First half industry results: Following the waterfall

Follow the water

ISO/PCI released first-half U.S. P&C results yesterday. First off, the numbers:

  • First half net more than doubled, to $16.5 billion this year from $6 billion in 2009.
  • Return on surplus followed suit of course, to 6.3% from 2.6%. This is kind of puny compared with the S&P500, which is returning 10.5%.

Then there is the story about surplus. So far this year, it’s up $19.1 billion, to $530 billion. But things aren’t quite so rosy.

Surplus grows mainly from net incomes. If net income doesn’t get paid out to shareholders as dividends, it stays in the company as surplus.

What’s happening this quarter is a nice example of how income and earnings flow into the balance sheet. If that doesn’t make sense to you, keep reading. It’ll be clear by the time you finish reading this.

Think of the earnings process as a waterfall. Revenue is a waterfall, some of which splashes into a pool at the bottom. The water that cascades into the pool is income. The pool itself is surplus.

As you can see, net income usually drives surplus growth, and this year is no exception. There are some remarkable capital contributions – outside investments flowing in ($24 billion, a record).  Most of that, $22.5 billion, comes from one company as a way for it to absorb an outside acquisition.

There’s also a lot of money flowing back out – dividends. (The water that eventually heads downstream, if you want to beat the metaphor.) So far in the first half, companies have dividended back $12.7 billion, nearly three times as much as the $4.7 billion a year ago.

So if you’re following the money – good for you – you see a gap:

  • Profits of $16.5B – this makes surplus grow.
  • Contributions to capital of $24B – this also makes surplus grow.
  • Dividends of $12.7B – this makes surplus shrink.

The net effect of these implies a $27.8 increase in surplus, but surplus rose $8 billion less than that. What else was a drag on earnings? There were some miscellaneous issues, but the main piece was the falling value of investments. Capital losses were $6.8 billion.

The way earnings work, net income does not include the change in the market value of the stocks and bonds you hold. Income only includes the profit or loss you book upon the sale of those securities.

But if you are an investor, or otherwise interested in the health of the industry, you want to consider the impact of the capital losses. Subtracting the $6.8 billion of capital loss from the $16.5 billion of net income leaves you with just under $10 billion increase in net worth from operations.

So remember the thin 6.2% return on surplus the industry recorded. It’s increase in net worth was 40% less than that – somewhere around 3.6%.

Better than losing money, I guess.

(Image courtesy

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