From a profitability perspective, 2018 will likely turn out to be a good year—maybe the best in more than a decade, in part because it started out quite well. The first half of 2018 produced a $6.0 billion underwriting gain (vs. a $4.6 billion loss in the first half of 2017). It is too soon to know how the storms of the third quarter will affect full-year underwriting results, but at the least this first-half profit will moderate any underwriting losses that emerge. Also, results from investing the industry’s assets rose in the first half of 2018 versus the comparable period in 2017: Net investment gains were $32.2 billion in the first half of 2018, compared to $27.0 billion in 2017, up 19.2 percent.
Two other measures of the industry’s health—revenue and capital—were positive in 2018:1H compared to 2017:1H. Net premiums written grew by 13.3 percent for the half, compared to 4.1 percent growth in the first half of 2017. Policyholders surplus—what in other industries would be called net worth—rose by 6.4 percent over its level at the end of the first half of 2017, ending at $761.1 billion.
The bottom line? Net income after taxes more than doubled, from $15.5 billion in the first half of 2017 to $34.0 billion in the first half of 2018. This is the strongest dollar profit for a first half since 2007. (Figure 1) The industry’s annualized rate of return on average surplus was 9.0 percent for the first half of 2018, compared to 4.4 percent for the comparable period in the prior year.
A note of caution: both the net premium growth and the investment income spikes were affected by what could be one-time events, which can change the perspective somewhat. These are discussed below.
Industry results were released by ISO, a Verisk Analytics company, and the Property Casualty Insurers Association of America (PCI).
The property/casualty (P/C) industry’s underwriting performance in the first half of 2017 was affected by a host of favorable conditions. A discussion of the key drivers of this first-half performance follows.
P/C insurers measure premium income in three ways, each of which gives a different insight into the industry’s activity. Direct premiums are amounts that policyholders pay. This is a basic gauge of “retail” activity. Net premiums written are calculated by subtracting amounts insurers pay for reinsurance from direct premiums, and are therefore a simple gauge of the net amount of risk that insurers plan to assume. Net earned premiums are derived by adjusting net premiums written to reflect that was provided.
ISO estimates that direct premiums written grew by about 6.0 percent. Net premiums written (for insurance subsequently to be provided) soared by 13.3 percent in the first half of 2018, up from the more typical 4.1 percent growth rate in the first half of 2017. Net earned premiums (for insurance actually provided) grew by “only” 10.2 percent, compared to growth of 3.4 percent in the comparable period in 2017.
In general, premiums may grow for any or all of several reasons. One reason is growth in the number and/or value of insurable interests (such as property and liability risks). Another is an increase in the willingness of buyers who had some or no insurance to purchase or add to their insurance protection, net of those who reduce or drop it. And a third is an increase in rates (the price per unit of coverage).
Moreover, changes in net written and net earned premiums are sometimes due to changes in reinsurance, as seems to be the case in 2018. As ISO/PCI comment, “the sharp acceleration of [net] premium growth is largely due to changes in reinsurance utilization, apparently prompted by the recent U.S. tax reform. Many insurers chose to significantly reduce the portion of premiums ceded to their non-U.S. affiliates because of the concerns about possible tax implications of the new law… [and also] one-time increases in written premiums associated with the returns of previously ceded unearned premium reserves.”
As a general rule, exposure growth is driven primarily by economic growth and development. For premium growth an appropriate measure of U.S. economic growth is nominal (not inflation-adjusted) GDP. (Figure 2) The percentage change in nominal GDP in the first two quarters of 2018 (vs. the same quarter in 2017) was 4.5 percent in the first quarter and 4.6 percent in the second quarter.
From the data available, it is not easy to determine to what extent premium growth is coming from an increase in insurance buyers, but some data are suggestive. For example, compared to the first half of 2017, the first half of 2018 saw continued growth in the number of people employed—especially those employed full-time—and net business formation and expansion. Figure 3 shows three types of business investment, all of which would imply increases in the purchase of commercial insurance. This all suggests that some people and businesses that had previously been un- or underinsured might have bought more coverage lately. Also, those who financed new cars or homes had to purchase insurance coverage to satisfy the conditions of their loans, even if their prior vehicles or residences were not insured.
The other important determinant in premium growth is rate activity. Rates tend to be driven by trends in claim costs, conditions in the reinsurance market, marketing and distribution costs, and investments in technology, among other factors.
Different segments of the industry saw markedly different premium flows. Net premiums written growth for insurers writing mainly personal lines (mostly auto and homeowners insurance) was 7.6 percent in 2018:1H. In contrast, net premiums written for insurers writing mainly commercial lines, excluding mortgage and financial guaranty insurers, rose by 25.6 percent in 2018:1H, vs. a 2.6 percent rise in 2017:1H. And insurers writing mainly balanced books of business saw net premiums written grow by 5.6 percent.
Although it is challenging to foresee the interplay the activity discussed above and macroeconomic factors, it is certainly possible that overall industry growth in net premiums written could keep pace with overall economic growth in 2018 to 2019.
Incurred losses and loss-adjustment expenses in 2018:1H rose by 3.6 percent versus the comparable prior period in 2017:1H. However, it is important to remember that, when comparing year-over-year experience, unusually high prior-year results can make even a normal or typical year appear to be a favorable one because the current-year data are being compared to atypically-high prior year data. To an extent, such is the case this year: incurred loss and loss-adjustment expenses rose by 7.2 percent in 2016:1H over 2015:1H and by 5.7 percent in 2017:1H over 2016:1H. Nevertheless, the 3.6 percent increase this year is considerably below the gain in earned premiums; if this relationship were expected to continue, all else being equal, this would indicate that rates would fall, at least for some lines of business.
