Insurance - 1991 U.S. Industrial Outlook

Insurance

Premium receipt of life insurance companies will increase 8 percent in 1991, with annuities leading the way. Premiums written by property-casualty insurers will grow 6.2 percent. Despite small commercial rate increases, large underwriting losses will reduce earnings in the property-casualty industry and insolvencies will remain at a high level.

LIFE INSURANCE

Premium receipt of life insurance companies increased 8.8 percent in 1990, to $265.9 billion, the result mainly to continued strong sales of annuity and health insurance contracts and a renewed consumer interest in life products. Measured by face value, sales of life insurance increased 4 percent. Life insurance companies' assets increased 10.2 percent, to $1.4 billion, while employment remained stable at 576,300.

The life insurance industry consists of companies that underwrite life insurance and annuities; they also underwrite accident and health insurance and manage pension and trust funds. The companies are classified in SIC 631 (Life Insurance) or in SIC 632 (Accident and Health Insurance). Stock companies, which are owned by shareholders, and mutual companies, which are owned by policyholders, constitute the two main types of insurance providers. Although almost 95 percent of insurance providers are stock companies, mutual companies accounted for about 45 percent of the industry's total assets and 36 percent of the total premiums received in 1989.

Income of Life Insurance Companies

Life insurers derive their premium income from three major types of products: life insurance, annuities, and health insurance. Premium income from life insurance products dropped slightly in 1989 (Table 1). In a turnaround, however, a midyear 1990 survey showed that sales of term insurance, variable, variable universal, and whole life grew significantly over 1989. Only sales of universal life policies decreased. Sales of single-premium policies remained flat in 1990. Traditional whole-life policies made up more than half of individual life insurance sales, while universal policies accounted for another quarter. Premium income from group life, which made up 20.6 percent of all life insurance premiums in 1989, was expected to have gone up again in 1990, but to have diminished as a percentage of sales. [Tabular Data Omitted]

Term life insurance is pure protection, whereas whole life consists of insurance and saving components. A whole-life policy builds value that can be cashed in or borrowed against. Universal policies are variations of whole life that enable a policyholder to adjust premium payments and death benefits. Another type of whole life is variable life; its death benefit and cash value depend on the value of the underlying assets, such as stocks, that back the policy.

Individual and group annuities accounted for the largest portion and had the highest rate of growth of all components of life insurance companies' premium receipts in 1989. There was a particularly strong increase in sales of individual variable annuities and annuities that qualify for certain tax benefits, such as deferrals and credits. Like variable life insurance, the value of variable annuities depends on their underlying assets. Tax-advantaged annuities include Individual Retirement Accounts (IRAs) and 401(k) salary deduction plans.

Life insurance companies are major providers of group annuities for employer-provided pension plans. Two-thirds of annuity sales come from group annuities, which had solid increases in 1989.

Premium receipts from health insurance grew in 1989. Group health policies, which are generally provided through employers, constituted about 75 percent of the $56.1 billion in health premiums that life insurers received in 1989. The percentage is diluted by the increasing proportion of group health contracts that are provided only as administrative services, under which the insurers does not assume the full risk for future claims.

Assets of Life Insurance Companies

The assets of life insurance companies consist mainly of financial instruments. These assets back insurance and annuity reserves that are legally required to pay future claims and to provide the necessary surplus and capital to meet solvency standard. This makes life insurance companies major institutional investors. Of total assets, corporate securities accounted for 51.1 percent at the end of 1989 (Table 2). Bonds have made up a significantly higher share since 1986. Policy loans as a percentage of assets decreased considerably, from 5.8 percent in 1986 to 4.4 percent in 1989. Government securities also became less significant as a component of assets. The proportion of real estate, mortgages, and other assets decreased slightly. [Tabular Data Omitted]

Overall, life insurers were financially sound and healthy in 1990. Operating revenues were up, while operating and administrative expenses remained under control. Investment income was solid. The solvency of a few smaller companies, however, is threatened by excess investment in questionable real estate and junk bond. Nevertheless, the incidence and threat of insolvency in the life insurance industry remains low compared with the property-casualty industry, and even more so when compared with the savings and loan industry.

