The property/casualty insurance industry: its past and prospects - The Insurance Industry, Retrospect and Prospect - Industry Overview

Business Economics, Oct, 1993 by Michael R. Murray

PROPERTY/CASUALTY insurance is an essential cornerstone of commerce. Much of the American economy would grind to a halt without affordable insurance. Many factories, stores, and offices could not face the risk of operating without it. Most individuals would be unable to finance their homes, and many would have difficulty arranging credit for other big ticket items including automobiles. Those who could finance vehicles might face financial ruin if they were involved in serious accidents. Thus, the health of the property/casualty insurance industry is essential to the economic health of the nation.

The property/casualty industry's ability to provide financial protection is determined by its net worth, known as its "surplus." Growth in insurers' surplus during the favorable years of each insurance cycle enables them to meet growth in the demand for insurance occasioned by economic growth and the changing needs of society. It also enables insurers to weather the unfavorable years of each insurance cycle. Longer term, the property/casualty industry's ability to attract and retain the capital necessary to provide financial protection is determined by the risk/return trade-offs governing capital flows.

INSURER FINANCIAL RESULTS

Due to a record $23.0 billion in catastrophe losses and the slowest premium growth in more than thirty years, the property/casualty industry's underwriting loss skyrocketed 83.9 percent in 1992 to $36.5 billion. Simultaneously, the industry's net investment income declined for the first time on record, dropping 1.2 percent to $33.8 billion. As a result, the industry suffered a $3.1 billion operating loss -- its first yearly operating loss since 1985 and just its fourth since 1960.

Table 1 shows that the industry's realized capital gains more than doubled to a record-high $10.4 billion last year, as some insurers sold assets to raise needed cash while others attempted to smooth the impact of 1992's catastrophes on their reported financial results. Realizing gains accumulated over years enabled many insurers to show a net profit after taxes. But, by cashing in better-performing assets, some insurers may have undermined their future investment income.

In sum, the property/casualty industry's net income after taxes plunged 58.0 percent to $6.0 billion in 1992. Its rate of return on year-end net worth fell by half, falling from 8.8 percent in 1991 to 4.4 percent last year. Having declined in four of the past five years, the industry's 1992 rate of return was only about 1/4 of the 15.9 percent rate of return achieved in 1987, the peak of the last insurance cycle.

The property/casualty industry's surplus, or statutory net worth, rose from $158.7 at year-end 1991 to $163.8 billion at year-end 1992. The $5.1 billion or 3.2 percent increase in the industry's surplus reflects the industry's $6.0 billion in net income. The new TABULAR DATA OMITTED capital raised by insurers was more than offset by their dividends to stockholders. Insurers' unrealized capital gains were outweighed by a variety of miscellaneous charges against surplus.

However, the increase in surplus is not necessarily indicative of a positive trend in insurers' financial strength. The property/casualty industry realized an estimated $6.1 billion in capital gains on bonds and raised $6.4 billion in new funds last year. Each exceeded the overall increase in surplus. Moreover, much of the new capital raised by insurers was not contributed by confident investors but by the parents of financially weakened property/casualty insurers. But for the atypical realized gains on bonds and capital infusions, the industry's surplus would have declined.

The Effect of Catastrophes

Many in the insurance industry have called 1992 the "Year of the Cats," referring to the large number of catastrophic events and the record losses incurred. Insured catastrophe losses rose from $4.7 billion in 1991 to $23.0 billion in 1992 -- more than all recorded catastrophe losses from 1986 to 1991 combined, even when adjusted for inflation. Losses from Hurricane Andrew ($15.5 billion) made it the most expensive single storm in history. Excluding losses from Hurricanes Andrew and Iniki ($1.6 billion), 1992 would still rank as the second worst year for insured catastrophe losses on record.

The property/casualty industry's loss and loss adjustment expenses rose by 11.0 percent in 1992. Excluding catastrophe losses, however, the industry's loss and loss adjustment expenses grew only about 3 percent. Catastrophes also had a significant effect on the industry's combined ratio, the ratio of losses and expenses to premiums. That key measure of underwriting profitability worsened by 7.1 points last year, climbing from 108.8 percent in 1991 to 115.9 percent. When insurers' 1991 and 1992 results are adjusted for abnormal catastrophe losses, the industry's combined ratio worsens by only 0.6 percentage points from 108.2 to 108.8.

The reinsurance sector was hit particularly hard by 1992's catastrophes. Reinsurers play a key role in the property/casualty industry, assuming (or insuring) some of the losses sustained by other insurance companies. Reinsurance is particularly important when catastrophe losses are high, as catastrophe reinsurance contracts are designed to shift large amounts of those losses to reinsurers. In the wake of last year's record catastrophe losses, reinsurers' combined ratio deteriorated nearly 12 points, rising from 107.1 percent in 1991 to 119.0 percent.