Even if we adjusted our figures to exclude unrealized gains and to include policyholder dividends (the approach used by the industry for its calculation), the industry's net gain for this 10-year period would still be about $52 billion. In either case, it is within management's discretion to realize investment gains or to not pay policyholders' dividends. CYCLICAL NATURE OF INDUSTRY PROFITABILITY While it is important to look at the figures for the most recent years, it should be noted that over the longer period the property/casualty industry has demonstrated profit and loss cylces. We believe that data covering longer periods give a more complete picture of the industry's profitability. Unlike most other industries, the property/casualty insurance industry is flexible with respect to capacity or supply. During profitable periods insurance companies can increase their capacity, take varied and greater risks, and generally lower their premium rates to achieve a greater market share. Such actions result in price competition as other firms lower their prices to retain their market share. Price competition results in a change from favorable premium profit margins to unfavorable margins, resulting in the underwriting profit and loss cycles. Attachments I and II illustrate the cyclical nature of the property/casualty industry profitability. Attachment I shows the year-by-year underwriting and investment results for the 12-year period from 1974 through 1985. Column 2 in that attachment, underwriting gains and losses, illustrates the cyclical nature of the industry. The earlier cycle bottomed out in 1975 with a $3.65 billion loss and peaked in 1978 with a $2.55 billion gain. Since 1980, underwriting losses have mounted again. However, available estimates by the industry and others indicate that the loss cycle bottomed out in 1985 and that the cycle has not turned upward. Attachment II illustrates the cyclical nature of property/casualty stock companies over the past 40 years. For purposes of illustration, we used the combined ratio concept, a ratio of claims and expenses to premium income. The attachment reflects the industry's underwriting results and premium pricing strategy; it does not include investment results. As can be seen, stock companies have had several underwriting cycles since 1945. FINANCIAL OUTLOOK FOR THE INDUSTRY APPEARS FAVORABLE From all indications, it appears that the trend towards larger underwriting losses has peaked. Available industry estimates show that over the next 5 years the industry expects substantial net gains. Our calculations, made from the industry estimates, indicate an expected net gain before taxes of more than $90 billion over the years 1986-1990. Analysts of the industry also generally predict favorable industry prospects. For example, an August 1985 study by Salomon Brothers, Inc.,1 forecasts that premiums written will grow at a 12 percent annual rate over the 1985-1989 period. The same study forecasts a 10 percent growth rate for incurred losses over the period. The study forecasts further that total industry profits will rise annually at a rate of 25 percent over the same period. More recently, the Best's Insurance Management Reports, dated April 7, 1986, estimated that net premiums written in 1985 had increased by about 22 percent over net premiums written in 1984. PROBLEMS IN THE GENERAL LIABILITY LINE Although the financial outlook for the industry as a whole appears favorable, the current difficulties in liability insurance are more pronounced in certain lines. One insurance line often mentioned in the context of high premiums and lack of availability is the general liability line. The general liability line, however, does not represent a major portion of the total property/casualty insurance business. Attachment III shows, for 1985, the relationship of this line to other property/casualty lines. The data were estimated by Best's which reports on 27 insurance line categories. For our purposes, we have grouped certain lines into one category; for example, personal and commercial automobile liability is shown as automobile liability. The figures in this attachment show that the general liability line represents a relatively small portion of the industry, accounting for about 7 percent of all property/casualty premiums written in 1985. However, underwriting losses attributable to this line accounted for about 22 percent of all underwriting losses. It should be 1 Salomon Brothers, Inc., "Property/Casualty Insurance Organizations, Five-Year Review and Outlook," 1985 edition, August 1985. noted, Mr. Chairman, that if a given company had specialized in this line of insurance, the proportion of losses could have been higher. Attachment IV shows our analysis of the amount of additional earned premiums that would have been needed for the general liability insurance line to have broken even in 1984. Basically, our analysis shows that the line could have broken even with an approximate 30 percent additional increase in earned premiums. (1984 is the most recent year for which we are able to make these estimates; the necessary data is not yet available for 1985.) I would like to make three points about our analysis. First, our analysis is based upon aggregate industry financial data which already includes the premium changes that took place in that year. Second, it is not appropriate to compare our industrywide break even analysis to individual policy rate increases. Third, let me repeat my earlier observation that the experience of individual underwriters could vary significantly from these industrywide aggregates. CONCLUSION In conclusion, Mr. Chairman, available financial information shows that, over the long term, the profitability of the property/casualty industry has been cyclical in nature. The data further indicate that over the last 10 years the industry has been generally profitable. There was an overall loss in 1984; however, the industry projects increasing premiums and more favorable prospects for the next few years. Indeed, the industry's estimates indicate a return to profitability in 1985. The data also show that while general liability insurance has received considerable attention recently, it represents a relatively small portion of the industry overall. Finally, our calculations show that, for 1984, the general liability line could have broken even with a 30 percent increase in earned premiums. That concludes my statement, Mr. Chairman. We would be pleased to respond to questions. ATTACHMENT I ATTACHMENT I UNDERWRITING GAINS, INVESTMENT GAINS, COMBINED UNDERWRITING AND INVESTMENT GAINS: aConsolidated totals eliminate double counting by excluding intercompany transactions between parent and subsidiary companies. ATTACHMENT II ATTACHMENT II Combined Underwriting Ratios for Property/Casualty aA combined ratio is a ratio of claims and expenses to premium income. Ratios below 100 represent underwriting gains and ratios above 100 represent losses. aLong-tailed insurance lines are lines characterized by third-party involvement (an injured party other than the insured) and by settlements that will occur in an unknown future time period. Short-tailed lines, on the other hand, typically involve only two parties (the insurer and the insured) and settlements that will take place within a relatively short time frame (generally a year or two) following a claim. bIncludes such long-tailed lines as reinsurance and group accident and health, as well as such short-tailed lines as burglary and theft, and aircraft. |