The outlook for the U.S. property & casualty insurance sector is now negative, according to Fitch Ratings, reflecting the challenging operating environment and expectation that competition is set to increase, while profitability has been on the wane.
Fitch Ratings is already negative on the global reinsurance sector and on the London insurance and reinsurance sector, the two most affected by the competition provided by the capital markets.
But the spread of negativity into U.S. P&C insurance perhaps reflects an element of the trend of over-spilling reinsurance capital flowing into primary lines, as well as ILS fund players looking to more directly access primary sources of insurance risk.
“The U.S. P/C industry is at a point in the market underwriting cycle where near-term conditions and profitability are likely to worsen further before any pricing improvement materializes,” explained James B. Auden, Managing Director, Fitch Ratings.
“Pricing continues to trend unfavorably in most major P/C segments and there is no catalyst in sight in 2017 that would promote a meaningful shift in pricing trends,” he continued.
Fitch expects further earnings deterioration in 2017 due to more competitive market conditions in U.S. P&C. But while market conditions are expected to worsen, Fitch maintains stable rating outlooks on U.S. commercial and personal lines P&C sectors, as strong capital strength supports insurers.
This is exactly the same message that was delivered on the global reinsurance market back in early 2014. Since that time the outlook on the reinsurance sector has remained negative, although high levels of capital have supported ratings and kept the sector rating outlook stable.
Capital caused the problems in reinsurance, as low levels of catastrophe loss meant traditional players collected excess capital, while at the same time the capital markets and insurance-linked securities (ILS) players were beginning to wield real influence in the renewal market and realising their cost efficiencies.
The result was pricing pressure, eroded profitability and rising competition in reinsurance, which has now resulted in an over-spill of capital into primary lines, which is no doubt exacerbating the issues Fitch has now reacted to.
Fitch’s view is that insurers will largely be able to absorb near-term volatility and manage the headwinds the sector faces for now, however underwriting profits are expected to be minimal, with a sub 100% combined ratio only just expected to make a profit in 2016 and an underwriting loss expected in 2017 with a statutory combined ratio around 101%.
While reinsurance capital has spilled over to pressure some areas of U.S. P&C primary lines, at the same time the capital markets are venturing into P&C insurance, through arrangements with managing general agents (MGA’s), by directly backing primary players and other ways of sourcing primary risks such as through the Citzens depopulation program.
While this isn’t putting ILS fund managers so directly into competition with U.S. primary players yet, it is adding pressure on pricing and increasing capacity levels, while at the same time perhaps taking some of the market segments away from traditional players.
It’s certainly a trend that is exacerbating the issues for the U.S. property & casualty insurance sector and this is likely to accelerate with some ILS fund managers now looking to write and source risks in large commercial risks, excess & surplus lines and other areas of the primary market.
“Weaker underwriting performance, combined with a reduced contribution to earnings from investment results, is placing considerable pressure on P/C insurer profitability,” Fitch Ratings explains.
Fitch expects the industry statutory return on surplus to drop to 6.6% in 2016, from 8.5% in 2015, with a further decline expected in 2017. If the sector suffered larger underwriting losses and even lower sustained returns on surplus (below 4%) beyond 2017, the rating agency said that its industry rating outlook could move to negative, meaning that individual company ratings could be adjusted.
Catastrophe losses for the U.S. P&C industry haven’t helped in 2016, increasing to $17 billion for the first nine months of 2016, up from $15.2 billion for the full-year 2015, driven by losses from severe wind and thunderstorm events in Texas and Florida. Fitch expects Hurricane Matthew will add losses in the range of $2 billion-$8 billion, which it notes to be the low-end of estimates.
There is another issue that the U.S. P&C market faces that is also negative and is likely to increase competition, result in more efficient competitor business models, and which is also pulling more reinsurance capital directly into primary risks.
The insurance technology or Insurtech wave.
“The P/C industry continues to undergo technological change particularly in the areas of distribution, policyholder interaction, risk selection tools, pricing and claims adjudication, and policy administration. While Fitch does not expect technology investments to necessarily lead to long-term return on capital improvement, keeping pace with technology is essential for expense structures and to minimize adverse selection risk,” Auden said.
But with so many Insurtech start-ups now looking to partner with providers of reinsurance capital, for the efficiency of the capacity, in order to shorten the risk to capital value chain and to tap into the expertise at managing large portfolios of diversified risk, there could be even more pressure waiting for U.S. P&C carriers who fail to keep up with the pace of change.
There are also Insurtech start-ups that are looking to partner directly with the capital markets, to provide the pipeline of risk that ILS and institutional investors are seeking and completely disintermediating the traditional primary carrier or even reinsurance carrier approach.
While a long way from mainstreaming the more radical and disruptive Insurtech initiatives promise to continue to ramp up the pressure on primary U.S. P&C carriers, while gradually stealing away risk that would once have been their core business.
As with the development of the negative outlook in reinsurance and the increasing competitive pressure, while profits and returns declined, the transformation of the insurance risk transfer market to one focusing on efficiency is clear here once again.
Primary carriers need to demonstrate the value they bring to the risk transfer chain and establish how best to profit from their intellectual capital output (as originators, analysts, pricers or structurers of risk) in the same way (as we’ve documented many times) that reinsurers need to.
A period of more sustained pressure may be coming, for both primary and secondary or reinsurance carriers, meaning the successful players will be those ready and willing to adapt, embrace new business models, leverage technologies to enhance efficiency and make the best use of third-party capital where it can enhance their own offering.