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The property/casualty insurance industry: its past and prospects.

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.


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.

Historically, catastrophe losses have averaged between 2 percent and 3 percent of the property/casualty industry's statutory net worth or surplus. In 1992, however, catastrophes totaled 12.1 percent of industry surplus. Because catastrophe losses can surge without warning to record levels at any time, catastrophes constitute a significant risk to individual insurers and the industry as a whole.


A.M. Best has reported that because of record catastrophe losses, increased regulatory scrutiny, and other factors, the number of insurers involuntarily ceasing operations rose from forty-six in 1991 to a record fifty-seven in 1992 -- surpassing the previous record of fifty-two in both 1985 and 1989 by 10 percent.

Losses from Hurricane Andrew reportedly caused the collapse of at least ten insurers in 1992. Losses from Hurricane Iniki claimed another three. Other weather-related disasters, including eleven major storms, contributed to the failure of several other carriers. In addition, the Los Angeles riots led to the collapse of one California-based insurer. Poor results in lines such as high-risk auto insurance and workers' compensation led to state action against still more insurers.

The fifty-seven that failed in 1992 represented 1.5 percent of the total number of property/casualty insurance companies. While both the number of failures and the failure rate (the number of failures as a percentage of the number of companies) tend to oscillate with the cycle in insurers' profitability, a long-term upward trend has occurred in the percentage of companies that fail each year. Defining insurance cycles as starting one year after a trough in the property/casualty industry's rate of return on net worth and ending at the next trough, the failure rate averaged 0.3 percent during the insurance cycle from 1976 to 1984. It then averaged 1.2 percent during the insurance cycle from 1985 to 1992 (assuming 1992 proves to be a trough in property/casualty insurers' rate of return).

In spite of the upward trend in the number of insurers that fail each year, many who follow the property/casualty industry have concluded that it does not face a solvency crisis like the one that plagued the savings and loan industry. This conclusion follows not only from insurers' substantial surplus but also from the recognition that most insurers do not keep a major portion of their assets in risky investments such as real estate, mortgages, and junk bonds. Nonetheless, insurers face significant uncertainty as to their liabilities, especially regarding their ultimate costs for environmental claims and other so-called "toxic torts."

Industry Assets

Many financial institutions have encountered financial difficulties in recent years due to losses on their investments in real estate; others have run into difficulties as a consequence of problems in the "high-risk, high-yield" or "junk" bond market. This had led some to question property/casualty insurers' financial soundness. However, the date show that insurers' exposure to losses in real estate and junk bonds is small.

As of year-end 1991, real estate accounted for less than 3 percent of the property/casualty industry's invested assets. Moreover, the industry's investment in lower grade bonds declined from an already low 7.4 percent of total cash and invested assets at year-end 1986 to 1.3 percent of cash and invested assets at year-end 1991. Excluding medium quality bonds, the share of the industry's cash and invested assets in "high-risk" bonds was even lower -- 0.5 percent.

The potential for insolvencies due to defaults on relatively risky investments can be assessed by examining the percentage of insurers with significant sums invested in such assets. The percentage of insurers with more than 15 percent of their cash and invested assets in lower-grade bonds and real estate declined from 21.1 percent in 1986 to 5.1 percent in 1989 and remained fairly steady through 1991. The share of total industry premium written by such insurers declined irregularly from a high of 25.2 percent in 1987 to 5.1 percent in 1991. Thus, the data indicate that significant numbers of insurers have reduced their exposure to problems in junk bond and real estate markets.


For many decades, the property/casualty industry has experienced cycles in its financial results. These cycles appear in any long-term series of premium growth rates, underwriting results, or rates of return. The following sections place the industry's 1992 financial results in historical perspective.

Loss and Loss Adjustment Expense Growth

The property/casualty industry's loss and loss adjustment expenses increased from $180.2 billion in 1991 to $200.0 billion in 1992. But, affected by last year's record catastrophe losses, that 11 percent increase paints a misleading picture of the underlying trends in loss and loss adjustment expenses. Excluding catastrophes, the industry's loss and loss adjustment expense increased only 2.7 percent.