Key Legislative and Regulatory Developments

The taxation of life insurance companies and their products are perennial issues at state and Federal levels, particularly as pressure grows to find new sources of revenue. Under consideration are changes that would equalize the relative amount of taxes paid by mutual and stock companies. Other proposals include limiting the deductibility of policyholder dividends, thus raising taxes on mutual companies, and basing taxes on specifically defined alternative measures of income, rather than on statutory income, as is the current practice.

Another issue is the taxation of interest income in insurance and annuity products (referred to as "inside build-up"), now subject to deferral or exemption, and the deferral of policy acquisition costs over a number of years. In addition, policymakers are debating whether to exempt from taxation premature distributions of death benefits to policyholders with terminal illnesses.

The McCarran-Ferguson Act of 1945, which left regulation of insurance companies to the state and exempts the industry from certain aspects of Federal antitrust law, forms the basic regulatory and economic framework of the industry. In 1990, for the first time ever, a bill to repeal the antitrust provisions of McCarran-Ferguson was approved by a committee in the House of Representatives. The insurance industry opposes repealing the law, which allows joint underwriting and data sharing. But a revision or repeal of McCarran-Ferguson is considered inevitable by many observers.

Another long-standing issue is the entry of banks into insurance. The industry argues that separation of powers between banking, securities, and insurance provides stability in the market and protects consumers. But proponents of greater integration of financial services argue that it would promote economic efficiency. Many states already allow state banks to sell and/or underwrite insurance. Delaware passed a law in 1990 that would have allowed state-chartered banks, even those owned by bank holding companies, to sell and underwrite insurance in any other state. But a ruling by the Federal Reserve Board in effect nullified the law.

One of the most critical issues that affects the life insurance industry is the Government response to an estimated 30 million Americans who have no health insurance. Another major problem is the long-term effect of AIDS on the industry.

INTERNATIONAL COMPETITIVENESS

As financial markets have become more global, U.S. life insurers have set up foreign branches, subsidiaries, and joint ventures. In addition to underwriting life, health, and pension products, the companies provide such auxiliary services as claims processing, investment services, and information systems. Insurers also have been active in some banking and securities markets overseas, where there are no restrictions separating such activities similar to those in the United States.

Japan, where life insurance is a preferred means of saving, had the largest life insurance market (excluding health insurance) in 1988, with $214.1 billion in premiums (Table 3). The United States was a close second, and the United Kingdom a distant third. [Tabular Data Omitted]

The extent of U.S. participation in life insurance markets around the world is reflected in Table 4. Foreign life insurance affiliates (branches and subsidiaries) of U.S. companies had more than $9 billion of sales (premium plus investment plus other income) in 1988. Although foreign sales of U.S. companies are small compared with the vast domestic market, foreign life insurance markets are growing faster. Canada, Europe, and Japan have been key markets for U.S.-owned life insurers (Table 5), and recently they have made significant entries into Korea, Taiwan, and other growing Asian markets. [Tabular Data Omitted]

Foreign insurance companies have greatly expanded their activities in the United States over the past few years, mainly through acquisitions, and in 1988 they accounted for an estimated 5.9 percent of total life insurance premiums. For all lines of insurance, foreign-owned companies operating in the United States received about 9.3 percent, of $40 billion, of total premiums in 1988.

The U.S. life insurance affiliates of non-U.S. parents had sales of about $19.9 billion in 1988, up from $16.8 billion in 1987 (Table 6). These affiliates controlled about $62.4 billion in assets in 1988. Among the most prominent recent U.S. acquisitions were the $5.2 billion purchase of Los Angeles-based Farmers Group by B.A.T. Industries of the United Kingdom in 1988, which included substantial life insurance operations, and the purchase of Businessmen's Assurance Company of Kansas City by the Italian insurance company, Generali-Assicurazioni Generali, S.p.A. [Tabular Data Omitted]

The European Community (EC) is directing its members to liberalize their markets for insurance. Several EC countries have opened their life insurance sector considerably to foreign investment, and some U.S. insurers have responded by acquiring local companies and establishing new operations, particularly in Southern Europe.

