The U.S. property/casualty (P/C) industry continued to show remarkable resiliency in 2021, notwithstanding the uncertainties resulting from the emergence of new variants of the COVID-19 virus. Underwriting performance, as measured by the combined ratio, has been stable at about 99% for 2018-2020. We expect the full-year 2021 combined ratio will again be about 99% as continued strong rate momentum and underwriting profitability in commercial lines rates offsets deterioration in personal lines results. After improving significantly in 2020 due to COVID-19-related social distancing measures, personal auto results came under pressure as miles driven recovered to near prepandemic levels and claims costs accelerated due to unforeseen inflationary pressures on replacement parts, labor costs, and new vehicle shortages driving up used car prices. We anticipate that rate increases in commercial lines will slow somewhat but continue to be at or above loss cost trends, while personal auto insurers pursue substantial rate increases as they attempt to catch up with rising claims costs.

Pandemic-related losses did not have a material impact on 2021 results. The impact remained concentrated in a few smaller lines, notably travel insurance, event cancellation coverage, and trade credit. Reduced business and leisure travel and fewer large in-person events continues to affect these lines because of reduced premiums and increased claims paid. These factors will continue to hurt these lines in 2022, with most of the expected impact to come from lower premiums, though paid losses should also decline due to insurers adopting additional exclusionary language. We continue to view the impact of the COVID-19 pandemic on the P/C sector as similar to a midsize natural catastrophe event. The primary insurers we rate in the U.S. P/C sector took about $5.8 billion in charges for COVID-19 in 2020, and there has been minimal additional reserving for COVID-19 in 2021. Fortunately for the industry, the courts have largely upheld the virus exclusions included in most commercial property policies in business interruption coverage disputes with policyholders.

Entering 2022, we expect capital adequacy to remain a relative strength for most of the P/C insurers that we rate. The industry's statutory capital and surplus rose 6.4% through the first nine months of 2021 to a record $987 billion. In addition to benefiting from positive underwriting performance, the industry's capitalization got a strong boost from capital markets appreciation in 2021. The S&P 500 index rose by 26% in 2021, including an 11% increase in the fourth quarter that likely boosted the industry's capital and surplus to over $1 trillion by year-end. During the year, many insurers also got a significant boost in net investment income from appreciation in their alternative investment portfolios--private equity, venture capital, and hedge funds (L.P., LLC, and other equity method investments)--that are marked-to-market.

A Quiet Year For Rating Actions

During 2021 there were only two rating changes in the sector--both downgrades. We downgraded RLI Corp. due to a change in expected capital adequacy, and we downgraded ProAssurance Corp. due to adverse trends in its medical professional liability claims reserves and capital adequacy challenges following a recent acquisition of NORCAL Group.

As we enter 2022, we expect few rating changes, with the number of upgrades and downgrades in the U.S. P/C insurance sector to be about equal over the next 12 months. This expectation is based on the high percentage--92%--of our financial strength ratings in the sector with stable outlooks. Though the COVID-19 pandemic is nearly two years old, the U.S. P/C sector has seen few rating actions. Most U.S. P/C insurers have maintained strong underwriting earnings and very strong balance sheets, notwithstanding the economic and capital markets volatility caused by the pandemic, and we expect this to continue. The financial strength ratings in the North American P/C sector remain predominantly in the 'A' category, representing about 72% of rated P/C insurers.

Chart 1

There are only three outlooks that aren't stable. Our ratings on AIG's P/C operations are on CreditWatch negative due to the pending divestiture of its life and retirement business. Our holding company rating on ProAssurance has a negative outlook due to remaining adverse loss trends and acquisition-related integration risks. Our ratings on Argo Group International Holdings Ltd. have a negative outlook due to concerns about internal controls over financial reporting and underperformance in its international operations.

