1999 - Year End 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 statutory rate of return of 6.6 percent for 1999, down from 9.2 percent in 1998 and 11.9 percent in 1997. The results were released by the Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).

Performance, Pricing and Capacity

Three factors took center stage in the property/casualty insurance industry’s 1999 financial results: the 39.5 percent surge in net underwriting losses, the 9.7 percent drop in net investment gains and the 0.9 percent increase in surplus

<b>Underwriting & Investment Performance</b>

Underwriting losses in 1999 were sharply higher despite lower catastrophe losses and the development of favorable pricing trends late in the year. The surge in underwriting losses reflects the inevitable outcome of the intensely competitive pricing environment over the past few years. Net written premiums increased 1.9 percent in 1999 while loss and loss adjustment expenses were up 4.9 percent. The wide gap between revenue and expenses gave rise to last year’s $6.6 billion rise in net underwriting losses, an increase of 39.5 percent.

Offsetting mounting underwriting losses with investment gains is becoming increasingly difficult. Interest rates, while rising somewhat late in the year, are still low by recent historical standards. Moreover, slow premium growth has reduced insurers’ ability to capitalize on the higher yields. Nevertheless, even small changes in interest rates can produce large impacts on the market value of the industry’s substantial bond holdings, which account for 65 percent of invested assets. Because yields and bond prices move in opposite directions, ISO estimates that 1999’s higher yields led to a $55 billion reduction in the market value of the industry’s bond holdings. In fact, 1999 was one of twentieth century’s most bearish years in the bond markets. Total returns on long- and intermediate-term government bonds were –8.96 percent and –1.77 percent, respectively, in 1999—the second worst year on record (since 1926), according to Ibbotson Associates.

These bond market factors, combined with record low stock dividend yields (just 1.4 percent for the S&P 500 group in 1999) and increased stock market volatility led directly to the 9.7 percent ($5.6 billion) drop in the industry’s net investment gain (which includes both investment income and realized capital gains).

<b>Pricing</b>

Pricing is the most important issue insurers must confront in 2000 and for several years to come. If the industry is perceived as being on a trajectory toward rate adequacy, Wall Street is likely to react enthusiastically.

Most companies have clearly gotten the message that the chronic underpricing in commercial lines can no longer persist. In a recent investment bank survey, nearly 60 percent of agents reported that renewal premiums during early 2000 were rising (compared to just 20 percent in mid-1999). Pricing strength was most pronounced in the workers compensation and commercial auto lines. Broadening of coverage terms is also becoming less common.

Avoiding a replay of the commercial segment’s experience with chronic underpricing appears to be a priority among insurers with personal lines operations. While the typical personal auto premium fell 2.9 percent in 1998 (the first decline in 25 years) and fell an additional 4 to 5 percent last year, rate increases appear to be gaining the upper hand in 2000. Many insurers are currently attempting to pass through rate increases of about 5 percent. The private passenger auto line accounts for nearly 40 percent of industry premiums, so maintaining profitability in this line is key. Most homeowners policies are renewing on the positive side as well. This line should be the fastest growing among the major property/casualty lines in 2000. Insurers are benefiting from strong exposure growth associated with record strength in the housing market and more risk-appropriate pricing in catastrophe-prone areas.

<b>Surplus & Investments</b>

Of lesser concern is the small $2.9 billion increase in surplus since year-end 1998. The increase of just 0.9 percent was the smallest gain since 1984, when the industry’s surplus shrank by 2.7 percent.

Higher underwriting loss, declining investment income combined with continued consolidation among insurers is slowing the rate of surplus formation among property/casualty insurers. The industry’s surplus grew at an average annual rate of 9.6 percent during the 1990s—nearly eleven times last year’s pace. Because surplus is synonymous with capacity, decelerating and even negative surplus growth might be viewed as welcome news by some Wall Street analysts because shrinking capacity often portends hard(er) markets and higher share prices. Analysts have estimated that the industry has at least $100 billion in excess capital.

Many companies are working to reduce excess capacity and appease Wall Street through aggressive share repurchase plans. During the first quarter of 2000, property/casualty companies announced plans to buy back $4.8 billion worth of their own stock, compared to just $1.7 billion during the first quarter of 1999.

<b>Combined Ratio</b>

The industry’s combined ratio of 107.9 in 1999 is higher than was expected earlier this year. The Insurance Information Institute’s annual "Groundhog" survey of industry analysts, released in early February, produced a consensus estimate of 106.7 for 1999 and 107.7 in 2000. The year-end results suggest that 2000 estimates for combined ratios will likely be revised upward.

The View from Wall Street: It’s Tough to be a P/C Insurer in a Dot-Com World

Wall Street was unkind to the property/casualty insurance industry in 1999. On a market cap weighted-basis, industry stocks lost 25.7 percent of their value compared to a gain of 21.0 percent for the Standard & Poor’s 500 Index. Life insurers as a group declined 9.6 percent. Multiline insurers and brokers had a good year, posting gains of 32.4 percent and 64.1 percent, respectively. Surprisingly, the Financial Services Modernization Act of 1999, signed by President Clinton on November 12, had no lasting impact on company valuations. While the stock prices of many insurers gained 20 to 25 percent immediately after Congress reached agreement on legislation in October, those gains were surrendered by year’s end.

Of course all eyes in 1999 and early 2000 were on the technology-laden Nasdaq. "Old Economy" industries such as insurers, manufacturers and retailers lagged far behind the returns in so-called "New Economy" industries related to the internet, telecommunications and biotechnology. During March, however, insurer stocks staged a strong comeback while the Nasdaq fell sharply. Prior to the comeback, the prices of many insurer stocks were at their lowest levels in years.

Despite the run-up in prices for insurer stocks in recent weeks, the valuations of many insurers remain low. For this reason, Wall Street remains full of rumors involving possible takeovers by U.S. rivals, foreign insurers and banks.

The decade ahead is full of promise and uncertainty. The nascent trends toward firmer prices and faster premium growth are hopeful signs likely to be appreciated by investors. The impacts of globalization, deregulation, financial services reform and integration will take years to unfold. Better management of catastrophic risk will likely bear fruit during the first decade of the next century while the promise and challenges of technology loom large.

Detailed industry income statements for the first nine months and third quarter of 1999 follow:

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