Insurance - Industry Overview

M. Bruce McAdam

Premium receipts of life insurers am expected to grow 4.5 percent in 1993 to about $285 billion. Net written premiums of property/casualty insurers are expected to increase 4 percent to about $240 billion. A slowly improving economy will be the basis for this growth. Asset problems for some life insurers and poor underwriting performance for some property/casualty insurers are expected to keep insolvencies at recent levels.

LIFE INSURANCE

Premium receipts of life insurance companies grew more than 3 percent in 1992, to surpass $272 billion. Stronger individual annuity sales and growing premiums for health insurance accounted for the bulk of the increase. Premium receipts for life insurance products grew little in 1992. Life insurance in force--the total face value of all policies--grew to more than $ 10 trillion. For related topics, see chapters 42 (Health and Medical Services), 45 (Commercial Banking), 48 (Mutual Funds), and 49 (Securities Firms).

The life insurance industry consists of more than 2,100 companies that engage in underwriting life insurance and annuities. Life insurers also engage significantly in underwriting accident and health policies, and in managing pension and trust funds. These companies are classified mostly in Life Insurance (SIC 631) and Accident and Health Insurance (SIC 6321). Stock companies, owned by shareholders, and mutual companies, owned by policyholders, are the two main types of insurance providers.

Life insurance companies earn premium income from three major product areas: life insurance, annuities (individual and group pension products), and health insurance. Based on industry surveys, premiums for life insurance products grew about 2.6 percent in 1992. Sales of individual universal policies decreased significantly, countered somewhat by strong growth in variable-type products in which policyholders assume most of the investment risk of the underlying assets.

Premium receipts for term insurance and traditional whole life policies, which make up the bulk of life insurance premiums, increased modestly. There was a small increase in sales of single premium life insurance after several years of sharp drops due to the loss of tax benefits in 1988. About one-fifth of income from life insurance products is from group policies that showed no growth in 1991.

In recent years, sales of life insurance products have shifted from investment-type products, such as universal and variable life insurance, back to traditional whole life and term insurance. Although growth has not been strong, traditional products are typically more profitable and their liabilities more predictable.

Income from both individual and group annuities unexpectedly fell to $123.6 billion in 1991 to 46.9 percent of all premium receipts (Table 1). Annuities are strongly associated with the well-publicized failures of large life insurance companies in 1991, which likely undermined consumer confidence for these products. Reportedly, group annuities fell again in 1992, although individual annuities rebounded, led by variable annuities. The 1991 decline in individual annuities was primarily due to the drop in sales of single premium deferred annuities.

[TABULAR DATA 1 OMITTED]

Insurers writing fewer guaranteed investment contracts, otherwise known as GICs, also contributed to the drop in sales of group annuities. Insurers have deemphasized GICs because the liabilities of GICs clash with the industry's need for higher-grade assets. In addition, a general shift by client companies from defined benefit pension plans to defined contribution pension plans diminished pension business for insurers. In defined benefit plans, current funding is based on expected future benefits, a specialty of insurers. Retirement benefits in defined contribution plans, however, are based solely on actual funds contributed. Most of the lost sales for GICs and defined contribution plans went to mutual funds and banks whose similar products do not require insurance expertise.

Premium growth from health insurance continued to increase in 1991 and 1992, driven almost entirely by cost pressures. Upward cost pressures drove the expansion. These pressures were exacerbated by "cost shifting" where, for instance, health care providers shift unreimbursed fees and expenses from public insurance programs to private insurance programs, such as health insurers, that do not impose cost controls.

The trend toward managed health care and the use of administrative services and self-insurance has also diminished the expansion of health premiums for life insurers. Life insurance companies are major providers of health insurance. Other providers of health insurance include Blue Cross/Blue Shield plans, property/casualty insurers, specialty health insurers, self-funded employer plans, and government programs. Group health, typically provided through employer health plans, accounted for more than three-fourths of health premiums for life insurers.

Investment income for insurers improved in 1991 and 1992 as insurers realized capital gains through falling interest rates and rising equity markets. These gains offset lower earnings from interest-bearing instruments. Insurers also reported growth in income from fee-based activities and other sources. Many insurers sought fee income to conserve capital.

The assets of life insurers increased about 9 percent in 1992 to nearly $1,700 billion. The proportion of corporate bonds decreased slightly in 1991 from 1990, while equities increased (Table 2). Taken together the mortgage and real estate portfolios of insurers declined both absolutely and as a percentage of assets from 1990 to 1991.

[TABULAR DATA 2 OMITTED]

Assets consist mainly of financial instruments such as stocks and bonds. These assets back insurance and annuity contracts required to pay expected claims, and provide the necessary surplus and capital to meet solvency standards. Life insurance companies are major institutional investors. Insurance and pension funds sheld almost one quarter of the financial assets in the United States in 1991.

The life insurance industry remains financially sound. Year-end 1991 and 1992 balance sheets improved for most companies. In the 1980's, however, basic changes in financial and insurance markets, such as rising interest rates and a shift to investment-type products, set the stage for an increase in insurance company insolvencies. In 1991, the weak economy, the depressed real estate market, the results of earlier investments in low-grade corporate bonds, and a sharp drop in consumer confidence were the immediate causes of several large, well-publicized failures. These insolvent companies did not, or could not, adjust to the changes in the market, resulting in severe asset and liquidity problem. Many analysts contend that the insolvencies of a few insurers are not indicative of the industry's fiscal health.

