S&P: Discipline Will Be The Key To Insurers’ Success in 2008

Standard & Poor’s Ratings Services has issued a report, noting the 2008 outlook for the North American property/casualty insurance, life, health, and reinsurance sectors are stable due to several years of strong earnings, improved levels of capital adequacy, ample liquidity, and strong balance sheets. The number of ratings raised over the next six months is expected to be offset by the number of ratings lowered. The balance masks the reality that competitive pressures are intensifying, credit markets are seeking more risk transparency, regulators are increasingly active, and capital has rarely been more expensive, the company said.

“The challenges across all sectors remain formidable as companies face temptation to write business against their built up capital (or in other words, excess capacity seeking deployment). Specific factors will influence some sectors more than others. Discipline in underwriting risk and the fortitude to maintain underwriting profitability, even for the sake of top-line growth, will determine the extent and length of the financial impact of softening market conditions,” S&P said.

The analyst indicated that enterprise risk management, in terms of gauging strategic risk tolerances and deploying capital to optimize competitive positions and earnings, will be an important key differentiator in determining which companies emerge from today’s underwriting down cycle and low interest rate environment poised to exploit better market conditions over the long term.

While current credit market conditions have challenged the financial services industry, the insurance sector is well-positioned, given its manageable levels of exposure, healthy liquidity, and strong capitalization levels, to navigate through the mark-to-market volatility in its investment portfolios, S&P said.

The company is completing a November 2007 survey that will examine comprehensively nonprime residential mortgage exposures in light of current market conditions.

Nevertheless, “Years of low interest rates have encouraged insurance company management teams to look beyond strong cash flows and price their products to generate underwriting profitability. The cruel reality of good operating performance coupled with the absence of substantial man-made or natural peril catastrophes is that capital builds, and ample capacity fuels competitive pressures,” S&P said.
The company said it is watching the pricing and the broadening of terms and conditions closely, with an eye toward their implications on establishing an adequate level of reserves in the nonlife sector. Asset/liability matching of increasingly more innovative and complex products in the life and annuity sector will continue to be the primary analytical focus for ratings.

The analyst predicted prudent share-repurchasing programs are expected to be an integral part of active capital management in 2008. However, with investor demand for healthier spreads at financial services companies, insurers may place less reliance on return on equity management techniques and opt instead to retain capital over the short term. Similarly, debt raising and insurance-linked capital-market solution activity are expected to slow until spreads for this sector narrow.

A weaker U.S. dollar relative to most major currencies may spawn mergers and acquisitions activity in the United States, S&P predicted, with companies looking to broaden the scope of their core product lines. “We are not expecting broad diversification into products that are not resident within the buyers’ portfolios, as this strategy did not historically add to shareholder value (although exceptions were observed),” the report said.

The U.S. insurance industry outlooks and related issues will be covered at Standard & Poor’s upcoming “Hot Topics Seminars.” These will be held on Dec. 11, 2007, at the McGraw-Hill Cos. auditorium, 1221 Avenue of the Americas, New York, NY, and Dec. 12, 2007, at The Langham Hotel, 250 Franklin Street, Boston. For the agenda and registration information, visit www.events.standardandpoors.com.

Source: S&P