By Robert P. Hartwig, Ph.D.
Vice President & Chief Economist
Insurance Information Institute
bobh@iii.org
The property/casualty insurance industry reported a statutory rate of return of 6.7 percent (on an annualized basis) through the first nine months of 2000, up from 5.6 percent during the first half of 2000 and 1999’s return of 6.6 percent. The results were released by the Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).
The Light at the End of the Tunnel: Getting Brighter
Financial results through the first three quarters of 2000 continue to indicate that the financial performance of the property/casualty insurance industry is gradually improving. The modest pace of the recovery suggests that insurers will likely experience an extended period of generally improving earnings in the years ahead, assuming normal levels of catastrophe losses.
Wall Street continues to signal this belief by sharply bidding up the stock price of most property/casualty insurers in spite of generally bear market conditions, a trend that began late in the first quarter. Positive developments in the first nine months of 2000 included:
- a 4.6 percent increase in net written premium (compared to 4.2 percent through the first half of 2000 and full-year 1999 growth of just 1.9 percent)
- a 2.2 percent increase in net investment income (compared to 1.5 percent through the first half of this year and a 3.3 percent drop in investment income in calendar year 1999)
- rising returns on statutory surplus
- a 2.1 percent decrease in surplus from end-1999
Premium Growth
The 4.6 percent increase in net written premium is the result of both strong (though slowing) economic growth and greater pricing discipline on the part of insurers. More risk appropriate pricing in catastrophe-prone areas is also a factor.
Pricing
Pricing remains the single most important factor in the industry’s current turnaround. Conning & Company and several major investment banks report that spring, summer and fall 2000 renewals for the commercial segment were up across the board for the first time in years. Conning reported that fall 2000 commercial rates were up more than eight percent compared to a decline of seven percent during the fall of 1998. Workers compensation, the largest of the commercial lines and the line in the greatest need of relief, is leading the way with increases averaging 9.5 percent, followed closely by commercial auto at nine percent. Combined ratios in both lines exceeded 115 in 1999. The commercial multiperil and general liability lines are also benefiting from the significantly improved pricing environment. Pricing in the commercial property, umbrella, and excess and surplus lines is also recovering. Increases of six to nearly nine percent are now the norm. Surveys by leading investment banks and other groups corroborate the Conning figures.
On the personal lines side, the price war in the personal auto line shows some signs of abating. The Insurance Information Institute estimates that personal auto rates in 2000 will rise an estimated 1.5 percent, the first increase in three years. Additional increases of two to four percent are likely in 2001. Rates fell 2.8 percent in 1998 and 3.2 percent in 2000 due, in part, to improving fundamentals but also to intense competition between insurers. The price cutting led to huge underwriting losses at many companies with personal lines operations and was a significant factor in the $6.7 billion (43.9 percent) increase in the first nine-month’s net underwriting losses. These losses have compelled many insurers to hold the line on further decreases in many states and are compelling them to raise rates in others.
Outlook for 2001: The Best in Years
The year ahead is pivotal for property/casualty insurers. Recovery means maintaining pricing discipline; a task which could become somewhat more difficult in the face of a slowing economy. Nevertheless, this year’s clear signs of recovery bode well for 2001 and were confirmed in a recent I.I.I. survey of Wall Street analysts. Indeed the forecasts for 2001—for the first time in many years—show an industry with significantly improved growth prospects and a slight improvement in underwriting performance.
Premiums
The consensus forecast for 2001 calls for an increase in net written premiums of 7.0 percent. If realized, the industry will grow at its fastest pace in nearly 15 years. Moreover, estimates for net written premium growth in 2000 have been revised significantly upward to 5.2 percent (from 2.9 percent in 1999’s survey). As mentioned previously, industry premiums grew by just 1.8 percent and 1.9 percent in 1998 and 1999, respectively, the smallest increases in post-World War II history.
Combined Ratio
The combined ratio for 2001 is projected to be 108.7, down from an estimated 109.7 this year. If realized, the industry will see its first decline in the combined ratio since 1997. The improvement is again attributable to a rebound in pricing in key lines, but successful management of expense ratios and lower catastrophe losses are also playing a role. In 2000, catastrophe losses are likely to be less than half the $8.3 billion recorded last year. The combined ratio projections for 2001 assume normal levels of catastrophe activity.
