Industry Profits Rise, But Price Competition Hurts Long-Term Growth

Property-casualty profits remained solid through the first three quarters of 2007, but intensifying price competition--resulting in zero net premium growth thus far--is threatening to undermine the bottom line, making 2008 a critical year in determining whether insurers learned their lessons from past soft market debacles.

Industrywide results reported quarterly by the Insurance Services Office Inc. and the Property Casualty Insurers Association of America showed that for the first nine months of 2007, p-c net income after taxes rose more than 7 percent compared with the same period for 2006--from $46.1 billion to $49.4 billion.

Meanwhile, policyholders' surplus--the industry's net worth, measured according to Statutory Accounting Principles--also rose 7 percent, up $35.6 billion to $521.8 billion.

However, ISO noted some slippage in overall profitability measured by its annualized rate of return on average policyholder surplus, which fell from 13.8 percent to 13.1 percent.

In addition, net gains on underwriting dropped 25.3 percent--from $24.3 billion for the first nine months of 2006 to $18.1 billion for same period this year.

The combined ratio over the period worsened by 2.3 points, going from 91.5 over the first three quarters of 2006, to 93.8 this year.

However, despite signs of deterioration, the fact is the industry as a whole has only recently been posting underwriting profits of any kind, or combined ratios below the magic 100 profitability figure.

In fact, ISO's assistant vice president for financial analysis, Michael R. Murray, pointed out that the industry's combined ratio of 93.8 is the second best for the first three quarters of any year since 1986.

However, he said, for insurers to reach an average rate of return of 13.9 percent--the long-term average for Fortune 500 companies--the p-c industry's combined ratio needed to be one point better.

How long the industry can keep up its stellar profitability figures is a big question, given the softening market's impact on premiums, with growth pretty much coming to a standstill this year.

While net earned premiums rose $4.1 billion to $329.3 billion over the period compared with 2006, earned premium growth slowed to 1.3 percent in 2007, compared with 4.7 percent for the first nine months in 2006.

Net written premiums were unchanged at $337.6 billion, compared with 5.1 percent premium growth through three quarters in 2006.

PCI's chief economist, Genio Staranczak, said that 2007's zero written premium growth would have been a record low were it not for one carrier ceding $6 billion in premiums to a foreign parent back in the nine-month period of 2005.

Examining losses, the ISO-PCI report said overall net loss and loss adjustment expenses, after reinsurance recoveries, increased 3.4 percent to $219.6 billion.

Excluding catastrophe losses, ISO and PCI said they estimate that net loss and loss adjustment expenses increased 6.2 percent to $214.5 billion in the first nine months.

Once again, insurers enjoyed a respite from any backbreaking catastrophe losses--the second quiet storm season following record hurricane losses in 2004 and 2005.

Indeed, catastrophe losses declined--from $7.8 billion in direct insured losses in the first nine months of 2006 to $4.8 billion this year.

Net catastrophe losses--including development of losses form the catastrophic hurricanes of 2005--dropped from $10.3 billion in 2006 to $5 billion in 2007.

While premium growth has virtually ground to a halt, investment returns provided some cushion.

Net investment income grew 5.4 percent to $39.5 billion during the first three quarters, while capital gains soared more than 5.5 times--from $1.5 billion in 2006 to $8.2 billion this year. Combining the two, overall net investment gains jumped 22.5 percent to $47.7 billion in 2007, up from $39 billion in 2006.

Robert P. Hartwig, president of the Insurance Information Institute, said results for the first nine months "are generally excellent, and so far have proven surprisingly resilient" in the face of the intense competition for business.

If the underwriting deterioration holds true to form as in past cycles, however, the industry's return on equity will bottom out in 2011 at about 1- or 2 percent, and not become profitable again until 2015 or 2016, he said.

"The most important question facing the industry today is whether this painful and destructive cycle can be broken, and with it, the commensurate surge in insurer impairments that invariably occur," according to Mr. Hartwig.

However, one mitigating factor, he said, is that changes in standard business practices from the past by carriers may be making a difference, translating into "a shallower market cycle" and a more modest dip in profits.

"Insurance CEOs continue to vow that it will be different this time around, and 2008 is quickly shaping up to be the year when the industry's fortunes will be cast," he said.

He went on to warn that insurers need to generate adequate returns for investors, maintain their financial strength and credit ratings, and avoid regulatory sanctions.

"A financially weak insurance industry is of no use to anyone, including policyholders--millions of whom depend on the industry to pay hundreds of billions of dollars in claims each year," he said.

He went on to note that while the p-c sector has shown results that bode well for the rest of 2007, and starts 2008 on a strong note, a deteriorating underwriting performance due to heightened price competition will mean more dependence on investment gains for earnings--"a shift that has already begun."

Zero growth in premiums means the industry's organic growth "has come to a screeching halt, and is, in fact, severely negative on an inflation-adjusted basis."

Slow premium growth, coming on top of surging surplus, he added, means "insurers face very difficult capital allocation decisions over the next several years."

With a lot of excess cash on the books, some insurers have sought to reduce capital through share repurchases, he said.

He also noted that "a spate of acquisitions in late 2007 suggests" an increased pace in consolidation in 2008.

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