Is it luck or talent for the insurance industry? Alirt Insurance Research, in its 2015 review, notes its composite of insurers posted a combined ratio under 100 for the third year in a row. It's the first time since the 1970s the industry has shown three back-to-back years of underwriting profit.
David Paul, a principal at Windsor, Conn.-based Alirt, says two factors cannot be overlooked. The first: lower catastrophe losses over the past three years compared with 2011 and 2012. "Certainly cat losses are helping," Paul says. "The numbers [combined ratio] are close enough to 100 where if you put a couple of points on for cats, it goes over 100. So I would definitely say the three light years of cats helps."
The second factor involves reserve releases. While the Alirt composite strengthened reserves in 2015 for the first time since 2005, reserve releases helped shave points off of the combined ratio in 2013 and 2014.
Paul points to comments recently made by W.R. Berkley Corp. CEO W. Robert Berkley regarding reserve releases. Berkley said:
"One of the questions that we've received from you and others when we were getting significant rate increase in the past several years [is], why was that not having a more direct impact on the loss ratio that you were using? And the answer was we had a fair amount of uncertainty or concern around what inflation might do, and we concluded that it was better to take a measured approach.
"In addition to that, just wanted to make a similar comment about trend overall if you include frequency. So as we see those trends proving to be a bit more benign, it would suggest that perhaps we will, over time, see more margin in the business … I think that ultimately, when the day is all done, much of the industry has benefited from a relatively benign period when it comes to frequency again as well as inflation. And that has been a pleasant surprise which has driven a lot of the positive development."
A measured approach
Paul says the idea of an insurer taking a measured approach to putting up reserves caught his attention. "Reserves are decided upon based on a spectrum," he notes. Actuaries will say that, based on their analysis, an insurer can pick a spot along the spectrum where it will put reserves.
"It struck me that insurers were probably making conservative picks betting inflation would pick up, given low interest rates and inflation," he says, noting that this would be only on reserves for long-tail business.
"And when they saw that, 'Hey, this growth in inflation we thought was going to play out hasn't happened,' they can continue to release reserves.
Up to this point, notes Paul, the idea of inflation growth hasn't been accurate — it has instead generally been trickling down since 2007. "So do they continue to make conservative loss picks based on inflation projections that may or may not come true?" Paul wonders, noting that it would be a reason to expect continued reserve releases on long-tail blocks of business.
The Alirt P&C Composite is comprised of 50 large U.S. property and casualty insurers, representing approximately 40% of total industry net written and 50% of total industry surplus.
Continue reading to see Alirt's breakdown of the industry's 2015 performance, based on its composite, in several areas through charts and analysis based on the reported results of its composite of insurers:
Underwriting and operating results
While underwriting results deteriorated slightly in both 2014 and 2015, the combined ratio remained under 100 in 2015, at 99.6. This represents the first time the industry has reported three consecutive years of underwriting profit since the 1970s.
Additionally, composite accident year results, at 99.5, outperformed reported results for the first time in a decade as the composite overall showed reserve strengthening as opposed to reserve releases. Still, Alirt notes that, while such a trend usually indicates a hardening market, that may not be the case this time, since the reserve strengthening was driven by a small number of outliers and does not appear to be an actual market trend.
The composite's operating ratio, which accounts for both underwriting and investment income, deteriorated to 90.2 in 2015, driven mostly by a continued slide in investment income. Alirtobserves, "It appears that profitability for the industry may have peaked in 2013 for the current firm market cycle given the very light catastrophe losses that year, stronger contribution from prior year reserve releases, two years of rising price increases from mid-2011 until early 2013, and a continued deterioration in net investment income in 2014 and 2015."
In fact, Alirt says the aggregate price increases of mid-2011 to early 2013 "have now completely faded, indicating that the mini-'hard' market of 2012 and 2013 has run its course.
"It appears that we have entered a softening rate environment, at least for the near term."
Premiums
While direct premiums rose 2% in 2015, compared to 2014, and net premiums climbed 3%, the rate of growth slowed in 2015, which Alirt says is in part because of the softening rate environment.
Net premiums in 2014 and 2015 were adjusted for a large reinsurance transaction involving the two lead subsidiaries in the Geico group.
The continued premium growth, even as rate increases disappear, likely stems from a rise in insurable exposures connected to the improving economy, and a reduced reliance on reinsurance leading to higher net premium retention, says Alirt.
"Given strong existing capacity and increased competition, it is likely that continued net written premium growth will depend on broader economic trends, as well as the ability of companies to potentially find new sources of insurable risk or to sell more insurance to existing insureds," Alirt contends.
