American International Group Inc., the company repaying a $182.3 billion government rescue, led the U.S. insurance industry to its best year since 2003 as investments strengthened.

Nineteen of the 22 companies in the Standard & Poor’s 500 Insurance Index are beating returns for the benchmark S&P 500 this year. AIG, based in New York, has nearly doubled and is the insurance index’s best performer. Warren Buffett’s Berkshire Hathaway Inc. has risen 22 percent this year. The index, which also includes MetLife Inc., the biggest U.S. life insurer, and brokers like Aon Corp., has advanced 15 percent, its biggest annual jump since 19 percent in 2003. The S&P 500 has risen about 13 percent so far in 2010.

The industry is building on a recovery that started last year when the insurance index rose 11 percent. Insurers, which are regulated by states, avoided much of the federal Dodd-Frank financial overhaul this year, said Malcolm Polley, chief investment officer of Stewart Capital Advisors LLC, a subsidiary of S&T Bancorp.

Insurers were “probably the best options in a troubled marketplace for financials,” Polley, who helps manage about $1 billion, said in an interview. “The whole financial-services sector got taken out and shot in 2008. It didn’t matter what kind of financial you were, people just wanted out. Now, you’re beginning to separate the wheat from the chaff.”

AIG’s Progress

AIG, once the world’s largest insurer, is shedding assets as it seeks to repay the U.S. government rescue and has reported improved investment results. Realized losses on investments cost the company $661 million in the third quarter, compared with $1.86 billion a year earlier. AIG surged 9.3 percent yesterday after saying it had secured $4.3 billion in bank credit lines, another step toward gaining independence.

MetLife has reported net income of more than $2.7 billion this year through Sept. 30 after a loss of about $2.2 billion in all of 2009. Third-quarter investment income rose 12 percent from a year earlier to $4.39 billion. New York-based MetLife has climbed 27 percent this year.

Prudential, the second-biggest U.S. life insurer, has advanced 20 percent so far this year. The Newark, New Jersey- based company’s third-quarter earnings gained after a rising stock market allowed the company to reduce reserves against minimum-return guarantees it makes to annuity customers.

“The insurance industry has done a pretty good job at bolstering its capital position,” Kenneth Janke, executive vice president and deputy chief financial officer at Aflac Inc., said in an interview. “Investors have shifted more toward going back to looking at the income statements of the insurance companies and not just the balance sheets.”

Berkshire, MetLife

Berkshire, based in Omaha, Nebraska, has been lifted by the acquisition of railroad Burlington Northern Santa Fe. Aflac, the world’s largest seller of supplemental health insurance, rose 23 percent as a stronger yen magnified revenue from Japan.

MetLife and Aflac are adding corporate debt to their portfolios as life insurers increase holdings in the securities at the fastest rate in six years amid near-zero interest rates. For the first time, life insurers own more than $2 trillion in the bonds issued by companies, according to data released by the Federal Reserve in Washington this month.

Corporate bonds are returning about 10 percent this year, including invested interest, according to Bank of America Merrill Lynch’s U.S. Corporate & High Yield Master Index. The debt returned a record 26 percent last year, after posting an 11 percent loss in 2008.

Catastrophes

Property-casualty insurers benefited from the biggest increase in sales in four years in the quarter ended Sept. 30, according to a report from ISO, a unit of Verisk Analytics Inc. Third-quarter policy sales rose 2.3 percent to $110.7 billion from $108.2 billion a year earlier.

Catastrophes striking the U.S. in the first nine months of 2010 caused $10.7 billion in insured losses this year, up about $400 million from the prior-year period, ISO said.

“The fact that there wasn’t a major hurricane, I think that gave people even more confidence that earnings would be coming through,” Ania Aldrich, who helps manage more than $5 billion at Cambiar Investors, said in an interview.

Competition on commercial rates and a weakening municipal-bond market may hurt property-casualty insurers next year, said Paul Newsome, an analyst with Sandler O’Neill & Partners LP.

State and local government bonds have lost 4.5 percent including invested interest so far this quarter, their worst performance since the first quarter of 1994, according to Bank of America Merrill Lynch’s Municipal Master Index.

“There are concerns about the financial strength of many municipalities across the country,” Newsome said in an interview. State and local bonds are “very important for property-casualty insurers.”