Profitability in the Insurance Industry

Profitability in the insurance industry is determined by combining both underwriting results and investment results. Despite incurring substantial underwriting losses over the 10-year period 1976 through 1985, the property/casualty insurance industry has more than offset those aggregate losses with investment gains. The underwriting losses resulted, in part, from the industry’s cash flow underwriting pricing strategy in which companies sacrificed underwriting gains in an attempt to attract more business and thereby enhance investment gains. We estimate that the industry had about $81 billion in after-tax income over this period. Because of the cyclical character of the industry’s underwriting experience, we believe that data covering longer periods, rather than concentrating on the last few years, provide better perspective on the industry’s profitability.

The industry disagrees with our 10 year profitability estimate of $81 billion—its method of calculation would show $54 billion. Even the lower estimate by the industry, however, shows that the industry’s average rate of return on net worth has not been out of line with those of other industries. We believe that the industry’s reported rates of return are conservative since they are based on reserves that have not been discounted. Furthermore, we believe that the relatively low rates of return earned in recent years are not necessarily indicators of serious longer term problems in the industry. Indeed, the industry reported substantial earnings improvement in 1986, and both Value Line and Salomon Brothers project substantial improvement in the industry’s profitability and rate of return on net worth for the next several years.

Profitability estimates for the medical malpractice and general liability lines depend primarily on the adequacy of the reserves for future payments of claims and whether those reserves are discounted to reflect their present values. If the reserves established to cover future loss payouts are inadequate, boosting the reserves to cover those losses will produce lower estimates of the profitability of the line. Conversely, the estimated profitability of the line will improve if the reserves are discounted. We have recommended in the past, and Congress has agreed, that for tax purposes reserves be established on a discounted basis.

Using reserve amounts as established by the industry and applying different assumptions about reserve adequacies and discounting, we developed four profitability estimates for each line. Essentially, those estimates show that over the 11-year period 1975 to 1985 the medical malpractice line incurred losses when the reserves were valued at their full estimated payout, but the line was profitable when the reserves were discounted to present values. The general liability line was profitable over this 11-year period under all but one of our estimating assumptions. In that estimate, we assumed that the reserves were not discounted to present values and that they were 20-percent deficient.

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