Although there were fewer catastrophic events in 2014 than inprevious years, net income after taxes for private U.S. propertyand casualty (P&C) insurers for the first nine months of theyear dropped by $5.1 billion to $37.7 billion, compared to $42.7billion over the same time period in 2013, according to new figuresreleased by ISO, a Verisk Analytics business, and the PropertyCasualty Insurers Association of America (PCI). Overallprofitability, measured by the annualized rate of return on averageP&C policyholders’ surplus, also dropped from 9.4% in the firstnine months of 2013 to 7.6% over the same period in 2014.

According to ISO and PCI, the drop was driven by a decline inpretax operating income with the decline partially offset by anincrease in realized capital gains on investments and lower federaland foreign income taxes. Insurers’ pretax operating income (thesum of net gains or losses on underwriting, net investment incomeand miscellaneous other income) fell by $8.9 billion to $36.6billion in the first nine months of 2014 from $45.5 billion in thefirst nine months of 2013.

On a positive note, the P&C insurers’ realized capital gainson investments—not included in operating income—rose $2.8 billionto $8.8 billion in the first nine months of 2014, compared to $6.0billion in the first nine months of 2013. Net investment income was$34.3 billion, the same for the first nine months of 2013 and2014.

Federal and foreign income taxes fell by $1.1 billion to $7.7billion in the first three quarters of 2014 from $8.8 billion inthe first three quarters of 2013.

The 2014 third quarter results are consolidated estimates forall private P&C insurers based on reports accounting for atleast 96% of all business written by private U.S. P&Cinsurers.

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Causes for the decline

The decrease in P&C insurers’ pretax operating income isattributed to a deterioration in underwriting results, with netgains on underwriting down to $4.3 billion in the first nine monthsof 2014 from $10.3 billion in the first nine months of 2013. ISOand PCI noted that the combined ratio, which is a key measure oflosses and other underwriting expenses per dollar of premium,climbed to 97.7% for the first three quarters of 2014, up from95.8% in the first three quarters of 2013.

Net written premiums continued steady growth, rising 3.9% in thefirst nine months of 2014 over the same period in 2013, butclaims-related expenses rose faster, said Dr. Robert P. Hartwig,CPCU, and Dr. Steven N. Weisbart, CLU, of the Insurance InformationInstitute, in a statement. P&C companies need to maintaincombined ratios below 95 to earn their cost of capital in a“still-challenging interest rate environment,” they explained.

According to Michael R. Murray, ISO’s assistant vice presidentfor financial analysis, “The deterioration in underwriting resultsraises questions about the quality or sustainability of insurers’earnings.” He also found other factors raising similar questionsabout earnings, including:

• The extent to which underwriting results benefited fromfavorable reserve development and the absence of hurricanelosses
• The extent to which insurers’ net income benefited fromrealized capital gains dependent on developments in financialmarkets
• Reports indicating commercial insurance markets may soon startto soften as a result of excess capacity.

Policyholders’ surplus

According to Hartwig and Weisbart, 2013 was an unusually strongyear. For perspective, they noted that profits for the first threequarters of 2012 were $27.8 billion and for the comparable periodin 2011 were $8.0 billion.”

Comparing the third quarter 2014 results ($673.9 billion) toyear-end 2013 results ($653.4 billion), Robert Gordon, PCI’s seniorvice president for policy development and research said that the$20.5 billion increase in policyholders’ surplus is “a testament tothe strength and safety of insurers’ commitment to policy holders.”Additions to surplus in 2014 included insurers’ $37.7 billion innet income after taxes, $7.1 billion in unrealized capital gains oninvestments (not included net income) and $4.2 billion in new fundspaid in. Those additions were partially offset by $23.6 billion individends to shareholders and $4.8 billion in miscellaneous othercharges against surplus.

Limiting their comparison to the first three quarters of 2014versus the same period in 2013, Hartwig and Weisbart observed thatthe $673.9 billion represented a gain of $50 billion (8%) inoverall industry capacity as measured by policyholders’ surplus(better known as net worth in other industries).

Results for M&FG insurers

P&C insurers’ 7.6% annualized rate of return for the firstthree quarters of 2014 was affected by a significant decline inrates of return for mortgage and financial guaranty (M&FG)insurers. According to ISO estimates, the annualized rate of returnfor M&FG insurers on average surplus fell to 14.8% for theperiod from 34.4% for the first three quarters of 2013.

M&FG insurers saw their net written premiums fall by 11.8%to $3.4 billion for the first nine months of 2014 from $3.9 billionfor the same period in 2013. Their net earned premiums fell 11% to$3.8 billion from $4.3 billion. But the loss and loss adjustmentexpenses (LLAE) rose to $1.8 billion from $0.3billion in 2013 astheir other underwriting expenses increased to $1.2 billion from $1billion. As a result, the segment’s net gains on underwritingdropped by $2.2 billion to $0.8 billion from $3.0 billion in2013.

Overall results

For the third quarter 2014, the industry overall achieved its18th consecutive quarter of growth in written premiums, following12 quarters of declines, said Gordon. “Moreover, the 95.5% combinedratio for third quarter 2014 was 9.9% better than the 105.3%average for the third quarter based on quarterly records extendingback to 1986.”

There are two main drivers of premium growth in the P&Cinsurance industry: exposure growth and rate activity, according toHartwig and Weisbart. They said that exposure growth—that is, anincrease in the number and value of insurable interests (such asproperty and liability risks)—is driven mainly by economic anddemographic growth and development. The other important determinantthey found in industry premium growth is rate activity. “Rates tendto be driven by trends in claims costs, conditions in thereinsurance market, marketing and distribution costs, andinvestments in technology, among other factors,” they said. Both ofthese factors are expected to contribute to P&C insurers’top-line growth for the rest of 2014 and into 2015.

For more detailed information about the P&C insurersfinancial results for the first nine months of 2014, click here. For more commentary and analysis by Hartwig and Weisbart,click here.