The U.S. insurance industry continues to move forward with
consistent improvement in earnings and decelerating combined ratios
from most of the primary insurers in the first half of 2013. The
expectations for the upcoming quarters also signal optimism. The
key driver of this betterment is the improvement in premium rates
for over a year, after prolonged softness. Further, favorable
reserve development and lower catastrophe losses helped insurers
show their potency.
The sector seems to be reaching a favorable pricing cycle and its
near-term outlook for pricing power remains upbeat in the wake of
rising demand from economically recovering American households. But
a dearth of positive catalysts is delaying the recovery process of
the insurers. Among the fundamental challenges, weak underwriting
gains and low investment yields stand out.
Catastrophe losses further add to the concerns. Though the industry
has not witnessed any severe weather disruption as of now, it is
braving the peak of the hurricane season (mid-August to late
October). So, any active storm as severe as last year's Superstorm
Sandy could cause widespread damage and result in billions of
insured losses. Notably, insured property losses due to Sandy were
much higher than the average over the last decade.
Though insurers are preparing themselves better to withstand
significant losses, the increased probability of a natural
catastrophe will continue to raise concerns. Some analysts expect
catastrophic losses to double every 10 years and the pace of
capacity buildup by the insurers to be insufficient to withstand
the resulting insured losses.
Moreover, the events outside the country -- such as continued debt
crisis in the Eurozone and financial issues in emerging markets --
will further limit the industry's growth prospects.
However, the overall health of the industry has improved somewhat
in the recent past riding on the ongoing economic recovery, after
enduring pricing pressures and reduced insured exposure since the
latest recession. Moreover, learning from past experiences,
insurers are resorting to expense saving measures to support
Rising premium rates should ultimately translate into margin
expansion and mitigate the negative impact of the still low
interest rate environment on insurers' investment income. Further,
increasing awareness on the risk of catastrophe, strong
underwriting discipline and favorable reserve development in the
recent quarters should place the industry at least one step ahead.
That said, though the market condition doesn't remain soft anymore,
reasonable hardening is not expected at least until the end of
2013. Moreover, a stressed balance sheet, lack of real employment
growth and legislative challenges are threatening insurers' ability
to rebound to the historical growth rate.
Also, limited organic growth opportunities and strict regulatory
capital requirements will push the industry more toward
consolidation. Insurers are seeking structural economies of scale
through mergers and acquisitions to enhance market share. While
this will help insurers stay afloat, inter-segment competition will
alleviate. So increasing profitability after complying with
regulatory requirements and coping with the challenges of
increasing catastrophic losses could prove difficult.
Zacks Industry Rank
Within the Zacks Industry classification, insurers are broadly
grouped in the Finance sector (one of 16 Zacks sectors) and are
further sub-divided into five industries at the expanded level:
Insurance - Accident & Health, Insurance - Brokers, Insurance -
Life, Insurance - Multiline and Insurance - Property &
Casualty. The level of sensitivity and exposure to different stages
of the economic cycle vary for each industry.
We rank all the 260-plus industries in the 16 Zacks sectors based
on the earnings outlook and fundamental strength of the constituent
companies in each industry. To learn more visit:
About Zacks Industry Rank
As a guideline, the outlook for industries with Zacks Industry Rank
of #88 and lower is 'Positive,' between #89 and #176 is 'Neutral'
and #177 and higher is 'Negative.'
The Zacks Industry Rank for Insurance - Accident & Health is
#22, Insurance - Multiline is #41, Insurance - Life is #65,
Insurance - Property & Casualty is #86 and Insurance - Brokers
is #180. Looking at the Zacks Industry Rank of the five insurance
industries, it can be safely said that the near-term outlook for
the group is 'Positive.'
Earnings Trend of the Sector
The broader Finance sector, of which the insurance industry is
part, remains in excellent shape with respect to earnings. Full
100% of the sector participants have reported second-quarter
results, which have been strong in terms of both beat ratios
(percentage of companies coming out with positive surprises) and
Both earnings and revenue beat ratios were pretty robust at 76.9%
and 61.5%, respectively. Also, total earnings for the companies
have shown an impressive 30.0% year-over-year increase on 8.5%
growth in revenues. This compares with a substantially lower
earnings improvement of 7.6% on 5.6% growth in revenues in the
first quarter of 2013.
The consensus earnings expectations for the rest of the year also
depict a fairly strong trend. Though earnings growth is expected to
slow down to 7.4% in the third quarter, a stupendous improvement of
28.6% is expected in the fourth quarter. Overall, the sector is
expected to register full-year growth of 16.9%.
