Unpacking the FIO Report: Why P&C Insurer Surplus Shrank for the First Time in 10 Years

Examining the FIO’s Latest Snapshot of the P&C Insurance Sector

The Federal Insurance Office (FIO) of the U.S. Department of the Treasury recently released its 2023 Annual Report on the Insurance Industry. A federal statute requires the FIO to publish an annual report on the prior year’s results in the United States insurance industry.

The Congress established FIO as part of the Dodd-Frank financial reforms enacted into law following the 2008-2009 financial crisis. The agency’s task is to monitor all aspects of the nation’s insurance sector, identifying risks contributing to future instability in the United States insurance markets. Insurance industry professionals here in Massachusetts will find it worth reviewing the details of the FIO’s latest annual snapshot, particularly the property and casualty (P&C) sector.

Overview of the FIO’s 2023 Insurance Industry Report

The Federal Insurance Office’s (FIO) 2023 Annual Report on the Insurance Industry provides a comprehensive review of U.S. insurance companies’ financial performance and condition in 2022.

The report is organized into the following key sections:

Introduction: Gives background on the FIO’s responsibilities and summarizes major activities since the prior year’s report.
Section II – Industry Financial Performance: Analyzes the 2022 financial results for life and health (L&H), property and casualty (P&C), and health insurers. This section notes that market volatility, inflation, and rising rates weighed on performance. Premium growth continued but slowed, while the industry saw its first surplus contraction since 2008, driven by capital losses. P&C insurers faced challenges from higher input costs, catastrophes, and cost of capital. However, tight asset-liability matching and surrender protections supported liquidity and capital strength. The section also examines investment and credit trends, stock performance, capital markets activity, lower M&A volume, cyber insurance, and offshore reinsurance. It concludes with an industry outlook.
Section III – Conclusion: Summarizes anticipated areas of focus for the FIO in the coming year based on the trends and issues highlighted throughout the report.

Unpacking the FIO’s Latest Analysis of the Property & Casualty Insurance Sector

The FIO report indicates the P&C sector saw direct premiums written reach a new record of $876 billion in 2022, a 10% increase over 2021. However, underwriting profitability declined last year due to higher loss ratios, especially for personal auto lines. The loss ratio for the overall P&C sector jumped to 66.4% in 2022 from 62.4% the prior year. Investment income rose due to higher interest rates, but capital gains decreased substantially. As a result, net income for the P&C sector dropped 31% in 2022, and the return on average equity fell to just 4.3% last year.

In terms of financial condition, the report showed policyholders’ surplus declined in 2022 for the first time in over a decade, attributed primarily to unrealized capital losses. Leverage ratios increased but remain within historical ranges. Liquidity metrics weakened somewhat, though cashflows did stay positive. The credit quality of P&C insurer investments improved slightly, but alternative investment holdings are still sizable at 8.5% of the total investment portfolio.

P&C Premiums Reached New Highs in 2022

Direct premiums written for P&C insurers totaled a record $876 billion in 2022, rising 10% over 2021 levels. This marks the second consecutive year of strong premium growth for the sector.
Premiums for personal lines rose 8%, while commercial lines increased 11% in 2022. For the first time in over a decade, commercial lines premiums exceeded personal lines.
Several factors drove growth:
- Many lines of business, but especially personal auto, had rate increases approved
- More expensive materials and labor costs from high inflation
- Greater exposure to catastrophic risks
- Stronger pricing in commercial lines

Underwriting Performance Suffered in 2022

Underwriting profitability declined significantly for P&C insurers last year. The combined ratio rose to 102.7% in 2022 from 99.7% in 2021. A ratio above 100% indicates underwriting losses.
Elevated loss ratios were the major driver of worsening underwriting results:
- Overall direct loss ratio jumped to 66.4% in 2022, up from 62.4% in 2021
- The loss ratio for personal auto lines reached 80.1% in 2022, a 10-year high
- Supply chain issues led to higher repair costs, affecting losses
Catastrophe losses from major events like Hurricane Ian contributed but were not sharply above 2021 levels.
Favorable prior-year reserve development continued but slowed in 2022.

Investment Results Declined but Remained Profitable

P&C’s net investment income rose 27% to $71 billion in 2022, aided by higher interest rates.
However, net realized capital gains fell 90% to just $2 billion last year as unrealized losses mounted.
Net investment gains remained positive but totaled 43% below 2021 levels.
Shorter-duration P&C investment portfolios benefited more from rising rates than longer-duration life insurer portfolios.
P&C insurers reduced equity allocation slightly in 2022, likely due to volatile markets.

Surplus Dropped in 2022 But Leverage Ratio Stabilized

Due to underwriting losses and investment declines, P&C policyholder surplus decreased 6.6% in 2022 – the first annual drop in over a decade.
Unrealized capital losses of nearly $98 billion eroded surplus in 2022 after large gains in prior years.
Net income fell 31% to $43.5 billion in 2022. Return on average equity dropped to 4.3%.
Leverage ratios edged up but remained relatively stable over a 10-year period.
Loss reserves increased at a slower 7.8% pace in 2022 but remained adequate.

The P&C industry’s Liquidity Positions Weakened Slightly but Remained Strong

P&C liquidity was impacted by inflation, driving up claims costs faster than premium growth.
Cashflows remained positive but slowed, with benefit payments up 20% in 2022, far outpacing the 7% premium increase.
However, short-term investments grew around 7% annually over the last ten years, supporting liquidity.
High-grade bonds remained the core of portfolios, averaging 95% of holdings over the last ten years.
Unaffiliated assets consistently remained 2 times the surplus level over the last ten years, limiting affiliated investment risk.
The current liquidity ratio dropped but remained robust at 139% in 2022, aided by asset-liability matching practices.

Cyber Insurance Continued Its Expansion but Still Made Up Only a Small Portion of the P&C Market

Direct premiums written for cyber insurance totaled $7.2 billion in 2022, a 51% increase over 2021. However, cyber insurance still comprises less than 1% of the total P&C insurance market.
Growth linked to continued but slowing cyber insurance premium rate increases:
- Average price hikes estimated around 62% in 2022: Slower than large increases in 2021
Cyber insurance market remains highly concentrated:
- Top 10 writers hold 52.3% market share in 2022
- Top 25 writers combine for over 86% of market share

Implications for Massachusetts P&C Insurers

The FIO report provides critical insights into the continuing challenges facing P&C insurers nationwide.

Inflationary pressures will persist, driving up loss costs
Catastrophe losses likely will continue to rise in frequency and severity
Economic uncertainty could lead to market volatility
Ongoing tightening of credit conditions with higher interest rates

Here in Massachusetts, we face additional regional concerns:

Catastrophe exposures are increasing, with more frequent severe storms in New England
Heightened cyber risks in our tech-heavy state
Longer timelines for regulatory approvals of needed premium rate increases