Insurance Industry Posts Strong Q1 Gains

After suffering its first ever net loss in 2001, an extraordinary and dismal year by anyone’s reckoning, the property/casualty industry finally received some good news as earnings reports for the first quarter of 2002 showed generally rising premiums, and earnings increases.

Before launching into a chorus of “Happy Days are Here Again,” however, some mitigating factors should be looked at. A sampling of first quarter results, predictions and comments is certainly encouraging, but “one swallow does not a summer make.”

American International Group, the world’s largest insurer in terms of equity capital, recorded a 6.7 percent increase in overall net income to $1.9803 billion in the first quarter, compared to $1.8553 billion in the same period for 2001.

Speaking at the company’s first-ever earnings conference call Chairman Maurice “Hank” Greenberg sounded an optimistic note. “AIG is off to a very good start in 2002. Excluding realized capital gains and losses AIG’s first quarter net income rose 11.1 percent to a record $2.13 billion.” He went on to note that “In the property-casualty business around the world, rates are continuing to strengthen as we have indicated in prior quarters, helping to produce strong results from our general Insurance business in the quarter.”

AIG’s figures also show that it took in over $6 billion from its p/c operations and twice that from its life insurance operations. Its combined ratio for the quarter dropped slightly from 95.89 percent to 95.76 percent.

Germany’s Allianz, nominally the world’s largest insurer, posted a 9.4 percent increase in total gross premium last year from 68.7 to 75.1 billion ($61.83 billion to $67.6 billion). Property/casualty insurance premium income rose by 9.8 percent from 38.4 to 42.1 billion ($34.56 to $37.9 billion), but its net income fell sharply.

European insurers don’t normally release quarterly results, but Allianz’ financial announcement stated that it’s earnings are on the way to recovery. “Allianz forecasts that the Group will be able to again achieve the continual growth of previous years during the current fiscal 2002. An increase of at least 4 percent is anticipated in total premium income based on exchange rates for the year 2001. The Board of Management expects net income for the year to increase to more than 3 billion euros [$2.7 billion].”

Other companies have released first quarter earnings results that support the trend. Hartford reported net income of $292 million, up 22 percent from the $240 million it earned in the same period last year. Erie Indemnity reported a 21.3 percent increase in net income for the quarter from $34.785 million to $44.201 million. Chubb reported first quarter net profits of $198.2 million or $1.15 a share, up from $175 million, or 97 cents a share, a year earlier.

The report from Bermuda’s XL Capital was instructive. While gross written premiums for the quarter more than doubled to $2.85 billion, compared to $1.1508 billion last year, and net operating income for the period increased to $210.4 million from $156.7 million, net income for the quarter decreased by 59 percent due to $106.02 million in losses from investments, coupled with $13.2 million from derivatives trading.

The Reinsurers
Among reinsurers, RenaissanceRe exceeded even its usual stellar performance, recording net income of $86.6 million in the first quarter, compared to $37.3 million in 2001. The company’s $3.72 earnings per share more than doubled 2001’s $1.84, and beat analysts’ consensus estimates by more than a dollar a share.

James N. Stanard, RenRe’s president and CEO, expects to see the trend continue. “Our record first quarter demonstrates the earnings power of our business in a period with low catastrophe losses,” he commented. “In addition, we achieved outstanding success, reflected by substantial revenue growth, across all our key business activities—catastrophe reinsurance, specialty reinsurance and catastrophe-exposed commercial insurance. Lower than usual first quarter loss activity, together with projected increases in 2002 premiums, lead us to be comfortable with estimates of $12.00 to $12.50 for 2002 operating EPS.”

The two reinsurance giants, Munich Re and Swiss Re, both of which were badly hit by the Sept. 11 attacks, also expect strong rebounds this year.

Munich Re announced in March that “owing to the price increases and pleasing growth in new business, it expects premium to grow overall in reinsurance by 11% to over 24bn [$21.6 billion] in 2002. The combined ratio, and thus the reinsurance underwriting result, should improve very noticeably in the current year.” The forecast comes after the company terminated almost one fifth—in premium volume—of the reinsurance treaties up for renewal in January, “because appropriate improvements in prices and conditions were not possible.”

Across the border, Swiss Re, which reported a Sw. Frs. 165 million ($101 million) loss for 2001, its first in 135 years, noted that, “Following an accelerated upswing in the insurance cycle, the business group is now operating in a fundamentally positive environment. In spite of currently favorable conditions, the focus will remain on underwriting discipline, tight capacity control and adherence to return on capital targets, to ensure the long term success of the business group.” Standard & Poor’s gave the company a vote of confidence at the end of April when it reaffirmed its triple ‘A’ rating.