Longer term, growth in noncatastrophe losses slowed from more than 17 percent in 1984 to a record low of less than 1 percent in 1991. Loss of market share to alternative insurance mechanisms such as self-insurance may have contributed to the deceleration in the growth of noncatastrophe losses. Weakness in the economy and moderation in inflation certainly played a part. Should economic growth or inflation accelerate, so too might the growth in property/casualty insurers' loss and loss adjustment expenses.

Combined Ratio

Because of record catastrophe losses, the property/casualty industry's combined ratio deteriorated to 115.9 percent in 1992 -- the third worst on record. Longer term, there has been a trend toward deterioration in the industry's combined ratios. Unlike results during the 1960s and much of the 1970s, the industry's combined ratio has not been better than 100 percent since 1978. Moreover, the industry's combined ratio exceeded 106 percent only once during the twenty-one years from 1960 to 1980. The industry's combined ratio has been worse than 106 percent in ten out of twelve years since 1981.

Written Premium Growth & RONW

Written premium growth slowed slightly from 2.4 percent in 1991 to 2.3 percent in 1992, the lowest rate of growth in more than thirty years and the second record low in as many years. The weak economy, moderate inflation, the use of higher deductibles, and continued growth in alternative insurance mechanisms such as self-insurance may all have contributed to 1992's slow premium growth.

The year 1992 also was the fifth consecutive year in which premiums rose less than 5 percent. But, from 1952 to 1990, premiums never grew less than 5 percent for even four consecutive years. During the 1970s, premium growth never fell below 6 percent per year.

Historically, changes in written premium growth rates have preceded changes in returns on net worth. When written premium growth rates increased, subsequent returns on net worth generally improved, and when written premium growth rates fell, subsequent returns on net worth generally deteriorated.

In the early 1980s, insurers responded slowly to deteriorating underwriting results. Premium growth averaged 4.3 percent per year from 1981 through 1983, and the industry's rate of return fell to a cyclical low of 1.9 percent in 1984. Premium growth then rebounded to more than 22 percent in both 1985 and 1986, and rates of return rose to a peak of 15.9 percent in 1987. Since then, premium growth has been low, averaging 3.3 percent per year from 1988 to 1992--less than the growth rate in each of the previous twenty-six years. And, except for a small increase in 1991, industry profitability, as measured by return on net worth, declined each year since 1988.

Investment Income

Property/casualty insurers' net investment income (excluding capital gains) declined by 1.2 percent in 1992, the first decrease in investment income on record (i.e., since 1960) and the third consecutive record low in investment income growth. The 2.7 percent average annual rate of increase in insurers' investment income from 1990 to 1992 contrasts with a 15.7 percent average annual rate of increase during the twenty years from 1970 to 1989.

Factors contributing to the slow growth in investment income include low interest rates and slow premium growth, premiums being a major source of funds for new investments. Insurers' 1992 investment income may also have been depressed by the liquidation of income-producing assets, particularly bonds, to raise cash and bolster surplus in the wake of record catastrophe losses.

Comparisons with Other Industries

This analysis compares insurers' rates of return on year-end net worth with those of other industries included in Standard & Poor's COMPUSTAT data base and with those of the Fortune Service 500 companies. Because of the cycles in insurers' results, comparisons of insurers' profitability with that of firms in other industries should examine data spanning at least one insurance cycle.

Because complete year-end 1992 data were not yet available from the COMPUSTAT data base, this analysis used data for the years 1975 to 1991. Those seventeen years make up two complete insurance cycles, each starting with a trough in insurers' rate of return and ending one year before the next trough.

From 1975 to 1991, property/casualty insurers' rate of return on year-end net worth averaged 10.8 percent compared with an average of 12.0 percent for the other industries for which COMPUSTAT data were available. In a ranking from most to lease profitable on average during that period, the property/casualty insurance industry placed fifty-two out of ninety-two.

The Fortune Service 500 consists of the 500 largest companies in various service industries. Because large firms may be more profitable than small firms, the following analysis compares the profitability of the Fortune Service 500 with that of large insurers as well as that of the entire property/casualty industry.

