PC First Half, 'Good, Bad and Ugly'

NU Online News Service, Sept. 26, 10:13 a.m.EST?The U.S. property and casualty industry's net incomeafter taxes rose 66.4 percent in first-half 2002, even as net worthof the firms was sagging, according to a study by two insurergroups.

Insurance Services Office Inc. in Jersey City, N.J., and theNational Association of Independent Insurers in Des Plaines, Ill.,reported net income for the sector increased to $4.6 billion from$2.8 billion in first-half 2001, primarily because of improvedunderwriting results.

Their study said the industry's surplus, or net worth, however,fell 2.3 percent to $282.9 billion at June 30 from $289.6 billionat year-end 2001 because of capital losses on investments.

Robert P. Hartwig, senior vice president and chief economist forthe Insurance Information Institute in New York, in a statement,called the results "good, bad and ugly."

"The good news is that the U.S. property-casualty insuranceindustry earned $4.6 billion in net income after taxes during thefirst half of 2002," he said. "That's also the bad news. Although$4.6 billion is a lot better than the $2.8 billion earned duringthe same period last year?it is, amazingly, $700 million less thanthe $5.3 billion earned during the first quarter of this year."

As for the "ugly" news, he said, "The industry's 3.3 percentstatutory rate of return through the first half of this year isbarely one-fourth of the industry's 12 percent cost of capital"?therate of return needed by the industry to be able to retain andattract capital over the long-run.

The report said the industry's net loss on underwritingdecreased 38.8 percent in first-half 2002 to $11.9 billion from$19.4 billion in first-half 2001, with acceleration in premiumgrowth and lower catastrophe losses contributing to the improvementin underwriting results.

Surplus declined in first-half 2002 largely because of $8.6billion in unrealized capital losses on investments as a result ofdeclines in stock markets. Those unrealized losses more than offsetadditions to surplus, including the industry's $4.6 billion in netincome, according to ISO and NAII.

The truly positive news, Mr. Hartwig said, is that net writtenpremium growth accelerated to 12 percent during the first halfcompared to 9.9 percent a year ago. He noted this is tempered bythe fact that investment gains (which consist of investment incomeand realized investment gains-losses) fell by 28.3 percent.

Similarly, he said, excitement over the drop in the combinedratio to 105 during the first half of this year from 111.1 lastyear is accompanied by concern over the $6.7 billion drop incapacity since year-end to $282.9 billion.

The 12-percent increase in written premiums in the first half of2002 is the largest first-half increase in premiums since 1987,when premiums rose 13 percent versus year-ago levels, the reportsaid.

John J. Kollar, ISO vice president for consulting and research,observed that, all else being equal, "one would expect premiums togrow in proportion to the economy. But, with just one exception,premium growth fell short of economic growth every year from 1988to 2000 as a result of softening in insurance markets."

Mr. Kollar added that, since then, insurance markets have beenfirming, "and the spread between premium growth and GDP growthwidened from 6.8 percentage points in first-half 2001 to 9percentage points in first-half 2002."

The figures are consolidated estimates for the entire industrybased on the reports of insurers that account for 96 percent of theU.S. p-c insurance business.

Catastrophe losses fell to $3 billion in first-half 2002 from$6.9 billion in first-half 2001, according to ISO's Property ClaimServices unit. At $3 billion, catastrophe losses through six monthshad fallen to their lowest level since first-half 1997, when therewere just $1.8 billion in catastrophe losses.

Overall loss and loss-adjustment expenses increased 3.9 percentto $134.3 billion in first-half 2002 from $129.3 billion infirst-half 2001, as non-catastrophe loss and loss-adjustmentexpenses rose 7.3 percent to $131.3 billion in first-half 2002 from$122.4 billion a year earlier.

According to ISO's PCS, other underwriting expenses?primarilyacquisition expenses, other expenses associated with theunderwriting process, pricing and servicing insurance policies, andpremium taxes?rose 7 percent to $45.9 billion in the first half ofthis year from $42.9 billion in the first half of last year.

Dividends to policyholders decreased 16.2 percent to $618million in first-half 2002 from $738 million in first-half2001.

