The deteriorating U.S. economy – with its waves of layoffs, dislocations in the credit and equity markets, and falling home prices – will present a challenge in 2009 for almost every domestic business sector, and insurance is no exception, according to Standard & Poor’s Ratings Services.
A recently published S&P report, “For North American Insurers, Strong Risk Management And Capital Adequacy Are Key Defenses Against Recession,” says that insurers have always needed to be mindful of their capital-management strategies, the pricing of their products, and risks in the equity and credit markets that can affect their business profiles, portfolios, profits, and ultimately, ratings. But it points out this is even truer in a recession, when missteps that might have only minor repercussions in sunnier times could now have harsher consequences.
The report is one of several outlook articles the ratings agency has published on the insurance sector. Reports of interest to the property/casualty insurance industry include: “2009 U.S. Personal Lines Outlook: Stormy Skies Aren’t The Only Worry” and “2009 U.S. Commercial Lines Outlook: Catastrophe And Investment Losses Could Lead To A Less Competitive Market,” both published between Dec. 10 and 12.
S&P notes in its report on North American insurers that in 2008 its outlook on several U.S. insurance sectors was revised to negative, meaning that over the next year to 18 months, more downgrades than upgrades are anticipated. Balance-sheet strength will likely erode for many insurers, while others will be affected by weak pricing or suffer losses from listing credit and equity markets. While 2009 will likely be a challenging year, S&P believes that strengths remain. Among the most notable are capital adequacy, which has remained relatively strong for the most part, and a better understanding of enterprise-wide risk.
S&P also believes that strong enterprise risk management (ERM) is increasingly critical to assessing the credit quality of North American insurance companies. The insurers that that can best identify, aggregate, and control their liquidity, credit and market risks during this economic downturn will be most able to manage their capital needs efficiently and incur the least erosion to their creditworthiness.
Personal Lines: Downgrades for 2009
Based on the likelihood of sector-wide weaker operating performance, S&P said it revised its outlook on the U.S. personal lines insurance sector, which includes automobile and homeowners’ coverage, to negative from stable.
Significant catastrophe losses of 2008 combined with lower investment income, sizable asset and investment losses brought on by general credit and equity market deterioration, reduced financial flexibility resulting from limited access to the capital markets, and recessionary fears, which potentially affect growth and earnings prospects, triggered the lowered outlook the ratings agency said.
S&P believes in the next 12 to 18 months, the number of personal lines companies with negative outlooks should increase, and downgrades should exceed upgrades in 2009. At this time, downgrades are expected to be only one or two notches (e.g., from ‘A’ to ‘A-‘ or ‘BBB+’).
S&P said it expects the current economic slowdown to continue through 2009, extending the challenging operating environment faced by insurers. “Errors in strategic judgment and execution of business fundamentals could hurt some insurers and their ratings, having a greater impact on the bottom line than when growth was high and operating margins were more robust,” S&P said.
It noted it had not revised the outlook for the U.S. personal lines insurance sector since May 2002, when the outlook was moved to stable from negative, where it had been since July 2001.
Commercial Lines Challenged Too
Commercial lines won’t fare much better than the personal lines sector in 2009, according to S&P. The ratings agency says ongoing price declines for commercial lines, substantial second-half catastrophe losses incurred as a result of such events as hurricanes Gustav and Ike and the wildfires in California, decreased investment income, and very substantial increases in unrealized capital losses added up to make for tough going in 2008.
Reflecting its belief that things aren’t going to get much better anytime soon, S&P is maintaining its negative outlook for the U.S. commercial lines P/C sector into the coming year.
While year-to-date ratings changes in commercial lines have been split evenly between upgrades and downgrades, S&P expects that in the next 12 to 18 months ratings downgrades will exceed upgrades in this sector.
“Our primary concern is the rapid deterioration in underwriting profitability that we have seen in 2008” S&P said in its report. S&P noted that by August of this year “prices had fallen to the point at which we believed that the sector’s favorable underwriting results of the past three years would turn into underwriting losses by 2009. The substantial hurricane-related catastrophe losses experienced in the third quarter have accelerated this timetable, and it now appears likely that the industry will record an underwriting loss for 2008.”
S&P also noted that “realized and unrealized capital losses on equity and fixed-income investments since the beginning of 2008 have significantly reduced the statutory capital and the capital adequacy of most insurers, in some cases to a level that is below the current rating. Though we believe capital adequacy currently remains at an appropriate level for most of the insurers we rate, further declines in asset values could weaken the capitalization of some companies enough to warrant a reduction in their ratings.”
The ratings agency said there is a “possibility of a silver lining.” It said current challenges may spur a “halt to the deterioration in commercial lines pricing. The public surveys of commercial lines pricing showed a slight moderation of price declines in the third quarter, and there is anecdotal evidence that this has continued in the fourth quarter.”
S&P said while that news is encouraging, it believes “it is too early to call a turn in the commercial-lines underwriting cycle.”
The reports are available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor’s credit ratings, research, and risk analysis, at www.ratingsdirect.com.
Source: Standard & Poor’s, www.standardandpoors.com