The median rate of return for the Fortune Service 500 was 12.0 percent in 1992, 7.6 percentage points higher than the rate of return for all insurers and 9.9 percentage points above the rate of return for large insurers. For the period from 1985 to 1992, the median rate of return for the Service 500 averaged 12.2 percent, compared with a 9.8 percent average return for the property/casualty industry and a 10.0 percent average rate for large insurers.


This past spring, the Society of Insurance Research conducted its annual Property/Casualty Operating Outlook Survey. Questionnaires were mailed to the chief executives at the largest 250 property/casualty insurers. The thirty-four responses represented more than 1/3 of the insurers writing more than $1 billion per year in premiums and roughly 15 percent of overall industry premium volume. They also represented all sections of the country, a reasonable mix of the distribution mechanisms used by insurers, and a healthy balance of personal and commercial lines expertise.

The following sections summarize respondents' views of the economic outlook and the prospects for the property/casualty industry. Although the composite projections cited below take on a precise appearance, remember that a range of diverse opinion that fed into them and the uncertainty that connotes.

Economic Outlook

Only 9 percent of the respondents felt President Clinton's election would have a beneficial effect on the economy. Another 28 percent felt Clinton's election would be a "neutral," while about 63 percent indicated that they expect Clinton's election to have negative effects.

Averaging the respondents' forecasts for real GDP growth, it appears that they collectively expected the nation's real GDP to grow a lackluster 2 percent this year. The consensus forecast called for real GDP growth in the neighborhood of 2.5 percent in 1994, with growth in real GDP expected to recede to about 2.2 percent in 1995. Thus, the survey suggests continuing growth but an economic recovery that can only be characterized as subpar in comparison to historical norms.

Inflation, on the other hand, was expected to accelerate in spite of the continuing relative weakness in the real economy. The Consumer Price Index (all items, all urban consumers) rose 2.9 percent in 1992. The respondents to the SIR's survey collectively forecast that it would climb 4.5 percent in 1993, 5.2 percent in 1994, and 5.7 percent the year after.

The Consumer Price Index for Medical Care increased 7.4 percent last year. The SIR survey indicates that inflation in medical care costs -- a key determinant of insurers' claim costs -- might gradually abate to 7.3 percent this year and 6.8 percent in 1995. Nonetheless, inflation in medical care costs was expected to remain stubbornly in excess of inflation overall.

The survey respondents' forecasts for interest rates suggested that the average yield on ten-year U.S. Treasury bonds would decline from 7.0 percent in 1992 to 6.7 percent in 1993. Thereafter, interest rates were expected to rise, with the average yield on ten-year U.S. Treasury bonds typically seen as rising to 7.9 percent in 1995. Although recent developments suggest that the average yield on Treasury bonds in 1993 will be lower than respondents expected, the forecast 1.2 percentage point increase in yields between 1993 and 1995 mirrors the anticipated acceleration in inflation.

The Property/Casualty Outlook

Just as those who responded to the SIR's survey were less than optimistic about the effect of President Clinton's election on the economy, they were less than optimistic about its effect on the property/casualty industry. Only 6 percent felt that Mr. Clinton's election would benefit the industry. 31 percent expected Clinton's election to be a "neutral" and 63 percent of the respondents indicated that President Clinton's election might have negative implications.

The composite projection for 1993 all lines property/casualty premium growth was only 3.5 percent, not much more than the record low rates of premium growth experienced in 1991 and 1992. Though projected premium growth accelerates to 7.0 percent in 1995, that would seem barely enough to keep pace with inflation and economic growth. The SIR's outlook survey yielded few, if any, indications that property/casualty markets should be expected to firm appreciably during the next few years.

Consistent with the relatively lackluster outlook for premium growth, the SIR survey indicated that underwriting profitability might improve only modestly through 1995. The composite projections for the all lines combined ratio, the ratio of losses and expenses to premiums, indicated that key measure of underwriting performance would improve from 1992's 115.9 to 112.7 in 1993, 110.5 in 1994 and 108.9 the year after. Much of the anticipated improvement in underwriting results this year may be attributable to a return to more normal levels of catastrophe losses. The improvement expected in 1994 and 1995 reflects the moderate acceleration in projected premium growth.

