1999 - First Half Results

<b>By Robert P. Hartwig, Ph.D.
Vice President & Chief Economist
Insurance Information Institute</b>
bobh@iii.org

The property/casualty insurance industry reported a rate of return of 7.2 percent (on an annualized basis) for the second quarter of 1999, down slightly from 7.6 percent during the same quarter in 1998. The industry’s rate of return for the first half of 1999 was 8.9 percent compared with 9.2 percent for calendar year 1998. The results were released by the Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).

The factors responsible for the industry’s performance during the second quarter of 1999 are essentially the same as those that have been driving industry results since early 1998: slow premium growth, high catastrophe losses and declining investment income. Despite the apparent weaknesses, the industry’s results were in line with expectations and contain several hopeful signs that the U.S. property/casualty insurance market is beginning to stabilize.

The annualized premium growth of 1.0 percent for the first half is disappointing. Nevertheless, it comes amid a notable firming of prices in some commercial lines and a get-tough attitude in underwriting. Various agent surveys indicate that price cutting has been reined-in. One year ago, the typical commercial lines renewal came with a 10 percent price cut, compared to cuts of about 4 percent and 1 percent in February and July of this year, respectively. In addition, some of the weakness in premium growth reflects the fact that major companies are now walking away from hundreds of millions of dollars in unprofitable business. Commercial auto and workers compensation are the lines most affected. Aggressive pricing in personal auto may replace commercial lines as the major impediment to significant premium growth for the remainder of 1999. The Insurance Information Institute estimates that automobile insurance rates for personal automobile insurance declined 2.8 percent in 1998. A decline of 4.5 percent is anticipated this year. Aggressive pricing by insurers—rather than improving fundamentals such as reduced bodily injury costs—is now the principal driving factor behind the decline.

Investment income’s 4.0 percent decline in the second quarter to $9.4 billion from $9.8 billion during the same quarter last year was expected. Through the first half of 1999, investment income has fallen 2.9 percent relative to the first half of 1998. While this means that investment income this year is likely to post a decline for just the fifth time since 1939, the magnitude of the decline is likely to be smaller than the 4-5 percent drop that had been expected. The modestly improved outlook for investment income is attributable to several factors including two recent rate hikes by the Federal Reserve, allowing insurers to generate higher returns on short-term investments. Also, a widening spread between the yields on munis (bonds issued by state and local governments) and yields on Treasury and corporate bonds is working to the advantage of insurers. Yields for Treasury securities with 20 years to maturity rose 101 basis points (1.01 percentage points) between December 1998 and June of this year while yields on high-grade corporate debt rose about 75 basis points over the same period. At the same time, munis with the same maturity rose just 39 basis points. This means that insurers can increase returns without increasing risk. Reports from the bond markets indicate that insurers are liquidating some of their muni holdings in favor of the more attractive yields on Treasurys and corporates. Better still, most munis can be sold at a significant capital gain, since they were acquired years ago at much higher yields than are available today. At year-end 1998, munis accounted for 28.1 percent of insurers’ invested assets, down from 31.0 percent in 1997. In fact, munis as a percentage of total bond holdings slipped below 50 percent last year for the first time in recent history.

Realized capital gains—which fell 24.1 percent compared with the second quarter of last year—are down a modest 3.2 percent for the first half. Rising interest rates, which provide some relief on the investment income side, have eroded some of the industry’s capital gains on its bond portfolio. On the other hand, the bull market in stocks continued as the S&P 500 rose 7.1 percent during the second quarter and 11.7 through the first half. It is important to note that the stock market’s rally occurred despite rising interest rates, a development that often creates fear among investors and sends share prices tumbling. Stock markets continue to be volatile this year, but the impact is limited because just 18 percent of invested assets are in the form of equities compared to a 65 percent share for bonds.

On the loss side there is mixed news. Loss ratios are deteriorating in some lines, most notably personal auto which is suffering the effects of intense competition. Rising medical inflation is also beginning to rear its ugly head, a factor that affects many lines. Abnormally high catastrophe losses continue to plague insurers, led by $1.5 billion in losses from May’s tornado outbreak that swept through Oklahoma, Kansas and 16 other states. ISO’s PCS unit reported more than $3 billion in catastrophe–related losses during the second quarter, marking the fifth quarter out of the last six with catastrophe losses of at least one billion dollars. Catastrophe losses through the first half of 1999 stand at $5.2 billion and are on a path that could match last year’s total of $10.1 billion. We are approaching the peak of what is expected to be a very active hurricane season. Insurers have already dodged two bullets, as Hurricane Bret—a category 4 storm—came ashore in August in Texas’ least populated county, causing just $30 million in insured losses, according to PCS. Hurricane Dennis narrowly missed the southeast coast of the United States during early September, eventually moving ashore in North Carolina as a tropical storm. Early estimates from insurance companies place losses at a relatively modest $100 million. The earthquake that struck Turkey August 17 killing more than 14,000 people is unlikely to have a major impact on U.S. insurers or reinsurers.

All of these factors contributed to a second quarter combined ratio of 106.6, slightly below the 107.0 recorded a year earlier. Through the first half of this year, the combined ratio stands at 104.9, compared with the 103.6 for the first half of 1998. This year’s combined ratio so far compares favorably with the 105.6 combined ratio recorded in 1998.

Competition will continue to be the most significant factor restraining premium growth. This, combined with the fact that policyholder surplus continues to rise at a respectable pace means that return on surplus will likely remain below desired levels given current trends in underwriting and investment performance. It should be noted that after several years of record merger and acquisition activity, there has been no appreciable exit of capacity from the industry. This realization, combined with stock market volatility, likely explains part of the sharp reduction in the value of M&A activity through the first half of 1999. Conning & Company reported in a recent study that the dollar value of M&A activity fell 71 percent during the first six months of 1999 compared to the same period last year, while the number of transactions fell 9 percent.

The second quarter’s financials contain telltale signs the industry is entering an extended transition period. Hopefully, these trends will continue in the remaining quarters of this year.

Detailed industry income statements for the second quarter and first half follow:

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