The U.S. insurance industry sees no respite from natural
catastrophe losses yet again this year. The 2012 Atlantic hurricane
season, which officially started on June 1 and will run through
November 30, is just a little more than half over and it appears
that it is not as mild as was expected earlier. Though insurers are
better prepared to withstand significant losses this time, the
after effect of this year's hurricane season will play a key role
in determining the sector fundamentals for 2013.
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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.
A dearth of positive catalysts is naturally making it harder for
insurers to recover fast.
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
possibilities, rising rates and pricing flexibility stand out.
It can be said that the overall health of the U.S. insurance
industry has improved to some extent in 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
first half of 2013. 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 and meeting the challenges of climate change 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 toward growth. 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 portfolios, higher hedging costs, lower
income from the variable annuity business and more burdensome
capital requirements will continue to restrict earnings growth of
the life insurers. Most life insurers have substantial exposure to
commercial real estate-backed loans and securities, which will lead
to 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 a sluggish economic recovery indicate
stability of the U.S. life insurers 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 major concern in the near- to
Most importantly, the tardy economic recovery is making it
difficult for life insurers to expand 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 sales.
In mid September, credit-rating agency Moody's -- a wing of
) -- has revised its outlook for the U.S. life insurance industry
to negative from stable. This action was primarily based on the
rating agency's expectation of continued pressure on life insurers'
earnings due to persistently low interest rates.
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.
Some life insurers have already gone back to the basics in order to
meet demand and escape financial and regulatory difficulties, but
this conservative stance will not be adequate for thriving. Life
insurance companies have to be more proactive to weather the
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 insurers such as
UnitedHealth Group, Inc.
Unfortunately, these insurance companies utilize a pre-existing
condition 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 condition clause and at the same time bring
in 32 million more people under coverage by 2019.
However, the legislation has had many detractors who contested
several of its stated benefits and considered it another
entitlement program that the country can ill afford. Finally, in
June 2012, the U.S. Supreme Court ruled in favor of the healthcare
reform, rejuvenating the industry by removing major uncertainties.
With respect to the individual mandate, which drew the most
attention as it requires all uninsured Americans to purchase a
minimum level of health insurance coverage, the Supreme Court ruled
that individuals failing to buy health insurance will have to pay a
tax fine, but forcing them to buy insurance will be illegal.
Employers will also be fined if they fail to provide insurance
coverage to their workers.
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 people into
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 August 2012, nonfarm payroll employment
inched up just 96,000 and the rate of unemployment marginally edged
down to 8.1%.
That said, 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 have been continuously
reducing the capital adequacy of most property-casualty insurers
since the latest recession. 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 market conditions. Low interest rates and
government bond yields are expected to compress profits in the
quarters ahead. However, an expected improvement in casualty rates
will partially offset the negatives.
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. This declining
trend in premium rates is expected to persist through the first
half of 2013, adversely affecting insurer profitability. The key
positive trend visible as of now is a slight improvement in some
insurance pricing after persistent deterioration for the last three
On the other hand, high catastrophe losses, stiff competition and
lower reinvestment yields are expected to depress profits for
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.
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 put underwriting profits under pressure.
However, in the recent months, reinsurance prices have increased
substantially. Also, reinsurers now have the capacity to meet the
demand for coverage despite catastrophe losses.
With signs of recovery in the capital markets (though still weak by
any standard), concerns related to reinsurers' ability to access
capital markets on reasonable terms have sufficiently eased.
However, lesser new business and rising expense ratios are the
major concerns for reinsurers at this point. An increased level of
price competition may also 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
Insurance companies 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
Eastern Insurance Holdings, Inc.
Ping An Insurance (Group) Co. of China Ltd.
Fidelity National Financial, Inc.
First American Financial Corporation
Homeowners Choice, Inc.
Stewart Information Services Corporation
United Fire Group, Inc
) 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.
Assured Guaranty Ltd.
CNO Financial Group, Inc.
The Allstate Corporation
The Chubb Corporation
Everest Re Group Ltd.
XL Group plc
HCC Insurance Holdings Inc.
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-casualty insurers. Moreover, the overall industry is
vulnerable to the ever-increasing threat of natural disasters.
Among the Zacks covered U.S. insurers, we prefer to stay away from
the Zacks #5 Rank (short-term Strong Sell) companies --
Meadowbrook Insurance Group Inc.
Old Republic International Corp.
American Safety Insurance Holdings Ltd.
EMC Insurance Group Inc.
Hallmark Financial Services Inc.
Mercury General Corporation
Selective Insurance Group Inc.
Phoenix Companies Inc.
StanCorp Financial Group Inc.