A View From The Press Box

Indeed, although first-quarter net income for U.S. property-casualty insurers fell for the second consecutive year and the combined ratio ticked up slightly, the industry’s bottom line remains at record levels, according to the latest consolidated results.

In a market that has been generally softening with the exception of coverage for coastal properties, net income after taxes dipped to $15.8 billion in the first three months of this year, down 5.5 percent from $16.7 billion in the same period last year—and 10.7 percent below the $17.7 billion recorded in first-quarter 2005.

Consolidated estimates based on reports accounting for at least 96 percent of all business written by private U.S. p-c insurers were supplied by the Insurance Services Office Inc. and the Property Casualty Insurers Association of America.

The industrywide numbers look even better after considering ISO and PCI’s notation that “much of the decline in first-quarter net income reflects a special transaction in which one U.S. insurer assumed $9.3 billion in liabilities from a foreign entity in exchange for considerations valued at $7.1 billion.” (ISO and PCI refused to name the carrier involved, but it didn't take much detective work to find that just last October, Equitas—the Lloyd’s runoff operation—bought $7 billion in reinsurance from National Indemnity Company, a member of the Berkshire Hathaway group.)

Also contributing to the industry’s drop in net income was the fact that the net gain on underwriting fell slightly—down about 1 percent to $8.3 billion—while net written premium growth slowed to an anemic 0.8 percent in first-quarter 2007 from an already stagnant 1.8 percent the year before.

Indeed, net written premium growth was “the weakest for any first quarter since 1992,” Michael R. Murray, ISO’s assistant vice president for financial analysis, noted in a statement, warning sellers to look out below. “Market surveys and U.S. government data indicate that escalating competition and declines in the price of insurance are cutting into premium growth.”

“That premiums grew only about one-sixth as much as gross domestic product is an indication that intensifying competition is leading to lower prices for most coverage in most locations—though property insurance remains scarce and expensive in some coastal areas,” added Genio Staranczak, PCI’s chief economist.

These factors had a negative impact on the industry’s overall return.

“Reflecting the declines in net income, the p-c industry’s annualized rate of return on average policyholders’ surplus (statutory net worth) dropped to 12.9 percent in first-quarter 2007 from 15.5 percent in first-quarter 2006 and 17.9 percent in first-quarter 2005,” noted ISO and PCI.

But even that result didn’t seem so bad when put into a longer-term historical context. “Insurers’ 12.9 percent rate of return for first-quarter 2007 was 1.8 percentage points above insurers’ 11.1 percent average first-quarter rate of return since the start of ISO’s quarterly data in 1986, but it fell short of the rates of return typically earned by firms in other industries,” said Mr. Murray.

There goes the industry again, singing the same blues about how its ROR lags that of other industries, citing unflattering comparisons to the Fortune 500. (Industry gadfly Bob Hunter, insurance director of the Consumer Federation of America, challenged what he characterized as an apples to oranges comparison when I met him back in late April, contending that the industry lumps stock and mutual companies together in its consolidated results, which distorts any comparison with a pure-stock index such as the Fortune 500. I have yet to hear anyone in the industry respond to that challenge.)

Mr. Staranczak of PCI also predicted eroding financial results for at least the short term, especially since the industry just entered the dreaded annual hurricane season.

“Seasonal patterns in the data also suggest that insurers’ rate of return will decline later this year,” he said. “Insurers’ profitability in the first quarter usually exceeds their profitability later in the year—in part because of the timing of weather-related catastrophe losses.”

However, the industry can’t cry poverty just yet, as the combined ratio of loss and underwriting expenses per dollar of premium rose just slightly to 91.7 in the first quarter, against 91.1 a year ago—still among the best results in the industry’s recorded history.

“The combined ratio for first-quarter 2007 is the second best for any first quarter since 1986—when ISO’s quarterly records begin,” Mr. Murray noted. Although, to put the result into context, he added that “it wasn’t good enough for insurers to achieve the rate of return typically earned by firms in other industries.”

Indeed, he said, taking into account 2007 investment results, financial leverage and tax rates, “ISO estimates that the combined ratio would have had to improve to 89.6 for insurers to have earned the 13.9 percent long-term average rate of return for the Fortune 500.”

Moreover, he added, “insurers must now post better underwriting results just to be as profitable as they once were.”

As an example, he noted that “in first-quarter 1987, when the industry’s combined ratio was 103.9, the annualized rate of return on average surplus was 15.9—three percentage points higher than the industry’s 12.9 percent rate of return for first-quarter 2007, even though the combined ratio was 12.2 points worse than the 91.7 combined ratio for the first quarter of this year.”

Meanwhile, the industry’s piggy bank got a bit fatter, as policyholders’ surplus—the industry’s statutory net worth—rose 1.9 percent to $496.6 billion as of March 31. The $9.4 billion gain is 29.3 percent less than the $13.4 billion increase in first-quarter 2006, the groups noted.

“The financial performance of the property-casualty industry during the first quarter of 2007 was generally excellent, but at the same time provided confirmation that the industry is now past its cyclical peak in profitability of 14.0 percent achieved in 2006,” Robert P. Hartwig, president of the Insurance Information Institute, said in a statement.

“The only question that now remains is how long the decline in profitability will last and how many years it will take to get to the bottom,” he added.

Noting that “many insurance CEOs vow that it will be different this time around” in terms of maintaining market discipline and profitability in the face of a generally softening market, Mr. Hartwig was somewhat skeptical.

“We shall see,” he said. “There are many reasons to suggest insurers will be more successful at navigating the treacherous soft market shoals that lay ahead. Yet, it is also true that managing the market cycle has befuddled several generations of CEOs.”

What do you folks make of the industry's results? Are insurers sitting pretty, or poised for a major decline in profits?