The U.S. tax reform has been heralded as a positive overall for re/insurers, but Morgan Stanley has pointed to a potential erosion of increased earnings as additional regulatory headline risks and an expected slowing of reserve releases take their toll on balance sheets.
Prior to Q4 earnings, Morgan Stanley had raised earnings per share estimates by 14% on average for domestic P&Cs.
However, market competition, firms reinvesting gains, and the impact of regulators make it less likely that re/insurers will see this level of profit increase in real terms.
Factors driving down profitability potential include state regulators pushing for lower rates for consumers and lower tax expenses could cause carriers to ease off insurance rate increases that they otherwise would have taken, in an attempt to garner more growth, said analysts.
In Morgan Stanley’s view, while rate rollbacks are unlikely, headline risk could cast a shadow over the industry into 2018 as “regulatory headline risk from some of the larger, more regulated states, have already occurred.”
Personal line carriers in particular could see more of their tax benefits ‘competed’ or ‘regulated’ away.
Although reserve issues have been overshadowed by discussions over pricing and rate increases, Morgan Stanley warned that weakening reserves shouldn’t be ignored, estimating the industry’s overall reserve position to be lacking about $2.5 billion as of the end of 2016.
The risk of adverse development will continue to rise over the next 12-24 months, particularly in other liability and commercial auto liability, although reserve releases are expected to slow further in 2018.
This slowdown will be a headwind for future earnings, as reserve releases boosted insurers’ earnings by about 20% over the last seven years and Morgan Stanley reminded that “stocks’ reaction to adverse reserve development can be quite harsh (specific examples in 4Q17 include JRVR and MHLD, both of which took reserve charges and saw their stocks down hard the next day) and investors should be watching company reserves closely.”
With regulatory challenges, the need for firms to invest heavily in InsurTech and innovation to remain competitive, and the impact of weakening reserves, any added boost to profits from changes to the U.S. tax regime shouldn’t be taken for granted by re/insurers who remain locked into a competitive industry still reeling from years of weakening prices and reserves.