Investment earnings in 1998 support net income despite underwriting losses, says Martin Sheffield.

The US property/casualty insurance industry's net income remained strong in 1998, despite a sharp increase in underwriting losses. The results were supported, in large part, by continued strong investment earnings.

Net income, at more than $30 billion, was down 17.6% - or $6.5 billion - from 1997's total industry income of $36.8 billion. The decrease was due largely to underwriting losses, which totalled $17.9 billion - about $12 billion greater than the $5.7 billion underwriting loss in 1997.

While operating income trailed 1997's results, realised capital gains added $18.2 billion to the total industry's net income. Without these gains, the drop in net income would have been more dramatic. The larger underwriting losses were primarily a reflection of remarkably high profitability in 1997. Catastrophe losses in 1997 were particularly low, costing the industry only one point on its combined ratio, or $2.6 billion. Over the past decade, the impact of catastrophe losses on the ratio has averaged approximately three points.

The 1998 results represented a return to typical underwriting results for the decade. The industry's pre-tax operating earnings and net income have risen steadily since 1994, while investment income has been stable. Underwriting losses also have remained steady, except for the anomalous 1997 results.

Capital gains bolster results
The industry posted operating income of approximately $23.2 billion in 1998, compared with $35.5 billion in 1997. While the impact of underwriting losses was significant in 1998, the benefit of realised capital gains played an important role in offsetting these losses.

Four companies ranked in the top 10 by net income have capital gains that are greater than operating income:
• Berkshire Hathaway Insurance Group, with $4.5 billion in realised capital gains and $2 billion in operating income;
• Nationwide Group, $1.2 billion in capital gains and $63.5 million in operating income;
• Safeco Insurance Cos., $415.5 million in capital gains and $350 million in operating income; and
• Reliance Insurance Group, $627.9 million in capital gains and $143.3 million in operating income.
Similarly, there is only a limited correlation between premiums written and net income. Although the top 100 capture about 80% of the industry's premium volume, of the 10 largest companies based on net income, only six are among the largest in premium volume. While Berkshire Hathaway led the net income ranking with over 12% of the entire industry's net income for the year, it ranked eighth in net premiums.

Travelers Property/Casualty Group, ranked fourth in net income with $1.4 billion, ranked seventh in net premiums written. Hartford Insurance Group, ranked fifth with net income of $1.1 billion, was 10th in net premiums written. The largest premium writer, State Farm Group, was sixth, posting net income of $996 million.Net income data in this article excludes dividends paid to stockholders and unrealised capital gains and, therefore, does not necessarily correspond to policyholders' surplus growth. Net income for a single year can be misleading, as federal income tax and reserve changes can have a material impact on yearly income.

For example, USAA, which posted a loss in pre-tax operating income, maintained its No. 14 ranking because it recouped a considerable amount, $96 million, in income-tax refunds. On the other hand, Berkshire Hathaway contributed the largest amount in federal income tax - over twice the amount of its closest rival and roughly one-fourth of the total industry. CGU Group posted a net loss of $326.2 million, because of reserve strengthening resulting from the 1998 merger of Commercial Union Insurance Cos. and General Accident. In 1997, Commercial Union ranked 62nd in net income, posting $101.6 million. Also, Fairfax Financial Group, with a loss of $143.3 million executed a number of acquisitions in 1998 and these required reserve strengthening.

No windfall likely from rate rise

A.M. Best anticipates continued growth in interest income in 1999, influenced primarily by the increase in invested assets, rather than the recent rise in interest rates. Insurers tend to invest in medium to long-term securities and typically hold them until maturity, limiting the benefit or detriment of interest rate flutations.Underwriting results are predicted to show continued erosion in 1999 as a result of continued soft market conditions. However, the unknown factor of realised capital gains could strongly affect year-end operating results again in 1999.

Martin Sheffield, is vice president, property/casualty division, A.M. Best Co. E-mail:; Web site: