Keefe, Bruyette & Woods (KBW) has warned that rising loss ratios, lower reserve releases, and normalised catastrophe losses will maintain underwriting pressure across the North American Property & Casualty (P&C) sector to at least 2020, in a recent equity research note.
KBW analysts have revealed that it’s updated its North American P&C industry earnings model following the release of ISO’s first-quarter 2017 results.
Following the update, KBW expects returns in the sector to decline through 2019, driven by a continuation of the low-interest rate environment, declining reserves, and normalised losses from weather events, all of which signals further deterioration of underwriting margins for insurers and reinsurers.
“We expect the combined ratio to keep rising overall as earned rate changes trail still-modest loss cost trends, which could worsen if inflation accelerates beyond the expectations embedded in current rates.
“Persistent and compounding rate decreases in most lines should prevent industry-wide loss ratio improvement, and we expect most carriers to target expense ratio savings (through strategic M&A and/or operational improvement initiatives) to control or constrain expense ratio pressures,” says KBW.
By their very definition, catastrophe losses are extremely volatile, but analysts at KBW feel the industry is “poorly positioned” to absorb such volatility. In fact, KBW explains that the trend of an increasing trailing-12-months’ ratio of cat losses to earned premiums, has led to a larger increase in the percentage of cat losses to core underwriting margins.
Catastrophe losses did increase in 2016 when compared with previous years, but the fact remains that a large, market-impacting event hasn’t occurred for some time. While insurers and reinsurers have benefitted somewhat from the benign loss experience, intense competition and ample capacity across the marketplace has pressured pricing and stressed underwriting returns, which in a low-interest environment, isn’t being offset by investment returns.
To offset some of the negativity and improve balance sheets, some re/insurers have been seen to aggressively release reserves. While this isn’t an uncommon, or unheard of approach, in the current soft market environment it appears reserves are running thin, meaning companies have less room to navigate the testing marketplace, and even less room to manoeuvre should a significant catastrophe event take place.
“We expect modest premium growth, rising core loss ratios, lower reserve releases, and normalized catastrophes to pressure underwriting margins through 2019, very modestly offset by expense savings. We expect slightly higher net investment income, reflecting higher (but volatile) alternative investment returns and slowly growing asset bases,” concludes KBW.