The U.S. insurance industry will probably breathe a sigh of
relief as the 2012 Atlantic hurricane season is expected to be much
calmer compared to 2011. This year's hurricane season, which
officially started on June 1 and will run through November 30, is
expected to be less conducive for tropical storms. In addition,
insurers are better prepared to withstand significant losses this
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However, insurers have yet to recover fully from the impact of last
year's series of natural disasters, and the industry continues to
reel under economic unrest that thwarts every attempt it makes to
grow. The dearth of positive catalysts is naturally making it hard
for insurers to recover.
These impediments aside, there are fundamental challenges that are
expected to come in the way of insurers' efforts to meet growing
investor expectations in the upcoming quarters. Among the possible
ways out, rising rates and pricing flexibility are primary.
It can be said that the overall health of the U.S. insurance
industry has improved to some extent in the recent quarters, after
enduring pricing pressures and reduced insured exposure for quite
some time. The market turmoil resulting from the Great Recession of
2008-2009 forced many companies to take immense write-downs, but
those are gradually becoming a thing of the past.
That said, continued soft market conditions, shrinking businesses,
a still-high unemployment rate, uncertain fiscal policy and
legislative challenges are threatening insurers' ability to rebound
to the historical growth rate. The industry continues to be
challenged by subdued premium volume growth in a perked-up economy
as well as a massive healthcare restructuring.
Though there are signs of economic recovery, its sluggish pace and
sudden drop offs are expected to continue at least through the end
of 2012. Also, structural economies of scale have pushed the
industry toward consolidation. As a result, inter-segment
competition within the industry has alleviated. Moving forward,
maintaining profitability after complying with regulatory
requirements could be a painful task.
We expect static growth from persistent soft market conditions to
result in further consolidation in the industry. Though there are
near-term opportunities for insurers, thanks to rapidly growing
sectors such as health care and technology, overall industry
conditions are expected to improve beyond 2012, provided the
economy turns to growth after recovery. The industry would likely
take a couple more years to overcome most industry challenges with
the help of an improved market mechanism.
Losses in the investment portfolio and lower income from the
variable annuity business will continue to hurt earnings of life
insurers. Most life insurers have substantial exposure to
commercial real estate-backed loans and securities, which will
result in further losses in the coming quarters.
As the industry's statutory capital level fell sharply during the
recession, life insurance companies 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
Moreover, regulatory changes under the Dodd-Frank Wall Street
Reform are still troubling life insurers as they pose strategic and
competitive challenges. In order to address such concerns, life
insurers may have to burn some of their financial energy.
The underlying trends amid sluggish economic recovery indicate the
stability of U.S. life insurers over the medium term with respect
to credit profile and financial prospects. However,
higher-than-average asset losses of life insurers, primarily
resulting from their real estate exposure, will remain a major
concern in the near- to mid-term.
Most importantly, the tardy economic recovery is making it
difficult for life insurers to enhance their customer base. In
fact, insurers are struggling to even retain their existing
clientele. Narrowed disposable income owing to high unemployment
and huge credit card debt has made it difficult for Americans to
invest in retirement products such as life insurance.
Moreover, the low interest rate environment is one of the major
risks for life insurers at this point. Investment income remains
weak as life insurers are experiencing low returns on fixed-income
instruments. Also, low rates are spoiling life insurers' efforts to
grow fixed annuities and universal life insurance
On the other hand, interest in cheaper products to cover only basic
risks has increased. So, returning to providing basic services and
reducing operating costs should be the primary course of action for
life insurers to realize some profit in the near term.
Some life insurers have already gone back to the basics in order to
meet demand and escape financial and regulatory difficulties, but
taking shelter from the icy winds will not be adequate for
thriving. Life insurance companies have to be more proactive to
weather the situation.
The U.S. healthcare system is significantly dependent on private
health insurance, which is the primary source of coverage for most
Americans. More than half of the U.S. citizens are covered under
private health insurance.
Unfortunately, these insurance companies utilize a pre-existing
exemption clause to control costs and maximize profit. The historic
healthcare reform legislation, which was passed by Congress in
2010, aims to prevent private insurance companies from using the
pre-existing clause and at the same time bring in 32 million more
people under coverage by 2019.
While the legislative overhaul brings more regulatory scrutiny for
private insurance companies, the net negative effect is far softer
than was initially feared. Also, the removal of this uncertainty is
a net positive in its own right.
Though the reform will provide more cross-selling opportunities for
health insurers, their overall profitability will be marred in 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 adding the extra 32 million.
