(MCO) Insurance Industry Stock Update – September 2011 – Industry Outlook

Despite a series of natural disasters and consequent above-average losses, the U.S. insurance industry could rebound only with help from rising rates and reduced pricing pressure. Though financials of U.S. insurance companies are still not strong enough to soak up losses from catastrophic events such as the recent Hurricane Irene, which affected a wide area of the U.S. East Coast, tight market conditions and a favorable rate environment on steady demand growth could significantly offset the damages.

Moreover, the financial dent caused by Hurricane Irene has been milder than what the market had presumed. It wasn’t as bad as it could have been due to perfect weather forecasts and rapid emergency actions. So the damage is expected to be mended in the near-to-mid term.

After enduring stress with respect to pricing pressure and reduced insured exposure through mid-2009, the overall health of the U.S. insurance industry has improved to some extent in recent quarters. Though the market turmoil forced many companies to take immense write-downs, the worst of the crisis appears to be now behind us.

However, long-lasting soft market conditions, shrinking businesses, a still-high unemployment rate and legislative challenges are threatening insurers’ ability to rebound to the historical growth rate. The industry continues to be challenged by subdued premium volume growth in a perked up economy as well as a massive healthcare restructuring.

Though there are signs of economic recovery, its sluggish pace is expected to continue at least through 2011. Also, structural economies of scale have pushed the industry toward consolidation. As a result, inter-segment competition within the industry has reduced. Moving forward, maintaining profitability after complying with regulatory requirements could be a painful task.

We expect static growth with persistent soft market conditions to result in further consolidation in the industry. Though there are near-term opportunities for insurers, braced by some rapidly growing sectors such as health care and technology, overall industry conditions are expected to improve beyond 2011, should the economy turn to growth post-recovery. Probably, the industry would take a couple of years to overcome most industry challenges with the help of an improved market mechanism.

Life Insurers

Losses in the investment portfolio and lower income from the variable annuity business will continue to hurt earnings of life insurers. Most life insurers have substantial exposure to commercial real estate-backed loans and securities, which will result in further losses in the coming quarters.

As the industry’s statutory capital levels fell sharply during the recession, life insurance companies will need to optimize their capital levels to address continuing challenges. In the short term, traditional sources of capital are expected to fulfill most of what life insurers need to stay in good shape. However, non-traditional sources of capital will take years to help these strengthen financials.

Moreover, regulatory changes under the Dodd-Frank Wall Street Reform are still troubling life insurers as they pose strategic and competitive challenges. In order to address such concerns, life insurers may have to burn some of their financial energy.

The underlying trends amid sluggish economic recovery indicate stability of U.S. life insurers over the medium term with respect to credit profile and financial prospects. However, higher-than-average asset losses of life insurers, primarily a result of real estate exposure, will remain a major concern in 2011.

Most importantly, the tardy economic recovery is making it difficult for life insurers to enhance their customer base. Even they are struggling to retain their existing clientele. Narrowed disposable income owing to high unemployment and huge credit card debt has made it difficult for Americans to invest in retirement products such as life insurance.

On the other hand, interest in cheaper products to cover only basic risks has increased. So, returning to providing basic services and reducing operating costs should be the primary course of action for life insurers to realize some profit in the near term.

Some life insurers have already gone back to the basics in order to meet demand and escape financial and regulatory difficulties, but taking shelter from the icy winds will not be adequate for thriving. Life insurance companies have to be more proactive to weather the situation.

Health Insurers

The U.S. health care system is significantly dependent on private health insurance, which is the primary source of coverage for most Americans. More than half of U.S. citizens are covered under private health insurance.

Unfortunately, these insurance companies utilize a pre-existing exemption clause to control costs and maximize profit. The historic health care legislation, which was passed by Congress last year, prevents private insurance companies from using the pre-existing clause, but at the same time brings in 32 million more people under coverage.

In total, the health care reform packs 95% Americans under health insurance coverage. Further, according to a new Commonwealth Fund report, 90% of American families live above the federal poverty level and are able to afford health insurance premiums.

While the legislative overhaul brings more regulatory scrutiny for private insurance companies, the net negative effect is far softer than was initially feared. Also, the removal of this uncertainty is a net positive in its own right.

Though the reform will provide more cross-selling opportunities for health insurers, their overall profitability will be marred in the long run as the negative impact of Medicare Advantage payment cuts, industry taxes and restrictions on underwriting practices will more than offset the benefits of the 32 million added coverage.

In August, Fitch Ratings said that it expects the publicly traded health insurers and managed care companies to generate strong earnings and interest coverage in the second half of 2011. Though minimum loss ratio requirements will remain a dent, the agency expects this to be offset by membership growth.

According to the agency, cash flow generated by most of the health issuers is more than sufficient to meet their ongoing business needs. As a result, an addition of meaningful leverage to their balance sheets is unlikely.

However, industry revenue is expected to decline beyond 2011 through 2015 as insurers will be forced to adjust these to comply with the health care legislation. Among others, providing coverage to everyone regardless of whether they had an expensive pre-existing condition would put their top line at stake.

Property & Casualty Insurers

Steep losses in the investment portfolios since the beginning of 2008 have significantly reduced the capital adequacy of most Property & Casualty insurers. The seizure of credit markets and rising concerns over defaults have pushed down bond prices sharply since then, causing significant realized and unrealized capital losses on insurer portfolios. As Property & Casualty insurers hold about two-thirds of the invested assets in the form of bonds, their capacity is highly sensitive to changes in credit market conditions.