In 1992, the bond market improved, stock prices rose, and declines in real estate values abated in many regions. Insurers used gains from bond and stock sales to help offset losses from under-performing assets. As a result, the overall quality of assets in the portfolios of life insurance companies has improved, highlighted by the distinct shift to higher grade bonds. Insurers have shored up their financial positions based on such factors as modest earnings, increased capital gains, use of reinsurance to control liabilities, postponed write-offs of under-performing assets, and slightly reduced dividends to stockholders and policyholders.

General financial improvement, however, does not affect all insurers. The number of insolvencies in 1992 was about the same as 1991, albeit the failures were not as large. Because the economy is weak and real estate problems persist, some life insurers remain in jeopardy. Most of the problem real estate loans, however, are concentrated in larger insurance companies with the means to ride out a downturn.

Health insurers that specialize in traditional indemnity insurance are under severe financial pressure from competing managed-care programs such as health maintenance organizations, from client companies that self-insure, and from rising medical care costs. Evidence shows that many of the insolvencies in recent years have been small health indemnity insurance companies unable to compete in this hostile environment.

Many life insurance companies continue to seek cuts in operating costs by reducing staff and home office expenses, and by focusing on reform of their agency and product distribution systems. Employment in the industry fell again in 1992 amid announcements by several companies of further staff reductions ahead.

In conjunction, there was much consolidation and company restructuring in the industry in 1991 and 1992. Merger and acquisition activity introduced administrative and distributive efficiencies. Many insurers acquired pieces of troubled companies. Others divested unprofitable or non-core product lines and operations. Foreign insurers have been especially active in this area through extensive acquisitions and investments in the United States.

Key Developments

The solvency of the insurance industry and its implications for public policy were again the dominant issues of 1992. In 1991, as stated before, several large life insurers became insolvent or were seized by regulators. A downturn in the economy caught these companies overinvested in distressed real estate and low-grade bonds. Even before these high-profile failures, policymakers in Congress and elsewhere had begun looking at financial difficulties in the industry prompted by concerns over the problems in the savings and loan industry and in commercial banking. Congressional inquiries have focused on the ability of the current state regulatory system to protect the public against insurance company failures. This includes detecting and preventing failures before they occur and protecting policyholders, primarily through a guaranty system, if failure occurs.

Critics of state regulation contend that the industry is too big, too diverse and too international for 50 different state regulators to supervise effectively its activities, to prevent insolvencies, and to protect policyholders. As a solution, critics have called for a larger Federal role in insurance regulation. Two congressional bills proposing expanded Federal oversight have advanced the debate.

Senate bill S. 1644, The Insurance Protection Act of 1991, would set minimum Federal standards for the certification of state insurance departments. Insurers licensed in certified states could operate nationally. The bill also provides for the regulation of reinsurance, the examination of insurers from certified states, a national guaranty fund, and Federal liquidation procedures.

The other major bill would have the Federal government regulate insurers directly as opposed to setting Federal standards for the states to follow. H.R. 4900, The Federal Insurance Solvency Act of 1992, would give insurance companies the option of obtaining a Federal certificate of solvency. Certified insurers would not be subject to state solvency regulation, although they would be subject to state licensing, rate, and form regulations. The bill would exempt large commercial property/casualty insurers from state rate and form regulation. The bill also would set up a guaranty fund for Federally certified insurers, financial standards for and certification of all foreign insurers and reinsurers, national licensing for agents and brokers, and financial examination and insolvency procedures for all Federally certified insurers. While neither of these bills is likely to be enacted in its present form, they set the direction for future debate.

Other congressional proposals address more narrow aspects of insurance solvency. These proposals include tightening pension regulations, establishing new requirements for foreign insurers and reinsurers, and strengthening Federal laws for insurance fraud and abuse.

Proponents of state regulation, led by the state regulators, claim the current system has done a good job of protecting policyholders and promoting market efficiencies. State regulators cite the success of the current system in handling the large failures of 1991. They contrast this to the problems in the savings and loan, and banking industries that are regulated by the Federal Government.

In a program driven by the National Association of Insurance Commissioners (NAIC), the states are moving to set up improved licensing and financial standards, better screening and surveillance of insurers, and improved guaranty fund programs and insolvency procedures. Improved financial standards may include new risk-based capital requirements based on the amount of asset, underwriting and other risks that an insurer faces, to augment the current minimum capital and surplus requirements.

Under the program, the NAIC will certify any state meeting these standards, thus easing the recognition of insurers from certified states in other states. The NAIC has certified 13 states so far, and more are expected in 1993. Critics of state regulation, however, say that this program is not enough because the NAIC does not have the authority to push it through all states or enforce it.

Banks in insurance remains a key issue. Current banking law restricts banks and bank holding companies to banking and bank-related activities. Banks can provide some types of insurance products such as credit life, but are restricted from selling or underwriting most insurance products, such as annuities, that are primarily savings and investment products.

For years, the banking industry has argued that allowing banks to operate more fully in the insurance and brokerage industries would increase competition in financial services, provide stability to the financial marketplace, improve economic and capital market efficiencies, and provide greater convenience for consumers. In addition, developments in Europe and Japan point to a competitive need to integrate U.S. financial services markets.