Growth in nonfarm payroll employment is expected to enhance health
insurers' customer base to some extent as these individuals will be
insured through their jobs. However, according to the U.S. Bureau
of Labor Statistics, in May 2012, nonfarm payroll employment inched
up by a disappointing 69,000 and the rate of unemployment unchanged
On the other hand, reducing government employment (down 13,000 in
May) will partially offset this benefit. Moreover, growth in
industry revenue is expected to decline until 2015 as insurers will
be forced to adjust the benefits to comply with the healthcare
legislation. Among others, providing coverage to everyone
regardless of whether they had an expensive pre-existing condition
would put their top lines at stake.
Property & Casualty Insurers
Steep losses in the investment portfolios since the beginning of
2008 have significantly reduced the capital adequacy of most
Property & Casualty insurers. The seizure of credit markets and
rising concerns over defaults have pushed down bond prices sharply
since then, causing significant realized and unrealized capital
losses on these insurers' portfolios. 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
While the ongoing recovery in the credit and equity markets is
leading to a reduction in unrealized investment losses, the premium
rates continue to decline, though at a slower pace.
Reduced financial flexibility and weak underwriting and reserves
have added to insurer woes. The only positive trend visible as of
now is a slight improvement in some insurance pricing after
persistent deterioration for two years since 2008.
Though premium rates are showing signs of stabilization in the
recent quarters, loss trends are rising at a faster pace. This will
ultimately lead to underwriting margins compression.
On the other hand, catastrophe losses, competition, lower
reinvestment yields and economic uncertainty will remain the
headwinds for Property & Casualty insurers' operating
performance in the near- to mid-term.
However, the Property & Casualty industry endured the latest
financial crisis better than the other financial service sectors.
Once the economic recovery gains momentum, insurance volume will
The recent quarters have been witnessing an increasing rebound in
claims-paying capacity (as measured by policyholders' surpluses),
which reflects the industry's resilience over the prior years.
Property & Casualty insurers started 2012 with positive net
income, aided by premium growth and lower catastrophe losses.
Strong capital adequacy and conservative investment strategies will
keep these insurers on solid financial footing in the upcoming
Losses from the investment portfolios of reinsurance companies have
gotten worse during the last few quarters. The deterioration
resulted from the supply-demand imbalance in reinsurance coverage
due to intense competition that kept pricing soft over the last few
Also, catastrophic events like Hurricanes Ike and Gustav were the
major culprits that pressure on underwriting profits. However, in
the recent months, reinsurance prices have increased substantially.
In fact, rising rates are expected to be more than sufficient to
offset 2011 catastrophe losses. Also, reinsurers now have the
capacity to meet the demand for coverage despite catastrophe
With signs of recovery in the capital market (though still weak by
any means), concerns related to reinsurers' ability to access
capital markets on reasonable terms have sufficiently eased.
However, lesser new business and rising expense ratios are major
concerns for reinsurers at this point. An increased level of price
competition also may hurt top lines in the upcoming quarters.
Moreover, reinsurance market capital levels are expected to be down
for reinsurers with huge exposure to the European sovereign debt
Insurers are suffering from the ongoing economic uncertainty and
challenges related to natural disasters. However, this tough period
brings opportunities for many large industry participants to grow
by attracting new customers and taking market share away from weak
rivals. The industry has been undertaking several structural
changes that will make underwriting and pricing schemes even more
attractive to consumers.
We remain positive on
Everest Re Group Ltd.
Allied World Assurance Company Holdings
CNA Financial Corporation
Greenlight Capital Re, Ltd.
White Mountains Insurance Group, Ltd.
Eastern Insurance Holdings, Inc.
Symetra Financial Corporation
) with a Zacks #1 Rank (short-term Strong Buy).
Other insurers that we like with a Zacks #2 Rank (short-term Buy)
American International Group, Inc.
The Allstate Corporation
The Chubb Corporation
Cincinnati Financial Corp.
RenaissanceRe Holdings Ltd.
Fidelity National Financial, Inc.
American Financial Group Inc.
Protective Life Corporation
We expect continued pressure on investment portfolios and lower
income from the variable annuity business to restrict the earnings
growth rate of life insurers. Also, reduced financial flexibility
and weak underwriting will hurt the earnings of many Property &
Among the Zacks covered U.S. insurers, we prefer to stay away from
the Zacks #5 Rank (short-term Strong Sell) companies --
Platinum Underwriters Holdings Ltd.
State Auto Financial Corp.
Assured Guaranty Ltd.
Meadowbrook Insurance Group Inc.
Genworth Financial Inc.