Property and Casualty Insurers Take a Pounding
Profits of the nation's 3,100 property and casualty insurers declined for the first time since 2001, down 7.6% from record profits of $76.1 billion in 2006 to $70.3 billion in 2007.
This decline was driven by a 34.4% decrease in net underwriting profits -- the core business of selling insurance -- which fell from a record high of $35.7 billion in 2006 to $23.4 billion in 2007.
With the full set of regulatory data now available for 2007 and the industry facing what could be a prolonged soft market, we sat down with Melissa Gannon of TheStreet.com Ratings to discuss 2007 results.
An almost $6 billion drop in profits seems significant. If this downturn continues, how much can the industry absorb?
The industry can actually absorb quite a bit. Putting this in historical prospective, insurers have been increasingly profitable since their last aggregate net loss of $3.2 billion in 2001. From 2002 through 2007, insurers enjoyed a combined $281.9 billion in profits, which has resulted in a record level of capital and surplus of $655.8 billion at Dec. 31, 2007.
Since we started following the P&C industry in 1993, there have been exactly two years in which the industry enjoyed a profit on its core underwriting business --last year and this year. So while underwriting profits were down in 2007, that follows a record year where underwriting results were not just positive but an extremely strong $35.7 billion. Having said that, if pricing continues to fall on nearly all lines of business, that underwriting profit could be mostly wiped out in 2008 and completely in 2009.
What about investment results? Did those fall also, contributing to the loss?
No, just the opposite. Net investment gains for 2007 were up 11.1% from $63.5 billion in 2006 to $70.5 billion in 2007. This is comprised of two components: net investment income and net realized capital gains. Net investment income increased $1.6 billion, a mild 2.6% increase over 2006 results. On the other hand, net realized capital gains, which are profits on the sale of investments, increased a whopping 153%, from $3.5 billion in 2006 to $9 billion in 2007. This increase is what prevented the decline in overall profits from being much worse and was primarily due to $3.7 billion earned on the sale of common stock during the year.
What's notable is that insurers now hold $3.2 billion in junk bonds rated single B or lower. This is an increase of $1.3 billion, or 913.3%, over 2006 levels. Although this represents less than half of a percentage point of the industry's capital and reserves, the amount could increase substantially as the fair value of insurers' non-government guaranteed bonds deteriorate further under the weight of the subprime mortgage crisis. General Reinsurance Corporation and Government Employees Insurance Company, both subsidiaries of
Berkshire Hathaway
(BRK.A) - Get Report
, have the largest increases of single-B or lower bonds from 2006 to 2007. They are $447.8 million and $282.4 million respectively. In addition, 203 other insurers saw increases in these very low-quality bonds.
Some of the large publicly traded insurers have already reported heavy first-quarter investment losses. Are you expecting more of the same, and does that concern you from a financial strength perspective?
Yes. I'm sure more first-quarter investment losses will be announced. Among others,
Prudential
(PRU) - Get Report
,
Hartford Financial Services
(HIG) - Get Report
and
MetLife
(MET) - Get Report
have announced major declines in first-quarter profits caused by investment losses. All three companies are very well capitalized and can absorb this hit. The industry as a whole has experienced a $280.6 million, or 75%, increase in capital and surplus since 2001. And risk-based capital ratios are at their highest levels. So the industry is very stable and able to withstand losses in the investment arena.
If we are, in fact, in a recession, what would be the impact on the industry?
The industry can be affected in several ways. On the investment side, the risk of loss is greater in the equity and fixed-income markets. On the underwriting side, insured risk is the primary driver of the business, but the overall economy can affect sectors such as auto insurance, where people would be buying fewer cars (or less expensive ones) or cancel their policies because they can't afford them. Workers' compensation claims tend to increase in a recession, which hurts the margin in that sector. A recession could also prolong the overall soft market where prices stay lower longer because businesses simply can't afford to pay more.
Companies with
of B-plus or higher are the ones that are most able to withstand the losses of a prolonged recession.
What do you look for when rating a company?
A: We evaluate companies on several levels including capitalization, reserve adequacy, profitability, liquidity and operational stability. Companies are put through stress tests to determine their ability to withstand moderate and severe economic downturn. This conservative approach allows us to identify companies early that are not positioned to weather the storm before it hits.
The current financial strength ratings for all property/casualty insurers as well as life, health, and annuity insurers can be found at the
.
This article was written by a staff member of TheStreet.com Ratings.