in a still challenging interest rate environment. While low interest rates will likely continue to present a challenge throughout 2016, even a modestly growing economy implies continued exposure growth.
The industry results were released by ISO, a Verisk Analytics company, and the Property Casualty Insurers Association of America (PCI).
The industry’s performance in the first three quarters of 2015 was positive but bore the effects of winter storms and several outbreaks of severe spring weather. A discussion of the key drivers of the nine-month performance follows.
Losses: Higher, But Not Catastrophic
Loss and loss-adjustment outlays for the first nine months were $260.0 billion, up $6.8 billion (2.7 percent) vs. the year-earlier period. Bad weather was partly to blame, but less so than in 2014.
The trend in insured losses caused by severe winter weather is rising; the effects of severe winters in 2014 and 2015 were both well above what the insurance industry has typically experienced. The $2.9 billion in winter losses for 2015 rose by $0.6 billion—+26 percent—from $2.3 billion in losses in 2014, and by $1.0 billion (+53 percent) from $1.9 billion in 2013. And although the insured damage from extreme cold and winter storms in early 2015 did not break the records set in the mid-1990s, 2015 will go down in history as one of the five costliest years on record for winter damage claims.
Auto claims also tend to spike during the winter months, due to slick roads. This was particularly true during the past two frigid years. In 2014, collision claim frequency rose 8.5 percent from 2013. In 2015, collision claim frequency stayed high—7.3 percent higher than in 2013.
Between 1995 and 2014, winter storm claims accounted for 6.8 percent of all insured U.S. catastrophe losses, placing the category third behind hurricanes and tropical storms (40.8 percent) and tornadoes (39.1 percent) as the costliest natural disasters, according to Verisk’s ISO Property Claim Services.
Also, NOAA reports that the first nine months of 2015 was the worst tornado season since 2011, as measured by number of tornadoes. Wildfire events in the drought-ridden West added to the tally of claims.
Breaking the underwriting performance down into catastrophe related and non-catastrophe related claims, ISO estimates that the $6.8 billion increase in overall claims consisted of a $1.7 billion drop (to $14.2 billion) in catastrophe related claims and an $8.5 billion increase (to $245.9 billion) in non-catastrophe related claims.
Reserve releases are generally associated with new estimates of expected costs for claims occurring in past accident years. Overall inflation continues to be remarkably low, likely contributing to these lower estimates, although prices for some items that comprise claims payouts have been increasing at higher rates than general measures of inflation (see the I.I.I.’s Inflation Watch spreadsheet). For the first three quarters of 2015, the industry reported releases of prior-year claims reserves totaling $9.3 billion, up from $8.9 billion of reserve releases in the first three quarters of the previous year. Released reserves go directly to the industry’s “bottom line.”
Combined Ratio: Underwriting Profits Continue
The industry’s overall underwriting gain was $7.1 billion, producing a combined ratio of 96.9 for the first three quarters of 2015. From a long-term historical perspective, quarterly underwriting losses have been the norm over the past several decades—especially the second calendar quarter. However, since the start of 2013, the industry has posted a quarterly underwriting profit in every single quarter except the second quarter. That’s three unprofitable quarters (2013:Q2, 2014:Q2, and 2015:Q2) and eight profitable quarters (2013:Q1, 2013:Q3, 2013:Q4, 2014:Q1, 2014:Q3, 2014:Q4, 2015:Q1, and 2015:Q3) out of the last 11.
Premium Income: Top Line Growth Continues
Also contributing to positive underwriting performance was continued premium growth, which rose by 4.1 percent in the first three quarters of 2015 from 4.0 percent growth in the first three quarters of 2014.
Premium growth differed significantly by line of business. Insurers writing mainly personal lines saw net written premiums rise by 5.5 percent (vs. a rise of 5.6 percent for the comparable period in 2014); insurers writing mainly commercial lines, excluding mortgage and financial guaranty insurers, saw net written premiums rise by 2.3 percent (vs. a rise of 2.7 percent for the comparable period in 2014); and insurers writing generally balanced books of business saw net written premiums rise by 4.7 percent (vs. 3.8 percent in the comparable period in 2014).
There are two main drivers of premium growth in the property/casualty insurance industry: exposure growth and rate activity. Exposure growth—basically an increase in the number and/or value of insurable interests (such as property and liability risks)—is driven mainly by economic and demographic growth and development. The record number of new cars sold in 2015 is a good example of exposure growth; even if old cars were being replaced one-for-one, the new cars represent higher value and possibly additional coverage (since they likely include comprehensive and collision, whereas older cars tend not to have these coverages). Although real (inflation-adjusted) GDP in the first quarter of 2015 rose at an anemic annual rate of 0.6 percent (in part due to the effects of the harsh winter and other one-time factors), economic growth snapped back in the second quarter, with real GDP expanding at a robust 3.9 percent annual clip, and at a moderate 2.0 percent annualized rate in the third quarter. Growth in key areas of the economy such as record new vehicle sales, strong multi-unit residential and commercial construction, and consistent employment and payroll growth are clearly benefitting the P/C insurance industry.