U.S. activity in Europe has been overshadowed, however, by European insurance companies that are consolidating their hold on the local market through acquisitions and mergers and positioning themselves for a pan-European presence. Indeed, as European insurers become larger, they also are becoming increasingly interested in obtaining a larger piece of the U.S. market through acquisition or direct entry.

The key to U.S. companies' long-term opportunities in foreign markets lies in the effectiveness of the rules and principles for trade in services being negotiated under the General Agreement on Tariffs and Trade (GATT). A successful agreement would establish multilateral rules giving signatory countries guidance on international trade and investment in services, including insurance.

Outlook for 1991

Premium receipts of life insurance companies will expand an estimated 8 percent in 1991, to $287.2 billion. Premium income from individual annuities will lead the way, with premiums for life and health insurance also showing persistent growth. Employment will remain essentially unchanged.

Long-Term Prospects

Major changes in the market may drastically alter the nature of the industry. Competition for premiums will intensify. New competition will come from other financial service firms, such as banks, which will expand their sales and underwriting capabilities if legal barriers fall. Competition will also come from foreign companies, particularly European companies, that will be looking for a larger share of the U.S. market. Finally, insurers will diversify and expand their product lines.

Demographic variables, such as income growth, wealth accumulation, population and workforce changes, and home ownership will determine the demand for pure insurance products over the long term. Life insurance products with a savings component will have to compete directly with mutual funds, time deposits, retirement savings, and other financial products. (For additional information, see chapter 49, Mutual Funds.) The rate of personal savings in the United States is expected to rise as the baby-boom generation reaches middle age, a time when people tend to save more. consequently, the market for life insurance products will expand, although profit margins will narrow in the face of increased competition. Some companies will succeed with niche products. The most promising areas for insurers' income growth are annuities and health insurance as aging baby-boomers increase their demand for retirement plans and health insurance.

Employer and individual use of tax-deferred retirement plans will increase over the next five years. Changes in the favorable tax status of IRAs and similar plans may significantly increase the demand for individual annuities. Income generated from group annuity income will increase as employers expand pension programs and benefits - particularly defined contribution plans - for their employees.

The long-term growth in health care premiums will mostly depend on how the United States addresses national health care issues. For example, if proposed mandatory employer-provided health insurance is enacted, it will bring additional business to private health insurers. Conversely, proposals calling for government-funded health care could reduce the role of private health insurance. (For additional information, see chapter 44, Health and Medical Services.)

Life insurance companies will have to reduce costs in order to remain competitive. Pressure will be on to find less expensive distribution systems and to reduce home-office expenses. Direct-mail marketing and sales through other financial institutions, retail outlets, and fee-based agents are some alternative methods to the traditional agency system.

On top of this, the stability and solvency of the industry could be affected by the growing incidence of AIDS, further weakness in real estate markets, and an inordinate amount of high-risk junk bonds in some insurers' portfolios. The industry could be headed for a period of consolidation as noncompetitive companies are acquired. In addition, the loss of antitrust immunity from a revision or repeal of the McCarran-Ferguson Act would further tend to push marginal companies into mergers.

Diminished returns on life insurance in the United States will prompt more companies to look for other investment opportunities. Many life insurance companies have already moved - or will move - into related financial services, including securities, banking and real estate. More companies will also take advantage of expanding foreign markets, especially in Europe and Asia.

PROPERTY CASUALTY INSURANCE

Net written premiums for property-casualty (P/C) insurance companies grew 4.4 percent in 1990, to $217.6 billion. The downward trend in commercial rates since 1987 leveled off in 1990, but adequate capacity and tough competition kept most rates from rising despite large increases in incurred losses. Coupled with a small increase in investment income, operating earnings after taxes declined sharply, to $5.6 billion. Asset growth slowed, while employment expanded 2 percent, to 557,200 in 1990.

