Tough Times for Insurers

Times are unquestionably tough for property and casualty insurance companies. According to a recent report released by industry trade group Property Casualty Insurers Association, profits in the industry dropped by almost 50% in the first quarter. Even if you disregard the losses at mortgage and financial guaranty companies, profits were still down 24%.

The industry has lost most of the pricing power that developed following the terrorist attacks on Sept. 11, 2001, and the market is weakening quickly. Many markets, particularly personal lines such as auto and homeowners insurance, are seeing price wars as companies struggle to build market share. After three years of underwriting profits, it appears that most P&C insurers will once again begin to experience underwriting losses. Unfortunately, the bond market is not cooperating; it will be more difficult than in years past for investment income to offset the losses.

A Changing Climate

The first-quarter losses could be a real problem for insurance companies the rest of the year. Traditionally, the first quarter is one of the best from an underwriting standpoint. Heavy losses from weather-related disasters usually come later in the year. According to PCI, however, insurers experienced underwriting losses of $600 million in the first quarter, and the second quarter has already seen one natural catastrophe that will hit several insurance companies. The heavy flooding in the Midwest will cause large payout and losses at companies that offer crop insurance. Companies like ACE Limited (ACE - commentary - Cramer's Take) and XL Capital (XL - commentary - Cramer's Take) could have their worst crop insurance losses in more than a decade. Beyond the flooding, lightning strikes have started hundreds of fires in California that could cause losses if they spread to more populated areas. Should the experts' prediction of a busy hurricane season pan out this year, underwriting losses could mount quickly for companies with large exposure to consumers and businesses in coastal areas.

The volatility of the stock and bond markets is hurting insurers as well. Many of them had substantial exposure to the mortgage-backed securities market and have had to write down assets in recent months -- XL Capital's CEO stepped down recently after the company had significant losses from subprime securities. Bond prices have been falling as the market has begun to reflect inflation fears from rapidly rising food and energy costs. Investment income for the group declined almost 20% in the first quarter of this year, slipping to just over $12 billion from $15 billion in the year-ago period.

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At the time of publication, Melvin had no positions in the stocks mentioned, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.