The U.S. insurance industry entered 2013 facing the ravages of Hurricane Sandy, which resulted in billions of insured losses. Though insurers were better prepared to withstand significant losses this time, the after-effect of the 2012 hurricane season was much more than expected.
The impediments related to the Superstorm Sandy aside, the industry continues to reel under economic unrest that thwarts every attempt it makes toward growth. A dearth of positive catalysts is naturally making it harder for insurers to recover fast. Among the fundamental challenges, weak underwriting gains and low investment yields stand out.
The events outside the country such as the European debt crisis will further limit the industry’s growth prospects.
However, stepping into 2013, it can be said that the overall health of the industry has shown some improvement in the recent past, after enduring pricing pressures and reduced insured exposure for quite some time. The market turmoil resulting from the latest recession forced many companies to take immense write-downs, but such an outcome is gradually becoming a thing of the past.
Lately, the industry has been witnessing pricing increases which should ultimately translate into margin expansion. Further, increasing awareness on the risk of catastrophe, strong underwriting discipline, on-track price and volume growth as well as favorable reserve development in the recent quarters should place the industry at least one step ahead.
That said, though the market condition doesn’t remain soft anymore, reasonable hardening is not expected at least until the end of 2013. Moreover, a stressed balance sheet, a still-high unemployment rate and legislative challenges are threatening insurers’ ability to rebound to the historical growth rate.
Also, structural economies of scale and the new capital requirements have pushed the industry toward consolidation. While this will help insurers meet minimum regulatory requirements and enhance awareness, inter-segment competition within the industry will alleviate. So, maintaining profitability after complying and meeting the challenges of climate change could be a difficult task.
A reduction in underwriting expenses and a modest increase in premiums have been helping life insurers increase net income in the last few quarters. But downward pressures on investment yields, higher hedging costs, lower income from the variable annuity business and more burdensome capital requirements will continue to mar profitability going forward. Most life insurers have substantial exposure to commercial real estate-backed loans and securities, which will lead to further losses in the coming quarters.
As the industry’s statutory capital level fell sharply during the recession, life insurance companies will need to optimize their capital levels to address the ensuing challenges. In the short term, traditional sources of capital are expected to fulfill most of what life insurers need in order to stay in good shape. However, non-traditional sources of capital will take years to strengthen financials.
Moreover, regulatory changes under the Dodd-Frank Wall Street Reform are still troubling life insurers. In order to address such concerns, life insurers may have to burn some of their financial energy.
The underlying trends amid a recovering economy indicate stability in the sector over the medium term with respect to credit profile and financial prospects. However, higher-than-average asset losses, primarily resulting from their real estate exposure, will remain a major concern.
The economic uncertainty is making it difficult for life insurers to expand their customer base. In fact, insurers are struggling to even 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.
Moreover, the low interest rate environment is one of the major risks for life insurers at this point. Investment income remains weak as life insurers are experiencing low returns on fixed-income instruments. Also, low rates are spoiling life insurers’ efforts to grow fixed annuities and universal life insurance sales.
In December, Fitch Ratings has affirmed the credit outlook for the U.S. life insurance industry at stable for 2013. This action was primarily based on the expectation of insurers’ improved liquidity and balance sheet strength. Further, the rating agency expects the nagging low interest rate environment to restrict earnings growth of the sector.
On the other hand, interest in cheaper products to cover only basic risks has increased. As a result some life insurers have already gone back to the basics in order to escape financial and regulatory difficulties.
Currently, the life insurers with favorable Zacks Ranks worth considering are Aviva plc (AV) with a Zacks Rank #1 (Strong Buy); Genworth Financial Inc. (GNW) and ING Groep NV (ING) with Zacks Rank #2 (Buy).
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 the U.S. citizens are covered under private health insurers such as WellPoint Inc. (WLP) and UnitedHealth Group, Inc. (UNH).
Unfortunately, these insurance companies utilize a pre-existing condition exemption clause to control costs and maximize profits. In 2010, the historic healthcare reform legislation — The Patient Protection and Affordable Care Act (PPACA) — was passed by the Congress with the intension of making health care facilities more affordable, preventing private insurance companies from continuing with the pre-existing condition clause and at the same time bringing in 32 million more people under coverage by 2019.
However, the legislation has had many detractors who contested several of its stated benefits and considered it another entitlement program that the country can ill afford. Finally, in June 2012, the U.S. Supreme Court ruled in favor of the reform, rejuvenating the industry by removing major uncertainties. Obama’s re-election further ensures a certain future to the law.