The property-casualty insurance industry consists of companies that underwrite insurance protection for individuals, commercial businesses, and others against losses of real and personal property or losses by third parties for which the insured is liable. P/C insurance companies are classified in SIC 633, (Fire, Marine, and Casualty Insurance,) or in SIC 632, (Accident and Health Insurance). There are an estimated 3,800 P/C insurance companies in the United States. Some are stock companies owned by stockholders, and some are mutual companies owned by policyholders.

Automobile insurance is the single largest source of premium income for P/C insurers, accounting for 43.6 percent of net written premiums in 1989 (Table 7). About 80 percent of automobile premiums written were from individual policyholders. Other major sources of premiums written are workers' compensation, liability lines, homeowners' multiple peril, and commercial multiple peril. Decreases in premiums written for liability insurance in 1988 and 1989 were due mainly to the rate cutting that followed sizable increases in the tight market of 1985 and 1986. Growth in premiums written for automobile insurance and workers' compensation relative to most other lines of business continued in 1990, although these lines also represented the biggest areas of underwriting losses for insurers. [Tabular Data Omitted]

The growth of reinsurance was expected to have been flat in 1990 after two years of decline. Reinsurance in insurance that insurance companies purchase to reduce, or spread, some of the risk they assume. In 1989, about $21.4 billion worth reinsurance premiums was written. Foreign-based reinsurers assumed $8.6 billion of this business (Table 8). The decline in reinsurance since 1987 has been due mostly to the current soft market and to increased risk retention by direct insurers. [Tabular Data Omitted]

Key Developments in 1990

Government regulation and control of the insurance market was the central theme of developments in the property-casualty industry in 1990. Solvency concerns captured most of the attention of state regulators. Federal lawmakers, and industry officials.

Nothing disrupts an insurance market more than insurers that are unable to meet legitimate claims. The incidence and severity of insolvencies has increased greatly since 1984, although the situation is not as critical as the problems in the savings and loan industry. Since June 1969, more than $3.3 billion has been paid out by state guaranty funds to make up for the unpaid liabilities of bankrupt insurers, the bulk since 1984. Because these payments are charged to solvent insurers, they diminish the financial soundness of the whole industry.

A 1990 congressional investigation found that the number of insolvencies could increase if nothing is done to address the problem. The report questioned the adequacy of state regulation and suggested Federal oversight might be needed.

The National Association of Insurance Commissioners, representing state regulators, has been pressing for tighter state rules to curb perceived industry abuses. Many insurers, mostly the larger ones, and some industry trade associations now believe the Federal Government may have to take a larger role in setting financial standards to protect policyholders. Another idea under discussion is a type of Federal guaranty similar to deposit insurance for banks.

Pressure to end the industry's antitrust immunity comes mainly from consumers who believe insurance, particularly automobile insurance, is too costly and too difficult to obtain. In California, Proposition 103, passed in 1988, required insurance companies to roll back P/C insurance rates 20 percent and removed state antitrust exemptions, although these requirements have been mitigated by the courts. Other states, such as New Jersey and Pennsylvania, have passed similarly motivated measures. In response, many insurers have curtailed affected lines of insurance or pulled out of certain states or lines of business altogether.

Growing antitrust concerns have prompted industry and the state regulators to stop insurance rating bureaus, such as the Insurance Services Office (ISO) and the National Council on Compensation Insurance, from issuing advisory rates that industry critics interpret as a form of price fixing. In 1990, the ISO began replacing advisory rates for some lines of insurance with historical loss information. As a result, insurance companies will have to calculate and file their own rates.

The so-called liability crisis of the mid-1980s, when many businesses were unable to obtain or afford liability insurance, has eased. But the fear is that the next downturn of the insurance market will lead insurers to restrict coverage, and that rates will escalate once again.

The insurance industry continues to support changes in tort law that it hopes will provide more certainty in the conduct of litigation. During the past several years, most states have enacted legislation to address one or more of the perceived problems with their tort litigation system. Product liability remains a particular problem because goods move in interstate commerce while the controlling laws vary by state. This creates uncertainty for both sellers and buyers of manufactured goods.

