In its release, A.M. Best said it’s also looking at the effect of a U.S. sovereign downgrade on the portfolios and financial strength of U.S. insurance companies.
“Continuing economic weakness in certain European countries and the debt crisis in the United States, which remains unresolved, have elevated the risk profile of life insurers,” A.M. Best said in the release, noting that it may revise its rating outlook for the U.S. life and annuity insurance sector to negative, from stable.
A.M. Best did say that some companies’ risk-adjusted capital positions are more affected in its stress tests — stress tests that examine each company’s risk management, business profile, liquidity position, earnings capacity, and other company specific characteristics. But in the main it found the following:
• Although the isolated event of a sovereign downgrade would not, on its own, have a significant impact on the financial-strength ratings of insurance companies with adequate liquidity, the impact on risk-based capitalization is real and must be addressed, particularly by life-insurance companies.
• The life-insurance industry is clearly more adversely impacted than the property and casualty (P&C) industry because of its exposure to investment risk through higher asset leverage. In addition to the larger impact to the life industry in this stress test, there are other significant issues the life industry would face (disintermediation, liquidity, etc.).
• Within the property-and-casualty and life industries, the impact of the stress test was not vastly different across company size and business line, but the impact did differ on a company-by-company basis. Those P&C companies that have large exposure to declines in the market value of bonds due to an increase in interest rates, and that also may need to realize the loss due to liquidity needs, could have ratings affected. The main concern in those cases is that the impact of that change on adjusted surplus causes capitalization to fall too low, and the company would be unable to meet liquidity needs in its operations or inflation-led impacts of loss costs.
To be fair, A.M. Best said many insurance companies have taken proactive steps to improve their capital positions, de-risk their product portfolios and position themselves for future growth.
“Overall capital positions are more robust and earnings trends have been more stable of late,” the company said in its release. “While substantial unrealized loss positions in general account investment portfolios have recovered to a positive gain position, the change in the sovereign credit quality is increasing the industry’s overall investment risk.”
Which insurers are at risk?
Ultimately, Best’s findings are a bit of a tease, prompting more questions: Which insurers are most at risk? Which are not? And, which insurers are worth buying, holding or selling? So we did some poking around.
At the moment, the only insurers ranked as strong buys (five stars) by S&P Equity Research are Prudential Financial Inc. and The Travelers Companies Inc.
According to S&P, Prudential has a stable of high-growth businesses that are positioned to gain market share. Plus, Prudential has “superior” financial flexibility and its earnings and return on equity are growing at a faster clip than that of its peers. What’s more, S&P said Prudential likely will resume buying back shares given its excess capital
S&P is looking for Prudential to hit $75 over the next 12 months, and the only risks in sight to its recommendation and target price, at least as of July 15, were these: currency risk; reserving risks for new guaranteed minimum benefits; acquisition integration risks; credit risk; equity market declines; and a prolonged period of low interest rates.
As for Travelers, Standard & Poor’s said the P&C firm has taken steps in recent years to improve its underwriting results and to take advantage of what’s viewed as a flight to quality within the property-casualty insurance market.
S&P called Travelers a prudent underwriter with an above-average quality balance sheet. S&P is looking for Travelers to hit $72 over the next 12 months. S&P did note, however, that the risks to its recommendation and target price include the following: The company may have to add to loss reserves for certain “long tail” liability lines of coverage, and there could be an erosion in underwriting trends, a surge in catastrophe losses, and an erosion in the credit quality of Traveler’s investment portfolio.
Caveat emptor
As for insurers to avoid because of the sovereign debt crisis or for other reasons, just a couple sink to the bottom. There’s Genworth Financial Inc. GNW -3.02% , which just announced that it expects to report an estimated net loss of $92 million to $112 million, and which Zacks Investment Research just downgraded to underperform. To be fair, the downgrade had more to do with its mortgage insurance business being under pressure. Zacks sees Genworth hitting $8.75.
And, it would be hard not to kick around American International Group Inc. AIG -0.61% . Zacks this week downgraded its recommendation on AIG to “neutral” from “outperform” over the long term and a strong sell over the short term, saying consistent weakness in its Chartis business is weighing heavily on the company’s financials.
As for the future, A.M. Best said the challenges faced by life- and annuity-insurance companies are well known. There’s global sovereign uncertainty; increased equity market volatility; ongoing weakness in the real-estate market; and lingering unemployment and weak consumer confidence. What’s not so well known is the duration of these challenges.
“The continued economic fragility will constrain life insurers’ ability to increase revenues and earnings,” the A.M. Best report said. “Clearly, raising the U.S. government debt ceiling would alleviate near-term concerns of default on the highest rated government securities and the potential fallout of such an unprecedented event. However, A.M. Best believes the raising of the debt ceiling on its own will not achieve long-term fiscal stability.”