Q1 results: Half-full, half-empty

Good news and bad news in US P&C industry results, released jointly by Insurance Services Office (ISO) and Property Casualty Insurers Association of America (PCI).

Good:

  • Q1 was profitable this year – $8.9 billion. A year ago, the industry posted a $1.2 billion loss.
  • Combined ratio improved to 101, from 102 a year ago.
  • Surplus keeps climbing, up to $540 billion, up from $512 billion last quarter and $438 billion a year ago. (So surplus is up 23% from a year ago.) Q1 surplus is just below the industry peak set at Q2 2007.
  • The economy is improving, though slowly. Insurance premiums tend to lag GDP changes by a year or so, so last year’s recovery could signal more insurable exposures and, ultimately, more premium.

More good news came from Conning & Co., whose annual survey of redundancy shows the industry continues to hold slightly more reserves than it strictly needs, despite releasing $19 billion last year.

All of this is fortuitous for the industry, as it tries to avoid being labeled as systemic risks to the economy. The label would subject insurers to taxes to fund future bailouts. But as Bob Hartwig of Insurance Information Institute argues:

No P/C insurer failed because of the financial crisis (compared to more than 250 bank failures to date), no claim went unpaid and no policy was canceled. Insurers continued to compete vigorously and introduce new products throughout the crisis whereas most banks radically scaled back their operations and product offerings.

The fact that P/C insurers recovered more quickly and completely than virtually any other segment of the financial industry is concrete proof that subjecting insurers to bank-style regulation would constitute a significant policy error . . .

The sticky wicket here, of course, is AIG, a conglomerate whose main business is insurance. But its credit-default swap fiasco did not come from insurance products.

So the industry has lots of capital – likely to be handy with a heavy hurricane season forecast – and is operating relatively normally. And results would be even better except for mortgage insurers. They are only 2% of premium but they lost $1.8 billion in the quarter.

But quell those shouts of joy a moment:

  • Premiums fell for the 12th consecutive quarter, caused by lower rates and an economy that is generating fewer exposures to insure. That hasn’t happened since the Great Depression. And as premium falls, expense ratios creep up. And high expense ratios lead to reductions in employment.
  • The return on average surplus was just 6.7% (8.3% without mortgage insurers). That’s higher than Q1 2009 (-1.2%, or 2.1% without mortgage insurers). But it’s below the 10.5% ROE for the Fortune 500 so far this year and less than the long-term cost of capital, also 10.5%.
  • Profits were buoyed by capital returns, as the first quarter stock market was strong. Since first quarter, the S&P500 is down about 7%. Those capital losses won’t all show up on the income statement, but they make it less likely that insurers will see capital gains in future quarters. On top of that, insurers are constantly rolling over their bond investments. And interest rates are a lot lower today than they were a couple of years ago, so income from bonds could also dip. That means insurers will have to start posting underwriting profits to keep ROE where it is. Hard to see that happening when . . .
  • Capital continues to surge (see the third bullet point from the ‘good’ section above). Rates are inverse to capital flows usually. So the soft market is likely to continue.
  • The premium/surplus ratio is as low as it has ever been. That’s a key measure of insurers’ ability to leverage investment returns into a high return on surplus.
  • All of these together – continued soft market, lower investment gains, more capital – would all seem to point to weaker results ahead.

I hasten to add that as a forecaster I sometimes run a little gloomy, like the farmer who loses his crop four times before he harvests it.

(Full disclosure: III is a client.)

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