Again in 1990, Congress worked on legislation that would provide some national uniformity in product liability by abolishing joint and several liability for noneconomic damages; set a two-year statute of limitations for bringing suits; and encourage the use of pretrial settlements and other alternative means of settling disputes.

Many businesses and other organizations have responded to the availability and affordability problems by self-insuring. Others have formed wholly-owned captive insurance companies, separately capitalized, to fund employee health care or workers' compensation. Catastrophic coverages in these areas, however, usually are placed in the traditional market. A 1990 survey estimated that risk financing alternatives amount to almost 30 percent of the P/C insurance market, with self-insurance accounting for two-thirds of the alternative market and other alternatives, such as group captives, comprising the rest.

To provide another means of risk financing, the Risk Retention Act to 1981, as amended in 1986, facilitates the formation of risk retention groups and purchasing groups. A risk retention group is capitalized by its members and state-licensed to provide liability coverage to its members. Purchasing groups are formed to buy group insurance from a commercial insurer at a discount.

The Secretary of Commerce recommended several amendments to Congress in 1989 to improve operations for groups formed under the act. A principal change would clarify the treatment of purchasing group insurers, allowing them to buy insurance without burdensome regulation. The amendment would also provide safeguards to assure that insurance providers are capable of meeting their financial responsibilities.

In 1990, it was reported that there were 69 risk retention groups, compared with 62 groups with an estimated $399 million of premiums written in 1989. There were 337 purchasing groups that reportedly had premiums written of $575 million in 1988. Environmental impairment, medical malpractice, and product liability are common areas of coverage by risk-retention and purchasing groups.

INTERNATIONAL COMPETITIVENESS

The U.S. property-casualty insurance market is the largest in the world. As shown on Table 3, the United States accounted for almost 46 percent of worldwide premiums in 1988, followed by Japan with 12.7 percent. (The nonlife market on Table 3 includes health insurance premiums and P/C premiums.) [Tabular Data Omitted]

Table 6 shows that the sales (premium income plus investment income plus other income) of U.S. nonlife affiliates of foreign direct investors totaled slightly less than $29.4 billion in 1988. This is a substantial increase from $13.5 billion in 1985. It is estimated that foreign-owned P/C insurance companies accounted for 13 percent, or about $26.0 billion, of P/C premiums written in United States in 1988. For all lines of insurance, foreign-owned companies received about 9.3 percent, or $40 billion, of premium receipts in the United States in 1988. [Tabular Data Omitted]

Table 5 shows that Canada, the Netherlands, and the United Kingdom had the most active U.S. insurance affiliates in 1988. The foreign-owned share of the U.S. market is expected to increase substantially. In 1989, BAT Industries of the United Kingdom acquired the Farmers Group, the tenth largest P/C insurance group in the United States, with $4.7 billion of premium income in 1989. In a deal expected to be consummated in early 1991, Europe's largest insurance company, the Allianz Group of Germany, will purchase Fireman's Fund Insurance Company, the 23rd largest P/C insurance company in the United States,

Foreign P/C insurance affiliates of nonbank U.S. parents had $16.2 billion of sales in 1988 (Table 4). This was down slightly from $17.0 billion in 1987. Europe and Canada were the largest sources of foreign business for these affiliates, although Japan and Latin America were also important markets for U.S. insurance affiliates abroad (Table 6).

Several events have enhanced the prospects for U.S. insurance companies to expand into international markets. In 1986, Korea and Taiwan opened their domestic insurance markets to American insurance companies, and many U.S. P/C insurers have opened offices in these and other Asian countries. In addition, a multilateral framework for trade in services is being negotiated under GATT. A successful agreement would create worldwide opportunities for all U.S. insurance companies.

The European Community holds great promise for property-casualty insurance companies. Insurance in one EC country will be able to write certain business in any other EC country. In addition, the EC has issued a directive that partially standardizes product liability laws among its members. Some U.S. insurers have already positioned themselves to take advantage of the business opportunities in the EC.