Chart 2

Economic Rebound Drives Strong Top Line Growth

P/C insurers benefited this past year from the improving macroeconomic environment. The U.S. economy rebounded sharply in 2021 to its strongest level in decades, driven by the rollout of COVID-19 vaccines that started early in the year and the benefit of monetary and fiscal stimulus measures by the Federal Reserve and U.S. government. S&P Global expects that real GDP surged to 5.5% in 2021--a 37-year high--from negative 3.4% in 2020. Above average economic growth should continue to provide a tailwind in the coming year. S&P Global's latest base-case forecast is for real GDP growth to slow somewhat to a still strong 3.9% in 2022, then fall to 2.7% in 2023.

Growth in P/C direct premiums written (DPW) has generally paralleled that of nominal GDP growth, except during hard P/C pricing cycles. As expected, these metrics diverged in 2020 as DPW continued to grow despite a decline in GDP because of the pandemic. However, this relationship was again evident in 2021 with nine-month DPW growth of 9.4% (based on data from S&P Market Intelligence) and nominal GDP growth forecasted at 9.2%.

Chart 3

Personal lines DPW rose 5.7% while commercial lines jumped by 13.7%, driven by strong rate increases in casualty lines, excluding workers' compensation. The most noticeable premium changes were in commercial property, commercial auto and other liability, which all saw DPW increase by about 20%. Companies have been aggressively raising rates in these lines, which likely contributed most of the growth, along with a rebound in economic activity and exposure units.

Underwriting Performance Remains Strong Overall

We expect the industry to report a slight underwriting profit for 2021 with a full-year combined ratio of about 99%, including a conservative assumption for second-half catastrophe losses. Robust rate increases drove improved underwriting margins in most commercial lines but were largely offset by deteriorating margins in personal lines following a sharp increase in repair costs and above average catastrophe losses. For 2022, we anticipate an industry combined ratio of 97-99%, assuming a return to a more normal 8 points of catastrophe losses.

Based on S&P Global Market Intelligence data, the industry's statutory combined ratio (including policyholders' dividends) was 99.6% for the first nine months of 2021, up slightly from 99.0% and 98.1% during the same periods in 2020 and 2019, respectively, and below the industry's five-year average of 100.3% (2016-2020). The reported loss ratio rose by over 2 points, which we believe is primarily the result of higher natural catastrophe losses and weakening personal auto results. This deterioration was partially offset by a 1 point improvement in the expense ratio, to about 26%; an increase in favorable prior-year reserve development; and a reduction in policyholder dividends from the inflated level of 1.2% in 2020 to a more normal 0.5%. Catastrophe loss data and prior-year reserve development are not yet available for the nine-month period. However, based on the six-month industry results published by the Insurance Services Office (ISO), we expect a deterioration in the underlying loss ratio of 1 point to 3 points.

The industry continues to benefit modestly from favorable prior-year reserve development, a long-term trend that we expect to continue. The $9.2 billion of favorable reserve development in first-half 2021 compares with $4.5 billion of favorable development in first-half 2020 and already exceeds the full-year $9 billion average for the past 15 years, which on average has reduced the combined ratio by about 2 percentage points. Favorable development reduced the combined ratio by 2.8 percentage points in the first half of 2021 and by 1.4 percentage points in the prior-year period.

Chart 4

P/C Insurers Demonstrates Pricing Discipline

The favorable momentum in commercial lines pricing that began in earnest in 2019 continued through 2020, notwithstanding the pandemic, and remained robust in 2021, with only a modest slowdown as the year progressed. Rate increases across most commercial lines continue to exceed loss cost trends, leading to improvement in underlying loss ratios.

As anticipated, the personal auto writers, who benefited from the coronavirus lockdown measures in 2020, saw a significant increase in claims frequency in 2021 as miles driven recovered to near prepandemic levels. However, claims severity also jumped in response to supply-driven inflationary pressure on used car prices, replacement parts, and labor costs, somewhat catching insurers by surprise. Partly offsetting these pressures on loss costs was the ending of shelter-in-place rebates provided to policyholders, which either increased premiums or lowered expenses, depending on how insurers accounted for it. In response to adverse loss cost trends, insurers have begun filing for approval from state regulators to increase rates high enough to slow and ultimately reverse the deterioration in underwriting margins.