For a detailed look at the earnings outlook for this sector and
others, please read our weekly
A reduction in underwriting expenses and a modest increase in
premiums have been helping life insurers increase net income in the
last few quarters. But downward pressure on investment yields due
to higher hedging costs, lower income from the variable annuity
business and more burdensome capital requirements will continue to
mar profitability going forward.
Moreover, life insurers have struggled with low interest rates
for years now as they primarily invest in long-term interest
earnings assets which were not able to generate sufficient returns
to match up their future commitments related to the policies sold
to various individuals.
However, the recent rise in the U.S. Treasury yields is expected to
change the fate of life insurers. Long-term bond yields finally
started rising since the middle of the year, after staying low for
a long stretch. As a result, cash flows of life insurers will be
invested at higher yields, leading to higher returns and increased
profit margins. Moreover, with rising rates, reinvestment risk will
On the other hand, until the rising trend of interest rates becomes
prominent with the continuation of the same for a few quarters,
life insurers will have to continue to seek alternative asset
classes to optimize return from investments. And the addition of
any risky asset class in their investment portfolios with hopes of
better yield may result in further losses.
As the industry's statutory capital level fell sharply during the
recession, life insurers will need to optimize their capital levels
to address the ensuing challenges. In the short term, traditional
sources of capital are expected to fulfill most of what life
insurers need in order to stay in good shape. However,
non-traditional sources of capital will take years to strengthen
The underlying trends amid a recovering economy indicate stability
in the sector over the medium term with respect to credit profile
and financial prospects. However, higher-than-average asset losses,
primarily resulting from their real estate exposure, will remain a
Further, the sluggish pace of economic recovery is making it
difficult for life insurers to expand their customer base. In fact,
insurers are struggling to even retain their existing
Narrowed disposable income owing to a still high unemployment level
and huge credit card debt has made it difficult for Americans to
invest in retirement products such as life insurance. Americans,
primarily the youth, have significantly reduced expenditures on
life insurance products, and are instead choosing alternative
investments that promise better returns.
Though the carriers are transforming their products and businesses
to make them attractive and profitable for customers, significant
improvement in demand is not expected in the near term.
However, rising long-term bond yields would increase investors'
appetite for spread-based products, such as fixed rate annuities.
Currently, the life insurers with favorable Zacks Ranks worth
StanCorp Financial Group Inc.
) with a Zacks Rank #1 (Strong Buy), and
Lincoln National Corporation
Symetra Financial Corporation
) with a Zacks Rank #2 (Buy).
As U.S. health insurers continuously preparing themselves to comply
with the mandates of the health care reform, their financials are
beefing up. Broad-based moderation in utilization has been
primarily boosting the bottom line of health insurers. Also,
increased access to capital and better retention opportunities are
helping them grow consistently despite tardy economic growth.
Moreover, the carriers have been witnessing better credit quality
in the recent quarters, reflecting a moderate industry risk.
In 2010, the historic health care reform legislation -- The Patient
Protection and Affordable Care Act (PPACA) -- was passed by the
Congress with the intension of making health care facilities more
affordable, preventing private health insurers from continuing with
the pre-existing condition clause and at the same time reducing the
number of uninsured by bringing in 32 million more people under
coverage by 2019.
The legislation had many detractors who contested several of its
stated benefits and considered it another entitlement program that
the country can ill afford. Finally, in Jun 2012, the U.S. Supreme
Court ruled in favor of the reform, rejuvenating the industry by
removing major uncertainties. Further, Obama's re-election in Nov
2012 essentially ensured the law's future.
Controversies did not stop in 2013, with many states declining from
participating in the new health insurance market and expanding
Medicaid -- the public health insurance program for low-income
families -- to avoid the additional costs involved in it. So far,
less than half the states have approved of the Medicaid
However, the development so far is expected to significantly reduce
the number of uninsured, making the U.S. one of the economically
sound countries that guarantees coverage.
While the legislative overhaul brings more regulatory scrutiny for
private insurers such as
UnitedHealth Group, Inc.
), the net negative effect is expected to be far softer than was
Although the full implementation of PPACA will be in 2015, the
industry is expected to see gradual changes through the reminder of
2013 and dramatic changes in 2014. While bringing more people under
coverage will add prospects for growth, the requirement to reduce
health care costs will lead to margin compression.