Economic Activity and Exposure Growth
The United States economy is slowing rapidly. The nation’s real (inflation-adjusted) gross domestic product surged 7.6 percent during the first quarter 2000, compared with the same period in 1999 while growth in the second quarter was a robust 5.6 percent. The third quarter, however, saw a marked decrease to just 2.4 percent, the slowest quarterly increase since the third quarter of 1996. The impact of the economy on the property/casualty insurance industry’s fortunes cannot be underestimated. A slew of negative economic statistics having impacts on exposure growth for property/casualty insurers include the following:
Investment Income
The 2.2 percent increase in investment income may at first appear to be unimportant, yet is actually one of this year’s most significant developments. Rising investment income during the first three quarters of 2000 indicates that the property/casualty insurers are on track to end a two-year slide in earnings on investments, which fell by 3.3 percent last year and 3.9 percent in 1998.
The Federal Reserve’s shift toward an anti-inflationary bias in 1999 led to several rate hikes during the second half of 1999 and the first half of 2000. However, the Fed’s actions have had little impact on long-term interest which have been held down by surprisingly high federal surpluses. Instead, short- term interest rates have increased substantially over the past year. Three-month treasury bills were yielding 6.3 percent in early December, compared to 5.3% a year earlier. Thirty-year mortgage rates, however, fell from a high of 8.6 percent in May 2000 to 7.5 percent in early December.
The current inversion of the yield curve (a situation where short-term rates are higher than long-term rates) is beneficial to insurers—especially as premium income continues to accelerate. Insurers will have more new dollars to invest at relatively high yields, with virtually no interest rate risk.
Relatively low long-term interest rates and the possibility that the Fed is likely to reverse course in 2001 with one or more rate cuts as the economy continues to decelerate make the possibility of recession less likely. Long-term interest rates could rise if a tax-cut plan is passed by the new president’s administration, leading to smaller federal surpluses and more pressure on credit markets.
The View from Wall Street: Back from the Brink
Wall Street was unkind to the property/casualty insurance industry in 1999. On a market cap weighted-basis, industry stocks lost 25.7 percent of their value, compared to a gain of 21.0 percent for the Standard & Poor’s 500 index. Life insurers as a group declined 9.6 percent.
All eyes in 1999 and early 2000 were on the technology-laden Nasdaq. “Old Economy” industries such as insurers, manufacturers and retailers lagged far behind the returns in so-called “New Economy” industries related to the Internet, telecommunications and biotechnology. The Nasdaq began to plummet, however, after reaching its peak of 5048.62 on March 10. During the remainder of that month and through most of the year, insurer stocks staged a strong comeback. Prior to the comeback, the prices of many insurer stocks were at their lowest levels in years.
By early December, the property/casualty group on a year-to-date basis had recorded a total return of 41.5 percent compared to a decline in the Nasdaq of 28.3 percent. The divergence is far more dramatic when measured from the Nasdaq peak on March 10. Since the bursting of the tech bubble, the Nasdaq has declined by 42.2 percent (through December 8) compared to a gain of 75.7 percent for the property/casualty group, a performance gap of nearly 120 points. The results for multiline insurers, life/health insurers and brokers—which have posted gains of 80.5 percent, 79.1 percent and 57.1 percent, respectively, are similarly dramatic.
The surge in interest in insurance stocks continues to be driven by several factors, including the ongoing shakeout among dot-coms and other tech stocks, rising earnings and relatively low valuations for insurance stocks, and the prospect of investing at a point that could mark a turn in the insurance cycle leading to improved profitability.
Surplus & Capacity
Of lesser concern is the $7.0 billion decline in surplus since year-end 1999. The decline represents just 2.1 percent of industry surplus and does not represent a threat to insurer solvency. Moreover, analysts have estimated the industry’s “excess” capital at $100 billion to $125 billion (based on a premium-to-surplus ratio of 1.2 to 1). If insurers are able to grow net income while at the same time reducing surplus, returns on equity will rebound quickly. Some insurers are also working to reduce excess capacity through stock buybacks and large dividend payouts, both of which reduce capacity by reducing surplus. Industry surplus will likely contract further during the fourth quarter of 2000 because of continued bearish stock market conditions.
A detailed industry income statement for the first nine months of 2000 follows:
