2014 - Year End Results

HIGHLIGHTS

In 2014 the property/casualty insurance industry had its second highest level of yearly profit in the post-crisis era (2013 was the only better year). Low catastrophe losses, modest premium growth, continued realized investment gains and other factors combined to deliver a return on average surplus of 8.4 percent, vs. 10.2 percent in 2013. The industry combined ratio in 2014 rose slightly to 97.0 from 2013’s 96.2, delivering an underwriting profit of $12.3 billion (compared to $15.2 billion in 2013). The industry’s overall net income after taxes (profits) for the year tallied $55.5 billion (though down from $63.4 billion a year earlier).

Top line growth also contributed to financial success. Net written premiums were up 4.1 percent in 2014, slightly below the 4.4 percent gain in 2013, but continuing a string of (now) three consecutive years of top line growth of 4 percent or higher. Persistently low interest rates remain a challenge for the industry as maturing bonds are reinvested in bonds with lower yields, so that net investment income for the year slipped by $1.2 billion (down 2.5 percent). Overall industry capacity rose to a record $674.7 billion as of December 31, 2014—up $21.3 billion, or 3.2 percent, from $653.4 billion as of year-end 2013.                   

The industry results were released by ISO, a Verisk Analytics company, and the Property Casualty Insurers Association of America (PCI).

Insurance Performance and Profitability Drivers

The industry’s performance in 2014 could be considered a return to long-term trends, neither as strongly profitable as in 2013 nor as catastrophe-impacted as in 2011 and 2012. Even the experience of the once-troubled mortgage and financial guaranty insurance segment more resembled long-term trends than its experience during the financial crisis period.

Premiums: Top Line Growth Continues

One contributor to favorable underwriting performance in 2014 was continued steady net written premium growth, although it slipped slightly to 4.1 percent growth from 4.4 percent in 2013. However, in contrast, net earned premiums grew at a faster rate in 2014 (by 4.3 percent) than in 2013 (4.1 percent).

There are two main drivers of premium growth in property/casualty insurance: exposure growth and rate. Exposure growth—basically an increase in the number and/or value of insurable interests (such as property and liability risks)—is fueled primarily by the rebounding U.S. economy. Real (inflation adjusted) GDP in 2014 rose slightly to 2.4 percent from 2.2 percent in 2013. Exposure growth in key areas of the economy such as new vehicle sales (now back to pre-recession levels), residential construction and employment growth (the best yearly numbers since 1999) clearly benefitted the P/C insurance industry. With the pace of real GDP growth expected to quicken in 2015 to nearly 3 percent, personal and commercial lines exposures—and the premiums they generate—should continue to expand modestly. With premiums for auto, home and major commercial lines all trending positively, overall industry growth could keep pace with overall economic growth in 2015, as was the case in the prior two years.

Continuing improvement in labor market conditions in 2015 is also critical to top line growth in the P/C insurance industry. Job growth benefits the entire economy, of course, but the associated expansion of payrolls benefits workers compensation insurers in particular. The U.S. economy added 3.075 million private sector jobs in 2014. Combined with increases in payrolls (up $364.9 billion last year), this drove billions of dollars in new premiums of workers compensation coverage in 2014. Workers compensation is likely to remain among the fastest growing major P/C lines of insurance in 2014 if economic growth and hiring continue as projected.

The other major determinant of industry premium growth is rate activity. Rates are a function of a number of forces, but perhaps the most important is past and expected-future claims. Net of reinsurance recoveries, incurred losses and loss adjustment expenses for all lines in 2014 rose to $334.7 billion, up 6.2 percent from $315.1 billion in 2013.

Catastrophe Losses and Underwriting Performance

Much of the credit for reasonably good underwriting performance in 2014 can be attributed to moderate catastrophe losses. While 2011 and 2012 ranked among the costliest on record for catastrophe losses, direct insured losses from catastrophes in 2013 fell by $22.1 billion to $12.9 billion. In 2014, catastrophe losses were somewhat higher, at $16.8 billion, but the total for the two-year period was below the average and the median for the prior decade. Wildfires, winter storms, hail storms, and tornadoes all took their toll, but there was no single event that did enormous damage. The overall result in underwriting during 2014 was positive, with the industry’s combined ratio rising only slightly to 97.0 compared with 96.2 in 2013.

Claims Reserve Releases

In addition to accelerating premium growth and lower catastrophe losses, favorable development of prior-year claims reserves in 2014 totaled $11.2 billion, a notable decrease from the $15.6 billion in reserve releases in 2013, according to ISO/PCI. Reserve releases are generally associated with lower-than-expected costs for claims occurring in past accident years. However, most of the drop in releases is attributable to performance in the mortgage and financial guaranty (MF&G) lines rather than representing an industry-wide trend. In 2013 reserve releases in these lines amounted to $3.5 billion of the industry’s $15.6 billion, but in 2014 reserve releases in these lines amounted to only $0.3 billion of the industry’s $11.2 billion. Without this tiny segment of the industry, reserve releases in 2014 would have been $10.9 billion vs. $12.1 billion in 2013.

Investment Performance: Interest Rates Remain Low

For the full year 2014, net investment gains (which include net investment income plus realized capital gains and losses) fell by $2.5 billion (-4.3 percent) to $56.2 billion, compared with $58.7 billion in 2013. In measuring insurance company net investment gains, accounting rules recognize two components: (i) net investment income; and (ii) realized capital gains or losses. Unrealized capital gains or losses are not considered income and affect only surplus on the balance sheet.

Net Investment Income in 2014

Net investment income itself has basically two elements—interest payments from bonds and dividends from stock. The industry’s net investment income for the full year 2014 was $46.2 billion, compared to $47.3 billion in 2013 (down 2.6 percent). Most of this income comes from the industry’s bond investments, which are mainly high quality corporates and municipals.

The environment for bond investing in 2014 was inhospitable. Average monthly corporate bond market yields in 2014, as captured by Moody’s AAA-rated seasoned bond index, dropped every month compared to the prior month, from 4.49 percent in January to 3.79 percent in December.

Although the U.S. economy is improving—slowly (real GDP rose only 2.4 percent in 2014)—it remains beset by the same forces that have held interest rates down for the past few years: unused capacity (in both capital resources and, despite improvement, the millions still un- or under-employed); cautious consumer and business spending, and low near-term future expectations for the economy; and Federal Reserve actions to keep both short-term and longer-term interest rates low, all of which contributed to low inflation expectations. However, the Fed has been signaling that it expects to end extraordinarily low short-term rates (which will likely raise longer-term rates) sometime in 2015 if it is convinced that the economy is improving sufficiently.

The other significant source of net investment income (apart from bond yields) is stock dividends. In 2014 market-wide dividends from all common and preferred stock were fairly steady but about 6 percent below levels achieved in 2013. Seasonally adjusted, net dividends in the first quarter of 2014 ran at an annual rate of $902.8 billion, in the second quarter at a $902.3 billion annual rate, in 2014:Q3 at an $898.4 billion annual rate, and in 2014:Q4 at a $917.0 billion annual rate. (For comparison, net dividends for the full year 2013 were $959.6 billion.) But stock holdings in general represent roughly only about one-sixth of the industry’s invested assets.

Realized Capital Gains

Realized capital gains in 2014 were $10.1 billion, compared to $11.4 billion in 2013. The broad stock market did fairly well throughout 2014—the S&P 500 rose 11.74 percent, providing opportunities for capital gains. Again, however, the industry’s overall stock allocation represents only about one-sixth of invested assets.

Policyholders’ Surplus (Capital/Capacity): New Record High Demonstrates Industry Strength and Resilience

Policyholders’ surplus as of December 31, 2014 stood at $674.7 billion, up $21.3 billion or 3.3 percent from year-end 2013. Policyholders’ surplus has generally continued to increase with the end of the Great Recession and two consecutive years without large-scale catastrophe losses. The fact that the industry was able to rapidly and fully recoup its losses to surplus even in the event of disasters like Sandy (which produced $18.8 billion in insured losses in 2012) is continued evidence of the P/C insurance industry’s remarkable resilience in the face of extreme adversity.

The bottom line is that the industry is, and will remain, extremely well capitalized and financially prepared to pay very large scale losses in 2015 and beyond. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.74, close to its strongest level in modern history.

SUMMARY

The property/casualty insurance industry turned in another year of good performance in 2014 in terms of underwriting performance and overall return on average surplus (profitability). In addition, policyholders’ surplus reached a new all-time record high. Profitability benefited again, as it did in 2013, from moderate catastrophe losses and prior-year reserve releases. Premium growth, while still modest, is now experiencing its longest sustained period of gains in a decade.

Fundamentally, the P/C insurance industry remains quite strong financially, with capital adequacy ratios remaining high relative to long-term historical averages.

A detailed industry income statement for 2014 follows.