A new report from AM Best has stated that a combination of factors which includes rising interest rates, increased unrealized losses, and declines in capital, has led to leverage ratios ticking up among US property & casualty (P&C) insurers.
The report, titled ‘U.S. P/C Insurers’ Leverage Ratios Remain Elevated Due to Declines in Capital’, highlights how the P&C industry’s aggregate leverage ratio increased from 19.5% to 23% in the third quarter of 2022, from year-end 2021.
According to the report, nearly every firm witnessed an increase in their debt to capital ratios in 2022 from year-end 2021, despite the majority reducing their long-term debt obligations.
42 publicly traded P&C companies were followed for the report. Most of the companies kept their appetites for long-term debt in check in 2022, and instead are focused on strengthening and making enterprise risk management (ERM), strong corporate governance, and stress testing capabilities integral to their operations.
“The rising interest rate environment is not only impacting the investing and operating environments for U.S. insurers, but it is also leading to a more cautious approach to capital-raising via debt issuance,” said Helen Andersen, financial analyst, AM Best.
“Macro-economic challenges such as inflation and capital markets volatility will likely hamper profitability compared with prior years. However, the shorter duration of bond portfolios may benefit P/C insurers in the rising rate environment because insurers can reinvest proceeds of maturing bonds at the current higher rates.”
According to the report, debut obligations continued to decline throughout the third quarter of 2022 from 2021, with capital at many companies also notably declining on a GAAP basis.
At year-end 2021, nearly one-quarter of invested assets in the P&C industry were allocated to equities, which dropped nearly 3% points by the third quarter of 2022. Best notes that this was driven partially by the stock market downturn, which resulted in unrealized losses.
Additionally, losses throughout the third quarter of 2022 have turned the interest coverage ratio negative in aggregate.
Best addresses how uncertainty surrounding the direction and pace of interest rate changes demonstrates the need for a strong asset-liability matching program and routine rigorous stress testing of insurers’ portfolios.
Further, the report adds that while losses may pressure insurers needing to service financial obligations, average liquidity across publicly traded P&C companies remains very high despite a decline through the third-quarter of 2022.