The other important determinant in industry premium growth is rate activity. Rates tend to be driven by trends in claims costs, conditions in the reinsurance market, marketing and distribution costs, and investments in technology, among other factors. Although it’s challenging to foresee the interplay of all of these and macroeconomic factors, it is certainly possible that overall industry growth in net written premiums could keep pace with overall economic growth in 2016.
Improving labor market conditions in 2016 will also affect top line growth in the P/C insurance industry. Job growth benefits the entire economy, of course, but the expansion of payrolls benefits workers compensation insurers in particular. The United States economy added 2.65 million nonfarm jobs in 2015, following a year in which it added 3.12 million; if the 2015 rate is sustained through 2016, the workers comp line will see another year of strong premium growth. Combined with inflation-level increases in the hourly earnings of employees (as has been the case for the past few years), payrolls are expected to continue growing, resulting in billions of dollars in new premiums written by workers compensation insurers in 2016.
For the first three quarters of 2015, net investment gains (which include net investment income plus realized capital gains and losses) were virtually flat vs. the year-earlier period—they rose by $0.4 billion (1.0 percent) to $43.7 billion, compared to $43.3 billion in the first three quarters of 2014. The comparatively small growth should not be misunderstood: 2015 saw the highest total net investment gains since 2007 ($47.8 billion), and the second-highest since the start of ISO’s records in 1986.
Net Investment Income
Net investment income has basically two elements: interest payments from bonds and dividends from stock. The industry’s net investment income for the first three quarters of 2015 was $34.85 billion, virtually identical to the $34.45 billion in the first three quarters of 2014 (up just $0.40 billion, or 1.1 percent). Most of this income comes from the industry’s bond investments, which are mainly high quality corporates and municipals.
Corporate bond market yields, as captured by Moody’s AAA-rated seasoned bond index, in 2015:Q1 averaged 3.6 percent, held at 3.5 percent in April, then “spiked” to over 4.0 percent in May and stayed there for the rest of the second and third quarters of 2015 (and, in fact, through 2015 year-end). And although the Federal Reserve Board raised short-term interest rates in December 2015, this is not expected to have much effect on long-term rates in 2016. Accordingly, in 2016, funds from maturing bonds will likely be reinvested at rates that might be lower than, or at best only slightly higher than, the yields of prior investments.
Although many—but not all—signs point to the U.S. economy improving, the same forces still appear to be present that have held interest rates down for the past few years: under-used capacity (both capital resources and slack in the labor market) compounded by low inflation, little real wage growth, cautious business spending and constrained government outlays. For the near-term future, the Federal Reserve Board’s Open Market Committee has indicated that although it expects to be raising short-term rates in 2016, the raises will likely be small and dependent on continued satisfactory economic data.
The other significant source of net investment income (besides bond yields) is stock dividends, which grew nicely in 2015. Seasonally adjusted, net dividends in 2015:Q1 rose by 2.5 percent (compared with 2014:Q1), in 2015:Q2 rose by 2.6 percent vs. 2014:Q2, and in 2015:Q3 rose by 6.1 percent. Stock holdings in general represent roughly only about one-sixth of the industry’s invested assets.
Realized Capital Gains/Losses
Only realized capital gains and losses affect insurer net income; unrealized capital gains and losses affect policyholders’ surplus. No growth here: realized capital gains from the first three quarters of 2015 were $8.87 billion, compared to $8.82 billion through the first three-quarters of 2014.
The broad stock market performed dismally in the first three quarters of 2015, in part reflecting broad concerns about both the domestic and global economy. For the first nine months, the S&P 500 was down 6.7 percent, heavily affected by the one-week drop in late August of 7.2 percent. As one result, the Federal Reserve Open Market Committee, which had expected in September to end the nearly seven-year-long suppression of short-term interest rates near zero, postponed that change. The near-term outlook for inflation remained below the Fed’s expectations and desires, driven by the plummeting price of oil. As the third quarter ended, most forecasters were lowering their predictions for global growth rates.
Policyholders’ surplus as of September 30, 2015, stood at $663.87 billion—down by $10.25 billion (-1.6 percent) from the year-earlier third-quarter period. Policyholders’ surplus has generally increased in recent years as industry profits rose and as assets held in the industry’s investment portfolio increased in value in the wake of the recovery from the financial crisis and Great Recession. The small drop in surplus is partly attributable to the industry’s $22.7 billion in unrealized losses from the stock market retreat, and was partly offset by strong gains in net income after taxes.
The bottom line is that the industry is, and will remain, extremely well capitalized and financially prepared to pay very large scale losses in 2016 and beyond. One commonly used measure of capital adequacy, the ratio of 12-month trailing net premiums written to surplus, currently stands at 0.77, close to its strongest level in modern history. (A ratio of 1.0 is considered strong, and a lower ratio is even stronger.)
The property/casualty insurance industry turned in a profitable performance in the first three quarters of 2015. In addition, policyholders’ surplus remained near its all-time record high. Despite a costly winter and a number of costly springtime weather events, rising non-cat losses, and persistently low interest rates, the industry recorded one of its most significant nine-month profitable spans. 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 the first three quarters of 2015 follows.
To view the full report from ISO and PCI, click here.