On the other side of the issue, the insurance industry, especially agents, oppose the entry of banks into the insurance business. Insurers and agents argue that current restrictions are necessary to protect consumers from unfair practices and assure the soundness of financial institutions. They say, for example, that banks are in a strong position to unduly tie insurance sales to loans. Many also fear that integrating financial services will compound solvency problems in both the banking and insurance industries.

In 1991, the Bush Administration put forth a far-reaching plan to modernize the financial services industry in the United States. The Administration plan called for a restructuring of banking and securities regulation, leaving insurance regulation to the states. The measure would allow banks, securities firms and insurance companies to enter each others' businesses through special financial services holding companies. There would be specific firewalls between each activity to safeguard against anticompetitive practices. The Administration proposal was narrowly defeated in Congress.

Other recent events affecting banks in insurance include a 1991 Federal law restricting state-chartered banks from underwriting or selling insurance nationwide except for certain grandfathered banks with insurance subsidiaries. A Supreme Court determination is pending on the right of certain small-town national banks to sell insurance nation-wide. Many states have allowed, or are considering allowing, banks to underwrite and sell insurance. In California, Proposition 103 gave state banks the power to sell many kinds of insurance. As of this writing, Pennsylvania was considering permitting state-chartered banks to underwrite and sell insurance.

Health care reform is a key issue. Proposals for reform, some in the form of congressional legislation, range from completely nationalized health insurance to enhancing private markets for the funding and delivery of health care. One hybrid proposal calls for each U.S. business either to provide health insurance to employees or to pay a set amount into a government health insurance plan. Another proposal stresses a plan with tax credits for the underinsured and with legal limits on medical liability costs as elements.

Outlook for 1993

Premium receipts for life insurance companies in 1993 are expected to grow 4.5 percent to about $285 billion. This projection reflects a slowly improving economy and consumer reluctance to buy some insurance products because of low yields and concerns about problem companies. Sales of individual annuities should be up, while demand for group pension and annuity products are expected to be flat. Growth of premium receipts from health insurance will be soft because of increased managed care and self-insurance, and less indemnity-type insurance. Sales of life insurance products are expected to increase modestly.

Overall, earnings for insurers should be positive, but below historical norms. Investment earnings should not be as strong in 1993 as in previous years. Interest rates are low, and industry analysts expect smaller gains from stock and bond investments. Insurer profitability should be adequate in 1993 because insurers are expected to stress improved earnings rather than gaining market share to strengthen balance sheets. Health insurance lines, however, are expected to be less profitable.

The asset quality of life insurers should improve further, although problems in commercial mortgages will persist. The rate of insolvencies is expected to remain at levels of recent years. In this environment, insurers will turn to mergers and acquisitions, and other forms of consolidation, to control costs and capture efficiencies. Employment in the life insurance industry is expected to decline again in 1993.

Long-term Prospects

The life insurance industry will go through considerable changes over the next few years. The long-term prospects for life insurance and annuity products of life insurance companies are good. Demographic variables, such as income growth, wealth accumulation, population and work-force changes, and home ownership will determine the demand for insurance products over the long term. The rate of personal savings in the United States is expected to rise with the movement of the baby-boom population into middle age. The ageing of the baby-boom population will raise the demand of individuals for products that provide for retirement income and for health care financing.

Competition for these markets, however, will increase. Banks may get additional powers to sell and underwrite insurance. Banks, mutual funds and other financial institutions will be offering investment and savings products that directly compete with insurance and annuity products. Foreign insurers will continue to expand into the largely unrestricted U.S. market.

Other means of financing and delivering health care--for example, employer self-insurance, government programs, and managed care services--will diminish the growth of private health insurance, especially indemnity insurance. Moreover, new products and markets, such as long-term health care, will not replace business lost elsewhere. Instituting national health insurance could end private health insurance altogether.

On the tax front, the Federal government, in a search for revenue, may tax the investment income of annuity products, the so-called "inside build-up." Lawmakers, however, are also looking at increasing tax benefits of Individual Retirement Accounts to spur long-term investment. This could be a boon to insurers.

Increased competition and lingering problems in real estate for some insurers should keep the rate of insolvencies at the same level as recent years. Real estate problems will persist as commercial mortgages mature over the next couple of years, but diminish as insurers restructure their portfolios and real estate markets recover. Mortgages should become a smaller part of portfolios.

The problem of insolvencies has already prompted state-level action to strengthen financial standards and tighten regulation. A larger Federal role in insurance regulation may follow, if pending congressional legislation is enacted. The Federal government may set basic financial standards for the states to follow or may regulate the industry itself. A national guaranty fund for insurance is possible, although Federal support seems unlikely.

These conflicting forces and issues will change the nature of competition in the industry. Profits margins will likely remain thin and returns on equity will remain below historical levels over the next few years. To compete, life insurance companies may have to consolidate operations, specialize in market segments, reduce operating costs, increase efficiency and service quality, and better manage their assets and liabilities. Larger, better capitalized companies will get a bigger share of the market, but smaller niche players will be strong competitors in selected markets.

To reduce costs there will be much pressure on the distribution system. Agents will have to accept less compensation or increase production. Insurers will look for cost-efficient marketing alternatives, such as direct mail, alliances with other financial institutions, financial advisors, and consultants. Insurers will be seeking new information and communications technology to increase efficiency in underwriting, distributing, investment, claims, and administrative activities.

