For the first three quarters of 2018, the property/casualty industry’s financial results were strongly profitable, thanks to positive contributions from insurance operations and investments.
The property/casualty industry’s financial results for the first three quarters of 2018 were quite profitable. This year’s $49.5 billion net income after taxes was the highest since the Great Recession (2010 through 2018) (Figure 1).
The turnaround in profitability of insurance operations is most visible in the net underwriting gains metric: $4.7 billion in net underwriting gains in 2018 vs. $21.0 billion in net underwriting losses in 2017.
In terms of rates of change, comparisons with the comparable period in 2017 might be somewhat misleading, since the industry’s overall profit and its underwriting performance in the prior comparable period — first three quarters of 2017 — produced the second-worst nine-month profit result since the end of the Great Recession.
Despite the large profit, the industry’s return on average surplus hit only 8.6 percent (on an annualized basis) for the first nine months. This merely equals the profitability readings of 2014 and 2015. Industry surplus, the denominator of the profitability fraction — is growing. Surplus hit another peak (Figure 2) largely due to the — at the time — surging stock market.
Net written premiums in the first three quarters of 2018 grew by $48.1 billion (+11.4 percent); in the comparable period in 2017 they grew by $16.2 billion (+4.1 percent) (Figure 3). As Figure 3 shows, an 11.5 percent rate of net written premium growth is far above what the industry has posted consistently every year since 2007.
Net earned premiums also grew sharply, by $37.8 billion (+9.3 percent), compared to the first three quarters of 2017. As noted before, the sharp upturn in net written and net earned premium is partly a result of changes some insurers made in their use of reinsurance, in response to provisions of the tax reform act that became law at the end of 2017.
The one-time tax play aside, 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 (Figure 4).
Overall economic growth in the first nine months of 2018 was stronger than expected at this stage of recovery from the Great Recession; real (inflation-adjusted) GDP rose at a rare 4.5 percent rate in the second quarter and 3.5 percent in the third quarter of 2018. Based on economic performance in the past several decades, one would have expected growth nearer to half of those rates. But the growth spurt is not expected to last. Early predictions for the fourth quarter of 2018 are in the mid- to high- 2 percents, and many are forecasting even lower growth in 2019.
Relatively strong exposure growth in 2018 involved both personal and commercial lines of insurance. On the personal side, sales of new cars and light trucks (including SUVs and minivans) were on pace to top 17 million units for the fourth year in a row, continuing a shift away from cars toward larger, heavier personal vehicles that, being more expensive to buy and to repair, bring higher physical damage premiums. On the commercial side, business investment in structures, equipment and software has continued more strongly than expected, and employment has grown more strongly than expected, spurring growth in commercial property and workers compensation exposures.
However, it is important to look at the data as granularly as possible to note significant variations in trends. For example, on the personal insurance side, homeowners exposures have grown quite slowly; a still-higher-than-usual share of the growth in housing units is in multi-unit structures (apartments and condos), representing smaller value/risk increases per insured than would be the case if these units were detached single-family homes. On the commercial side, part of the surge in business investment in structures and equipment was centered on the energy sector (i.e., oil and gas drilling), particularly in periods in which prices for oil and gas had been rising. If you exclude business investment in this sector in 2018, the exposure growth in structures and equipment, while positive, was not such a spurt.
Employment growth in the first nine months of 2018, at 1.70 million (seasonally adjusted), was the third-highest first-9-month growth since the Great Recession (2.02 million in 2014 and 1.75 million in 2016). Moreover, growth in higher risk occupations, such as construction and manufacturing, was stronger in the first nine months of 2018 than in the first nine months of any year since the Great Recession. Note, however, that exposure growth does not automatically and directly translate into premium growth; many other factors—for example, such as the degree of competition, market regulation, and expected claims—also can play a significant part.
The broadest conventional measure of underwriting results is the combined ratio—the percentage of losses, loss-adjustment expenses, and all other non-investment expenses—outgo—to premiums—income. A ratio above 100 percent means insurance operations were unprofitable; one under 100 percent indicates profit. For the first nine months of 2018, the property/casualty industry combined ratio was 97.3 percent. The comparable figure for 2017 was 104.1 percent. (Figure 5).