Surplus and premium leverage
Surplus (above) was positive for the fourth consecutive year in 2015, but growth was just 1.5% compared with 5.2% in 2014. Alirt says operating earnings of $21.4 billion were offset by net capital losses of $2.4 billion and net capital — shareholder dividends less surplus paid-in — upstreamed to parent organizations of $14.1 billion.
"Poor equity market performance in 2015, especially relative to the three prior years, also depressed surplus development in the period as all but 14 of the composite companies reported net capital losses," Alirt says, adding 2015 was just the third time in the past 13 years that its composite of companies reported net capital losses.
Alirt says 31 of the 50 insurers that make up its composite reported an increase in surplus in 2015, and five companies reported increases of 10% or more. Allianz Global Risks U.S. Insurance Co.'s surplus climbed 145% as its parent contributed Fireman's Fund Insurance Co. to the company. Surplus for U.S. Fire Insurance Co. — lead Crum & Forster company — was up 31%, also benefitting from a surplus infusion from its parent, Fairfax Financial.
Of the 19 companies reporting surplus declines, eight reported decreases of 5% or more. Ace American Insurance Co. suffered the largest decline at -13.8%, followed by Philadelphia Indemnity Insurance Company (-12.4%) and lead Chubb insurer Federal Insurance Co. (-10.5%).
Annualized underwriting leverage, on both a gross and net basis, remained essentially flat. The low net premium leverage, adjusted for the two Geico transactions, "continues to reflect more than ample financial capacity in the broad U.S. property & casualty market," says Alirt.
Earnings
Returns on equity (above) and returns on earned premium (below) deteriorated for the consecutive straight year in 2015, but remained above the 2011 and 2012 periods that saw higher catastrophe losses and weaker pricing.
Only four companies in Alirt's composite reported pretax operating losses; Alirt notes they are mostly personal lines predominant companies — Amica Mutual Insurance Co. (-6.5%), State Farm Mutual Automobile Insurance Co. (-4.9%), and Farmers Insurance Exchange (-2.6%) — in addition to AIG's Lexington Insurance Co. (-3.2%).
Alirt says 11 composite companies reported pre-tax return of premium exceeding 20% in 2015, with the strongest profitability metrics reported by Travelers Casualty & Surety (35.5%) and Travelers Indemnity Co. (29.4%), Chubb's Federal Insurance Co. (31.7%) and Pacific Indemnity Co. (25.5%), Sentry Insurance (31.0%), Hartford Fire Insurance Co. (27.5%) and Auto-Owners Insurance Co. (25.0%).
Investment returns
The composite's net investment yield fell 13 basis points to 3.36% in 2015 compared to 3.49% in 2014. Alirt says net capital gains had provided a boost to total investment return in the past several years, "but these gains declined in 2014 and turned to losses in 2015 on weak equity market conditions." Alirt adds, "The composite's portfolio yield has now fallen by approximately 125 basis points since 2007, as the Federal Reserve continues to maintain its key lending rate at very low levels, even after a quarter point hike in late 2015."
Reserves
The Alirt composite strengthened prior-year reserves for the first time since 2005. The majority of the reserve additions were driven by poor results in the personal auto line for accident year 2014, with insurers making large reserve adjustments for that year in Q4 2015.
"Reserve development for the nearest accident year (2014) shifted dramatically in Q4, from reserve releases of $4.1 billion at nine months 2015 to a release of just of $914 million as of year-end 2015," Alirt explains. State Farm Automobile Insurance Co., Alirt notes, reported an over $2 billion swing in its 2014 accident year reserve position in in the fourth quarter of 2015.
Three composite insurers within the AIG pool also took large reserve increases, but the composite's commercial lines writers reported aggregate reserves releases of $1.4 billion in 2015, Alirt says.
Alirt's Paul says he does not see 2015's reserve strengthening as the beginning of a trend. Pointing to the activity among personal auto insurers in the fourth quarter of 2015 to strengthen 2014 reserves, Paul says, "They just saw something in the reserves for 2014 where they said, 'We have to reverse all this. Things came in worse than we anticipated a year after writing the business.'
Because the overall 2015 composite reserve strengthening was driven so much by that, Paul says, "I really do see [2015 reserve strengthening] as the exception of what's going on in the general market."
Alirt's commercial lines index and personal lines index
Alirt's P&C Composite Index measures industry financial performance. The index fell for commercial and personal lines insurers after climbing for the three years prior. Alirt says, "While the personal lines combined ratio was at break-even, and the commercial lines combined ratio was several points better, the performance of the commercial lines composite was dampened by lower risk-adjusted capitalization and liquidity as well as somewhat weaker cash flow." However, Alirt calls the index scores "still fairly robust," reflecting "the current solid financial profile of the broad P&C industry."
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