Private U.S. property/casualty insurers saw their net written premium growth slow to 3.4 percent in 2015 from 4.2 percent a year earlier, while their net income after taxes grew to $56.6 billion in 2015 from $55.9 billion in 2014, according to ISO, a Verisk Analytics (Nasdaq:VRSK) business, and the Property Casualty Insurers Association of America (PCI).

Insurers’ overall profitability as measured by their rate of return on average policyholders’ surplus remained virtually unchanged at 8.4 percent, even though their combined ratio deteriorated to 97.8 percent from 97.0 percent and their net underwriting gains declined to $8.7 billion from $12.2 billion. Insurers’ net investment income increased to $47.2 billion in 2015 from $46.4 billion a year earlier, but realized capital gains decreased to $9.4 billion from $10.3 billion, resulting in $56.6 billion in net investment gains for 2015, essentially unchanged from 2014.

Analysis and Discussion

Dr. Robert P. Hartwig, CPCU, and Dr. Steven N. Weisbart, CLU

The property/casualty insurance industry had another year of moderate profits in 2015, as measured by a return on average surplus of 8.4 percent, virtually the same as in 2014. Challenged by continuing low interest rates and a slumping stock market, the industry nevertheless posted modest premium growth and a below-100 combined ratio for the fourth straight year. Overall industry capacity (policyholder surplus) slipped slightly to $673.7 billion as of December 31, 2015, but was still extraordinarily strong, as measured by a premium-to-surplus ratio of 0.76—virtually the strongest it has ever been.

Performance and Profitability Drivers

 The industry’s performance in 2015 could be characterized as its “new normal,” neither as profitable as in 2013 nor as affected by catastrophes as in 2011 and 2012. Indeed, in many respects, 2015 looked a lot like 2014.

One contributor to positive underwriting performance in 2015 was continued net written premium growth. Net written premiums in 2015 crossed the half-trillion-dollar mark (to $514.0 billion), although the rate of increase slipped slightly to 3.4 percent growth from 4.2 percent in 2014. Net earned premium growth also slowed in 2015 (growing by 3.7 percent) compared to 2014 (4.4 percent growth over 2013).

There are two main drivers of premium growth in property/casualty insurance: 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 determined mainly by inflation and by the health and growth of the U.S. economy (including factors such as population growth and composition, household formation, housing preferences, and more). By most measures, inflation continued to be remarkably low; the Consumer Price Index for 2015 was near zero (actually +0.1 percent). Real (inflation-adjusted) GDP growth in 2015 remained at 2.4 percent (it was also 2.4 percent in 2014), although the annual rate masked starts and stops during the year (2015:Q1 growth rate was 0.6 percent, 2015:Q2 was 3.9 percent, 2015:Q3 was 2.0 percent, 2015:Q4 was 1.4 percent, all expressed at annual rates).

Exposure growth in key areas of the economy such as new vehicle sales (at record-breaking levels, according to some reports), business investment, industrial production, construction and overall employment growth (the second-best yearly job gains since 1999, trailing only 2014) raised the value of exposures covered by the P/C insurance industry. With the pace of real GDP growth expected (at this writing) to slow in 2016 to somewhere in the range of 1.8 to 2.3 percent, personal and commercial lines exposures—and the premiums they generate—should continue to rise modestly. With premiums for personal lines and some commercial lines (such as workers comp) trending positively, overall industry premium growth could continue to slightly lag the rate of overall economic growth in 2016, as was the case in 2015.

Continuing improvement in labor market conditions in 2015 also aided top line growth in the P/C insurance industry. Job growth benefits the entire economy, of course, but it directly affects workers compensation insurers. Compared to employment in December 2014, the U.S. economy added 2.8 million nonfarm jobs by December 2015 (not seasonally adjusted)—the second highest yearly job growth numbers in the 21st century. Combined with pay raises for continuing workers, payrolls rose $319.1 billion by year-end 2015, driving billions of dollars in new premiums for workers compensation coverage in 2015. This job growth is likely to continue, though at a somewhat slower pace; the economy is getting closer to full employment, but there is still slack in the labor market (for example, the numbers of “involuntary part-time” and “discouraged” workers are still above their typical levels in prosperous times) and wage increases appear to be slightly higher than the rate of inflation. As a result, if economic growth and hiring continue as projected, workers compensation exposure is likely to remain among the faster-growing major P/C lines of insurance in 2016.

The other major determinant of industry premium growth is rate activity. Rates are a function of a number of forces, but perhaps the most important is past and expected-future claims. Net of reinsurance recoveries, incurred losses and loss adjustment expenses for all lines in 2015 rose to $350.2 billion, up 4.6 percent from $334.9 billion in 2014.

