P&C Industry First-Half Net Income Falls Over 50%, But Some Positive Signs Seen

Although property and casualty insurer net income fell 59.3 percent in the first half, reflecting weakness in the economy and plummeting investment gains, industry leaders saw positive signs in terms of lower underwriting losses and rising policyholders' surplus.

The quarterly report on industrywide results by the Insurance Services Office Inc. and the Property Casualty Insurers Association of America said net income for the first six months of 2009 dropped to $5.8 billion, down $8.2 billion from last year's $14.1 billion first-half profit.

The main driver of the severe drop in the industry's bottom line was a more than 50 percent cut in net investment gains–$12.4 billion this year, down from the $24.9 billion reported for the first half of 2008.

Offsetting the deterioration in overall results was an improvement in net underwriting losses–down to a loss of $2.2 billion for the first half of 2009, compared with a loss of $5.6 billion last year.

As a result, the combined ratio for the first half dropped to 100.9 compared with 102.0 in 2008. For the second quarter, the combined ratio fell to 99.5, far lower than the 104.1 figure reported in the same period last year.

However, while an improvement, PCI's president and chief executive officer, David Sampson, put this benchmark result into perspective.

“While the 100.9 percent combined ratio for first-half 2009 compares favorably with the 103.8 percent average combined ratio for all first halves since 1986, 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,” said Mr. Sampson.

Indeed, insurers posted a 2.5 percent rate of return during the first half of 2009, “down from 5.5 percent for the first half of 2008, but up from negative-1.2 percent during the first quarter of 2009 and positive-0.5 percent for all of 2008,” noted Robert P. Hartwig, president of the Insurance Information Institute, in his commentary on the results.

Mr. Hartwig added that “negative first-quarter profitability was more than offset by a 6.3 percent return on average surplus during the second quarter.”

Still, “2009 is the second-lowest first-half rate of return since the start of ISO's quarterly data in 1986, and seven percentage points less than the 9.5 percent average first-half rate of return for the past 24 years,” said Michael R. Murray, assistant vice president for financial analysis at the Jersey City, N.J.-based ISO.

However, two sectors in particular–mortgage and financial guaranty insurers–dragged down industrywide figures, with their annualized rate of return falling to negative-77 percent from negative-67 percent last year. Excluding these two troubled segments, the insurance industry's annualized rate of return declined to 5 percent for the first half of 2009 from 8 percent last year, Mr. Murray pointed out.

“Mortgage and financial guaranty insurers continued to suffer disproportionate losses on underwriting consequent to the recession, foreclosures and defaults on securities,” he said. “But their underwriting results improved significantly, largely consequent to special arrangements between one insurer and its financial counterparties.” He did not name the carrier in question.

Mr. Murray pointed out that “mortgage and financial guaranty insurers' net written premiums declined 25.8 percent to $3.4 billion in first-half 2009. But their loss and loss adjustment expenses fell 35.7 percent to $6.2 billion, and their combined ratio improved to 171.5 percent in first-half 2009 from 237.3 percent in first-half 2008.”

The report noted that overall net written premiums dropped by 4 percent, or $9.4 billion, to $213 billion for the first half of 2009. Net earned premiums declined $6 billion, or 3 percent, to $211 billion.

“With insurers competing with one another for shares of a shrinking economic pie, market surveys indicate the recession contributed to continued softening in commercial insurance markets,” according to Mr. Murray.

On a positive note, PCI's Mr. Sampson said that despite the struggling economy, “the insurance industry remained profitable and policyholders' surplus increased.”

“Property and casualty insurers continued to be healthy and competitive despite an extraordinarily difficult operating environment complicated by the worst recession in decades and the lingering effects of an unprecedented financial crisis that brought down many once iconic banks and Wall Street institutions,” he added.

Mr. Hartwig said the results “provide the first evidence of a rebound in profitability for property and casualty insurers in the wake of the financial crisis that began in mid-2007.”

“In another sign of recovery,” Mr. Hartwig also cited the fact that “capacity in the industry–as measured by policyholders' surplus–rebounded for the first time in two years. Policyholders' surplus increased by $25.9 billion, or 5.9 percent, to $463.0 billion during the second quarter from $437.1 billion at the end of the first quarter. This reversal is notable and important.”

He said property and casualty insurance industry capacity had “plunged by an alarming $84.7 billion, or 16.2 percent, over the previous five quarters from the pre-crisis peak of $521.8 billion at the end of the second quarter of 2007.”

Mr. Hartwig went on to say that while U.S. Federal Reserve Chair Ben Bernanke recently declared the recession technically over, it “does not portend a period of unbridled growth and prosperity.”

The wounds from this recession, he remarked, are deep and in some cases permanent, with growth coming only after “a slow and fitful recovery.” He estimated it will take two- or three years to replace the insurable exposures that were lost since the recession began in mid-2007.

Because of this economic reality, “the current profit recovery must be kept in perspective,” warned Mr. Hartwig. “While net income is once again positive, a 2.5 percent rate of return is woefully inadequate by any standard.”

He explained that the industry's “equity cost of capital stood at approximately 10.5 percent during the first half of 2009. This means that there is an eight percentage point gap between the rate of return that investors in the industry expect to earn given the risks they are being asked to assume and the industry's actual return of 2.5 percent in the first half of 2009.”

He cautioned that “failure to earn the cost of capital over an extended period of time could result in the exit of capital and, more importantly, difficulty in raising capital after a major capital event,” such as a significant catastrophe, “particularly in the current capital-constrained environment.”

The numbers in the ISO/PCI report are consolidated estimates for all property and casualty insurers based on reports that account for at least 96 percent of all business written by private U.S. insurers.