P-C Industry Still Quite Profitable, But Soft Market Starts Cutting Into Margins

Net gains on underwriting fell 38.9 percent to $19 billion in 2007–down from $31.1 billion the year before.

While the industry still wrote insurance profitably last year, posting a combined ratio of 95.6 in 2007, that critical figure deteriorated 3.2 points from 92.4 in 2006.

Partially offsetting the decline in net gains on underwriting, insurer net investment gains–the sum of net investment income and realized capital gains–climbed 13.9 percent to $63.6 billion in 2007, up from $55.8 billion in 2006.

Carriers took a big hit in the fourth quarter, as after-tax consolidated net income fell 36.2 percent to $12.5 billion, down from $19.6 billion in 2006.

The figures are consolidated estimates for all private U.S. p-c insurers, based on reports accounting for at least 96 percent of all business written by those carriers.

Despite the deterioration in underwriting results, the 95.6 combined ratio for 2007 "is the second best for any year since 1959, when ISO's annual records begin," noted Michael R. Murray, ISO's assistant vice president for financial analysis.

However, Mr. Murray said underwriting results "weren't good enough for insurers to achieve the rate of return typically earned by firms in other industries."

With full-year 2007 investment results, financial leverage and tax rates figured in, ISO estimates that the combined ratio would have had to be more than two points better–93.3–for insurers to have earned the same 13.9 percent long-term average rate of return as the Fortune 500.

David Sampson, PCI president and chief executive officer, said today's low interest rates and investment yields mean "insurers must now post significantly better underwriting results just to be as profitable as they once were."

The industry's combined ratio for 2007, he said, was 12.5 points better than for 1986, but even with improved underwriting results, the rate of return for 2007 was 2.7 points below 1986, Mr. Sampson noted.

The report found that deterioration in underwriting results is due to weakness in pricing and an increase in losses and loss adjustment expenses.

"Despite ongoing problems in some coastal property insurance markets, government data suggests that escalating competition is cutting into premiums," Mr. Sampson said.

He added that "all else being equal, one would expect premiums to rise as the economy grows and inflation increases the amount of insurance people need. However, written premiums fell 0.6 percent in 2007, even though the nation's gross domestic product increased 4.9 percent."

Mr. Murray agreed that "escalating competition" is "taking a bite out of commercial lines premiums." Citing "ISO MarketWatch" data, he said commercial lines premiums on renewals fell 3.4 percent in third-quarter 2007, "with the latest reports from agents, brokers and risk managers all indicating that commercial insurance markets have continued softening since then."

"Looking at the bigger picture, ISO's analysis indicates that insurers' recent results have led to an increase in the supply of insurance, which is contributing to widespread downward pressure on the price of insurance in competitive markets that is benefiting both consumers and businesses alike," said Mr. Murray.

At this point, it is too soon to tell whether there has been a fundamental change in the dynamics of insurance cycles that will lead to a soft landing, or whether competitive pressures will continue escalating as they have in the past, according to Mr. Sampson.

"The financial performance of the property-casualty insurance industry for 2007 actually turned out to be quite good in historical terms," observed Robert P. Hartwig, president of the Insurance Information Institute in New York. "From an underwriting perspective, last year was the twentieth-best year since 1926, while 2006 was tied for fifth best (with 1935)."

Indeed, he added, "the 92.4 combined ratio recorded in 2006 together with last year's 95.6 figure represent the best back-to-back underwriting performances in more than a half century, when the average combined ratio in 1953/1954 was 93.4."

He said last year's results "proved to be surprisingly resilient in the face of an increasingly price-competitive environment, a weak economy and turmoil in the financial markets." However, he added, "the 2007 results provided confirmation that the industry is now well past its cyclical peak in profitability of 14.4 percent and its cyclical trough in the combined ratio of 92.4, both achieved in 2006."

In other words, it's all downhill from here for awhile for most insurers.

"One major cause for concern is the fact that negative premium growth in 2007 means that industry growth has come to a screeching halt and is, in fact, severely negative on an inflation-adjusted basis," Mr. Hartwig observed.

"Another [concern] is the rapid accumulation of capital on insurer balance sheets," he added. "The current slow-growth environment means that insurers face very difficult capital allocation decisions over the next several years."

While most insurers have "sought to reduce capital primarily through share repurchases," he noted, "a spate of acquisitions in late 2007 suggests, however, that the pace of consolidation could accelerate in 2008."

Donald Light, senior analyst with Celent, a Boston-based financial research and consulting firm, said 2007′s results "show that the soft market is finally impacting the industry's top- and bottom lines."

He added that even though "by historical standards, it was actually a very good year…[that] doesn't buy you much love these days." He cited "plenty of chilling detail behind these numbers," including deterioration in both net income and ROE.

"The real questions for the property-casualty industry are the same as for the entire U.S. economy," he said. "How low will we go, and when will we get there?"

For Table of annual results: