Keefe, Bruyette & Woods (KBW) has updated its 2018 Property and Casualty (P&C) industry earnings model, concluding that the outlook for the sector is mixed, with improved ratios and investment yields offset by earned premiums and catastrophe losses that were worse than previously projected.
KBW’s revised industry model, which factors in the recently published 4Q17 results from Verisk’s ISO, observed that the mixed results were likely to drive mid-single-digit industry return on equity (ROE).
Overall, net written premium, net investment income, reserve releases, and core loss and expense ratios were better than previously expected, while net earned premiums were considerably down with catastrophe losses high due to the Q4 California wildfires.
The industry experienced its highest net written premium growth rate since 4Q03, with rates up 6.3% year-on-year, which KBW attributed to nominal GDP growth, continued increases across Personal and Commercial Auto lines, and initial rate increases across most Commercial lines.
Combined ratios are expected to stabilise as commercial lines rate increases approach loss cost trends, although underwriting margin compression could be exacerbated if levels of inflation exceed expectations or if there is heightened regulatory pressure to adjust rates.
KBW also found that the industry’s core loss ratio was considerably lower than previously forecast, potentially due to predicted margin improvement in auto lines and more optimistic loss picks on other lines.
Catastrophe losses were up almost 250% year-on-year, with the industry’s 11.4% catastrophe loss ratio well in excess of KBW’s normalised 2.5% forecast, reflecting the impact of the California wildfires.
Expense ratios are improving thanks to premium growth, higher reinsurance ceding commissions, lower incentive compensations accruals, and stable wage growth, and have likely remained higher than in previous cyclical bottoms due to investments in IT, data analytics, and underwriting infrastructure.
KBW expects most carriers to control their expense ratio pressures by targeting expense ratio savings through strategic mergers and acquisitions (M&A) and operational improvement initiatives, although core loss ratio deterioration should also be limited by rates increases across some Commercial Lines.
Additionally, operating income over 2018 and 2019 should benefit from the recently introduced U.S tax bill, while rising core loss ratios will stabilise later in the year as reserve releases shrink, according to KBW’s updated forecast.