Diminished returns on life insurance in the United States also will prompt the stronger insurance companies to look for other investment opportunities. Many life insurance companies, mainly through holding companies, have moved, or will move, into related financial services including securities, banking activities, and real estate. More US. life insurance companies will take advantage of expanding foreign markets, especially Europe, Asia, and--with the North American Free Trade Agreement--Mexico.

PROPERTY/CASUALTY INSURANCE

Net written premiums for property/casualty insurance are expected to increase slightly more than 3 percent in 1992 to about $230 billion. This modest growth has been due mainly to the slow economy and subdued rates in most commercial lines. An overabundance of capital in the industry and the availability of alternative markets has kept rates low. Improvement in underlying cost factors has helped constrain losses from claims. Nevertheless, record catastrophe losses in 1992, led by Hurricane Andrew's $7.8 billion, will severely hurt insurers' operating earnings. Only solid investment performance, mainly from selling assets to capture capital gains, will keep operating earnings positive for 1992.

The property/casualty insurance industry provides financial protection for individuals, commercial businesses and others against losses of property or losses by third parties for which the insured is liable. P/C insurance companies are classified in Fire, Marine and Casualty Insurance (SIC 633). There are an estimated 3,800 P/C companies. Most are organized as stock companies, some as mutual companies.

The biggest premium increases among property/casualty insurers in 1991 was for private automobile insurance that rose $4.4 billion to $82.8 billion (Table 3). Much of this growth is attributed to largely to new rate increases that were needed to offset underwriting losses.

[TABULAR DATA 3 OMITTED]

In commercial lines, premiums for workers' compensation inched up only $300 million in 1991 to $31.3 billion, following a decade of strong growth. States that denied requests for rate increases in workers' compensation contributed to the slowdown. Premiums in other commercial lines either fell or changed little in 1991. Most notably, liability insurance other than for automobiles fell for the fifth straight year. The use of captives and other risk funding alternatives has affected premium growth in liability lines for insurers. The overall decline in commercial lines likely continued in 1992 as a direct result of the economy and slowing inflation. A soft economy reduces the number of claims (excluding catastrophe losses). A reduction in inflation produces claims costs that are less than industry projections.

In addition, the abundance of capital kept commercial rates at low levels. The amount of capital available to underwrite business determines the supply of insurance protection. An overabundance of capital sharpens competition for underwriting business and restrains rates (prices).

Reinsurance premiums grew to $25.3 billion in 1991 from $23.0 billion in 1990 (Table 4). Foreign-based reinsurers assumed about $10.4 billion, or 41 percent, of this business. Reinsurance is insurance that primary insurance companies buy to reduce and spread their risks. The increase in reinsurance premiums was due mainly to rate increases for catastrophe risks and liability lines. These increases also reflect rate increases in foreign markets, particularly Europe. The upturn in reinsurance rates suggests that rates in the U.S. primary market may be poised for increases.

Table 4: U.S. Reinsurance Market
(in billions of dollars)
Premiums                     1987   1988   1989   1990   1991
Total reinsurance            22.5   21.2   21.6   23.0   25.3
  Domestic reinsurers(1)     15.2   13.4   12.8   13.9   14.9
   Professional reinsurers   12.2   11.1   10.7   11.7   12.7
   Direct writers             2.9    2.3    2.1    2.2    2.2
  Foreign reinsurers(2)       7.3    7.8    8.8    9.1   10.4
(1) Net written premiums; detail may not add to total due to rounding.
(2) Net premium paid to reinsurers located outside the U.S. Includes life insura
nce ceded
abroad.
  SOURCE: U.S. Department of Commerce; National Underwriter, Property & Casualty
/Risk &
Benefits Management Edition, July 6, 1992.

The overall financial situation of P/C insurers did not improve in 1992. The rate of insolvencies remained at levels of recent years. Losses from catastrophes, such as Hurricane Andrew, helped push many smaller insurers into severe financial difficulties.

Asset quality is not a problem for most P/C insurers because investments are relatively liquid and secure. There is a concern, however, that insurers have not increased reserves for losses sufficiently. This could affect future performance. Insurers cashed out many of their investments to pay for record losses, but still drew down reserves because of the slow economy and drop in inflation. As a result, realized capital gains supported a small earnings increase in 1992. Unlike 1991 (Table 5), however, operating earnings did not add much to policyholders' surplus in 1992. In addition, some analysts question the reliability of reinsurance recoverables.

[TABULAR DATA OMITTED]

Insurers did move to streamline operations and reduce expenses in 1992. Employment fell 1.6 percent to 551,600. This was accompanied by some restructuring and a refocus by many insurers on core business. Merger and acquisition activity was strong in 1991 and 1992, highlighted by several large acquisitions by foreign firms. In addition, agents and brokers reported falling income because of reduced commissions and slower business.

Key Developments in 1992

Concerns about the solvency of insurance companies and proposals for Federal regulation of insurance dominated developments in 1992. The incidence and severity of insolvencies in the P/C industry have been at an increased level since 1984. There were 20 interstate insolvencies of P/C companies in 1991 and 16 in the first seven months of 1992.

Common causes of insolvencies of P/C insurers range from general mismanagement--such as deficient loss reserves, too rapid growth, and overstated assets--to outright fraud. Problems with reinsurance collectable and overreliance on narrow lines of business are other examples analysts often cite as causes of insolvencies. This contrasts with problems with real estate and junk bonds, that underlie some major insolvencies in life insurance.

