Posted on 22 Apr 2009
Standard & Poor's (S&P) reported in its recent study that property/casualty (P/C) insurers trying to keep adequate capital levels will face a tough challenge continuing past this year.
S&P reported that while most in the P/C sector should be sufficiently capitalized for their rating, further declines in equity and credit markets could adversely affect capitalization and accelerate the erosion of insurer financial strength.
The study, “Property And Casualty Insurance Capitalization: The Pressure Is On," sees a “tough 2009 and beyond,” while acknowledging that P/C insurers have been “somewhat more resilient” than other industries with respect to maintaining strong overall capital positions.
S&P pointed to the current pricing cycle as an example. Many product lines, the report stated, have seen only modest rate increases of late, "not a change that suggests a complete re-pricing of risk or efforts to recoup significant balance sheet losses through higher prices.”
However, investment volatility over time could take its toll on P/C capitalization, said S&P. The report stated that while most P/C insurers' investment holdings are high-quality, some firms have exposed their investment portfolios to counterparty risk concentrations as well as to lower-rated investments in pursuit of improving overall yield.
S&P also said the recession is forecast to be the deepest and longest since the Great Depression, “and we believe that any P/C insurance company with significant credit risk or equity concentrations in its capital structure will likely be strained.”
“Although at this time we do not expect the prevailing negative macroeconomic conditions to impair the long-term financial strength of the insurance industry,” the report said, “there will likely be short-term stresses at both operating and holding companies.”
S&P added that commercial mortgage and real estate markets could face problems if negative economic trends extend beyond residential real estate. Commercial mortgage portfolios have held up very well for insurers in recent years, but the report noted an increase in delinquencies is expected for 2009.
Speaking to the consequences of possible capitalization problems, the report said, “Declines from historically high levels of capitalization could expose insurers to potentially inadequate capitalization for their ratings when their ability to fund accelerating capital needs weakens as a result of lower earnings, a higher cost of capital and increasingly reluctant capital markets.”
Damien Magarelli, S&P credit analyst, said in a statement, “The potential impact on P/C insurers' capital adequacy is due to three distinct areas: investment-related volatility, decline in time value of money credit due to the drop in interest rates, and the potential for adverse prior years' reserve development.”
He added that “P/C insurers, especially those with significant business concentration in long-tail liability lines, will likely face increasing challenges to maintain adequate loss reserve margins as the tough business and economic environment continues to influence their operating profitability.”
S&P said it is monitoring the impact of investment portfolio exposures on insurers’ capitalization, noting that, so far, “companies have largely been able to manage these risks.”