The underwriting loss in first-half 2002 amounts to 7 percent ofthe $169 billion in premiums earned during the period, down from12.7 percent of the $153.5 billion in premiums earned during thecomparable period last year.

Don Griffin, NAII assistant vice president for business andpersonal lines, said the decline in catastrophe losses accountedfor 1.7 percentage points of the 6 percentage point improvement inthe industry's combined ratio for first-half 2002.

"The bulk of the improvement in the industry's combinedratio?4.3 percentage points?reflects the excess of growth inpremiums over growth in non-catastrophe losses and otherexpenses.," he said.

Reflecting the improvement in underwriting results, theindustry's net income after taxes rose despite a decline ininsurers' investment income and realized capital losses oninvestments.

Net investment income?primarily dividends earned from stocks andinterest on bonds?declined 4.9 percent to $17.8 billion infirst-half 2002 from $18.7 billion in first-half 2001. Insurersrealized $564 million in capital losses on investments infirst-half 2002, in contrast to the $5.3 billion in gains oninvestments realized in the first half of last year.

Combining net investment income and realized capital losses infirst-half 2002, the industry's net investment gain amounted to$17.3 billion, down 28.3 percent from $24.1 billion in first-half2001.

"The 4.9-percent decrease in investment income in first-half2002 versus year-ago levels reflects a decline in the yield oninvestments," noted Mr. Kollar. "Insurers' average holdings of cashand invested assets during the first half of 2002 were 1.2 percentabove their average holdings of cash and invested assets in thefirst half of 2001, but the annualized yield on cash and investedassets fell 6 percent."

He noted that with the average yield on 10-year Treasury noteshaving fallen from 4.93 percent in June to 4.26 percent in August,"and with pressure on the Federal Reserve Board to keep interestrates low to bolster a sagging economy and weak stock markets, lowyields are apt to impede the growth of investment income goingforward."

The industry earned $28 million in income from othermiscellaneous operations in the first half of this year, incontrast to losing $763 million on such operations in first-half2001. Pre-tax operating income?the sum of gains or losses onunderwriting, net investment income, and other miscellaneousincome?rose to positive $6 billion in first-half 2002 from negative$1.5 billion in first-half 2001.

Also contributing to the increase in net income after taxes, theindustry's federal income taxes fell 29.8 percent to $752 millionfor the first-half 2002 from $1.1 billion a year ago.

The $6.7 billion decline in the industry's consolidatedsurplus?its assets minus its liabilities?in first-half 2002compares with a $19.2 billon decline in first-half 2001. The $6.7billion decline in surplus reflects the excess of $8.6 billion inunrealized capital losses on investments, $3.3 billion in dividendsto shareholders, and $1 billion in miscellaneous charges againstsurplus over $4.6 billion in net income after taxes and $1.5billion in new funds paid in.

The $8.6 billion in unrealized capital losses on investment infirst-half 2002 is down $10.2 billion from $18.8 billion inunrealized capital losses in first-half 2001.

The $3.3 billion in dividends to shareholders is down $3.3billion from $6.6 billion in the first half of last year.

The $1 billion in miscellaneous charges against surpluscontrasts with $2.3 billion in miscellaneous additions to surplusin the first half of 2001.

The $4.6 billion in net income after taxes is up $1.9 billionfrom $2.8 billion during the first six months of 2001.

The $1.5 billion in new funds paid in compares with $1.1 billionin the first half of 2001.

Combining realized and unrealized capital losses, insurerssuffered $9.2 billion in overall capital losses on investments infirst-half 2002?an improvement from $13.5 billion in overallcapital losses in first-half 2001.

"While the increase in first-half net income is welcome news,the industry's recovery since last year's terrorist attack has beenhampered by adverse developments in financial markets," commentedNAII's Mr. Griffin.

"The decline in surplus in first-half 2002 reflects capitallosses on investments attributable to the tremendous weakness instock markets during the period as exemplified by the 13.8 percentdecline in the S&P 500 through the end of June," said Mr.Griffin.

He continued that given that the S&P 500 dropped a further15.8 percent from the end of June through Sept. 23, "and theuncertain outlook for stock markets, capital losses on investmentsmay continue to eat into insurers' surplus for some time tocome."