P-C Insurers Post Record Combined Ratio, As Net Income Soars To $64 Billion

During an interview with NU, Mr. Murray said he believes 2006 has been somewhat mischaracterized as an abnormally low disaster year, describing it instead as normal for catastrophe losses.

He cited other factors contributing to the stellar underwriting result, including favorable auto claims frequency trends, overall loss reserve releases totaling about $6 billion for prior years, federal class-action reform and state tort reforms.

Highlighting the impact of reserve releases, Fitch Ratings analysts in New York and Chicago reported early this month that it was the "first time in recent memory" industrywide underwriting results benefited from favorable development. They said the reversal, in part, reflects the fact that the 1997-to-2001 problematic accident years have finally matured.

The Fitch report–which tabulated results for 50 publicly traded insurers writing $249 billion in earned premiums–said total reserve releases shaved 1.3 points off the overall 2006 combined ratio. (Fitch results are based on generally accepted accounting; ISO figures employ statutory accounting used for reporting to U.S. insurance regulators.)

Mr. Murray said that in addition to reserve releases, improved auto frequency and tort reform trends, "the fruits of the prior hard market were being harvested" in 2006, noting that the favorable trends all coincidentally converged in what he termed a "Goldilocks fashion," making everything "just right" for insurers last year.

"More often than not in the insurance industry, everything breaks wrong. Once in awhile, we catch a break," he said.

The break was nearly record-breaking, as the 92.4 combined ratio beat a 2004 combined ratio of 98.4, which was the last ratio under 100, according to records retained by NU. It also came in better than 2003′s 100.1 ratio (which had a lower level of catastrophe losses than 2004), and still lower than 1997–which, at 102, was the only other year at all close to 2006 in the decade.

In those years, ISO/PCI commentaries typically reported on what the combined ratios would have been had Mother Nature been kinder. For example, for 2004, the groups reported that the 98.4 combined ratio would have been 97.3 had cat losses come in at the lower 2003 level. And in 2003, the 100.1 actually recorded would have been 98.2 had cat losses been at the 2002 level.

However, even with normalized levels of catastrophe losses, those years were far from the 2006 result, which was the best since 1935, according to Robert P. Hartwig, president of the Insurance Information Institute in New York. "So extraordinary is the 2006 underwriting result that it is unlikely to be repeated for decades," he said in a written commentary.

Indeed, insurers "abhor making a profit," said Mr. Murray, citing evidence of downward pricing, indicating insurer gains are already being competed away in 2007.

Genio Staranczak, PCI's chief economist, said during a media conference call that high profits inevitably lead to increased competition and lower rates.

Over the long term, insurers have not been profitable, the experts agreed.

"Cumulatively, even including last year's record gain on underwriting, insurers suffered net losses on underwriting totaling $135.3 billion during the 10 years ending 2006," Mr. Murray wrote in ISO's report.

Mr. Staranczak added that declines in investment yields have eaten into insurer returns. "The average yield on insurers' cash and invested assets dropped from 7.3 percent during the decade ending 1986 to… 4.8 percent during the decade ending 2006," he said. "Individual insurers must now achieve better underwriting results than they did in the past just to achieve the same level of overall profitability."

Although signs of price cuts were evident last year, the industry managed to post an increase in net written premiums, which climbed 4.3 percent to $443.8 billion.

The seeming disparity between falling price indicators and rising overall net premium levels has several explanations.

The often-cited quarterly surveys from the Washington-based Council of Insurance Agents and Brokers, which revealed insurance price declines between 6- and 10 percent last year, for example, only reflect one side of the market–the commercial side, experts noted.

On the personal lines side, however, Mr. Murray said that overall prices are also dropping countrywide. Citing a U.S. government consumer price index for tenants and households insurance, he said it fell nearly a full percentage point in 2006, marking the first annual decrease in this CPI since it was first recorded in 1999.

As some individual insurers redeploy capacity away from the coasts, and others raise prices in cat-exposed areas, "rates for homeowners insurance are actually coming down in the Heartland," he said.

According to Highline Data (a sister company of NU), direct written premiums before reinsurance cessions rose less than net premiums in 2006, with the direct figures rising 1.5 percent in 2006, suggesting another possible reason why net premiums grew while prices fell–higher insurer retentions.

As U.S. insurers take on increased exposures and retain more of the premiums they once ceded to foreign reinsurers, are the lower prices they're charging consumers still adequate to cover the exposures?

"Obviously, if you look at media accounts along the coasts, there are insurers who do not believe they are," Mr. Murray said. "It's too easy to talk about the insurance market as if it's one large monolithic thing," he added, noting that the maxim "location, location, location" is as applicable to insurance as it is to real estate.

During a media conference call, Mr. Murray and the other experts were forced to repeat the same arguments in response to the opposite question–whether prices are unjustifiably excessive given the magnitude of insurer profits.

"You have look at the profit figures from a longer-term perspective," Mr. Staranczak advised. "We had a very crummy year in 2001, when we actually lost money because of 9/11." He added that the p-c industry's return on equity was 7 percent over the last decade, compared with 13 percent for Fortune 500 companies.

According to Mr. Hartwig, "to look at $63.7 billion as a measure of what should happen to homeowners rates in Florida, Louisiana or Mississippi is not appropriate," noting that insurance laws require each type of insurance within each state "to stand on its own financially."

"It's also unfair" to use auto insurance profits from drivers in Buffalo, N.Y., or workers' compensation profits from employers in western New York to subsidize homeowners in Florida, he said, responding to a reporter from Buffalo, who went on to question why rates aren't falling more in his area.

For the industry overall, in his written commentary Mr. Hartwig examined historical peaks and troughs in profits since 1975, predicting that the next profit peak won't occur until 2015 at the earliest.

In the meantime, he predicted a 14 percent return for 2006 will fall to 12.5 percent in 2007, 10 percent in 2008–then to low single digits, possibly as early as 2010.

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