In most years, as Figure 4 shows, catastrophe-related claims in the first half of the year are between 6 percent and 8 percent of total claims, but they can be quite volatile. This is in part because the second calendar quarter is the prime season for tornadoes, so an active tornado year can spike catastrophe claims. In the first half of 2016, the industry’s experience with catastrophe-related losses was $14.6 billion, rose to $18.0 billion in 2017:1H, and dropped to $14.6 billion this year. Non-catastrophe losses also rose, to $186.7 billion from $176.4 billion (up 5.8 percent). As a result of the lower-than-last-year catastrophe claims, total losses and loss adjustment expenses rose by only 3.6 percent, to $201.3 billion. Note that these numbers are net of reserve releases, discussed next.
Reserve releases are generally associated with new estimates of expected costs for unsettled open claims from past years. Overall inflation continues to be unexpectedly low, likely contributing to these new lower estimates, although prices for some items (such as building materials) that comprise claims payouts have been increasing at higher rates. For the first half of 2018, the industry reported releases of prior-year claims reserves totaling $9.6 billion, up from $6.9 billion released in the first half of 2017.
The industry’s overall net (of policyholder dividends) statutory underwriting gain of $6.0 billion in the first half of 2018 compares to an underwriting loss of $4.6 billion for the first half of 2017. From an historical perspective, underwriting losses have been the norm over the past several decades. According to ISO, underwriting profits have occurred in only about 1 in every 6 calendar quarters since 1986, when ISO’s quarterly data began. As Figure 5 shows, the net underwriting gain for 2018:1H is the largest in a first-half since 2007.
Different segments of the industry had different underwriting experiences. The combined ratio for insurers writing mainly personal lines (mostly auto and homeowners insurance) improved—significantly—to 95.8 in 2018:1H.
Since the housing bubble burst in 2008, for a few years the mortgage & financial guarantee (M&FG) sector of the P/C industry disproportionately weighed down overall industry results, and because this line of business is written by only a few companies—some of them monoline carriers—it became common to report commercial lines insurers’ results excluding M&FG data. This continues to be the case, even though the line has returned to profitability. As a result, the combined ratio for insurers writing mainly commercial lines excludes mortgage and financial guaranty insurers; it improved (fell) to 95.4. And insurers writing mainly balanced books of business experienced a combined ratio of 99.4 in 2018:1H.
At the end of the first half of 2018, industry cash and invested assets totaled $1703 billion, up by $84 billion (+5.2 percent) from the comparable period in 2017. For the first half of 2018, net investment gains—which include net investment income plus realized capital gains and losses—rose by $5.2 billion (+19.2 percent) to $32.2 billion, compared to $27.0 billion in the first half of 2017.
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.
The industry’s net investment income for the first half of 2018 was $26.8 billion, up from $23.4 billion in the comparable year-earlier period, an increase of $3.4 billion, or 14.6 percent. As noted above, some of the increase in investment income is attributable to a 5.2 percent increase in the amount of money invested.
Net investment income itself has basically two elements—interest payments from bonds and dividends from stock. As an indicator of prevailing corporate bond yield levels, yields in Moody’s AAA-rated seasoned bond index averaged 3.84 percent in the first half of 2018, virtually the same as in the first quarter of 2017 (bookending a dip to an average of 3.61 in the second half of 2017).
The other significant source of net investment income (besides bond yields) is stock dividends, which were also virtually the same as in the comparable quarters in 2017. Stock holdings in general represent roughly only about one-fifth of the industry’s invested assets.
According to ISO/PCI, another dimension of the increase in net investment income was “the timing and magnitude of dividends from insurers’ subsidiaries outside of the U.S. P/C universe. Such a dividend can include the earnings accumulated within a subsidiary over [a] long time and, while considered investment income, can also include return of capital. Three insurers were most notable for large changes in their investment income from such ‘external’ subsidiaries, with two posting elevated investment income in first-half 2018 and one in first-half 2017. Excluding these three insurers, the net investment income grew 2.1 percent.”
Realized capital gains in 2018:1H were $5.4 billion. This is 50 percent higher than the 2017:1H result ($3.6 billion). As Figure 5 shows, a $5.4 billion gain is the second-highest result for a first-half-year since 2007. Strong stock market gains in the second quarter of 2018 provided opportunities for realizing capital gains.
Policyholders’ surplus as of June 30, 2018 stood at $761.1 billion—up $45.9 billion (+6.4 percent) from the year-earlier period. Policyholders’ surplus has generally continued to increase in recent years as industry profits rose, and as assets held in the industry’s investment portfolio increased in value in the recovery from the financial crisis and the Great Recession. The fact that the industry was able to recoup its losses to surplus even in the wake of disasters like superstorm 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 out very large scale losses in 2018 and beyond. One commonly used measure of capital adequacy, the ratio of net premiums written to surplus, currently stands at 0.77, close to its strongest level in modern history (a lower number represents greater strength).
The P/C insurance industry turned in a profitable overall performance in the first half of 2018. Policyholders’ surplus reached a new all-time record high. Premium growth 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 the first half of 2018 follows.
To view the full report from ISO and PCI, click here.
To view the press release from ISO and PCI, click here.