Premium growth in 2015 was significantly different for the personal lines vs. commercial lines. Insurers writing primarily personal lines saw premium growth of 5.2 percent—down from 5.8 percent in 2014 but still quite strong. Insurers writing primarily commercial lines saw premium growth of 1.4 percent—down even more sharply from 2014 (which had a growth rate of 2.9 percent)—and those with balanced books of business saw premium growth of 3.6 percent.

Catastrophe Losses and Underwriting Performance

Some of the credit for positive underwriting performance in 2015 can be attributed to what has come to be thought of as “moderate” catastrophe losses. Back in the 1990s, a “normal” CAT year produced claims in the high-single-digit billions of dollars. Fifteen billion in catastrophe claims was unusually high. In the last 15 years CAT losses reached or exceeded $30 billion six times. From the viewpoint of the combined ratio, in the 28 years prior to Hurricane Hugo in 1989, CAT claims rarely added even 2.5 percentage points. But since Hurricane Hugo in 1989, there have been only seven years (out of 28) in which CATs added fewer than 2.5 percentage points to the industry’s combined ratio. In 2014, ISO and PCI estimated U.S. catastrophe losses at $15.5 billion. In 2015, wildfires, winter storms, hail storms and tornadoes all took their toll, but there was no single event that did enormous damage; still, total U.S. CAT claims in 2015 were estimated to be $15.2 billion. The overall result in underwriting during 2015 was such that the industry’s combined ratio rose only slightly to 97.8, compared with 97.0 in 2014.

Claims Reserve Releases

In addition to premium growth and moderate catastrophe losses, favorable development of prior-year claims reserves in 2015 totaled $8.0 billion, a notable decrease from the $11.2 billion in reserve releases in 2014, according to ISO/PCI. Reserve releases are generally associated with lower-than-expected costs for claims occurring in past accident years.

Investment Performance: Interest Rates Remain Low

For the full year 2015, net investment gains (which include net investment income plus realized capital gains and losses) were unchanged from 2014 at $56.6 billion. 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 2015

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 2015 was $47.2 billion, compared to $46.4 billion in 2014 (+1.9 percent). Most of this income comes from the industry’s bond investments, which are mainly high quality corporates and municipals.

The environment for bond investing in 2015 was challenging. Average monthly corporate bond market yields in 2015, as captured by Moody’s AAA-rated seasoned bond index, dropped from 3.8 percent in December 2014 to near 3.5 percent for the first four months of 2015, then rose to about 4.0 percent for the last eight months of 2015, ending at 3.97 percent. For perspective, yields in 2014 were somewhat higher (4.25 percent or higher for the first half of the year and 3.9 percent or higher for most of the last half of the year, except December). For 2016, the environment is not expected to change materially from 2015.

The U.S. economy still faces the same forces that have held interest rates down for the past few years: unused capacity (in both capital resources and labor); cautious consumer and business spending; low near-term future expectations for the economy; and Federal Reserve actions to keep short-term interest rates low, all of which contributed to low inflation expectations. Further, although the Federal Reserve Open Market Committee has begun raising short-term rates, it has signaled that it will do so gradually and depending on economic data, so that most forecasters do not expect interest rates to rise much in 2016.

The other significant source of net investment income (apart from bond yields) is stock dividends. In 2015, market-wide net dividends from all common and preferred stock were fairly steady at $888.6 billion, about 3.3 percent above levels achieved in 2014. For the industry on average stock holdings constitute roughly only about one-sixth of the industry’s invested assets.

Realized Capital Gains

Realized capital gains in 2015 were $9.4 billion, compared to $10.3 billion in 2014. The broad stock market was essentially flat in 2015, providing few 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 Continued Strength and Resilience

Policyholders’ surplus as of December 31, 2015 stood at $673.7 billion, down $1.5 billion or 0.23 percent from year-end 2014. Thanks to a surging stock market until 2015, policyholders’ surplus has generally continued to increase with the end of the Great Recession and three consecutive years without large-scale catastrophe losses. But the lack of stock gains in 2015 ended (or at least stalled) this trend. 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 2016 and beyond. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.76, close to its strongest level in modern history.

The property/casualty insurance industry turned in another year of good performance in 2015 in terms of underwriting performance and overall return on average surplus (profitability). In addition, policyholders’ surplus remained near an all-time record high. Profitability benefited again, as it did in 2013 and 2014, from moderate catastrophe losses and prior-year reserve releases. 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.

To view the full report from ISO and PCI, go to http://www.verisk.com/downloads/InsuranceResultsReport2015Q4.pdf