Rate increases for commercial lines remained strong and well above loss cost trends during 2021 (see chart 5). The average rate change for standard commercial lines peaked in the third quarter of 2020 at 10%, according to the quarterly pricing survey conducted by the Council of Insurance Agents & Brokers (CIAB). Inflation worries have prompted much of the rate increases and were particularly evident for umbrella/excess casualty, where rates have been increasing 17%-23% during 2020 and 2021; in directors and officers' coverage, where rates have increased in the mid-teens for the past six quarters; and in commercial auto, where rates saw increases of high-single digits to low teens. Commercial property rate increases also remained in the low teens mainly because of the elevated natural catastrophe losses of the past two years and inflation in construction costs. Rates for cyber insurance have increased rapidly in the past year to 28% in the third quarter of 2021 from 8% in the third quarter of 2020 as deteriorating underwriting results from ransomware losses prompted an accelerated push for higher rates.

Chart 5

Since late 2020, the average rate change has declined somewhat to 8% in the third quarter of 2021 from 10% in the third quarter of 2020, which is still comfortably in excess of the average loss cost trend of around 5% referenced by many insurers. With the compounding of rate increases in excess of loss trends, more insurers are achieving rate adequacy in larger portions of their book and so are able to dial back their rate increases. The only major line where the pricing dynamics are different continues to be workers' compensation, where rates have been flat to modestly negative in recent years due to a very favorable long-term decline in claims frequency.

Personal auto rate increases haves been in the mid-single digits for the past two years, but rates are poised to move higher in 2022 in response to the normalization of claims frequency and higher severity. This is a fairly recent development. In the first half of the year, auto rates appeared to be moderating somewhat, which we expected given the sharp decline in claims frequency over the past year and increased competition. However, the spike in the cost of repairing or replacing vehicles last summer caught insurers somewhat off guard, accelerating the need for rate increases. For homeowner's insurance, we expect continued mid-single digit rate increases due to more frequent natural catastrophes and other weather-related events, as well as the more recent increase in the cost of building materials and labor.

The P/C market has ample capital, which has generally led to more competition and declining rates in past pricing cycles. However, with interest rates hovering near historic lows and inflationary pressures leading to higher loss costs, we think the industry's underwriting discipline will continue and rates will remain strong in the coming year. But rate increases should slow somewhat as past rate actions enable insurers to achieve adequate underlying profitability and returns on capital.

Elevated Losses From Natural Catastrophes Persisted In 2021

Property lines were again challenged in 2021 as an active Atlantic hurricane season, an unusually severe winter storm event in Texas, Western wildfires, and convective storms in the Midwest led to another above-average year for weather-related losses. The 2021 Atlantic hurricane season was the third-most active on record, producing 21 named storms (average about 14). The most notable was Hurricane Ida, which Swiss Re estimates caused $30 billion to $32 billion of insured losses. Also notable was winter storm Uri, the unusual ice-storm that froze much of Texas in February and caused an estimated $15 billion of insured losses. Significant losses in the fourth quarter include an estimated $3 billion for the late-season tornado outbreak that devasted portions of the Midwest--particularly in Kentucky--and an estimated $500 million for the late December wildfires near Boulder, Co.

S&P Global Ratings expects insured losses from natural catastrophes will again exceed the previous 10-year average annual losses. For the first half of 2021, catastrophe losses increased by $4.2 billion to $28.9 billion, from $24.7 billion in first half 2020, according to ISO estimates. With most predictive models projecting increased climate volatility dominated by higher wind speeds, more severe inland storms, and costlier secondary perils translating to higher insured loss damage, we anticipate the average annual natural catastrophe loss ratio edging closer to the high-single digits.

Chart 6

Rising Costs Will Weigh On Underwriting Profitability

Headline inflation readings came in stronger than economists anticipated in 2021. October 2021's 6.2% jump in the headline Consumer Price Index (CPI) from a year earlier was the sharpest increase since November 1990. S&P Global Ratings' U.S. core CPI forecasts (year-over-year percent change) for 2021 and 2022 are 3.4% and 3.5%, respectively, up from 1.7% in 2020. While we expect consumer pricing pressure to moderate later in 2022, we believe insurers will continue to pass along higher costs through rate increases while maintaining appropriate administrative expense to alleviate margin pressure.