With respect to the individual mandate, which drew the most attention as it requires all uninsured Americans to purchase a minimum level of health insurance coverage, the Supreme Court ruled that individuals failing to buy health insurance will have to pay a tax fine, but forcing them to buy insurance will be illegal. Employers will also be fined if they fail to provide insurance coverage to their workers.
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 over 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 adding the extra 32 million people into the system.
Consequently, growth in industry revenue is expected to decline until 2015 as insurers will be forced to adjust the benefits 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 lines at stake.
Property & Casualty Insurers
Property-casualty insurers are still feeling the pressure on their investment portfolios due to the prevailing low interest rate environment. This, along with the inability to raise rates, has been continuously reducing the capital adequacy of most carriers.
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. The seizure of credit markets and rising concerns over defaults have pushed down bond prices sharply since the latest recession, causing significant realized and unrealized capital losses on these insurers’ portfolios. However, an expected improvement in casualty rates will partially offset the negatives.
Moreover, catastrophe losses continue to keep the balance sheets of a number of carriers under pressure. This, combined with stiff competition and lower reinvestment yields, is expected to depress profits for property-casualty insurers going forward.
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. This declining trend in premium rates is expected to persist through 2013, adversely affecting insurer profitability. The key positive trend visible as of now is a slight improvement in some insurance pricing after persistent deterioration for the last three years.
However, the property-casualty industry endured the latest financial crisis better than the other financial service sectors. Once the economic recovery gains momentum, insurance volume will grow rapidly. With growing employment in the private sector and recovery in the housing markets, a number of carriers have already started seeing growth in insurance sales.
The recent quarters have been increasingly witnessing a rebound in claims-paying capacity (as measured by policyholders’ surpluses), which reflects the industry’s resilience over the prior years. Conservative investment strategies and capital restructuring efforts will continue to help property-casualty insurers improve their financial footing in the upcoming quarters.
Losses from the investment portfolios of reinsurance companies have gotten worse during the last few quarters. The deterioration resulted from the supply-demand imbalance in reinsurance coverage due to intense competition that kept pricing soft. Also, catastrophic events were the major culprits that put underwriting profits under pressure.
However, reinsurers have been seeing capital growth over the last few quarters and this trend is expected to continue. Despite the losses from Sandy, the capital generation, though slowed down, is not clogged. Actually, reinsurers now have the capacity to meet the demand for coverage and keep loss ratios within their budgets despite catastrophe losses. In addition, reinsurance prices have also been gradually increasing.
With signs of recovery in the capital markets (though still weak by any standard), concerns related to reinsurers’ ability to access capital markets on reasonable terms have sufficiently eased.
However, excess supply due to the lack of coverage expansion and rising expense ratios is the major concern for reinsurers at this point. An increased level of price competition may also hurt top lines in the upcoming quarters.
Moreover, reinsurance market capital levels are expected to be down for reinsurers with huge exposure to the European sovereign debt crisis.
Insurance companies are suffering from the ongoing economic uncertainty and challenges related to natural disasters. However, this tough period brings opportunities for many large industry participants to grow by attracting new customers and taking market share away from weak rivals. The industry has been undertaking several structural changes that will make underwriting and pricing schemes even more attractive to consumers.
Recently, Hurricane Sandy, which affected portions of the Caribbean and the Mid-Atlantic and Northeastern United States, will increase the demand for primary non-life insurance and reinsurance.
We remain positive on Selective Insurance Group Inc. (SIGI), Hallmark Financial Services Inc. (HALL), Stewart Information Services Corporation (STC), Ageas SA/NV (AGESY) and CNO Financial Group Inc. (CNO) with a Zacks Rank #1 (Strong Buy).
Other insurers that we like with a Zacks Rank #2 (Buy) include AmTrust Financial Services Inc. (AFSI), Berkshire Hathaway Inc. (BRK.A), PartnerRe Ltd. (PRE), The Travelers Companies, Inc. (TRV), Manulife Financial Corporation (MFC), Lincoln National Corporation (LNC), Employers Holdings, Inc. (EIG), FBL Financial Group Inc. (FFG), Fortegra Financial Corporation (FRF) and Prudential plc (PUK).
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 many property-casualty insurers. Moreover, the overall industry is vulnerable to the ever-increasing threat of natural disasters.
Among the Zacks covered U.S. insurers, we prefer to stay away from the Zacks Rank #5 (Strong Sell) companies –– American Safety Insurance Holdings Ltd. (ASI), Greenlight Capital Re Ltd. (GLRE), China Life Insurance Co. Ltd. (LFC), Kemper Corporation (KMPR), Meadowbrook Insurance Group Inc. (MIG), MetLife Inc. (MET) and Principal Financial Group Inc. (PFG).
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