Congress, as described in the life insurance section, is investigating solvency problems in the insurance industry. Some influential members of Congress question the adequacy of state regulation to solve these problems. Indeed, legislation has been introduced calling for a larger Federal role in insurance.

State regulators, through the National Association of Insurance Commissioners, are addressing solvency issues with a program that would accredit states meeting certain standards for insurance regulation and supervision. Insurance companies from states that don't meet these standards may face severe restrictions on their activities in accredited states. The program calls for stronger financial standards, more examinations of insurers, improved accounting procedures and practices, stiffer requirements for reinsurance credits, and mandatory audits by independent actuaries and accountants, among others. The goal is early detection of financially troubled insurers. Many states have legislation pending that deals with accreditation standards. So far, 13 states have been accredited. The NAIC plans to accredit most states by 1994. Despite efforts to ward off Federal regulation, the NAIC has asked for Federal legislation to help it with insurance fraud, and may ask for legislation to help regulate foreign insurance companies.

Congress is considering proposals to reform the McCarran-Ferguson Act. The act exempts insurers from Federal antitrust law except for cases of boycott, coercion, and intimidation so long as the states regulate the business of insurance. Although much of the industry opposes the loss of antitrust exemptions, some in the industry consider current antitrust exemptions unnecessary as long as certain data sharing and cooperative activities are protected.

In a related matter, the Supreme Court in its current session will review an antitrust suit that 19 state attorneys general originally filed in 1988 against 32 U.S. and foreign insurance companies and industry organizations. The Court will review allegations that defendants engaged in a boycott in the mid-1980's by manipulating general liability policy forms. In addition, the Court will review whether defendants forfeited antitrust immunity by allegedly conspiring with foreign insurers. The review will determine whether the case will be heard in Federal court. The case could change the way the industry does business.

In September 1992, the U.S. Senate rejected an Administration bill that would have created a uniform product liability system. Supporters of the measure claim it would have brought more certainty and consistency to the system. Defenders of the current system say it justly compensates victims and punishes negligent manufacturers whose products injure users.

Losses from environmental liability claims are a major concern for insurers and reinsurers. Large claims, especially for toxic wastes and asbestos damages, are made years, or even decades, after the incidences. For example, a recent study estimated the cost of cleaning up known hazardous waste sites at more than $750 billion over 30 years. The estimate, however, does not include litigation costs that are frequently higher than the clean up itself. Often, insurers are stuck with both bills. Because of the unpredictable nature and extent of losses in these areas, insurers find it extremely difficult to set up proper loss reserves. Many proposals have been made to change the Superfund law and to introduce other legislation to more efficiently clean up the sites.

The growth of alternative risk financing methods has changed the nature of competition in commercial insurance over the past few years. Many buyers of insurance responded to the liability crisis of the mid-1980's--in which the availability and affordability of liability insurance became severely restricted--by finding other ways to finance the risks. Also, many buyers are now "self-insuring" their most predictable business risks. Although a misnomer, "self-insurance" can be as simple as assuming the risk of loss entirely as an expense of doing business. Many buyers are also self-insuring by taking larger deductibles on their commercial insurance policies.

When risk funding or risk transfer needs become larger and the risks less predictable, many companies form separate subsidiaries, known as captive insurers. A wholly-owned captive usually covers only its parent's risk financing needs, but often insures third parties as well. Two or more companies, however, may set up a "group captive" insurer to share the risks among themselves. Doctors and lawyers often set up group captives for professional liabilities such as malpractice insurance.

Companies form many captive insurers in other countries, such as Bermuda, where tax laws and regulatory requirements are less stringent than in the United States. A 1991 industry surveys estimates that risk financing alternatives were more than 30 percent the size of the commercial P/C market. Self-insurance alternatives made up most of this market.

To provide another means of risk financing, the Liability Risk Retention Act of 1986 allows the formation of risk retention groups and purchasing groups. A risk retention group is an insurance company, licensed in one state, that provides liability insurance for its members who are in the same or similar business activities. While licensed in only one state, risk retention groups can do business in all states. Purchasing groups are formed by members in the same or similar business activities to buy insurance from a commercial insurer. In June 1992, there were 400 purchasing groups and 73 risk retention groups. It is estimated that risk retention groups had more than $500 million of annual premiums in 1991. Environmental impairment, medical malpractice and product liability are common areas of coverage for risk retention and purchasing groups.

The Bush Administration has proposed further amendments to the act. The amendments would establish new solvency safeguards for insurers of purchasing groups while maintaining a streamlined regulatory procedure. The amendments also require membership control of both risk retention and purchasing groups and assure that both regulators and group members receive all the information they need about their insurer.

The adequacy of rates in private automobile insurance and in workers' compensation is an issue that has immediate and long-term implications for the insurance industry and for local economies. Many insurers claim that rates in some states are too low to be profitable, while many consumers believe rates are too high. As a result, some insurers have pulled out of several states and abandoned certain lines of business. Moreover, many states continue to restrict rate increases or demand rollbacks and refunds, some based on voter referendum. Automobile and workers' compensation lines accounted for 51 percent of P/C premiums in 1991, and represented the largest underwriting losses for insurers. Rising medical care costs have compounded the problems in these lines by increasing the amounts paid out in claims.

