25 January 2018Insurance

US insurers ‘passed’ 2017 but heavy 2018 losses would present real test: S&P

While the US property/casualty (P/C) insurance sector passed the ‘capital test’ in 2017 in the wake of record catastrophe losses, the real test will be how the industry fares if 2018 losses mimic last year's activity and if reserve development becomes unfavourable, according to a report from S&P Global Ratings.

The report, called ‘US P/C Insurance Sector Outlook Remains Stable, But Something Has Got To Give’, suggests that one reason the industry endured the losses was that the sector had enjoyed a good build-up of excess capital through multiple years of benign hurricane activity and (to a lesser extent) earnings generation.

“But here is the Catch 22: Lack of category 3 or higher hurricanes over a 12-year span and cheap reinsurance have led to pricing complacency – particularly in commercial property,” the report said.

“The industry is stable but somewhat in a state of flux, and it may take time to fully grasp the extent of 2017 catastrophe losses, given the $20 billion-$40 billion gap between the amounts reported by companies so far and consensus estimates of total losses among industry participants.”

S&P Global Ratings credit analyst Tracy Dolin said that during 2018 S&P will scrutinize the effectiveness of insurers' enterprise risk management programmes and react to developing insurer losses that materially exceed risk tolerances.

“Another avalanche masking true underwriting results is 10+ years of favourable reserve development, which we acknowledge is not sustainable, but we have not seen the turning point. After a prolonged period of pricing complacency leading to rate inadequacy in many product lines, something has got to give in 2018. Even though we expect pricing to improve, our combined ratio forecast near 100% implies a bleak pricing correction," said Dolin.

S&P noted that even though insurers have an arsenal of data analytic tools to improve underwriting performance, risk tolerances are their Achilles heel. “Data analytics can only go so far for insurers with subpar internal performance targets and/or inability to meet their cost of capital. We are sceptical of insurers that believe they can achieve double-digit returns on equity through the underwriting cycle, but tolerate consecutive years of underperformance and/or reliance on the continuation of healthy reserve releases to reach underwriting profitability.”

It added that very strong capitalization supports our stable outlook on the US P/C insurance sector. “However, we foresee potential downward rating actions on insurers coming more from underwriting challenges and/or adverse reserve development than from capital declines. The sector benefits from excess capital levels, but it needs to improve its operating fundamentals to maintain this edge. In fact, our stable sector outlook depends on it.”

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