What Goes Into a 'Stable' Outlook for P&C?

Recent reports generally agree that the property and casualty industry outlook for 2014 is “stable,” with rate increases continuing, but moderating from the pace of the last two years.  

Ratings agency Moody's Investors Service recently gave the global P&C industry a stable outlook for next year. Fitch Ratings yesterday offered a similar assessment, giving a stable ratings outlook to both commercial and personal lines, and a stable sector outlook as well. 

Fitch says its ratings outlook reflects that “a large majority of ratings in Fitch's universe currently have stable rating outlooks, and over the next 12−18 months limited rating changes for individual issuers are anticipated.”

The sector outlook takes into account improved fundamentals in the industry, but also an expected peak in the market cycle. “Returns on capital are forecast at approximately 8.5% in 2013 and 7.4% in 2014, and are unlikely to improve further in the current hardening market phase to the double-digit levels achieved from 2004−2007 due to looming competitive pressures and the profit strain from low investment yields,” Fitch says.

Fitch's report provides insight into some of the key factors that point to a stable outlook for the P&C industry.

Demonstrated Aggregate Loss Reserve Strength 

Fitch notes that 2013 will be the eighth consecutive year of favorable calendar-year prior-period reserve development. The ratings agency notes that, aside from benefitting from conservative reserve levels in the 2003−2006 accident years, the prolonged low-interest rate/inflation environment “has also promoted stability in loss costs and reserve adequacy.”

Fitch expects the pace of favorable development to decline in 2014, and notes that some key segments, such as workers' compensation and commercial auto, have shown reserve weakness. Additionally, some companies such as Tower Group, Meadowbrook Insurance Group and QBE North America have reported recent adverse reserve development.

But Fitch says it continues to believe that the industry's overall loss reserve position is adequate.

Reinsurance Competition Benefits Primary Insurers

Fitch says ample traditional reinsurance underwriting capacity “is augmented by considerable growth in third-party capital and alternative vehicles such as catastrophe bonds and side cars.”

The ratings agency says insurance securitizations “have reached a critical-mass level” and are likely now a permanent fixture in the reinsurance market. 

Catastrophe bond issuance, Fitch notes, reached near-record levels of more than $6 billion through the first 11 months of 2013, with expected strong issuance during the final month of the year.

As a result, reinsurance pricing is projected to decline at 2014 renewals, says Fitch. 

Primary insurers, therefore, “will have a greater opportunity going forward to reduce the overall reinsurance spend, or optimize property reinsurance structures and add to top-layer coverage without ceding additional premium relative to prior years.”

Signs of Slower Premium Rate Increases 

Broad-based rate increases across nearly all segments for the last two years have represented “the most significant factor behind the turnaround in insurers' operating performance,” according to Fitch.

While the increases are expected to continue in primary insurance lines, Fitch notes there are signs that the pace is beginning to slow. The ratings agency points to the Council of Insurance Agents & Brokers' Quarterly Commercial Market Pricing survey, which indicates that rates across all segments were up 4.3% in the third quarter versus 5.2% in the previous quarter. 

For personal lines, Fitch says MarketScout's monthly barometer has hovered between 3% and 4% throughout 2013.

Fitch says it anticipates a more pronounced flattening in pricing to materialize in the second half of 2014.

Low Yields Restrict Investment Income

“Total reported statutory investment returns will be boosted by substantial unrealized investment gains from equity investments in 2013, barring unusual year-end market movement,” says Fitch. “Investment income from interest and dividend payments will decline modestly in 2013 as growth in investment assets is not offsetting reductions in portfolio yields.” 

Fitch says investment contributions to earnings will continue to be pressured as Federal Reserve monetary policy “remains expansionary and supportive of lower rates.”

Uncertainty of Terrorism Reinsurance Program Renewal

The Terrorism Risk Insurance Act (TRIA) is set to expire at the end of next year, and Congress is hearing from all sides about whether to renew the program, allow it to sunset or renew it with major alterations.  

Over the last decade, says Fitch, commercial-property insurers have enhanced their ability to measure and model exposure to terrorism events, with net exposures managed through the availability of large reinsurance limits through TRIA. 

Withdrawal of the program without readily available substitute coverage “will likely move insurers to exclude terrorism from property coverage to manage risk aggregations in urban centers deemed at greater risk of terrorist events,” Fitch notes.

The ratings agency adds, “Regulatory requirements in most states do not allow insurers to exclude terrorism coverage from workers' compensation policies. Without a program similar to [TRIA], insurers may choose to withdraw workers' compensation underwriting capacity from urban markets to manage risk concentrations.”

Catastrophe Losses Below Historical Norm

While cat losses were below historical norms in 2013, Fitch stresses that the “modest respite…does not diminish perspectives on the potential risks of natural disasters as population and property exposures in coastal areas and earthquake prone regions continue to expand.”

Fitch notes that losses from hail storms, tornadoes and forest fires were still substantial in 2013, but hurricane season was far less eventful, with just 13 named Atlantic storms, two hurricanes and no major hurricanes. According to the National Oceanic and Atmospheric Administration (NOAA), this was the least active hurricane season since 1982.

Outlook Sensitivities

While Fitch gives a stable outlook to the industry, it points out the following potential factors that could change that outlook to negative:  

• “A Sequence of Adverse Events: While an unforeseeable large loss event could sharply reduce the industry's capital position, at current capitalization and leverage levels, it would likely require a series of adverse events to unfavorably shift capital levels to a magnitude that would promote a change to a negative rating outlook.
• “Volatility from Catastrophic Events: Exposure to insured losses from natural catastrophes remains the largest source of underwriting volatility for property/casualty insurers. Projected modeled losses from tail events, such as a Category 4 Miami hurricane or New Madrid earthquake would sharply affect capital for a wide number of insurers and reinsurers and provoke other unforeseeable potential market disruption.
• “Sharp Loss Cost Trend Shift: Low inflation and more muted economic growth have promoted greater stability in loss cost trends and continued reserve strength. An interest rate/inflation shock would not only affect asset values, but also claims costs. Unanticipated sharp changes in general inflation or major loss cost components such as medical expenditures, litigation settlements or commodity prices, would potentially foster an extended period of insurance underpricing and reserve deficiencies, particularly in longer tail business segments.”