Unlike most commercial lines, in which rates are set in a competitive fashion, rates in private automobile and workers' compensation are usually determined, or directly influenced, by state authorities. State regulation is designed to assure that rates are adequate to maintain the solvency of insurers, but not so high as as to be unfairly discriminatory. These lines of business are important because they have economic and social implications beyond insurance. If people cannot afford auto insurance, they may not go to work. If companies cannot afford workers' compensation insurance, they may shut down or move to another state. Reportedly, however, many states are allowing modest rate increases in these lines, although a few states still experience severe underwriting problems because of political pressures.

Outlook for 1993

Net written premiums for property/casualty insurance companies are expected to increase 4 percent in 1993 to more than $239 billion. A slowly improving economy would be the main reason for growth. Rates in commercial lines should start to turn up, but will be tightly constrained by excess capital and competition from alternative markets. Premiums for automobile insurance and workers' compensation will grow because of expected rate increases by state authorities to keep pace with costs and solvency concerns. Political action in some states, however, will limit rate increases in these lines. These lines will remain less profitable than desired in many states for many insurers.

The financial health of the industry will be questionable in 1993. Despite premium growth, operating earnings for the industry will be small in 1993, and may turn negative if catastrophe losses mount again. Underwriting losses may increase if insurers start rebuilding reserves. Investment income will not be strong because of lower interest rates. Realized capital gains will not add to earnings as in 1991 and 1992.

Policyholder surplus will grow slowly, but could diminish if unexpected underwriting losses reduce earnings below zero and unrealized capital gains are not helpful. Insolvencies should remain at the same level as in recent years. Many smaller to mid-size companies will remain vulnerable to market conditions. Some smaller companies with overexposures. in the disaster areas, such as South Florida, will fail.

Long-term Prospects

The long-term prospects of the industry will depend mostly on how much and how fast rates increase over the next several years. Commercial rates will head upward, but will be sporadic and limited. Many factors suggest rates are heading upward. Reinsurance rates for catastrophe risks are high and increasing. Rates in the primary markets in Europe are climbing. Premiums for surplus lines insurers increased again, suggesting commercial insurers may be avoiding some risks. (Surplus lines insurers are unlicensed insurers. They underwrite risks that licensed insurers reject.) In addition, there is a general fear that many companies have inadequate loss reserves. Thus, insurers will need to increase rates to bring reserves to adequate levels or face pressure from regulators, rating agencies and stockholders.

Rate increases, however, will be sporadic and limited by line of business. Capital in the industry is relatively strong despite Hurricane Andrew and other catastrophes. There is enough capital for existing premium levels. New capital also keeps coming into the industry as shown by the increase in foreign investment. Alternative markets are strong, as much business would flee from commercial insurers to these markets if rates jumped. In addition, insurance companies may be reluctant to raise rates too far, too fast, fearing a political backlash, as happened during the liability crisis of the mid-1980's. Rates will stay down if low inflation and slow economic growth keep losses in check. Also, political pressure from consumer groups will hold rates in personal lines at lower levels.

In this environment, stronger or more efficient companies with a better capital position will get larger market shares. Weaker companies will need to streamline or consolidate. They may have to join with stronger companies or find other capital sources. Foreign investment, especially from Europe, will provide some of this capital. Thus, merger and acquisition activity will remain high for the next few years.

Many companies will not survive. The rate of insolvencies will remain at current levels. Insolvencies could increase if the economy does not pick up or catastrophe losses jump suddenly. The failure of a large P/C company, although not foreseen, could strain the capacity of state guaranty funds. This could lead to other failures as the effects of the failure move through the industry.

State-level action to improve solvency regulation, now underway, should be largely in place by 1994. This should lessen many of the problems related to solvency. The prospect of Federal regulation of insurance, however, will increase in the next few years, if solvency problems grow. At a minimum, we can expect Federal measures on penalties for insurance fraud and regulating foreign insurers. There is also a good chance of McCarran-Ferguson reform to narrow the antitrust exemptions of the industry.

Finally, the long-term financial health of the industry may depend on resolution of problems with health care costs, environmental liability, workers' compensation and automobile insurance. Federal action may also be taken to reform the product liability system.

INTERNATIONAL COMPETITIVENESS

Insurance and financial markets are becoming increasingly global. Advances in information and communications have made it possible for even the smallest investor to purchase financial instruments from almost anywhere abroad. The rise in personal incomes and savings in many areas around the world and the need to protect this wealth provides significant opportunities for life insurers. This environment makes it possible for life insurance companies to seek premiums and place investments globally.

The growth of multinational companies and international trade and investment has prompted the growth of international nonlife insurance companies and insurance brokers to service the local and global needs of companies for protection from all types of risk. Thus, insurers from Europe, Asia and the United States have expanded internationally through branches, subsidiaries, joint ventures and reinsurance operations. In addition to providing insurance products, insurance companies also transfer services and technologies such as claims adjusting, risk management, actuarial, investment and information technologies.

The United States has the largest insurance market in the world with 35.6 percent of $1,356 billion premiums worldwide (Table 6). Japan is the second largest market with 20.5 percent of world premiums. The United Kingdom, Germany, and France were the next largest markets as premiums in Europe totaled $460 billion in 1990.

