Posted on 25 Aug 2010
A soft market coupled with a weak economy made for less than stellar results for the nation's property/casualty insurers overall, and mid-year 2010 financials reflect a necessary boos from the industry's reserve releases, say analysts.
The analysts go on to say that prospects for the industry aren't likely to begin firing on all cylinders until and unless the U.S. economy does so as well.
Ten major insurers that release their quarterly results reported $4.9 billion in net income for the first half. This compares with $177 million in net income for 2009's first half, when the results reflected American International Group Inc.'s $2.53 billion loss and Hartford Financial Services Group Inc.'s $1.22 billion loss.
Net premiums written for the 10 insurers increased 0.6% to $65.95 billion. The group posted a 98.1% combined ratio for the first half vs. 94.7% for the same period in 2009.
“Results are still fairly good,” said Andrew Colannino, vp with Oldwick, N.J.-based A.M. Best Co. Inc., although the combined ratios are starting to increase gradually because of market conditions. Capitalization is “still pretty strong for the industry, but there are head winds with the economic conditions in terms of top-line growth,” he said.
“We're seeing the soft market even more entrenched,” said James Auden, an analyst with Fitch Ratings in Chicago. “Pricing in commercial lines is still declining in most areas and you're seeing earned premium declines year to year for many companies, so that's a challenge right there.”
Observers say reserve releases were a major factor in insurers' first-half results.
Paul Bauer, New York-based vp and senior credit officer at Moody's Investors Service, said reserve releases “continue to be surprisingly high. At some point, we would expect reserve releases to decline, but that's continued to provide a strong boost to earnings.” Moody's overall opinion of reserve adequacy is that it is “probably break-even to a slightly redundant level,” he said.
“The overarching theme from those reserve releases is simply that inflation has stayed so low...that the assumptions that went into reserves established a couple of years ago are proving to be too conservative, because most companies had some expectation for some inflation. It just didn't happen last year,” said Paul Newsome, analyst with Sandler O'Neill & Partners L.P. in Chicago.
In some cases, however, reserve releases are a “bit optimistic, because we do see deterioration in reserve adequacy,” said Best's Mr. Colannino.
“I think we're getting to the point that the bucket can no longer be tapped” for additional reserve releases, said Amit Kumar, vp with Macquarie Securities Group in New York. “If you see companies continuing to maintain or increase the pace of reserve releases, in my mind that would be a question mark on these companies.”
At the same time, observers say property/ casualty insurance rates continue to soften.
“Things seem like they are getting worse, not better,” said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York.
“There's no catalyst at this point other than just continued earnings weakness, so it looks like (firming insurance pricing is) something that won't happen for at least a few more quarters, barring some sort of event,” Moody's Mr. Bauer said.
“From a stock-specific standpoint, the extent to which companies can execute a strategy in this soft market is going to bifurcate the industry in terms of the winners and the losers,” said Cathy Seifert, an equities analyst with Standard & Poor's Corp. in New York. The winners will “continue doing what they are doing, which is basically hold the line on pricing, employ some active capital management and make sure the balance sheet is in order,” she said.
“There's not much you can do, quite frankly,” she said.
Stewart Johnson, a portfolio manager with Stamford, Conn.-based Philo Smith & Co., said, “It's pretty obvious that the economy seems to be the root of the problem, meaning with a slowdown in the economy, there's less demand for commercial insurance and we haven't had any reduction in the supply for the insurance.”
With reduced demand and a stable supply, prices decline, Mr. Johnson said.
Mr. Kumar pointed to a recent warning from the Federal Reserve that the pace of the U.S. economic recovery has slowed. “Economic improvement is needed for any improvement in premiums for the commercial lines players; and with that not happening, unless there is a big event in the industry, there really is no compelling reason for rates to change going forward,” he said.
The outlook is for “more of the same,” said Mr. Newsome. Companies are “grinding their way through the soft market. The better companies will be as selective as they can be in writing business, and it'll be awhile before we see which companies really knew what they were doing and which didn't from an underwriting perspective. But it's not a terribly bright outlook for the commercial insurers at the moment.”
Meanwhile, S&P credit analyst John Iten noted that asbestos and environmental losses are making a comeback in insurers' financial statements. He cited last month's announcement by Fireman's Fund Insurance Co. that it was adding $301 million to its asbestos and environmental reserves and CNA Financial Corp.'s agreement to cede $1.6 billion in asbestos and environmental liabilities to Berkshire Hathaway Inc. (BI, July 19).
“It seems like asbestos will be an issue affecting results for at least some insurers this year,” Mr. Iten said.
In addition, insurers remain active in buying back their stocks. “They have no place to grow, must put capital somewhere, so they're returning it to shareholders,” said Mr. Gallant.
Stock buybacks are “a good use of excess capital,” said Mr. Kumar. “It's a fairly easy soft-market strategy if you are a company which has no real organic catalyst for top-line growth.”
Another way to dispose of excess capital is mergers and acquisitions.
“An ongoing soft market will lead to more M&A activity,” said Mr. Johnson. “Without business to write, capital is being accumulated, which lowers (returns on equity) and eventually, if your ROE gets low enough—at least for publicly traded companies—shareholders are going to become disgruntled and unhappy, and sometimes the demand for change includes being bought by someone.”
“While there's a willingness on the part of potential buyers” to fund acquisitions because of their fairly healthy capital position, “it's difficult to have boards approve an acquisition” of their firms with stocks trading below their book value, Mr. Bauer said. “And for some of the acquiring companies, the fact that their own stock values are somewhat depressed makes it hard to use their own stock” for an acquisition.