P/C insurers’ profitability drops in first-half of 2006

Increased competition will eventually undermine results, says industry analyst

The U.S. property/casualty insurance industry’s net income after taxes fell 9.3 percent to $28.3 billion in first-half 2006 from $31.2 billion in first-half 2005 as investment results deteriorated. Reflecting the decline in net income after taxes, the industry’s annualized rate of return on average surplus (net worth) fell to 13 percent in first-half 2006 from 15.6 percent in first-half 2005, according to ISO and the Property Casualty Insurers Association of America (PCI).

Contributing to the declines in net income after taxes and overall profitability, the industry’s net investment income — primarily dividends from stocks and interest on bonds — dropped 3.5 percent to $24.5 billion in the first half of this year from $25.4 billion in the first half of last year. Realized capital gains on investments (not included in net investment income) tumbled 66.4 percent to $0.9 billion in first-half 2006 from $2.6 billion in first-half 2005. Combining net investment income and realized capital gains, overall net investment gains fell 9.3 percent to $25.4 billion through first-half 2006 from $28 billion through first-half 2005.

Also contributing to the declines in net income after taxes and overall profitability, the industry incurred $12.3 billion in federal income taxes in first-half 2006 — 20.3 percent more than the $10.2 billion in income taxes the industry incurred in first-half 2005.

The figures are consolidated estimates for all private property/casualty insurers based on reports accounting for at least 96 percent of all business written by private U.S. property/casualty insurers.

Underwriting remains solid
Partially offsetting the deterioration in investment results and the increase in income taxes, insurers’ net gains on underwriting increased to $15.1 billion in first-half 2006 from $12.8 billion in first-half 2005. The combined ratio improved 1 percentage point to 92 percent in the first half of 2006 from 93 percent in the first half of 2005.

“While the hurricane season isn’t over and the potential for catastrophic losses from a natural disaster still remains, insurers’ underwriting results for first-half 2006 were very solid,” said Genio Staranczak, PCI chief economist. “At 92 percent, the combined ratio for first-half 2006 was the best first-half combined ratio since the start of quarterly records extending back to 1986. Insurers also earned profits on underwriting in the first-half of 2005, but catastrophe losses in the second half quickly erased those underwriting profits and more. It is also important to put first-half results in perspective. Insurers lost money on underwriting in the first half of each year from 2003 back to 1986. Summing first-half results for the past 21 years, the industry is still $129 billion in the red on underwriting.”

“Even if we aren’t struck by any major storms, we are already seeing signs that recent results are spurring increased competition in insurance markets not exposed to hurricanes and that increased competition will eventually undermine premium growth and underwriting results,” noted Michael R. Murray, ISO assistant vice president for financial analysis. “While stories about price increases and insurance availability problems in coastal states hammered by Hurricanes Katrina, Wilma and Rita continue to appear almost daily, the countrywide CPI for tenants’ and household insurance dropped 1.5 percent in second-quarter 2006 compared to its level a year earlier, and the CPI for motor vehicle insurance rose a scant 0.3 percent — far less than the 4 percent increase in consumer prices overall. Moreover, commercial insurance rates fell an average of 3 percent countrywide for accounts of all sizes, according to the Council of Insurance Agents and Brokers.”

Overall results
Overall underwriting results improved even though catastrophe losses increased. Catastrophes caused $5.3 billion in insured property losses in first-half 2006, up 71.8 percent from $3.1 billion in first-half 2005, according to ISO’s Property Claim Services (PCS) unit.

The improvement in underwriting results in first-half 2006 reflects the excess of growth in premiums over growth in loss and loss adjustment expenses, other underwriting expenses and dividends to policyholders.

Net written premiums climbed $6.4 billion to $223.3 billion in first-half 2006 from $216.9 billion in first-half 2005, with written premium growth accelerating to 2.9 percent in first-half 2006 from 2.2 percent in first-half 2005.

Net earned premiums rose $5.7 billion to $215 billion in first-half 2006 from $209.3 billion in first-half 2005, but earned premium growth slowed to 2.7 percent in first-half 2006 from 3.2 percent in first-half 2005 and a cyclical peak of 11.8 percent in first-half 2003. At 2.7 percent, first-half earned premium growth had slowed to its slowest pace since 1999, when earned premiums grew 0.9 percent.

Overall loss and loss adjustment expenses increased $0.2 billion, or 0.1 percent, to $141.3 billion in first-half 2006 from $141.1 billion in first-half 2005. Non-catastrophe loss and loss adjustment expenses declined $2 billion, or 1.4 percent, to $136 billion in first-half 2006 from $138 billion a year earlier.

Other underwriting expenses — primarily acquisition expenses, other expenses associated with underwriting, pricing and servicing insurance policies, and premium taxes — rose $3 billion, or 5.5 percent, to $58 billion in the first half of this year from $54.9 billion in the first half of last year.

Dividends to policyholders rose 16.9 percent to $0.6 billion in first-half 2006 from $0.5 billion in first-half 2005. The net gain on underwriting in first-half 2006 amounts to 7 percent of the $215 billion in premiums earned during the period, up from 6.1 percent of the $209.3 billion in premiums earned in first-half 2005.

“Premiums and losses both would have grown faster if not for a special development affecting reported results,” noted Staranczak.

“Even at an adjusted 3.5 percent, written premium growth in first-half 2006 fell far short of growth in the economy,” added Murray. “U.S. gross domestic product (GDP) — a dollar measure of national output — rose 6.9 percent in first-half 2006 compared to its level a year earlier. That premiums rose only about half as much as GDP is another indication that competition is leading to lower prices in many insurance markets, despite ongoing problems in specific markets affected by last year’s record catastrophe losses.”