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<b>By Robert P. Hartwig, Ph.D.
Vice President & Chief Economist
̽»¨¾«Ñ¡ Information Institute</b>
bobh@iii.org

The property/casualty insurance industry reported a rate of return of 10.9 percent (on an annualized basis) for the first quarter of 1999, down from 11.6 percent during the same quarter in 1998. The industry’s rate of return for all of 1998 was 9.3 percent. The results were released by the ̽»¨¾«Ñ¡ Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII).

The factors responsible for the industry’s performance during the first quarter of 1999 are the same as those that drove industry results throughout 1998: slow premium growth, high catastrophe losses and falling investment income. Despite the apparent weaknesses, the industry’s results were surprisingly good and contain several hopeful signs that the U.S. property/casualty insurance market is beginning to stabilize.

First, premium growth of 1.6 percent actually represents a strengthening relative to the 1.4 percent increase recorded for calendar year 1998. This encouraging result is being driven by a firming of prices in some commercial lines, particularly workers’ compensation. Strong economic growth, characterized by record new motor vehicle and home sales is also benefiting insurers.

Second, the one percent decline in investment income to $9.6 billion from $9.7 billion during the same quarter last year was much less than anticipated, particularly since investment income for all of 1998 (over 1997) fell 4.6 percent. Indeed, investment income for 1999 had been expected to fall by 4-5 percent. A full-year decline of this magnitude is now highly unlikely. The significantly improved outlook for investment income is attributable to sharply higher interest rates during the first quarter. Yields on treasury securities with maturities of five years or more rose about two-thirds of a percentage point during the quarter. The yield on 10-year Treasury bonds, for example, rose from 4.64 percent on December 31, 1998 to 5.28 percent on April 1, 1999. Interest rates have continued to rise during the second quarter.

Third, realized capital gains—which rose 16.8 percent compared with the first quarter of last year—remained strong due to two factors: a continuation of the bull market in stocks and accumulated capital gains in the industry’s bond portfolio. As mentioned in the ISO statement, the S&P 500 posted a 4.6 percent gain during the first quarter. It is important to note that the stock market’s rally occurred despite rising interest rates, a development that often spooks financial markets and sends share prices tumbling.

Of course, rising interest rates also destroy capital gains on bonds (because interest rates and bond prices move in opposite directions), but the loss of capital gains from the higher interest rates was small compared to the capital gains that have accumulated in the industry’s bond holdings over the years. Although yields on medium-to-long term Treasury securities rose about 60 - 65 basis points (0.60 to 0.65 percentage points) during the quarter, they were still about 30 basis points lower than during the same period in 1998, 130 basis points lower than in 1997, and 200 to 300 basis points lower than they were during the early 1990s. In fact, interest rates have been meandering their way slowly downward for nearly 20 years, meaning that the vast majority of medium and long-term bonds acquired within the last two decades appreciated in value. Bonds account for nearly 70 percent of the industry’s invested assets. The majority of the industry’s stock holdings have also appreciated substantially during the 4½-year old bull market.

All of these factors contributed to a better-than-expected first quarter combined ratio of 103.0. While well above the 100.2 recorded a year earlier, this quarter’s combined ratio was a significant improvement over the 110.4 combined ratio from the fourth quarter of 1998 or last year’s full-year combined ratio of 105.7.

Problems, of course, remain. Competition will continue to restrain premium growth and abnormally high catastrophe losses continue to vex the industry. The quarter’s $1.85 billion in catastrophe–related losses marks the fourth quarter with catastrophe losses of at least one billion dollars out of the last five quarters. That streak will continue at least through the second quarter of this year. According to ISO’s PCS unit, the tornado outbreak that swept through Oklahoma, Kansas and 16 other states during the first week of May caused $1.49 billion in damage. Looking further down the road, the third quarter contains the peak months of what is expected to be a very active hurricane season. Last year, hurricanes caused nearly $3.5 billion in insured losses in the United States.

The first quarter’s financials contain telltale signs the industry is beginning to experience a modest rebound. Hopefully, these trends will continue in the remaining quarters of this year.

A detailed income statement for the industry follows:

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