While the ongoing recovery in the credit and equity markets is leading to a reduction in unrealized investment losses, the premium rates continue to decline, though at a slower pace.

Reduced financial flexibility and weak underwriting and reserves have further added to insurer woes. The only positive trend visible as of now is a slight improvement in some insurance pricing after continued deterioration for two years since 2008.

However, the Property & Casualty industry endured the recent financial crisis better than the other financial service sectors. Once the economic recovery gains momentum, insurance volume will grow rapidly.

The recent quarters have been witnessing increasing rebound in claims-paying capacity (as measured by policyholders’ surplus), which reflects the industry’s resilience over the prior-years.

Earlier this month, Moody’s Investors Service, a wing of Moody’s Corp. (MCO) revised its outlook for U.S. Commercial Lines Insurers to stable from negative. According to the rating agency, the sector weathered the recent financial crisis better than other insurance sectors despite challenges related to catastrophes, underwriting and capital market volatility.

Besides benefiting from the recent stabilization of industry-wide pricing, commercial insurers maintain solid capital adequacy and balance sheet strength.

Reinsurers

Losses from the investment portfolios of reinsurance companies have gotten worse during the last few quarters. The supply-demand imbalance in reinsurance coverage due to intense competition had kept pricing soft over the last few years.

Also, catastrophic events like Hurricanes Ike and Gustav were the major culprits that pressure on underwriting profits. However, in the recent months, reinsurance prices have increased substantially. In fact, rising rates are expected to be more than sufficient to offset recent catastrophe losses.

With signs of recovery in the capital market (though still weak by any means), concerns related to reinsurers’ ability to access capital markets on reasonable terms have sufficiently eased.

Earlier this month, Moody’s Investors Service, had revised their outlook on the international reinsurance sector to stable from negative based on strong risk management and underwriting discipline showed by the industry in the prior year. Also, the agency expects increased demand to boost reinsurance rates.

However, diminishing new business and rising expense ratios are major concerns for reinsurers at this point. An increased level of price competition also may hurt top line in the upcoming quarters.

OPPORTUNITIES

We remain positive on Eastern Insurance Holdings, Inc. (EIHI), RLI Corp. (RLI), ProAssurance Corporation (PRA), Investors Title Co. (ITIC) and Donegal Group Inc. (DGICA) with a Zacks #1 Rank (short-term Strong Buy).

Other insurers that we like with a Zacks #2 Rank (short-term Buy) include CIGNA Corporation (CI), CNO Financial Group, Inc. (CNO), FBL Financial Group Inc. (FFG), American Safety Insurance Holdings Ltd. (ASI), AmTrust Financial Services, Inc. (AFSI), First American Financial Corporation (FAF) and Mercury General Corporation (MCY).

American International Group Inc. (AIG) currently retains a Zacks #3 Rank which translates into a short-term Hold rating.

WEAKNESSES

We expect continued pressure on investment portfolios and lower income from the variable annuity business to restrict the earnings growth rate of life insurers. Also, reduced financial flexibility and weak underwriting will hurt the earnings of Property & Casualty Insurers.

Among the Zacks covered U.S. insurers, we prefer to stay away from the Zacks #5 Rank (short-term Strong Sell) companies –– Horace Mann Educators Corp. (HMN), AXA (AXAHY), SeaBright Holdings, Inc. (SBX) and Amerisafe Inc. (AMSF).

AMTRUST FIN SVC (AFSI): Free Stock Analysis Report

AMER INTL GRP (AIG): Free Stock Analysis Report

AMER SAFETY INS (ASI): Free Stock Analysis Report

CIGNA CORP (CI): Free Stock Analysis Report

CNO FINL GRP (CNO): Free Stock Analysis Report

DONEGAL GRP -A (DGICA): Free Stock Analysis Report

EASTERN INSURNC (EIHI): Free Stock Analysis Report

FIRST AMER FINL (FAF): Free Stock Analysis Report

FBL FINL GRP-A (FFG): Free Stock Analysis Report

HORACE MANN EDS (HMN): Free Stock Analysis Report

INVESTORS TITLE (ITIC): Free Stock Analysis Report

MOODYS CORP (MCO): Free Stock Analysis Report

MERCURY GENL CP (MCY): Free Stock Analysis Report

PROASSURANCE CP (PRA): Free Stock Analysis Report

RLI CORP (RLI): Free Stock Analysis Report

Zacks Investment Research

About vitalstocks

This is a sample profile field. Vitalstocks is the operating company for Stockbloghub. This will place the picture of the author or company in the profile. Here is another extra line of information.

Comments

Powered by Facebook Comments


Similar Posts: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Credit Services | Financial

RSS feeds: AFSI | AIG | American International Group Inc | American Safety Insurance Holdings Limited | Amerisafe Inc. | AMSF | Amtrust Financial Services Inc (NY) | ASI | CI | CIGNA Corporation | CNO | Conseco Inc. | Eastern Insurance Holdings Inc | EIHI | FAF | FBL Financial Group Inc. | FFG | First American Corporation | HMN | Horace Mann Educators Corporation | Investors Title Company | ITIC | MCO | MCY | Mercury General Corporation | Moody's Corporation | PRA | ProAssurance Corporation | RLI | RLI Corporation | SBX | SeaBright Insurance Holdings Inc | Credit Services | Financial |

Other Posts by | RSS Feed for this author