Table 6: World Insurance Markets,(1) 1990 Premiums
(in billions of dollars)
Country                   Total(2)     Life    Nonlife(3)
Total, all countries    1,355.7       707.3    648.5
  United States           482.1       205.8    276.4
  Canada                   31.8        16.0     15.8
  Europe                  460.0       222.3    237.6
    United Kingdom        101.7        65.6     36.1
    West Germany           92.5        35.6     56.9
    France                 74.3        39.1     35.2
    Italy                  30.2         7.7     22.6
    Netherlands            24.1        12.5     11.6
    Switzerland            19.6        11.0      8.7
  Asia                    334.0       239.1     94.9
    Japan                 278,3       203.3     75.0
    South Korea            27.4        22.4      5.0
    Taiwan                  6.8         4.8      2.1
  Latin America             9.4         2.3      7.1
  Africa                    14.4        9.3      5.1
  Oceania(4)                23.9       12.5     11.5
(1) Includes centrally planned economics.
(2) Detail may not add to total due to rounding.
(3) Nonlife business includes accident and health insurance as well as property/
casualty
insurance.
(4) Includes Australia, New Zealand, and South Pacific Islands.
SOURCE: Sigma, 1992, Swiss Reinsurance Co.

For life insurance, the United States had $205.8 billion in premiums in 1990, followed closely by Japan with $203.3 billion. These figures, which do not include health insurance, show the extent to which the Japanese save through insurance. The United States, with 42.6 percent of world premiums in 1990, leads the world market for nonlife insurance. Japan had 11.6 percent, Germany 8.8 percent and the United Kingdom 5.6 percent. The size of the U.S. nonlife market is due mainly to health insurance and to casualty insurance. Private insurers, rather than the public sector, provide much of the health insurance in the United States. Compared to other countries, the tort-liability system in the United States leans strongly toward fully indemnifying people harmed as the result of the action or products of others.

U.S. insurers have become more active in foreign markets in recent years. U.S.-owned insurers in foreign countries had sales (premium income plus investment income plus other income) of $30.6 billion in 1989, the latest year data was available (Table 7). Canada, Europe and Japan are key markets for U.S. insurers (Table 8). Most foreign sales were from nonlife operations, but U.S. life insurers have recently become more active overseas. For example, U.S. life insurers have moved strongly into South Korea, Taiwan and other Asia markets.

Table 7: Foreign Insurance Affiliates(1) of U.S.
Companies
(in billions of dollars except as noted)
Item                          1983    1985    1987    1989(2)
All insurance:
Number of affiliates           621     617     631     610
Total assets                  46.9    56.4    80.4    89.6
Sales(3)                      16.3    17.9    27.0    30.6
Life insurance:
Number of affiliates            88       87      86      80
Total assets                  20.0    21.3    28.6    27.5
Sales(3)                       5.9     5.6     7.8      -
Accident & health insurance:
Number of affiliates             34      34      39      51
Total assets                   2.2     3.0     6.3      -
Sales(3)                       0.9     1.0     2.1      -
Other insurance(4):
Number of affiliates           499     496     506      479
Total assets                  25.1    32.0    45.5      -
Sales(3)                       9.5    11.2    17.0     16.8
(1) Affiliates include entities at least 10 percent owned by a nonbank U.S. pers
on.
(2) Preliminary estimates.
(3) Sales equals premium income plus investment income plus other income.
(4) Include nonlife insurers, agencies, brokerage firms and other insurance rela
ted companies.
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, US. Direct
Investment Abroad, various issues.
Table 8: Sales(1) of Foreign-Owned Insurance
Companies, 1989
(in millions of dollars)
                        Foreign-owned    U.S.-owned
                          insurers        insurers
Country(2)               in the U.S        abroad
All countries            54,356          30,572
  Canada                 12,270           6,847
  Europe                  31,914         10,285
    Switzerland             6,965              -
    European Community    23,926              -
      United Kingdom      10,882              -
      Netherlands          6,736              -
      West Germany         2,463              -
  Latin America(3)           199           5,259
  Japan                      444           5,851
  Australia                    -             365
(1) Sales equals premium plus investment plus other income for insurance affilia
tes that are
10 percent or more owned by any one foreign person.
(2) Country of ultimate beneficial owner (UBO).
(3) Includes offshore centers such as Bermuda and the Bahamas.
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct
Investment in the United States, 1991, and U.S. Direct investment Abroad, 1991.

Foreign-owned insurers and other insurance services had sales of $54.4 billion in the United States in 1989, up from $39.1 billion in 1987 (Table 9). Foreign-owned property/ casualty insurers in the United States earned an estimated $28 billion, or 13.5 percent, of premiums in 1989. Foreign-owned life insurance companies in the United States had an estimated 6.1 percent of premium receipts of life insurers in 1989. Foreign-owned life insurance companies in the United States had $22.2 billion in sales in 1989, up from $16.8 billion in 1987.

Table 9: Foreign-Owned Insurers(1) in the
United States
(in billions of dollars except as noted)
Item                     1983   1985   1987     1989
All insurance:
  Number of companies      -       -    1,071   1,115
  Total assets           53.1    67.2   110.1   170.6
  Sales(2)               21.9    23.9    39.1    54.4
Life insurance:
  Number of companies      -        -     233     247
  Total assets           23.4     33.8   53.3    77.0
  Sales(2)                8.8     10.5   16.8    22.2
Other insurance(3)
  Number of companies      -       -      838     903
  Total assets           29.8     33.4   56.8    93.6
  Sales(2)               13.0     13.5   22.3    32.1
(1) Companies are members of affiliates which are 10 percent or more owned by an
y one
foreign person. Includes branches and subsidiaries.
(2) Sales equals premium income plus investment income plus other income.
(3) Includes nonlife insurers, agencies, brokerage firms and other insurance rel
ated companies.
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct
Investment in the United States, various issues.

