Investments plague Canadian and U.S. insurers

The 1999 third quarter returns for both Canadian and U.S. property and casualty insurers show little improvement in net earnings, with the return on investment of both sectors now hovering at around the 7% mark.

The real problem child surfacing from the first nine-month results from both Canada and the U.S is a dramatic decline in investment performance and realized capital gains. While the Canadian figures for the third quarter suggest a moderate improvement in underwriting performance as we enter a new year (this saw a modest decline in the combined ratio for the first nine months of 1999), in contrast the U.S. market reported a staggering 52% surge in underwriting losses for the first three-quarters of last year. The U.S. figures also show for the nine-month period a massive US$9.9 billion decline in the industry’s surplus due to unrealized capital losses on investments held. In response to the poor interest-based investment environment, Canadian insurers saw realized investment gains for the first nine months drop to less than half of that reported for the same period in 1998.

Canadian performance

Insurers’ earnings for the first nine months of 1999 remained at a disappointing level, observes Paul Kovacs, economist of the Insurance Bureau of Canada (IBC) in his latest quarterly financial analysis.

Although the Canadian insurance market produced mild signs of underwriting strengthening for the nine months when compared with the first three-quarters of 1998, a Cdn$334 million decline in investment gains resulted in an overall $74 million drop in net earnings. Almost all performance indicators, other than on investment, show moderate improvement for the full three quarters of the year, Kovacs notes, with the combined ratio clocking in at 105% compared with 107.6% for the same period in 1998, and premiums rising by half of a percentage point. Claims for the nine-month period also dropped by 2% compared with the previous year’s figures.

Although little can be done on the investment front, Kovacs points out that the current rate of return for the Canadian property and casualty sector is inadequate. In response, insurers have to focus on improving underwriting performance. “Industry earnings cannot be sustained at these levels…It is essential to secure greater improvements in underwriting performance. Harder markets, particularly the larger markets, must be evident if earnings measures are to clearly move back up to reasonable rates again.”

Although premiums for the third-quarter of 1999 rose by 1.4%, claims for the same three-months came in 2.5% higher, resulting in almost a full percentage point hike in the loss ratio to 74.3% compared with the same period in 1998. The third quarter’s combined ratio came in at 107.1% (1998 third quarter: 106.4%). In contrast, the underwriting loss for the third quarter of last year dropped by 17% to $218 million compared with the $263 million reported for the same period of 1998. Investment income for the third-quarter amounted to $613 million, showing a 14% decline on the level for the same period the year prior. As Kovacs observes, the level of investment income reported for the third-quarter of 1999 accounts for only 70% of the record $887 million disclosed for the same period in 1997. And, he states, “despite the steady aggregate results [on underwriting], there is much variability in performance [for the third quarter of 1999] by line of business. Personal property markets are weakening across the country, with the exception of the Prairies…In contrast, commercial property markets are holding steady or improving except in Quebec.”

U.S. performance

The U.S. market saw net earnings for the first nine months of 1999 drop by 24% to US$17.7 billion compared with the same period the year prior, the Insurance Services Office Inc. (ISO) and National Association of Independent Insurers (NAII) report. As a result, the market’s annualized rate of return for the three-quarters plummeted to 7.3% from 10% for the same period in 1998.

The earnings decline is largely attributed to a 52% rise in underwriting losses for the 1999 period to $15.4 billion while the industry’s net investment income fell by 3.3% to US$28.4 billion compared with the same period in 1998. The decline in net earnings was softened from a 39% reduction in pre-tax operating income to US$11.9 billion for the nine months due to lower federal taxation.

“Escalating losses on underwriting, declining investment income, a decrease in realized capital gains, and losses on other operations combined to cause the 24.1% decline in the industry’s net income after taxes through nine-months 1999. If there is a bright spot in the industry’s performance, it is third-quarter premium growth,” says John Kollar, vice president of consulting and research at the ISO. Third-quarter premiums rose by 3.4% compared with the same period in 1998, although the overall rate of increase for the nine months of 1999 came in lower at 1.8%. “While still weak, premium growth on a quarterly basis last exceeded 3% in second-quarter 1997,” Kollar notes.

However, the higher loss ratio boosted the combined ratio for the nine months of last year to 106.4% compared with 104.1% reported for the same period in 1998. “Underwriting results would have been even worse were it not for a decline in catastrophe losses,” he adds, pointing to almost 18% drop in the cat loss for the first three-quarters of 1999 to US$7.9 billion.

In addition, the U.S. market suffered a US$9.9 billion decline in its surplus level to US$323.4 billion by the end of the third quarter of 1999. This was due to unrealized investment losses arising from poor investment performance. However, as Robert Hartwig, chief economist of the Insurance Information Institute (III), observes, this represents a mere 3% decline and hardly threatens the solvency of insurers. And, he points out, the decline reflects the value of unrealized investments, the status of investment portfolios will vary in accordance with the performance of the investment markets. Of greater concern is the hike in underwriting losses, he notes. “Simply stated, much of the business written in 1998 and 1999 was underpriced and higher underwriting losses are among the inevitable consequences of chronic underpricing…The inability of most property and casualty insurers to offset mounting underwriting losses with investment gains or additional premiums during the bearish third-quarter led to a relatively poor earnings outlook and sent many p&c stocks plummeting to 52-week lows by early October. Under pressure from Wall Street, a number of insurers announced restructurings designed to cut costs, increase efficiency and jump-start revenues.”