We also believe social inflation will continue to drive higher insurance claims cost with the growth of third-party litigation funding (TPLF), a $17 billion global asset class according to Swiss Re. Business lines generally most susceptible to social inflation are product liability, commercial auto liability, medical malpractice, cyber, and general and professional liability.

We examined the number of active multidistrict litigation cases and case type to identify the lines most likely to experience underwriting pressure. Based on the case type in the docket ending Dec. 15, 2021, we surmise underwriting earnings attributed to product liability, cyber, general liability (including commercial multiperil liability), and professional liability will likely be the most affected over the next 24 months. Multidistrict litigation (MDL), a type of mass tort, is a specialized process used by the U.S. District Court system to centralize complex lawsuits for pretrial proceedings.

Chart 7

Investments in technological capabilities to achieve economies of scale appear to have contributed to meaningful expense reduction in the last 10 years. The increased use of technologies will likely continue to drive efficiency foundational to growth, claims handling, and, ultimately, strong operating performance. From 2011 to 2020, the noncommission expense ratio declined by 2 percentage points to to 16.2% in 2021 from 18.2% in 2011--which we believe is at least partly attributable to this increase.

Modest Investment Changes In Response To Yield Pressures

While capital markets were not as volatile in 2021 as in 2020, many P/C insurers stayed the course with minimal changes to allocations during the year. P/C insurers maintain a relatively conservative investment mix, although allocations to equities and alternative investments continued to grow, in large part reflecting strong stock and limited partnership investment returns. The shift has helped to offset the continued challenge of low yields on the fixed-income portfolio.

For the first nine months of 2021, the net yield on invested assets dropped approximately 5 basis points, to approximately 2.7%. However, this translated to a $2.8 billion increase in investment income for the industry on a year-on-year basis due to a 10.5% increase in investment assets (on a static investment asset base, investment income would have dropped by approximately by $0.9 billion for the year), according to S&P Market Intelligence data.

Chart 8

Investment portfolios remain predominantly made up of fixed-income investments, representing over 54% of the portfolio allocation as of Sept. 30, 2021 (according to S&P Global Market Intelligence)--but this is the lowest level it has been in the last 10 years. The credit quality of the fixed-income portfolio remains strong with over 75% of the bonds invested in NAIC 1 securities. However, allocations to NAIC 2 and speculative-grade bonds (NAIC 3-6) ticked up moderately compared with prior years. While we continue to believe that insurers are not chasing yield to boost their returns on capital, especially given a generally hard pricing environment creating better opportunities for underwriting returns, the data shows they are making tweaks.

Chart 9

The share of high-risk assets has been gradually growing over the years mainly because of the allocation to unaffiliated equity and preferred securities that represented about 22% of the total industry investments and other invested assets reported in Schedule BA of statutory annual statements (includes hedge funds, private equity, real estate and other asset classes), which represented about 9% of total investments as of year-end 2020. The additions to alternative asset classes and equity exposure benefited returns in 2021 (especially as measured on a generally accepted accounting principles basis) due to strong unrealized gains.

Chart 10

Despite lower yields, investment income continues to drive earnings for the industry, even before recognizing the benefit from the unrealized appreciation of common stock that flows directly through capital and surplus (not the income statement) for statutory reporting purposes. Looking ahead, we expect that higher rates, equity markets appreciation, and a larger base of invested assets will continue to support P/C insurers profitability. While S&P Global's base-case economic forecast calls for a gradual rate increases in 2022, those benefits will take time to affect the portfolio yield.

P/C insurers continue to reevaluate their environmental, social, and governance (ESG) driven investments, but at this point we do not believe there have been any tangible changes to investment allocations from these initiatives.

