For three years in a row, quarter after quarter, property/casualty insurers produced an underwriting profit. The streak continued in the first quarter of 2016 but appears to have ended in the second quarter. The culprit? Incurred losses and loss adjustment expenses that spiked by 8.1 percent in the second quarter (compared to the second quarter of 2015) and by 7.2 percent for the first half of the year. Overall profit was also weaker because results from investing the industry’s assets also deteriorated in the first half of 2016 versus the comparable period in 2015: net investment gains were $26.5 billion in the first half of 2016, compared to $31.6 billion in 2015, down 16.0 percent.
Other measures of the industry’s health were positive but weaker in 2016:1H compared to 2015:1H. Net written premiums grew by 3.0 percent for the half, compared to 4.1 percent growth in the first half of 2015. Policyholders surplus—what in other industries would be called net worth—rose by 1.1 percent over its level at the end of the first half of 2015. The industry’s overall rate of return (profitability) on capital fell from 9.2 percent in the first half of 2015 to 6.4 percent.
In reviewing this analysis, it is important to keep in mind that, although the first half of 2016 was not as strong as the equivalent period of 2015, in a sense this is not a fair comparison. That is because the first half of 2015 was an unusually strong period for the property/casualty industry, presenting a high hurdle for any subsequent period’s performance.
The industry results were released by ISO, a Verisk Analytics company, and the Property Casualty Insurers Association of America (PCI).
Underwriting performance: Incurred claims spike
The property/casualty industry’s underwriting performance in the first half of 2016 was affected by a host of adverse conditions in the second quarter of the year. A discussion of the key drivers of this first-half performance follows.
Premium growth: Top line growth continues
As noted, net written premiums grew by 3.0 percent in the first half of 2016, down from the 4.1 percent growth rate in the first half of 2015. In general, premiums may grow for any or all of several reasons. First, there is growth in the number and/or value of insurable interests (such as property and liability risks). Second, there is an increase in the willingness of buyers who had some or no insurance to purchase or add to their insurance protection, net of those who reduce or drop it. And third, there is an increase in rates (that is, the price per unit of coverage).
As a general rule, exposure growth is driven primarily by economic growth and development, but there was relatively little economic growth in the first half of 2016. The commonly used measure of economic growth is real (that is, inflation-adjusted) GDP; but in the first half of 2016 this measure rose at an estimated annual rate of only 1 percent. In terms of value of economic units, the general level of prices, as measured by the Core CPI (the Consumer Price Index, excluding the effect of food and energy), rose at about a 2 percent annual rate.
From the available data it is not easy to determine to what extent premium growth is coming from an increase in insurance buyers. Compared to the first half of 2015, the first half of 2016 saw modest population growth, continued growth in the number of people employed—especially those employed full-time—and net business formation and expansion. This all suggests that some people and businesses that had previously been un- or under-insured might have bought more coverage lately. Also, those who financed new cars or homes had to purchase insurance coverage to satisfy the conditions of their loan, even if their prior vehicle or residence was not insured. Still, in virtually every arena this growth was proceeding at a slower pace than in 2015:1H.
Some economists believe that the U.S. economy is approaching full employment status. Even at full employment payrolls will grow with an expanding economy and a growing population, but not as fast as in an economy rising toward full employment.
The other important determinant in industry 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 is 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 – 2017.
Different segments of the industry saw markedly different premium flows. Net written premium growth for insurers writing mainly personal lines (mostly auto and homeowners insurance) was 6.0 percent in 2016:1H. In contrast, net written premiums for insurers writing mainly commercial lines, excluding mortgage and financial guaranty insurers, fell by 0.9 percent in 2016:1H, down 3.2 percentage points vs. 2015:1H. And insurers writing mainly balanced books of business saw net written premiums grow at 3.7 percent.
Catastrophe and non-cat losses
In most years, catastrophe related claims are a small percent of total claims, but we focus on them because they can be quite volatile, as was the case in 2016 compared to 2015. In the first half of 2016, the industry’s experience with catastrophe related losses worsened vs. 2015—from $11.0 billion a year ago to $14.5 billion this year (up 31.8 percent). Non-cat losses also rose, but to a lesser extent, to $169.2 billion from $160.4 billion (up 5.5 percent). As a result, total losses and loss adjustment expenses rose by 7.2 percent, to $183.7 billion. Clearly, the large rise in claims costs in relation to 3 percent premium growth contributed to decreased profits.
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. For the first half of 2016, the industry reported releases of prior-year claims reserves totaling $5.9 billion, down from $7.8 billion in the first half of last year.
