Property/Casualty Insurance – 2015 First Half Results

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

Highlights The U.S. property/casualty industry had a strong first half in 2015. Overall net income after taxes (profits) in the property/casualty (P/C) insurance industry increased by $5.0 billion (up 19.2 percent) in the first half of 2015 to $31.0 billion from $26.0 billion in the year earlier period. The industry’s overall rate of return (profitability) on capital—as measured by policyholders’ surplus— rose from 8.1 percent in the first half of 2014 to 9.2 percent in the first half of 2015. Both insurance operations and investments contributed to the strong showing.

Net written premium growth continued at its prior pace—up 4.1 percent in the first half of 2015, the same rate of growth as in the first half of 2014. The industry’s insurance operations, as captured in its combined ratio, improved by 1.3 points to 97.6 during the first half of 2015 compared to 98.9 a year earlier. (A ratio under 100 means that the industry paid out less in claims and expenses than it took in via premiums; lower is better.) Maintaining combined ratios below 100 is absolutely essential in order for the industry to continue posting reasonable levels of profitability in an interest rate environment that remains challenging. Despite the low interest rates, the industry’s $31.6 billion in net investment gains—consisting of net investment income plus realized capital gains—were the highest for the first half of a year since ISO’s records began in 1986.

The industry results were released by ISO, a Verisk Analytics company, and the Property Casualty Insurers Association of America (PCI).

Profitability Drivers: Modest Claims Growth Helps

The property/casualty industry’s performance in the first half of 2015 was positive but bore the effects of an extreme winter and several outbreaks of severe spring weather. 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 4.1 percent in the first half of 2015, the same growth rate as in the first half of 2014. In general, premiums grow for several reasons. One is because there is growth in the number and/or value of insurable interests (such as property and liability risks). Another reason is because there is an increase in the willingness of buyers who had little or no insurance to purchase or add to their insurance protection, net of those who reduce or drop it. A third reason is an increase in rates.

Exposure growth is driven primarily by economic growth and development. The commonly used measure of economic growth is real (inflation-adjusted) GDP; in the first half of 2015 it rose at an estimated annual rate of 2.3 percent. But for insurance premium purposes, the better indicator of exposure growth is nominal—not inflation-adjusted—GDP growth, which was approximately 3.5 percent for the first half of 2015. So we can infer that although economic growth contributed to the 4.1 increase in net written premiums, that is not the whole story.

From the available data it is not easy to determine to what extent premium growth is coming from an increase in insurance buyers. Continued strong growth in the number of people employed—especially those employed full-time— suggests that some people who had previously been un- or underinsured 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.

Job growth benefits the entire economy, of course, but expanding payrolls benefit workers’ compensation insurers in particular. The U.S. economy added 1.69 million nonfarm jobs in the first eight months of 2015; if that rate is sustained through the rest of the year, there will be 2.6 million more workers than at the end of 2014. Combined with slightly above inflation-level increases in employees’ earnings (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 being earned by workers’ compensation insurers in 2015. How long this level of exposure growth in workers’ compensation can be sustained is hard to forecast; an increasing number of 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 premi ums could keep pace with overall economic growth in 2014.

Growth in key areas of the economy such as new vehicle sales, multi- unit residential construction, and consistent employment and payroll growth are clearly benefiting the P/C insurance industry. For the remainder of 2015 and into 2016, the consensus forecasts call for nominal GDP growth to hold steady at about 3.5 percent.

Different segments of the industry saw different premium flows. Net written premiums for insurers writing mainly personal lines (mostly auto and homeowners insurance) was 5.3 percent in 2015:1H, down 0.4 percentage points from the comparable period in 2014. In contrast, net written premiums for insurers writing mainly commercial lines, excluding mortgage and financial guaranty insurers, grew 2.2 percent in 2015:1H, down 0.5 percentage points. And insurers writing mainly balanced books of business saw net written premiums grow at 5.0 percent, up 0.7 percentage points. 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. In the first half of 2015, the industry’s experience with catastropherelated losses improved vs. 2014—from $13.0 billion a year ago down to $10.8 billion this year (down 16.9 percent). In contrast, non-cat losses rose to $160.5 billion from $155.2 billion (up 3.4 percent). As a result, total claims rose by 1.8 percent, to $171.3 billion. Clearly, the small rise in claims costs in relation to four percent premium growth contributed to increased profits. Profits would have risen even if catastrophe claims costs had been just as high as in the first half of 2014, but the fact that they fell in the first half of 2015 also contributed to profitability.

Reserve Releases

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 2015, the industry reported releases of prior-year claims reserves totaling $8.1 billion, up slightly from $7.9 billion in the first half of last year.

Combined Ratio and Underwriting Profits

The industry’s overall underwriting profit of $3.39 billion on a combined ratio of 97.6 in the first half of 2015 far surpassed the $0.24 billion profit for the first half of 2014. However, the first-half numbers blur the experience of two very different calendar quarters in 2015. Net underwriting gains for the first quarter were $4.06 billion and for the second quarter were $0.67 billion in losses. 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) was unchanged (at 100.1) in 2015:1H vs. 2014:1H. In contrast, the combined ratio for insurers writing mainly commercial lines, excluding mortgage and financial guaranty insurers, dropped by 0.8 percentage points, to 94.3. And insurers writing mainly balanced books of business saw a combined ratio fall from 104.0 in 2014:1H to 99.4 in 2015:1H.

Investment Performance: Improvement but Interest Rates Remain Low

For the first half of 2015, net investment gains—which include net investment income plus realized capital gains and losses— rose by $1.4 billion (+4.5 percent) to $31.6 billion, compared to $30.2 billion in the first half of 2014. 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 2015 was $23.4 billion, compared to $23.0 billion in the first half of 2014 (up 1.6 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 2015 were lower than in the first half of 2014. As an indicator of prevailing interest rate levels, yields in Moody’s AAA-rated seasoned bond index averaged 4.5 percent in the first quarter of 2014, then receded to 4.2 percent in 2014:Q2. In contrast, yields in 2015:Q1 averaged 3.6 percent, held at 3.5 percent in April, then “spiked” to 4.1 percent in May and June 2015. And although the U.S. economy is improving, the Fed has reiterated that it expects interest rates to stay low for a substantial amount time. The small increase in investment income mainly reflects the rise in the amount of invested assets net of the effect of reinvestment of longer-term maturing bonds at lower prevailing interest rates than the previous investments paid.

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, higher-than-normal unemployment, especially considering the low employment/ population ratio and labor-force participation rate; 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 2015:Q1 rose by 2.5 percent (compared with 2014:Q1) and in 2015:Q2 rose by 2.6 percent vs. 2014:Q2. Stock holdings in general represent roughly only about one-sixth of the industry’s invested assets.

Realized Capital Gains

Realized capital gains in 2015:1H were $8.2 billion. This is a relatively strong 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, 2015 stood at $672.4 billion—up $0.35 billion (+0.5 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 2015 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.

Summary

The property/casualty insurance industry turned in a profitable performance in the first half of 2015. In addition, policyholders’ surplus reached a new all-time record high. Despite an unusually costly winter and a number of costly springtime catastrophes, rising non-cat losses, and persistently low interest rates, the industry posted another profitable quarter aided by capital gains and 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.

A detailed industry income statement for the first half of 2015 follows.

To view the full report from ISO and PCI, go to http://www.verisk.com/ downloads/InsuranceResultsReport2015Q 2.pdf