The Pandemic Hasn't Affected Capital Strength

Our stable outlook for the industry is built upon a foundation of very strong capitalization. Capital adequacy remains a strength to the ratings of most P/C insurers. The industry's statutory capital hit a record high, driven by continued recovery in the capital markets following significant declines in 2020, along with generally strong underwriting results. Rated U.S. P/C insurers, as a group, had a 21% risk-based capital buffer at the 'AA' level per our capital analysis as of year-end 2020, slightly up from the buffer level one year prior because of a higher capital base.

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Chart 12

Overall, industry statutory capital rose to $986.7 billion as of Sept. 30, 2021 (according to S&P Market intelligence), compared with $927.8 billion as of year-end 2020. Higher capital generation in the first nine months of 2021 was primarily due to approximately $44.4 billion of unrealized gains and net income of about $43.5 billion, which dividends totaling $23.3 billion somewhat offset. We expect insurers to hold similar capital levels through 2022 to maintain capital adequacy and ratings stability. Any level of capital above this could be available for opportunistic acquisitions and more aggressive shareholder returns (share repurchases and dividends).

S&P Global Ratings recently published proposed criteria revisions for our analysis of insurer capital adequacy that will be applicable to insurance companies (see "Request For Comment: Insurer Risk-Based Capital Adequacy--Methodology And Assumptions," published Dec. 6, 2021). We believe that the criteria as currently proposed could lead to changes in up to 35% of Capital & Earnings assessment and rating changes on up to 10% of ratings in the global insurance sector, with more upgrades than downgrades.

Robust Capital Markets Activity

For the first nine months of 2021, insurers were very active in the capital markets. The debt markets continued to offer attractive rates for long-term debt and hybrid issuances, leading to a combination of refinance activity and new debt for working capital needs. With a pause in share repurchases in 2020 due to the pandemic, this activity came back with a vengeance in 2021.

Insurers mostly used debt issuance to prefund upcoming maturities; however, some insurers used issuances to fund acquisitions or bolster the balance sheet for general corporate purposes. Through Dec. 15, 2021, insurers raised approximately $11.2 billion of debt and hybrid securities at a weighted average coupon of 3.2% compared with $14.2 billion for full-year 2020 at a similar weighted average cost. Despite the higher volume of issuance over the past two years, financial leverage and coverage for most insurers have remained within tolerances, with operating performance and lower cost of debt supporting fixed charge coverage levels.

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In terms of the maturity of the bonds issued, insurance companies issued more debt with maturities greater than 20 years in 2021. Of the total debt issued of $11.2 billion, 72% had maturities of more than 20 years, while 28% had maturities of less than 20 years. The longer maturity debt experienced a drop in the average coupon rate to 3.5% as compared with 4.2% in 2020, while the weighted average coupon rate for debt maturing in less than 20 years remained stable at approximately 2.6% for 2021 and 2020. Insurers understandably took advantage of this yield shift. For 2022, we expect debt issuance to be somewhat lower since some upcoming maturities have already been prefunded.

In first nine months of 2021, there was a significant increase in the share buyback activity totaling $12.1 billion, compared with $4.5 billion for the same period in 2020. The rise reflects increased share repurchases done by Allstate, Chubb, Hartford, and Travelers, which together repurchased $8.7 billion worth of shares compared with $2.6 billion for the first nine months of 2020. Share buybacks for the first nine months of 2021 were much higher when compared with the past full three years (2018-2020), and they grew for the first time since 2015. The increase in share repurchases was attributable to improved profits and capital build-up during 2020 that was deployed in 2021 due to greater visibility on how the pandemic is affecting both the economy and issuers. Given the share repurchase authorizations in place, we expect activity to continue at a relatively high pace in 2022, albeit slower than 2021.

Chart 14

Reinsurance Coverage More Expensive But Still Available

Property and casualty reinsurance pricing continues to harden, reflecting a continuation of what the industry has been experiencing during the past few years. Those challenges continue to be a result of elevated natural catastrophe losses--exacerbated by inflation and supply chain issues--with a higher proportion from secondary perils, uncertainty around COVID-19 related losses, and alternative capital and retrocession capacity constraints. With the Jan. 1, 2022, renewal season now closed, the market navigated uncertainty leading to delayed firm order terms for catastrophe risk, indicating potential mismatches of pricing with capacity.