Regarding losses and loss-adjustment expenses, we can consider them as having three components: (1) catastrophe claims and adjustment expenses; (2) non-catastrophe claims and adjustment expenses; and (3) changes in reserves for claims attributable to prior years. The trends in these components differ. Catastrophe claims are quite variable; non-catastrophe claims are generally predictable; and reserve changes are in between. The improvement in the combined ratio resulted from a drop in catastrophe claims and an increase in reserve releases.
Non-catastrophe claims reached $297.4 billion in the first nine months of 2018, up 6.4 percent from the comparable period in 2017. Some of this increase comes from exposure growth, some from inflation and some is random variation.
Catastrophe (CAT) claims were $25.9 billion, down $13.1 billion (-33.7 percent) from the comparable period in 2017. This drop should not be taken as a low level of CAT claims; 2017, with its three major hurricanes (Harvey, Irma, and Maria), wildfires, and other natural catastrophes, was an unusually high catastrophe year.
For several years, insurers have been releasing reserves for prior-year claims even when some observers thought they would not be able to do so. This year, not only did the pattern of reserve releases continue, it actually increased. For the first nine months of 2018, insurers released $11.3 billion of loss reserves, up from a $6.7 billion release in the first nine months of 2017. This release contributed to lowering the numerator in the 2018 combined-ratio fraction by 2.5 percentage points.
Growth in demographics/economics can increase claims as well as it raises exposures/ premiums. For example, in the workers compensation (WC) line of business, 2018 saw more factory job creation than in in any year since 1997. These jobs are more hazardous than many jobs in the services part of the economy, commanding higher WC premiums. In addition, wage increases that had been inching up since the end of the Great Recession grew on average by 3 percent in the first nine months of 2018 over 2017. More workers, particularly in riskier occupations, earning higher incomes generally bring more, and more expensive, workers compensation claims, as indemnity benefits are linked to wages.
For the first three quarters of 2018, net investment gains (which include net investment income plus realized capital gains and losses) rose vs. the year-earlier period—up by $1.4 billion (+2.8 percent) to $50.2 billion, compared to $48.8 billion in 2017. To keep this rise in perspective: although this is a record for net investment gains in dollar terms for the industry’s first nine months (Figure 6), it is possible that the plunge in the stock market in the fourth quarter of 2018 will generate capital losses that keep the full calendar year result shy of a record.
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 2018 was $40.9 billion, up by 15.7 percent from $35.4 billion in the first three quarters of 2017. 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, generally were higher throughout 2018 than in 2017. In the first quarter of 2018 they averaged 3.75 percent; in the second quarter averaged 3.94 percent; and in the third quarter averaged 3.91 percent. This compares to a falling trend and generally lower yields (3.96, 3.80, and 3.65 percent) for the first three quarters of 2017. In general,
The other significant source of net investment income (besides bond yields) is stock dividends, which rose slightly during the first three quarters of 2018. The level of dividends in third quarter 2018 was 2.9 percent higher than in the third quarter a year earlier. Stock holdings in general represent between one-fifth and one-fourth of the industry’s invested assets.
Only realized capital gains and losses affect insurer net income; unrealized capital gains and losses affect policyholders’ surplus. Realized capital gains from the first three quarters of 2018 were $9.3 billion, down from $13.5 billion through the first three quarters of 2017.
As the third quarter ended, most forecasters were lowering their predictions for global growth rates and equity market performance.
Driven in part by unrealized capital gains, policyholders’ surplus as of September 30, 2018, stood at $781.5 billion—its highest level ever. Policyholders’ surplus has generally increased in recent years as industry profits rose and as assets in the industry’s investment portfolio increased in value in the wake of recovery from the financial crisis and the Great Recession.
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 bottom line is that the industry is, and for the foreseeable future will remain, extremely well capitalized and financially prepared to pay very large scale losses in 2019 and beyond.
The combined effect of underwriting profits and an uptick in investment gains produced an overall 8.6 percent rate of return on average surplus (profitability) in the first three quarters of 2018—more than double the 4.2 percent in the first three quarters of 2017. Policyholders’ surplus hit a record. This was thanks in part to continued exposure growth. Also premium growth, while still modest, is now experiencing its longest sustained period of increases in a decade. Fundamentally, the property/casualty industry remains quite strong financially, with capital adequacy ratios remaining high relative to long-term historical averages.
An industry income statement for the first three quarters of 2018 follows.
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