Lloyd’s tempered its recent announcement of an estimated $4.13 billion loss for 2001 by stating that, “There can be no doubt the market has hardened very rapidly in the last six months, characterized by tougher underwriting standards, rising prices, higher deductibles and more rigorous terms and conditions across all lines.”

Reinsurance, however, manifests the first signs of trouble. “My impression is that the [reinsurance] market is definitely tightening,” said Paul Walther, the head of Florida-based Reinsurance Directions. “As good as the results might be they are tarnished by prior claims.” Walther also noted that just when the ART market could be expected to become a more prominent factor, it has been “impacted by Enron,” making potential investors more cautious of special purpose vehicles.

The Brokers
Brokers are seeing their profits rise as well. MarshMac recorded that its first quarter net income rose 13 percent to $418 million compared to $369 million in 2001, despite a fall in revenues at its Putnam Investment division, which declined by almost $100 million. Its brokerage and risk management activities produced gains of around 9 percent, earning $1.48 billion, producing operating income of $462 million, compared to $381 million in the same period last year.

Aon, however, was forced to issue a warning that its profits would be cut back to between 36 and 39 cents a share instead of the 55-cents analysts had forecast. The main cause—a $56 million claim for the reimbursement of World Trade Center losses, which is in litigation.

While an overall consensus certainly shows that 2002 is likely to be a very profitable year, it’s still only the end of the first quarter, and some long term issues have yet to be dealt with—the 900-pound gorillas waiting in the closet, more or less.

According to the Insurance Services Office (ISO) and the National Association of Independent Insurers (NAII), “The property/casualty insurance industry suffered a $7.9 billion net loss after taxes in 2001. The industry’s statutory surplus, or net worth, fell $27.7 billion, or 8.7 percent, to $289.6 billion at year-end 2001 from $317.4 billion at year-end 2000.”

The reasons behind last year’s disaster, which have been extensively detailed, were basically Sept. 11 and a massive fall in equity values on world stock markets, coupled with interest rate cuts, i.e. less money earned even less money while unprecedented claims were being made. While Q1 2002 is encouraging, the p/c industry will need more than three months of improved results to even begin to offset what happened last year

“There’s now an overriding fear of volatility,” said Walther. “Companies did not expect the across the board losses caused by 9/11. They’re ‘gun shy,’ and they’re not prepared to consider alternatives for clients, much less attempt to work out something [that may carry excessive risk].”

This mind set clashes with the positive signs, noted by many agents, brokers and companies, of increased overall demand for insurance, especially in commercial property, business interruption and workers’ compensation. The realization that disasters like Sept. 11 can strike again, and the magnitude of the disruption they can cause, has made insurance protection a high priority item for many companies. Rising premiums are one result, as the first quarter results show, but in some sectors, notably those exposed to terrorist attacks, such as commercial property owners, coverage has simply dried up.

Industry leaders like AIG’s Greenberg and Berkshire Hathaway’s Warren Buffet have been outspoken not only in emphasizing the need for careful underwriting procedures, but in trying to find solutions to insuring terrorist risks. Neither could be accused of being advocates of government intervention, yet both have called for some form of federal reinsurance. In posting a potential trillion-dollar loss, Buffett concluded in his annual letter to Berkshire’s shareholders that, “Only the U.S. government has the resources to absorb such a blow.”

Terrorism Pool?
Maybe Congress will follow where others lead. The German government recently adopted a plan to create a terrorism insurance pool, similar to the one that’s been in place in the U.K. since the early ’90’s. It set up a pool of 3 billion ($2.7 billion) after Sept. 11, and will now backstop that with an additional 10 billion ($9.02 billion) which will cover property damage claims related to terrorism, excluding airline claims, which already have recourse to emergency insurance measures from most governments.

So far no such plan has been adopted in the U.S., despite proposals pending in Congress. Unless it is, the U.S. p/c industry will continue to face the dilemma of trying to limit underwriting risks, while complying with regulations that require them to write certain kinds of coverage. The insurance commissioners of both New York and California recently refused to adopt the broad exclusionary provisions on terrorist coverage suggested by the ISO. Meanwhile, as Walther indicated, reinsurance of any risks where terrorism is involved has become extremely hard, if not impossible, to place, and when by some miracle coverage is written, it’s very expensive.