Cross-border trade in insurance is a small, but important part of the U.S. insurance market (Table 10). U.S.-based insurers earned $6.2 billion in foreign premiums (exports) in 1991. Premiums of $11.4 billion went to foreign-based insurers (imports) to cover risks in the United States. Most premiums sent abroad went to Europe or the off-shore centers, like Bermuda, for reinsurance. In fact, reinsurance premiums sent abroad represent more than 40 percent of the reinsurance market in the United States (Table 4).

[TABULAR DATA 10 OMITTED]

Foreign companies have expanded their insurance activities in the United States over the past few years mainly through acquisitions. Foreign outlays for acquisition or establishment of insurance companies in the United States has totaled more than $16 billion since 1981. This included $5.8 billion in 1988, mostly because of the $5.2 billion invested by Batus Inc. (UK) in the Farmers Group, an insurance company in California. Other recent foreign investments of prominence include the Axa Groupe (France) putting $1 billion in the Equitable Life Assurance Society of New York and the 1991 purchase by Allianz (Germany) of the Fireman's Fund of California valued at $3.1 billion.

Regulatory and trade developments around the world are creating opportunities for U.S. insurance companies. The European Community (EC) is directing its members to liberalize their markets for insurance. Several EC countries, especially in Southern Europe, have opened their insurance sectors more to foreign investment. Insurers in one EC country can write certain nonlife insurance in any other EC country. Recent EC directives harmonize accounting and regulatory standards making it easier to transact business across EC borders. The EC also has formulated directives and proposals that address issues in product liability, pollution liability, pensions, and automobile insurance. Some US. insurers have already positioned themselves to take advantage of the business opportunities created by these and other changes in the EC.

The economies of Latin America, although small, are growing quickly. Many Latin American countries are liberalizing their insurance markets by privatizing government-owned insurers, allowing foreign investment, and deregulating their markets to be more competitive. Even larger opportunities are available in the dynamic economies of Asia where business, wealth and personal incomes are expanding rapidly. In particular, Taiwan and South Korea have attracted many U.S. insurers in recent years.

Long-term opportunities for U.S. insurance companies in foreign markets may depend on the effectiveness of the rules and principles the United States is negotiating in the Uruguay Round Group of Negotiations on Services under the General Agreement on Tariffs and Trade. A successful agreement would establish a multilateral set of rules that would provide signatory countries with guidance on international trade and investment in services, including insurance. These rules would allow insurers to enter and operate in foreign markets equally with domestic insurers.

U.S. insurers also would gain from a North American Free Trade Agreement (NAFTA). NAFTA would provide U.S. insurers expanded investment opportunities in Mexico; Canada being open already. U.S. insurers would operate equally with Mexican insurers. The NAFTA also liberalizes some types of cross-border insurance among the countries, such as reinsurance and marine insurance. In addition, it will provide broader access to Mexico's insurance market for agents, brokers and insurance service firms such as claims adjusters and actuaries. Although the Mexican insurance market had just $3.5 billion in total premiums in 1991, the market and opportunities for U.S. insurance companies should expand with a NAFTA.--M. Bruce McAdam, Office of Finance, (202) 482-0346, October 1992.

[TABULAR DATA OMITTED]

Additional References

1992 Life insurance fact book, American Council of Life Insurance, 1001 Pennsylvania Ave., NW, Washington, DC 20004. Telephone: (202) 624-2000. 1992 Property/Casualty Insurance Facts, Insurance Information Institute, 110 William St., New York, NY 10034. Telephone: (212) 669-9200. Best's Aggregate and Averages, A. M. Best Co., Oldwick, NJ 08858. Telephone: (201) 439-2200. Business Insurance, 740 Rush St., Chicago, IL 6061). Telephone: (312) 280-3174. Employee Benefit Research Institute, 2121 K St., NW, Suite 600, Washington, DC 20037-1896. Telephone: (202) 659-0670. International Insurance Council, 1212 New York Ave., NW, Suite 250, Washington, DC 20005. Telephone: (202) 682-2345. Life Insurance Marketing and Research Association, Inc., P.O. Box 208, Hartford, CT 16141-0208. Telephone: (203) 677-0033. National Association of Insurance Brokers, 1401 New York Ave., NW, Washington, DC 20005. Telephone: (202) 628-6700. National Association of Insurance Commissioners, 120 West 12th St., Suite 1100, Kansas City, MO 64105. Telephone: (816) 842-3600. National Underwriter, National Underwriter Co., 43-47 Newark St., Hoboken, NJ 07030. Telephone: (201) 963-2300. Reinsurance Association of America, 1025 Connecticut Ave., NW, Suite 512, Washington, DC 20036. Telephone: (202) 293-3335. Sigma, Swiss Reinsurance Co., 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 Ave., NW, Washington, DC 20036. Telephone: (202) 223-7845. Standard and Poor's Insurance Rating Service, 25 Broadway, New York, NY 10004. Telephone: (212) 208-1367.

COPYRIGHT 1993 U.S. Department of Commerce
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