Reinsurers held the line for rate needs, as evidenced by the Guy Carpenter U.S. Property Catastrophe Rate-On-Line index increasing 10.8%, the largest increase since 2008. The large increase is a reflection of continued challenges in the reinsurance industry, including climate change and change in appetite by some market participants. While the property catastrophe capacity mainly in working layers and loss affected accounts was challenged somewhat, aggregate protection faced even greater capacity constraints leading to meaningful price increases for those that renewed.

Shifting to casualty capacity, reinsurers were accommodative for pro rata business with ample capital available and greater competitive pressures tipping the scale in favor of primary insurers during the negotiation process. This allowed primary insurers to keep more risk if they would like to benefit from favorable pricing trends across most lines of business or negotiate more favorable ceding commissions, which are now generally in excess of 30%. On the flip side, casualty excess of loss protection saw reinsurers continue to push for rates to offset pricing challenges in the past and saw volatile performance due to social inflation.

Despite some of the noise within the marketplace, we expect insurers were able to renew most existing coverage levels with the ability to add more tail protection if desired or use more insurance-linked securities as needed. However, insurers are increasing their retentions, especially in the working layers, to manage their cost as reinsurance coverage is more expensive this year.

Reserve Development Is Favorable Overall, But Problems Persist In Commercial Auto And Other Liability

Changes in loss factors beyond what is incorporated in reserve assumptions--notably what appears to be a higher inflationary trend based on rising defense costs, supply-chain disruptions, and labor shortages--could exacerbate reserve volatility across many lines. However, the long-term industry trend of reserve releases appears set to continue, at least in the near term. In the first half of 2021, the industry released about $9.2 billion of reserves, up from $4.5 billion of favorable development from the same period a year ago, according to the ISO. Moreover, in the past 15 years (2006–2020), the industry released nearly $141 billion of reserves, lowering the reported combined ratio on average by about 2 percentage points.

Of the $596 billion in statutory loss reserves (excluding loss adjustment expenses) reported at year-end 2020, the industry held an impressive 51% ($306 billion) in incurred but not reported (IBNR) reserves, up from 49% at the end of 2019 and 47% in 2015. Property lines, other liability, accident and health, and, to some extent, auto liability contributed the bulk of the IBNR uptick at year-end 2020.

During 2020, P/C insurers reported a net $7.6 billion of favorable reserve developments from prior accident years, compared with $5.6 billion of reserve releases in 2019 for all lines, excluding mortgage and financial guaranty. Similar to the prior year, the industry has been releasing reserves from workers' compensation and short-tail lines. Excluding these lines, the industry booked $2.9 billion of unfavorable development, the second consecutive year of this reserve development pattern. As expected, the biggest culprits for the $2.9 billion in unfavorable development were commercial auto liability and other liability, which together booked nearly $5.7 billion of adverse development. The year before, adverse development for these lines was $5.6 billion.

Chart 15

Overall, we believe the broader industry is holding a prudent reserve margin. We, however, remain cautious on workers' compensation, as nearly 40% of the $6.3 billion of reserve releases from this line came from the less mature accident years between 2017 and 2019, considering continued rate decreases. Since 2004, workers' compensation rates cumulatively have declined over 40%, according to the National Council on Compensation Insurance (NCCI).

We believe the industry may continue to strengthen reserves for long tail casualty lines as long-term expectations for loss cost inflation and litigation expenses significantly depart from reserve assumptions.

Wave Of Life Divestitures Subsides, Followed By A Return To More Typical Merger And Acquisition Activity

Mergers and acquisitions (M&A) almost got off to a roaring start in 2021 when Chubb Ltd. made an unsolicited offer to acquire Hartford Financial Services Group last March. However, the offer was ultimately rejected, and deal activity was again focused on divestitures of noncore businesses and bolt-on acquisitions. Strong underlying market conditions and robust valuations likely dampened any appetite for transformative acquisitions despite cheap financing being readily available.

