How Were NU Profit Leaders Determined?

o Must be an individual insurer that is not part of a larger group, or be an organization that reported combined results to regulators in 2005 (combined filers).

In some cases, combined filers do not include every company we may recognize as a member of an insurance group. For example, Zurich Group consists of two combined filers: Farmers Insurance Group (ranked 158) and Zurich Insurance Company Group (ranked 184).

o Must have reported non-negative combined ratios on its regulatory filings in each of the six years from 2000-2005.

This requirement eliminated from our analysis 43 insurance organizations that did not report underwriting data sufficient to calculate combined ratios for each of the last six full years.

Among the insurers eliminated by this requirement were the U.S. operations of Bermuda start-up Arch Capital (recording an average combined ratio of 87.7 over the last four years) and specialty insurer, three-year-old James River Insurance Group, based in Richmond, Va. (with a three-year average combined ratio of 89.8).

o Must have reported net written premiums greater than $100 million in the latest full year.

With this requirement, we attempted to eliminate insurers that are too small to produce reliable combined ratios that are indicative of actual performance. When premium levels are extremely small, minimal losses or sizeable loss levels in a single year can skew six-year average ratios.

To be consistent with our prior analysis, we applied this size requirement to the most recent year only. Extending this requirement over the entire six-year period of our analysis, however, would have produced more credible results and booted top-ranked Stonebridge Casualty from our list.

In 2000 and 2001, the affiliate of Dutch life insurer Aegon, with less than $20,000 in net p-c premiums in each year, recorded combined ratios of 22.4 and 46.1, respectively, pushing the overall six-year average down to 76.3. In contrast, the average combined ratio for the most recent three years was roughly 102.

o Must not specialize in lines not traditionally considered property-casualty lines.

Specifically, our criteria excluded filers with 75 percent of their 2005 premiums in financial or mortgage guaranty, accident and health, surety, fidelity, credit or "other write-in" lines from analysis, thereby dropping 13 insurance organizations that would have otherwise ranked among the top-25 profit leaders (mainly mortgage and financial guaranty insurers).

The limitation, however, was not enough to eliminate three significant writers of accident and credit lines of business– Stonebridge Casualty, Courtesy Insurance and IDS Property Casualty–from contention for the profit leaders' title. (See related article, page 12 for details.)

Taken together, our criterion reduced the universe of property-casualty organizations to 221. Among these, we have classified 111 as commercial writers (shown on page 14). These organizations recorded 55 percent or more of their 2005 net written premiums in commercial lines, while 86 others recorded at least 55 percent of their premiums in personal lines. (See page 19.) The remainder had mixed books of business.

Profit Measure

The starting point of our analysis is the "U.S. Insurance" product of NU affiliate Highline Insurance Data Services–a monthly CD-ROM-based product which compiles annual statement data reported to U.S. insurance regulators.

The database contains variables to allow users to immediately capture six full years of combined ratios for reporting insurance entities, leading us to choose the six-year average combined ratio as the principal measure of profit for our analysis.

(While a longer-term average would provide a better of picture of long-term profit trends, we worked within the six-year limit to allow Highline Data's subscribers to reproduce our results.)

The Profit Leaders tables published in this issue rank the entities based on their six-year average combined ratios from lowest to highest. Six-year averages, however, are not sufficient to isolate insurance organizations that are consistently profitable. A company reporting three years at a combined ratio of 75 and three at a dismal 125 has a breakeven average, for example. With that in mind, we added a volatility measure to the accompanying charts.

Our volatility index ranges from a low level of 2.2 percent for the insurer with the tightest range of combined ratio results–Beverly, Mass.-based Electric Insurance Company, a multi-line, multi-state insurer tracing its roots and 40 percent of its customer base to employees of General Electric–to a high of 224 percent for Mississippi Farm Bureau, with its roots among farmowners and ranchowners. This carrier reported net results in only one state–Mississippi–where the homeowners line was pummeled with storm losses in 2005, producing a combined ratio for that year that was nearly 350 points above the average of the prior four.

To give further insight into the consistency of results, we highlighted five consistently stellar performers in green on the accompanying Leaders chart (page 13). These cream-of-the-crop insurers reported combined ratios that fell among the 50 lowest in each of the six years studied.

At the other end of the spectrum, 10 consistently poor performers, highlighted in red on our list on our Laggards chart (page 20), reported combined ratios among the 50 worst for every year from 2000 to 2005.

Two-year operating ratios are also shown on the accompanying charts. These short-term profit indicators include a measure of investment performance.

Omaha, Neb.-based Berkshire Hathaway, which reported significant combined ratio swings in 2001 and prior, was the third best ranked entity based on two-year operating ratios. They finished behind Deerfield, Fla.-based Courtesy and Johnston, Iowa.-based crop insurer Agri General.

Proceed With Caution

Beyond the problems with averages, for some insurers combined ratios are a particularly poor measure of profitability.

One such statistical anomaly, as we indicated last year, is Delaware-based Nuclear Electric Insurance, which still had the worst six-year average combined ratio among the groups we analyzed, but has actually been quite profitable in some years.

Insuring nuclear utilities for the costs of interruptions, decontaminations and other risks, in fact, was such a profitable business in 2003, for example, that Nuclear Electric reported the best loss ratio among all the insurers we analyzed for that year.

Distributing high dividends from underwriting and investment earnings, however, landed the combined ratio at the bottom of the list.

Combined ratios are only one measure of profitability–and an imperfect measure of financial strength. Rating agencies, for example, review underwriting profit together with capitalization, parental support, risk management and other factors before opining on financial strength. And because of the size of the entities included in our list, many of the companies are not rated by the major rating firms.

The editors who compiled our rankings have not attempted to analyze financial statements or audit data. As such, we have accepted the data as reported, making no attempt to determine whether loss reserves are sufficient, reinsurance is recoverable, or other items impacting underwriting income are accurately reported.

We note that had we performed a similar analysis in the 1990s, Reliance Group, with combined ratios consistently below 100, would likely been listed among the profit leaders before its eventual insolvency.

Further highlighting the problems inherent in accepting reported data at face value, we note that just two months after our profit rankings were published last year, Transguard Insurance, a trucking insurer that we had listed as the second-most profitable insurer, reported adverse loss development significant enough to prompt a ratings downgrade from A.M. Best (from "A-minus" to "B-double-plus").

It was not an accounting restatement or underwriting losses in the last two years, however, that removed Transguard from the profit leaders published in this issue. With premiums falling below $100,000 in 2005, the company failed to meet the size requirement for inclusion in this report.

Had Transguard met the size requirement, even though its most recent six years of combined ratios now average 93.5–more than 15 points above the one published in last year's report–Transguard would still have ranked among the top-25 profit leaders.