Although there were fewer catastrophic events in 2014 than in previous years, net income after taxes for private U.S. property and casualty (P&C) insurers for the first nine months of the year dropped by $5.1 billion to $37.7 billion, compared to $42.7 billion over the same time period in 2013, according to new figures released by ISO, a Verisk Analytics business, and the Property Casualty Insurers Association of America (PCI). Overall profitability, measured by the annualized rate of return on average P&C policyholders’ surplus, also dropped from 9.4% in the first nine months of 2013 to 7.6% over the same period in 2014.

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

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

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

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

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Insurance file folders with claims categories

Causes for the decline

The decrease in P&C insurers’ pretax operating income is attributed to a deterioration in underwriting results, with net gains on underwriting down to $4.3 billion in the first nine months of 2014 from $10.3 billion in the first nine months of 2013. ISO and PCI noted that the combined ratio, which is a key measure of losses and other underwriting expenses per dollar of premium, climbed to 97.7% for the first three quarters of 2014, up from 95.8% in the first three quarters of 2013.

Net written premiums continued steady growth, rising 3.9% in the first nine months of 2014 over the same period in 2013, but claims-related expenses rose faster, said Dr. Robert P. Hartwig, CPCU, and Dr. Steven N. Weisbart, CLU, of the Insurance Information Institute, in a statement. P&C companies need to maintain combined 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 president for financial analysis, “The deterioration in underwriting results raises questions about the quality or sustainability of insurers’ earnings.” He also found other factors raising similar questions about earnings, including:

  • The extent to which underwriting results benefited from favorable reserve development and the absence of hurricane losses
  • The extent to which insurers’ net income benefited from realized capital gains dependent on developments in financial markets
  • Reports indicating commercial insurance markets may soon start to soften as a result of excess capacity.

Policyholders’ surplus

According to Hartwig and Weisbart, 2013 was an unusually strong year. For perspective, they noted that profits for the first three quarters of 2012 were $27.8 billion and for the comparable period in 2011 were $8.0 billion.”

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

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

Financial results with upward arrow

Results for M&FG insurers

P&C insurers’ 7.6% annualized rate of return for the first three quarters of 2014 was affected by a significant decline in rates of return for mortgage and financial guaranty (M&FG) insurers. According to ISO estimates, the annualized rate of return for M&FG insurers on average surplus fell to 14.8% for the period 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 billion for the same period in 2013. Their net earned premiums fell 11% to $3.8 billion from $4.3 billion. But the loss and loss adjustment expenses (LLAE) rose to $1.8 billion from $0.3billion in 2013 as their other underwriting expenses increased to $1.2 billion from $1 billion. As a result, the segment’s net gains on underwriting dropped by $2.2 billion to $0.8 billion from $3.0 billion in 2013.

Overall results

For the third quarter 2014, the industry overall achieved its 18th consecutive quarter of growth in written premiums, following 12 quarters of declines, said Gordon. “Moreover, the 95.5% combined ratio for third quarter 2014 was 9.9% better than the 105.3% average for the third quarter based on quarterly records extending back to 1986.”

There are two main drivers of premium growth in the P&C insurance industry: exposure growth and rate activity, according to Hartwig and Weisbart. They said that exposure growth—that is, an increase in the number and value of insurable interests (such as property and liability risks)—is driven mainly by economic and demographic growth and development. The other important determinant they found in industry premium growth is rate activity. “Rates tend to be driven by trends in claims costs, conditions in the reinsurance market, marketing and distribution costs, and investments in technology, among other factors,” they said. Both of these 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 insurers financial results for the first nine months of 2014, click here. For more commentary and analysis by Hartwig and Weisbart, click here.