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Insurance Industry Stock Outlook - May 2013 - Zacks Analyst Interviews

By: Zacks.com
Posted: 5/21/2013 4:42:00 AM
Referenced Stocks: AFL;AGO;AIG;AMSF;ASI

The year 2013 started off much better than expected for the U.S. insurance industry, with most of the primary insurers beating first quarter earnings estimates and reporting relatively low combined ratios. Moreover, the sector continued to witness rising premium rates which started a year back after a long period of softness.

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.

Climate change further adds to the concerns. The ravages of Superstorm Sandy resulted in billions of insured losses last year. 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, an increasing probability of natural catastrophes due to growing global warming will continue to raise concerns. This is without mentioning the tornado devastation in Moore, Oklahoma this week, which, although nowhere near as concentrated as the East Coast, will nonetheless result in further losses for insurers.

The events outside the country such as continued debt crisis in the Eurozone will further limit the industry's growth prospects.

However, the overall health of the industry has improved somewhat in the recent past riding on an economic recovery, after enduring pricing pressures and reduced insured exposure since the latest recession.

Rising premium rates should ultimately translate into margin expansion and mitigate the negative impact of the ongoing 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 the regulatory requirements and coping with the challenges of climate change 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-Property & Casualty is #6, Insurance-Multiline is #13, Insurance-Accident & Health is #50, Insurance-Brokers is #60 and Insurance-Life is #71. Looking at the Zacks Industry Rank of the five insurance industries, one could certainly say that the near-term outlook for the group is 'Positive.'

Life Insurers

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 a low interest rates, higher hedging costs, lower income from the variable annuity business and more burdensome capital requirements will continue to mar profitability going forward. Also, low rates are spoiling life insurers' efforts to grow fixed annuities and universal life insurance sales.

As the Federal Reserve plans to hold interest rates at low levels through mid-2015, life insurers will have to seek alternative asset classes to optimize return from investments. However, the addition of any risky asset class in their investment portfolios with hopes of better yield may lead to 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 financials.

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 major concern.

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 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. 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.

In December, Fitch Ratings has affirmed the credit outlook for the U.S. life insurance industry at stable for 2013. This action was primarily based on the expectation of insurers' improved liquidity and balance sheet strength.

However, the rating agency expects statutory capital growth to be moderate in 2013 given subdued earnings growth due to the low interest rate environment. Also, the agency does not expect a significant improvement in portfolio credit quality due to the expected weakness in investment income.

Currently, the life insurers with favorable Zacks Ranks worth considering include Protective Life Corporation ( PL ) and StanCorp Financial Group Inc. ( SFG ) with a Zacks Rank #1 (Strong Buy), and China Life Insurance Co. Ltd. ( LFC ) with a Zacks Rank #2 (Buy).

Health Insurers

As U.S. health insurers are preparing themselves to comply with the mandates of the health care reform, their financials are expected to remain strong. 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 a future to the law.

While the legislative overhaul brings more regulatory scrutiny for private insurers such as WellPoint Inc. ( WLP ) and UnitedHealth Group, Inc. ( UNH ), the net negative effect is expected to be far softer than was initially feared.

Although the full implementation of PPACA will be in 2014, the industry is expected to see gradual changes through the reminder of 2013. 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? Read our 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 finally reach a period of better premium rates. However, property-casualty insurers are still feeling the pressure on their investment portfolios due to the prevailing low interest rate environment. 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 investment income.

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. And with credit markets remaining weak plus bond prices 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, once the economic recovery gains momentum, insurance volume will grow rapidly. With growing 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.

Currently, ProAssurance Corporation ( PRA ), XL Group plc ( XL ), Hilltop Holdings Inc. ( HTH ) and AXIS Capital Holdings Limited ( AXS ) with a Zacks Rank #1 are worth a look in the property-casualty industry.

OPPORTUNITIES

The industry has been undertaking several structural changes that will make underwriting and pricing schemes even more attractive to consumers. Also, improving financial fundamentals on the back of favorable macroeconomic trends make the stocks of a number of industry participants appear attractive.

We remain positive on Alleghany Corporation ( Y ), American Safety Insurance Holdings Ltd. ( ASI ), White Mountains Insurance Group, Ltd. ( WTM ), Assured Guaranty Ltd. ( AGO ) and Eastern Insurance Holdings, Inc. ( EIHI ) with a Zacks Rank #1.

Other insurers that we like with a Zacks Rank #2 (Buy) include The Chubb Corporation ( CB ), Cincinnati Financial Corp. ( CINF ), Everest Re Group Ltd. ( RE ), PartnerRe Ltd. ( PRE ), American International Group, Inc. ( AIG ), Cigna Corp. ( CI ), The Hartford Financial Services Group, Inc. ( HIG ), MetLife, Inc. ( MET ), Prudential Financial, Inc. ( PRU ) and Amerisafe, Inc. ( AMSF ).

WEAKNESSES

We expect continued pressure on investment yield 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 Rank #4 (Sell) stocks: ING Groep NV ( ING ), AFLAC Inc. ( AFL ), Loews Corporation ( L ), Meadowbrook Insurance Group Inc. ( MIG ) and Stewart Information Services Corporation ( STC ). Currently, there are no stocks with a Zacks Rank #5 (Strong Sell).

AFLAC INC (AFL): Free Stock Analysis Report

ASSURED GUARNTY (AGO): Free Stock Analysis Report

AMER INTL GRP (AIG): Free Stock Analysis Report

AMERISAFE INC (AMSF): Free Stock Analysis Report

AMER SAFETY INS (ASI): Free Stock Analysis Report

AXIS CAP HLDGS (AXS): Free Stock Analysis Report

CHUBB CORP (CB): Free Stock Analysis Report

CIGNA CORP (CI): Free Stock Analysis Report

EASTERN INSURNC (EIHI): Free Stock Analysis Report

HARTFORD FIN SV (HIG): Free Stock Analysis Report

HILLTOP HLDGS (HTH): Free Stock Analysis Report

ING GROEP-ADR (ING): Free Stock Analysis Report

LOEWS CORP (L): Free Stock Analysis Report

CHINA LIFE INS (LFC): Free Stock Analysis Report

METLIFE INC (MET): Free Stock Analysis Report

MEADOWBROOK INS (MIG): Free Stock Analysis Report

PROTECTIVE LIFE (PL): Free Stock Analysis Report

PROASSURANCE CP (PRA): Free Stock Analysis Report

PARTNERRE LTD (PRE): Free Stock Analysis Report

PRUDENTIAL FINL (PRU): Free Stock Analysis Report

EVEREST RE LTD (RE): Free Stock Analysis Report

STANCORP FNL CP (SFG): Free Stock Analysis Report

STEWART INFO SV (STC): Free Stock Analysis Report

UNITEDHEALTH GP (UNH): Free Stock Analysis Report

WELLPOINT INC (WLP): Free Stock Analysis Report

WHITE MTN INS (WTM): Free Stock Analysis Report

XL GROUP PLC (XL): Free Stock Analysis Report

ALLEGHANY CORP (Y): Free Stock Analysis Report

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