With economic, interest-rate and competitive challenges expected to persist through 2013, the title of Conning Research and Consulting's latest report aptly sums up the firm's recipe for insurance-industry success in a year marked by numerous headwinds: “Nothing to Be Gained by Waiting for Things to Get Better.”

The report's theme is reinforced perhaps most clearly when Conning discusses the investment landscape for insurers. “Continued low interest rates will drive investment yields and investment income lower. Companies will be increasingly compelled to find a way to move forward, no longer willing or able to wait for an improving interest rate environment,” the report states.

Conning adds, “We believe many companies had been planning on some reversion of interest rates to higher levels, which perhaps has led to some inertia. This inertia is reinforced by conservative investment policies and customary rules of thumb that limit significant change. With the Federal Reserve now pegging its securities purchasing activity to the unemployment rate and GDP growth, interest rates could remain low even longer than previously expected.”

In the report, fully titled “U.S. and Global Insurance Industry Outlook 2013, Economic, Capital Markets, and Regulatory Challenges Continue: Nothing to Be Gained by Waiting for Things to Get Better,” Conning questions if this new reality will drive changes in insurers' investment portfolios, but the firm notes that so far there have been “relatively few significant actions.” Conning adds, “We do expect this topic to be front and center for many insurer boards and managements this year.”

Conning credits Allstate with taking “one of the bolder actions” on this front. In December 2012, the insurer indicated a change in its investment strategy, putting greater emphasis on hard-asset and infrastructure investments and a greater allocation to public and private equities.

“[Allstate] also highlighted its views of the risks in the bond market, and as a result Allstate expects it will harvest a portion of its unrealized gains and expects longer-term bonds to become a smaller portion of its investment portfolio,” Conning states.

But the idea of adapting to a changing landscape is not confined to investments. The Conning report also discusses how insurers are responding to increased catastrophes.

Cat-loss experience since 2004 has averaged around $24 billion per year, or 5.4 points on the loss ratio, Conning says, noting that this is “much higher than the average of the preceding 10 years.” Both 2011 and 2012 saw cat losses that were more than 50 percent higher than the long-term average, the firm adds.

“For insurers, the magnitude of losses has been less at issue than the type of loss and where they have occurred,” says Conning. The firm says high losses in the Gulf of Mexico in 2004 and 2005 drove insurers to shift exposures to the Midwest, only to see two of the highest years ever for U.S. tornado loses in 2008 and 2011.

“In 2013, we expect the industry will experience a repricing of Midwest property exposures, at both the primary and the reinsurance levels,” says Conning.

The report adds, “Volatility seems to be the new normal for most property insurers. Adding to the uncertainty has been political reactions, as governors and state-insurance departments were quick to weigh in on the non-applicability of hurricane deductibles immediately following Sandy.”

Structural change also appears likely for reinsurers, says Conning, as capital-market alternatives challenge the traditional reinsurance model. “Many investors seeking higher returns than available in the bond or equity markets have found the ILS [insurance-linked securities] market to be a viable uncorrelated asset class with attractive historical returns,” says the report, adding that with demand from investor capital exceeding the supply of alternative-reinsurance products, downward pressure on reinsurance rates could result.

Reinsurers have responded by becoming active cat-bond issuers, and also by forming affiliations with ILS funds, “creating their own internal ILS capabilities, and raising third-party capital in sidecar vehicles.”

Conning says, “It is clear that many reinsurers are determining how best to provide risk-transfer solutions to their clients while at the same time not losing business to the ILS market. This convergence of reinsurance and capital markets will continue to play out, although returns for reinsurers and ILS investors are likely to suffer.”

For the P&C sector in general, Conning describes the landscape as constrained, if gradually improving. “Our overall outlook for the [P&C] industry is for moderate premium growth and modest underwriting losses for 2013 and 2014, assuming a 'normal' level of catastrophe loss activity,” the report says.

Conning expects the recent trend of rate firming to be constrained by the industry's strong surplus position. “Companies are not yet abandoning marginal business, hoping instead to hang on until conditions improve,” Conning says, in an observation that appears to go against the general theme and title of the report.

Special Reports /

Report: Insurers Must Adapt to Changing Landscape, Not Wait for Improvement

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