Outlook for 1991

Net written premiums for property-casualty insurance companies will increase 6.2 percent in 1991, to $231.1 billion. Commercial rates will begin to rise late in 1991 if the current soft market ends. However, rates will not rise enough to offset growing losses from claims. Thus, underwriting losses will reach new levels. Investment income will grow little, barely keeping insurers' overall operating earnings positive. Asset growth will be below normal because of poor earnings. Some P/C companies will experience severe financial difficulties and the incidence of insolvencies will remain high, but manageable.

Long-Term Prospects

After they begin to rise, rates for commercial insurance will continue to rise for a couple of years. Competition in the industry will keep rates from rising too fast or too far. In addition, insurers will be reluctant to raise rates too much, lest they produce a public backlash. Expectations are that rates will rise modestly across most lines of business rather than in selected lines, as happened during the liability crisis. The movement to alternative methods of risk financing will dampen growth in the industry and increase the relative amount of catastrophic risk carried by P/C insurers. Ultimately, this could affect the solvency of the industry.

Competition from foreign insurance companies will increase. Many foreign companies already compete in the U.S. reinsurance or surplus lines market, or both. As the EC insurance market consolidates, European insurers will move even more strongly into the U.S. market, primarily through acquisitions.

Market liberalization in the EC offers U.S. property-casualty insurers the biggest opportunity to expand overseas. American insurers also will expand into Asian as well other foreign market. A global economy with increasing international trade and investment and with large and growing multinational companies will require insurance companies that have a worldwide presence.

The prospect for some form of federal regulation will increase in the next few years, especially if solvency problems grow. The insurance industry also will be affected by how such major problems as escalating health-care costs are resolved. - M. Bruce McAdam, Office of Service Industries, (202) 377-0346, September 1990. [Tabular Data Omitted]

PHOTO : Premiums written by property-casualty insurance companies will rise 6.2 percent in 1991, with auto insurance the biggest component.

PHOTO : Despite growing losses from claims, stiff competition will keep property-casualty rates from rising in 1991.

Additional Reference

1990 Life Insurance Fact Book, American Council of Life Insurance, 1001

Pennsylvania Avenue, NW, Washington, DC 20004. Telephone: (202)

624-2458. 1990 Property/Casualty Insurance Facts, Insurance Information Institute,

110 William Street, New York, NY 10034. Telephone: (212) 669-9200. Best's Aggregate and Averages, A.M. Best Company, Oldwick, NJ 08858.

Telephone: (201) 439-2200. Business Insurance 740 Rush Street, Chicago, IL 60611. Telephone: (312)

280-3174. Liability Risk Retention of 1986, Operations Report, 1989, U.S. Department

of Commerce, Washington, DC 20230. Telephone: (202) 487-4650 Life Insurance Marketing and Research Association, Inc., P.O. Box 208,

Hartford, CT 06141. Telephone: (203) 677-0033. National Association of Insurance Brokers, 1401 New York Avenue,

Washington, DC 20005. Telephone: (202) 628-6700. National Association of Insurance Commissioners, 120 West 12th Street,

Suite 1100, Kansas City, MO, 64105. Telephone: (816) 842-3600. National Underwriter, National Underwriter Company, 43-47 Newark

Street, Hoboken, NJ, 07030. Telephone: (201) 963-2300. Reinsurance Association of America, 1025 Connecticut Avenue, NW,

Suite 512, Washington, DC, 20036. Telephone: (202) 293-3335. Risk Retention Reporter, Insurance Communications, P.O. Box 5014,

Pasadena, CA 91115. Telephone: (818) 796-4972. Sigma, Swiss Reinsurance Company, 50/60 Mythenquai, P.O. Box 8022,

Zurich, Switzerland. Telephone: (01) 208-2543. Source Book of Health Insurance Data, Health Insurance Association of

America, 1025 Connecticut Avenue, NW, Washington, DC 20036.

Telephone: (202) 223-7845.

COPYRIGHT 1991 U.S. Department of Commerce
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