Unless exclusions are more broadly allowed, and unless the U.S. government becomes the ultimate reinsurance provider for terrorism, and perhaps for other uninsurable or otherwise potentially disastrous claims (asbestos and toxic mold come to mind), the industry will continue to be exposed to another disaster like Sept. 11. Any income gains it may make in a quarter, or even in several years, could be wiped away.

Gorillas Galore
The volatility of the securities markets, and the risk factors which affect investments are a second “900 pound gorilla” looming over the industry. XL’s first quarter experience is a textbook example of the fact that you can write a lot of premium, reduce your losses, increase your operating net, and still see your income drop because of your investments, which have nothing to do with insurance. The money earned on the “float,” the funds insurers receive in premiums, which are held to be paid out on future claims, is perhaps the most critical element in determining overall net profit. If the returns on those investments stagnate, or decline, it becomes increasingly difficult to support loss ratios that frequently exceed 100 percent.

According to a recent study by Conning & Co., however, p/c insurers are on balance pretty good investors. While the study covered only the period 1996-2000, thus avoiding the dot com disasters suffered last year, it found that conservative investments seemed to have fared the best over the period.

Conning identified 30 companies that “distinguished themselves by their investment income performance during the 1996-2000 period. These 30 companies took a variety of paths to success, but several clear patterns were apparent:

The Home Run Hitters earned an average 12.7% return on assets over the study period. They achieved success by earning high returns on both bond and stock portfolios.

The Equity Wave Group used a higher-than-average allocation of assets to common stocks to earn 10.5% overall returns, even though their stock portfolio returns were only average.

The Strategic Equity Investors maintained average allocations to the equity market, but earned among the highest returns on their stock market investments. With high equity returns and average bond returns, they achieved enviable success.

That’s good news, if the same pattern holds for the future. However, Conning’s Clint Harris noted that, “we found that higher investment returns enticed insurers to write to higher loss ratios which may have caused reserve deficiencies.” Investment values can decline much more rapidly than loss ratios can be reduced, which creates a problem and underscores the need for careful underwriting.

The lasting effects—the “ripples,” as Walther calls them—of Sept. 11 on capacity and capital may be another gorilla in the closet, although perhaps a smaller-sized one. By some estimates as much as $33 billion in new capital has flowed into the industry since Sept. 11, over $12 billion in Bermuda alone. The increase is to some extent offset by companies that have withdrawn from the market or reduced their activities.

Historically new capacity has depressed premiums, and this time there may also be a correlation between the current preoccupation with more conservative risk analysis and underwriting standards. Reinsurers like Munich Re, Swiss Re and RenRe have made the use of catastrophe models a sine qua non for their underwriters.

While no one can argue against this as a sound business practice, Walther sees some problems. “Many of them [reinsurance companies] have lost their appetite for truly underwriting risks; they’re so scared that they’re reappraising what they should be doing, and they end up deciding only to do what they know best.” He feels that eventually there will be too much capacity in some areas, auto insurance for instance, that will drag down premiums, while in other sectors there will be too little and that on balance there will be less innovation.

This puts the industry in a double bind. If everyone adheres to conservative underwriting standards, and accepts only risks that don’t carry any long-term or high loss consequences, the excess capacity pursuing that business will ultimately drive down premiums. On the other hand, accepting the riskier business exposes the insurer to larger potential losses.

Walther also observed that for the most part the new Bermuda-based insurers are being staffed with people who are long time industry veterans, and can be expected to run them well. The new players don’t have the long-tail liabilities that older companies do. He then noted that St. Paul recently announced it was spinning off its reinsurance operations as Platinum Re, a new Bermuda-based company, retaining only a 24.9 percent stake. Zurich spun-off its reinsurance operation as Converium last fall. Gerling is apparently seeking to withdraw from the market, and there are persistent rumors that GE wants to sell off Employers Re. “If the market’s so great, why are they all getting out of the game?” he asked.

The above considerations should be kept in mind when viewing all those rosy first quarter results. You might also ask what any of this has to do with you as an agent. More than you might think. You’ll have no trouble paying a bit more to renew fire, theft and liability coverage on “Mike’s Garage,” but Mike might have to pay a lot more if he wants business interruption coverage and for his workers’ comp, especially if some of his mechanics have been around for a while. Oh, yes, and congratulations on getting the contract to find coverage on that new 25-story building they’re going to put up out by the Interstate. Hope you find someone who’s willing to write it. You’ll earn every dollar of that commission.