M&A for U.S. P/C insurers totaled approximately $13.3 billion in 2021, with seven announced deals, up from $10.4 billion in 2020 and $4.9 billion in 2019. These M&A volumes represent acquisitions completed by U.S.-domiciled companies where the acquiring company writes predominantly primary P/C business and the transaction size is greater than $100 million. The bulk of the acquisition value came from two transactions representing approximately 81.5% of the $13.3 billion--Chubb's acquisition of international accident and health (A&H) operations from Cigna and Brookfield Re's deal to acquire American National.

Chart 16

Notable transactions during the year include Chubb's agreement to acquire the life and A&H operations of Cigna in several Asia-Pacific markets, which will significantly boost the scale of its supplemental medical and A&H business in that region. Brookfield Re's acquisition of multiline insurer American National Group represents another meaningful entrance by an alternative asset manager into the life insurance market but includes a P/C business that has meaningful scale. Liberty Mutual's agreement to acquire State Auto Group is an opportunity to further enhance its presence in existing core markets by expanding its independent agent distribution network. Allstate's acquisition of Safe Auto Insurance Group Inc. represents the company leveraging the technological capabilities of National General to support acquisition capabilities in the non-standard auto market.

The most meaningful acquisition could be Progressive's acquisition of Protective Insurance Corp. While the overall size was small, it represents the addition of more comprehensive commercial line offerings with the capability to also underwrite larger commercial auto fleets, which supports Progressive's strategy to diversify away from purely auto coverages over the last decade.

Responding to the capital markets discount of life businesses owned by non-life insurance groups, many players looked to simplify their business structure and enhance shareholder value through divestitures. For those enterprises that sold annuity operations, the growing pressure from alternative asset managers, increased offshore competitors with lower tax requirements leading to more challenging pricing, and legacy blocks with higher crediting rates forcing a riskier investment portfolio and higher capital requirements led to some of this activity. While all the divestitures are not complete--AIG is still working through their strategic split of the life and P/C businesses--these actions have generally been received favorably by the market. Of the remaining insurers with life operations, we do not expect many further divestitures due to the product focus, value proposition to policyholders, challenges associated with difficult lines of business, and the capital diversification benefits they receive.

We expect 2022 will mirror some of the acquisition activity completed during 2021 with transactions being more incremental rather than transformational. As market conditions remain fairly supportive across most lines of business, we believe insurers will continue to focus on gaining scale organically, supplementing with inorganic growth to add capabilities or expertise. Looking ahead, we expect increasing costs of capital to moderate valuations somewhat, creating opportunities for consolidation once pricing momentum is taken out of the market, but we would not expect that within the next 12 months.

Physical Risk Is A Significant Environmental, Social, And Governance Factor For Property Insurers

Insurance companies have long been on the forefront to understanding and managing risks on climate-related areas that could significantly affect their standing with stakeholders such as investors, regulators, and policyholders. (See "ESG Credit Indicator Report Card: North And Latin America Insurance," on Nov. 29, 2021.)

We consider physical risk as a major threat regarding the frequency and size of atmospheric events affecting (re)insurers that write predominantly property risks. We identified physical risk as a leading environmental risk factor, either moderately negative (E-3) or negative (E-4) in our credit considerations on 27 of the 63 North America (re)insurers that write P/C business (about 43%).

Common characteristics for companies we assess as E-4 are generally linked to their appetite for large exposures to property catastrophe risks relative to their capital strength. While appetite for property catastrophe risks is also present among companies we assess as somewhat less risky (E-3), we generally view their exposure as less elevated relative to their capital strength. For companies with ESG factors we consider neutral (assessed as E-2), we view environmental risk as less material to the ratings due to their general focus on nonproperty lines underscored by a highly diversified portfolio and utilization of reinsurance.

As part of our ratings analytical process, we assess insurers' sustainable effort and readiness on mitigating relevant ESG risks that could have profound influence on their business fundamentals. In recognition of the threat climate change poses to individuals, businesses, and communities--and therefore their bottom line--we believe insurers' ability to monitor, measure, and analyze the financial impact of ESG will grow increasingly critical to our credit fundamentals.

Appendix: U.S. P/C Insurers' Rating Scores Snapshot