Heavy use of foreign reinsurance and shifting investment strategies are helping U.S. property-casualty insurers emerge from a year marked by nearly $50 billion in direct insured property-catastrophe losses without a bottom-line disaster, experts say.

Through nine months, net income rose 4.4 percent to $28.8 billion, and the year-to-date combined ratio–at 100–was the second best nine-month ratio on record, according to a report by the Jersey City, N.J.-based Insurance Services Office and the Property Casualty Insurers Association of America in Des Plaines, Ill. What's more, consolidated surplus jumped 5.2 percent to $414.3 billion as of Sept. 30 from $393.8 billion at year-end 2004.

In a commentary published in conjunction with the figures, Robert Hartwig, senior vice president and chief economist for the Insurance Information Institute in New York, noted that the $20.4 billion surplus increase–attributable mainly to the $28.8 billion of net income and to new capital of $6.3 billion–”was not expected” in the wake of this year's hurricanes.

“The figure reflects the broad spread…of risk through heavy use of reinsurance–much of it foreign,” he said. “Consequently, a significant share of the impact on surplus associated with the storm season of 2005 will ultimately wind up on insurance industry balance sheets in countries like Switzerland, Germany, Great Britain, France and Bermuda.”

Another bright spot in the nine-month earnings picture was net investment income (consisting mainly of interest on bonds and stock dividends), which grew 14.9 percent after adjusting for special dividends (25.9 percent before adjusting). In contrast, in 2004, investment income grew 2.4 percent.

Mr. Hartwig explained that despite stronger cash-flow positions, flat or declining long-term interest rates dampened investment income levels in recent years. However, while the average yield on 10-year Treasury securities during the first nine months was 4.22 percent–not much different than comparable yields in 2003 and 2004–insurers have responded to a flattening yield curve by accumulating significant assets with very short maturities.

Coincidentally, the ISO/PCI results were published last week on the same day that the yield curve made front-page headlines in the Wall Street Journal and other financial newspapers. Those reports noted the 10-year Treasury yield slid below the two-year note to invert the yield curve (a typically upward sloping representation of bond yields plotted by maturity from shortest to longest).

For insurers, investment gains through nine months more than offset a $2.8 billion net underwriting loss, and when ISO compared total losses and expenses against net written premiums of $320.6 billion and net earned premiums of $309.9 billion, the combined ratio still managed to come in at just about break-even, or 100.

According to the ISO/PCI report, ISO's quarterly records date back to 1986, and within that timeframe, only the nine-month combined ratio for 2004 was better than last year's result–with the 2004 ratio coming in at 97.8.

The U.S. p-c insurance industry managed to post its break-even combined ratio in spite of $47.6 billion in direct insured losses from Hurricanes Dennis, Katrina, Ophelia and Rita–nearly double the $27 billion in direct property-catastrophe losses through nine months of 2004, according to ISO's Property Claim Services unit.

ISO estimates that net catastrophe losses impacting the bottom line for U.S. insurers writing on a voluntary basis were in the range of $27-to-$32 billion, up from $15.8 billion through nine-months 2004. ISO determined net catastrophe losses by reducing the direct loss figures for losses covered by residual market mechanisms and losses ceded to foreign reinsurers.

Commenting on the combined ratio result, Mr. Hartwig characterized it as “uncanny,” adding that the “surprisingly low” level stands as “stunning proof of the resilience of the industry.”

While catastrophe losses moved financial results off a record-breaking pace that had the industry on track to post its highest profit level prior to Hurricane Katrina and other storms, in the aftermath of the catastrophes other experts were also caught off guard by the relatively low nine-month combined ratio. In fact, full-year combined ratio forecasts put forth by rating agencies just within the last few weeks now look pessimistic in light of the ISO/PCI report.

James Auden, an analyst for Fitch in Chicago, said the ISO/PCI report figures came as “quite a surprise,” adding that Fitch's recent forecast for a full-year combined ratio of 105.5 isn't likely to hold up. Now, he suspects that a better projection might be around 101 for the year.

One factor contributing to the difference, he said, is a lower level of net catastrophe losses indicated by the ISO/PCI report. Fitch's 105.5 forecast anticipated $56 billion in net catastrophe losses for U.S. insurers–nearly $10 billion higher than the ISO figures reveal. “That's 2.5 combined ratio points right there,” he noted.

Mr. Auden still expects continued development of hurricane losses to push the full-year result higher than the break-even nine-month figure. Even insurers don't yet know the full extent of their losses from third-quarter catastrophes, he added.

“What the ISO results do demonstrate is the amount of loss that's in the reinsurance market–in Lloyd's and Bermuda,” he said.

In Fitch's “Review and Outlook” report published last month, the rating agency estimated that global reinsurers lost $18-to-$20 billion in surplus as a result of catastrophe losses. While this is a significant chunk, equating to 5-to-6 percent of year-end 2004 surplus, it's a manageable portion, Fitch said, keeping a stable outlook on the reinsurance sector.

Standard & Poor's, which has a negative outlook on the reinsurance sector, had offered a less pessimistic forecast of the primary insurance year-end combined ratio than Fitch, putting its estimate at 102.5.

According to Mr. Hartwig, a survey of analysts indicated an expected combined ratio of 97.9 for 2006. While S&P estimates a higher 2006 level–at 99.5–Fitch projects the same 97.9 figure, and Mr. Auden said the ISO/PCI results haven't prompted him to rethink that.

There are two considerations involved in that projection, he said. Fewer catastrophes in 2006 are likely to bring the combined ratio down from the 2005 level, he said. On the other hand, if better-than-expected underwriting results continue to hold up for the year, there will be less of a push for rate increases in 2006.

For 2005, the ISO/PCI report reveals weak premium growth figures for the first nine months and third quarter of 2005–a 0.5 percent decline in written premiums for nine months and a 6.0 percent decline in the quarter. But ISO and PCI reported that industry results were impacted by a transaction in which one unidentified U.S. insurer ceded $6 billion in premiums and losses to its foreign parent. Excluding this transaction, net premiums for the industry rose 1.3 percent for the first nine-months.

Even the adjusted 1.3 percent premium growth figure, however, is a record low according to ISO records dating back to 1986, the report said. Even after adjusting for the transaction, the third-quarter saw a slight decline–0.5 percent–representing the first such drop in ISO's records.

Mr. Hartwig said analysts are forecasting premium growth of 2.5 percent for full-year 2005, and 4.9 percent in 2006.

The ISO/PCI figures are consolidated estimates for p-c insurers accounting for about 96 percent of all business written in the United States.

Tables: ***Add source lines to each….Source: ISO/PCI

Special Reports /

Despite Disaster Losses, Industry Profits Higher Through Nine Months

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