SIR survey respondents' projections for growth in the property/casualty industry's surplus, or net worth, also reflected their lackluster expectations for premium growth. More specifically, the survey suggested that the industry's surplus would show no growth in 1993 and that it would then rise only 1.5 percent in 1994 and 3.1 percent in 1995.

The SIR also asked respondents to forecast the number of property/casualty insolvencies. The survey suggests that the number of insolvencies will fall from a catastrophe-swollen fifty-seven in 1992 to about thirty in 1993 and twenty-eight in 1995. These projections compare with an average of forty-four insolvencies per year during the eight years from 1985 to 1993. There were only eleven insolvencies per year on average during the previous eight years.

Issues Affecting the P/C Industry

Changes in the laws and regulations that govern the insurance industry can significantly affect not only insurers' financial performance but also the price and availability of insurance. At present, a wide range of unresolved issues add uncertainty to the outlook for both insurers' results and insurance markets.

The SIR survey asked respondents to identify the issues likely to have significant effects on the property/casualty industry over the next five years. The issues cited most frequently included national health care reform, risk-based capital requirements, a customer service focus, and federal solvency regulation.

No one yet knows what, if any, form of national health care reform will eventually become law, but the associated changes in health care costs and health care financing could have significant effects on the property/casualty coverages that provide for medical care. Workers' compensation, personal injury protection, automobile liability, and other forms of liability insurance could all be affected.

While the effects of the National Association of Insurance Commissioners' pending imposition of risk-based capital requirements remain to be seen, Capitalization in the Property/Casualty Insurance Industry (Insurance Services Office, Inc., June 1992) shows that even a carefully conceived risk-based capital formula could prove inefficient -- sometimes failing to indicate soon-to-be-insolvent insurers need additional capital and sometimes suggesting that otherwise healthy insurers need additional capital. It is difficult to determine what will happen in insurance markets if risk-based capital requirements increase the amount of net worth insurers must have for each risk they assume.

SIR survey respondents' concerns about "a customer service focus" may reflect a belief that pricing competitively may not be enough to attract and retain profitable business in the future. While some view insurance as a commodity business, others maintain that superior customer service can distinguish one insurer's products from those of the pack. However, competing in terms of customer service may require substantial investments in new technologies: technologies that enable insurers to eliminate mountains of files and access complete customer histories the instant the telephone rings; and imaging technologies that not only provide basic data but customer correspondence and photographs that can speed claim adjusting.

Federal solvency regulation could help screen out unsound foreign reinsurers and might provide a beneficial second line of defense in the event that state solvency regulation proves inadequate. However, the National Association of Insurance Commissioners has taken strong action in recent years to bolster state solvency regulation. If state regulation is sufficient, dual regulation may add expense and confusion without benefitting the public.


The historical data cited in this article were taken from Insurer Financial Results: 1992 (Insurance Services Office, Inc., June 1993). That study utilized underwriting and financial data compiled and published by A.M. Best Company through 1991, except as noted. For 1992, that study employed data compiled by Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII), as published in Operating Results: Year-End 1992 Analysis, dated March 30, 1993.

The Reinsurance Association of America (RAA) provided the data about reinsurers' results. A.M. Best compiled the data about the number of failed insurance companies and failure rates. The Property Claim Services Division of the American Insurance Services Group, Inc. provided the data on catastrophe losses.

Standard & Poor's COMPUSTAT service furnished data about the profitability of noninsurance industries. Rates of return on stockholders equity for the Fortune Service 500 were provided by Fortune magazine. An ISO analysis has shown that rates of return on stockholders equity are essentially equivalent with rates of return on net worth.

Michael R. Murray is a Senior Research Associate, Insurance Services Office, Inc., New York, NY and Cochair of the Survey Research Committee of the Society of Insurance Research.
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Title Annotation:The Insurance Industry, Retrospect and Prospect
Author:Murray, Michael R.
Publication:Business Economics
Article Type:Industry Overview
Date:Oct 1, 1993
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