Combined ratio and underwriting profits
The industry’s overall underwriting loss of $1.50 billion in the first half of 2016 compares to an underwriting profit of $3.5 billion profit for the first half of 2015. From a long-term historical perspective, underwriting losses have been the norm over the past several decades. According to ISO, underwriting profits have occurred in only about one in every six calendar quarters since 1986, when ISO’s quarterly data began.
Since the burst of the housing bubble in 2008, the Mortgage & Financial Guarantee sector of the P/C industry has disproportionately weighed down the overall industry’s results and, because this line of business is written by only a few companies—some of them monoline carriers—it became common to report commercial lines insurers’ results excluding M&FG data. This continues to be the case, even though the line has returned to profitability.
Different segments of the industry saw different underwriting experience. The combined ratio for insurers writing mainly personal lines (mostly auto and homeowners insurance) declined to 103.1 in 2016:1H. In contrast, the combined ratio for insurers writing mainly commercial lines, excluding mortgage and financial guaranty insurers, rose to 96.0. And insurers writing mainly balanced books of business experienced a combined ratio of 99.6 in 2016:1H.
Investment performance: Improvement, but interest rates remain low
For the first half of 2016, net investment gains—which include net investment income plus realized capital gains and losses—fell by $5.06 billion (-16.0 percent) to $26.51 billion, compared to $31.56 billion in the first half of 2015. This is another application of the caution about point-to-point comparisons: 2016:1H compared to the year-earlier half year looks weak at least in part because the industry’s $31.6 billion in 2015:1H net investment gains were the highest for the first half of a year since ISO’s records began in 1986.
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
Net investment income itself has basically two elements—interest payments from bonds and dividends from stock. The industry’s net investment income for the first half of 2016 was $22.07 billion, compared to $23.40 billion in the first half of 2015 (down 5.7 percent). Most 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 half of 2016 moved in unexpected ways. As an indicator of prevailing interest rate levels, yields in Moody’s AAA-rated seasoned bond index averaged 3.6 percent in the first quarter of 2015, then rose to near 4.0 percent in 2015:Q2 as the economy was thought to be strengthening. In contrast, yields in 2016:Q1 averaged 3.9 percent, then slipped to 3.6 percent in 2016:Q2. And although the U.S. labor market seems to be improving, the Fed has reiterated that it expects interest rates to stay low for a substantial amount of time.
The bond market is still beset by the same forces that have held interest rates down since the Great Recession ended (officially, in June 2009): Unused capacity—in both capital resources and, by some measures, some slack in the labor markets; cautious consumer and business spending; low near-term future expectations for the economy; and low inflation expectations (and thus, low nominal bond yields).
The other significant source of net investment income (besides bond yields) is stock dividends. Seasonally adjusted, net dividends in 2016:Q1 were flat compared with 2015:Q1 and in 2016:Q2 fell by 0.9 percent vs. 2015:Q2. Stock holdings in general represent roughly only about one-sixth of the industry’s invested assets.
Realized capital gains
Realized capital gains in 2016:1H were $4.44 billion. Although this is slightly more than half of the 2015:1H result ($8.16 billion), it is actually a more or less typical result, at least by recent historical standards. Realized capital gains in the first half of 2012, 2013, and 2014 were $1.7 billion, $3.9 billion and $7.2 billion, respectively.
Policyholders’ surplus (capital/capacity): Sustained high demonstrates industry strength and resilience
Policyholders’ surplus as of June 30, 2016 stood at $680.6 billion—up $7.5 billion (+1.1 percent) from the year-earlier period. Policyholders’ surplus has generally continued to increase 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 financial crisis and Great Recession. It is worth noting that surplus increased despite very high catastrophe losses in 2011 and 2012. The fact that the industry was able to rapidly and fully recoup its losses to surplus even in the wake 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 2016 and beyond. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.75, close to its strongest level in modern history.
The property/casualty insurance industry turned in a profitable performance in the first half of 2016 but broke its string of consecutive quarters with an underwriting profit. In addition, policyholders’ surplus reached a new all-time record high. 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 half of 2016 follows.
To view the full report from ISO and PCI, click here.
First Half 2016 Financial Results*
|Net Earned Premiums
|Incurred Losses (Including loss adjustment expenses)
|Net Underwriting Gain (Loss)
|Pre-Tax Operating Gain
|Realized Capital Gains (Losses)
|Net After-Tax Income
|Surplus (End of Period)
*Figures may not add to totals due to rounding. Calculations in text based on unrounded figures.
**Includes mortgage and financial guaranty insurers.