<b>By Robert P. Hartwig, Ph.D.
Vice President & Chief Economist
Insurance Information Institute</b>
bobh@iii.org
The property/casualty insurance industry reported a statutory rate of return of 7.3 percent (on an annualized basis) through the first three quarters of 1999, down from 10.0 percent during the same period in 1998. The industry’s rate of return for the third quarter of 1999 was 3.1 percent compared with 9.8 percent in the third quarter of last year and 9.2 percent for calendar year 1998. The results were released by the Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).
Performance, Pricing and Capacity
Two factors stand out in the nine-month results: the 51.8 percent surge in net underwriting losses and the $9.9 billion decline in surplus since year-end 1998.
<b>Underwriting Performance</b>
Underwriting losses through the first nine months of 1999 were sharply higher despite accelerating premium growth and lower catastrophe losses during the third quarter. What remains to explain the surge is the cumulative effect of the intensely competitive pricing environment over the past few years. Simply stated, much of the business written in 1998 and 1999 was underpriced and higher underwriting losses are among the inevitable consequences of chronic underpricing. Loss and loss adjustment expenses were up 4.6 percent to through the first nine months of 1999 compared to the same period in 1998. The inability of most property-casualty insurers to offset mounting underwriting losses with investment gains (down 3.3 percent) or additional premiums (up just 1.8 percent) during the bearish third quarter led to a relatively poor earnings outlook and sent many property-casualty stocks plummeting to 52-week lows by early October. Under pressure from Wall Street, a number of insurers announced restructurings designed to cut costs, increase efficiency and jump-start revenues.
<b>Pricing</b>
Of paramount importance is the recognition that chronic underpricing cannot persist indefinitely. This message has gotten through to the top (and back down to the bottom), but price discounting—especially in commercial lines—has built-up freight train-like momentum over the past few years. Fortunately, it appears as though this runaway train is coming to a screeching halt. Conning and Company’s most recent agent survey revealed that the key commercial lines are renewing with far smaller discounts during Fall 1999 than six months or a year ago. The average workers’ compensation renewal was –2.9 percent in Fall 1999 compared to –9.7 percent in the Spring and –14.1 percent in Fall 1998. Likewise, general liability policy renewed at –0.8 percent compared to –10.1 percent one year ago. Similar trends are evident in excess & surplus lines, commercial multi-peril, commercial property, commercial auto and umbrella coverages. Conning’s findings are echoed by similar surveys conducted by investment bankers.
<b>Surplus & Investments</b>
Of lesser concern is the $9.9 billion decline in surplus since year-end 1998. The decline represents just three percent of industry surplus and does not represent a threat to insurer solvency. Moreover, it is merely transient. As mentioned in the ISO release, unrealized capital losses of $15.7 billion were largely responsible for the decline. The third quarter was a bearish one in both the stock and bond markets. The S&P 500 Index dropped 6.2 percent during the quarter while intermediate-term interest rates rose by 5 to 10 basis points (a basis point is equal to 1/100 of a percentage point). The bear markets also sliced into the industry’s ability to produce income from realizing capital gains. Since October 1, however, the S&P 500 Index has more than recouped its third quarter losses, surging into record territory by early December. On December 3, the S&P 500 was up 16.6 percent for the year compared with 4.4 percent at the end of the third quarter. Interest rates, however, rose an additional 10 to 15 basis points reflecting the Federal Reserve’s recent decision to raise rates. Higher interest rates erode capital gains but boost investment income. While investment income through the first nine months of 1999 is down 3.3 percent, it is better than the 4 to 5 percent decline that had been anticipated for the year.
Despite the resurgence of the stock market, higher underwriting loss and declining investment income combined with continued consolidation among insurers is slowing the rate of surplus formation among property/casualty insurers. The industry’s surplus grew at an average annual rate of 10.7 percent during the 1990s (through year-end 1998), but rose just 8.1 percent last year. Because surplus is synonymous with capacity, decelerating and even negative surplus growth might be viewed as welcome news by some Wall Street analysts because shrinking capacity often portends hard(er) markets and higher share prices.
<b>Combined Ratio</b>
The industry’s combined ratio of 106.4 through the first nine months is consistent with expectations. The Insurance Information Institute’s annual "Early Bird" survey of industry analysts, released in November, produced a consensus estimate of 106.2 for 1999 and 106.9 in 2000. The report also suggests that the third quarter’s uptick in premium growth is not a mere blip in the data and will likely be sustained into the new year. The consensus estimate for growth in net premiums written in 2000 is 2.9 percent.
Shaping the Future
Shifting the focus away from short-term financial results, it is important to note several important developments affecting the industry’s long-term growth prospects that occurred in recent months:
<b>Financial Services Modernization:</b> Signed by President Clinton on November 12, this long-awaited piece of legislation swept away provisions in the Glass-Steagall Act of 1933 and the Bank Holding Act of 1956 that barred affiliations among banks, securities firms and insurers. The stock prices of many insurers gained 20 to 25 percent after Congress reached agreement on legislation in October.
<b>World Trade Organization Membership for China</b>: Inked in Beijing on November 15, China will now get U.S. backing in its bid to join the WTO in 2000. If successful, the markets in the world’s most populous country—and one of its fastest growing nations–—would become accessible to U.S. insurers. Presently, insurance premiums per capita in China are about $11 and account for just 1.5 percent of gross domestic product (GDP) compared to $2,571 in the United States and 8.5 percent of GDP.
<b>Metropolitan Life Demutualization:</b> The news in late November that Met Life had filed registration papers for what might be the biggest initial public offering (IPO) in history produced a buzz on Wall Street normally reserved for companies ending in "dot-com." The IPO, which could raise up to $6.5 billion, will likely make Met Life the most widely held stock in America as the ownership interest of the company’s 11 million-plus policyholders is converted to stock. An IPO of this magnitude and breadth of ownership is could rekindle institutional investor interest in the insurance sector as a whole and introduce the insurance industry to the rapidly growing legions of technology-fixated direct traders.
Closing the Chapter on the 1990s
The 1990s is likely to be a decade that will go down in infamy for the insurance industry. Pricing in the property/casualty and reinsurance sectors remained soft for much of the decade. The underwriting cycle, a twentieth-century fixture of the property/casualty insurance business, never (re)appeared. Capacity and competition grew even as catastrophes saddled insurers with nearly $90 billion in losses during the 1990s–a figure unimaginable in 1989. The GAAP return on equity for the property/casualty insurance sector during the 1990s was an estimated 8.6 percent compared to 12.7 percent for the Fortune 500 group. Thousands of insurers disappeared or sold significant pieces of their business. Across all-industry segments, there were more than 3,000 mergers and acquisitions valued at nearly $400 billion.
The decade ahead is full of promise and uncertainty. The nascent trends toward firmer prices and faster premium growth are hopeful signs. The impacts of globalization, deregulation, financial services reform and integration will take years to unfold. Better management of catastrophic risk will likely bear fruit during the first decade of the next century while the promise and challenges of technology loom large.
Detailed industry income statements for the first nine months and third quarter of 1999 follow:
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