Also, while the reform will provide more cross-selling
opportunities for health insurers, their overall profitability will
be limited over the long run as the negative impact of Medicare
Advantage payment cuts, industry taxes and restrictions on
underwriting practices will more than offset the benefits of
bringing more people under the umbrella.
Consequently, substantial growth in industry revenue is not
expected until 2015 as insurers will be forced to adjust the
benefits to comply with the health care legislation. Among others,
providing coverage to everyone regardless of an expensive
pre-existing condition would put their top lines at stake.
(Want to know more about the future prospects of health insurers?
Health Insurance Stock Outlook
Property & Casualty Insurers
Market hardening has been the key to improvement for
property-casualty insurers in the recent quarters. After struggling
with falling prices for years, insurers seem to have finally
reached a period of better premium rates. However,
property-casualty insurers are still feeling the pressure on their
investment portfolios due to the overall interest rate environment
which is still low. This has been continuously reducing the capital
adequacy of most carriers.
Along with continually improving pricing power, better preparation
to withstand catastrophe-related losses should help insurers
perform better in the upcoming quarters despite the pressure on
As property-casualty insurers hold about two-thirds of the invested
assets in the form of bonds, their capacity is highly sensitive to
changes in credit market conditions. Moreover, with credit markets
remaining weak and bond prices still hovering at low levels due to
persisting concerns over defaults, insurers may incur significant
realized and unrealized capital losses on their portfolios in the
upcoming quarters. Moreover, catastrophe losses continue to keep
the balance sheets of a number of carriers under pressure.
However, the ongoing recovery in the credit and equity markets is
leading to a reduction in unrealized investment losses. Also, the
recent rise in long-term bond yields is expected to somewhat
increase the property-casualty insurers' investment income.
Moreover, once the economic recovery gains momentum, insurance
volume will grow rapidly. With improved employment in the private
sector and recovery in the housing markets, a number of carriers
have already started seeing growth in insurance sales.
The recent quarters have been increasingly witnessing a rebound in
claims-paying capacity (as measured by policyholders' surpluses),
which reflects the industry's resilience over the prior years.
Conservative investment strategies and capital restructuring
efforts will continue to help property-casualty insurers improve
their financial footing in the upcoming quarters.
EMC Insurance Group Inc.
Everest Re Group Ltd.
) -- all with a Zacks Rank #1 -- are worth a look in the
The industry has been undertaking several structural changes that
will make underwriting and pricing schemes even more attractive to
consumers. Also, improving fundamentals on the back of favorable
macroeconomic trends make the stocks of a number of industry
participants appear attractive.
We remain positive on
Employers Holdings, Inc.
FBL Financial Group Inc.
Eastern Insurance Holdings, Inc.
Health Insurance Innovations, Inc.
Global Indemnity plc
State Auto Financial Corp.
) with a Zacks Rank #1.
Other insurers that we like with a Zacks Rank #2 include
American International Group, Inc.
Allied World Assurance Company Holdings, AG
Cincinnati Financial Corp.
CNA Financial Corp.
Fidelity National Financial, Inc.
We expect continued pressure on investment yield and lower income
from the variable annuity business to restrict the earnings growth
rate of life insurers at least in the near term. Also, reduced
financial flexibility and weak underwriting will hurt the earnings
of many property-casualty insurers. Moreover, the overall industry
is vulnerable to the ever-increasing threat of natural disasters.
We would suggest staying away from the Zacks Rank #5 (Strong Sell)
stocks such as
Meadowbrook Insurance Group Inc.
American Safety Insurance Holdings Ltd.
Donegal Group Inc.
AMER INTL GRP (AIG): Free Stock Analysis Report
AMER SAFETY INS (ASI): Free Stock Analysis
ALLIED WORLD AS (AWH): Free Stock Analysis
CINCINNATI FINL (CINF): Free Stock Analysis
CNA FINL CORP (CNA): Free Stock Analysis Report
DONEGAL GRP -A (DGICA): Free Stock Analysis
EMPLOYERS HLDGS (EIG): Free Stock Analysis
EASTERN INSURNC (EIHI): Free Stock Analysis
FBL FINL GRP-A (FFG): Free Stock Analysis
FIDELITY NAT FI (FNF): Free Stock Analysis
GLOBAL INDEMNTY (GBLI): Free Stock Analysis
HEALTH INS INN (HIIQ): Free Stock Analysis
MEADOWBROOK INS (MIG): Free Stock Analysis
STATE AUTO FINL (STFC): Free Stock Analysis
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