Key Takeaways
- Rising interest rates reduced the market value of property/casualty (P/C) insurers' fixed income portfolios and generally accepted accounting principles (GAAP) shareholders' equity, while declines in the value of equity holdings, elevated natural catastrophe losses, and deteriorating personal auto underwriting results pressure the net earnings of some insurers.
- As insurers report their third quarter results, we will be updating our earnings forecasts and assessment of capital and earnings, as measured by S&P Global Ratings' proprietary risk-based insurance capital model.
- We expect to make negative revisions to the ratings or outlooks of those insurers whose capitalization has fallen materially below our expectations and whose projected earnings and capital management options, in our view, will be insufficient to rebuild capitalization to a level consistent with our current ratings over the next 24-36 months.
S&P Global Ratings has revised its view on the U.S. property/casualty (P/C) sector to negative from stable, reflecting our expectation of weaker credit trends over the next 12 months, including the distribution of rating outlooks, existing sector wide risks, and emerging risks. The change, in our view, reflects the negative impact on capital of rising interest rates and consequent decline in the market value of fixed-income portfolios captured within accumulated other comprehensive income (AOCI). It also reflects the negative impact on reported GAAP earnings of the decline in the value of equity investments, natural catastrophe losses including Hurricane Ian, and higher claims costs, particularly in personal lines.
Rating Activity Relatively Quiet So Far This Year
Rating activity has been relatively muted so far in 2022. There has only been one rating downgrade and no upgrades (excluding actions driven by mergers and acquisitions or changes in group status). However, since the beginning of the year our distribution of rating outlooks within the sector--an indicator of potential future rating actions--has become more negative. In January 2022, 92% of our financial strength ratings had stable outlooks, and 8% had negative outlooks or were on CreditWatch with negative implications. As of Oct. 21, the percentage of stable outlooks in our portfolio had fallen to 80%, while negative and positive outlooks comprised 17% and 3%, respectively. We expect this negative trend in outlook revisions to continue.
Capital Cushions Declined In First Half Of 2022
As noted during our second quarter earnings review webcast on Aug. 25, the aggregate capital cushion enjoyed by the P/C insurers that we rate, based on their GAAP financials at year-end 2021, deteriorated materially in the first half of 2022 (see chart). This was largely because of the decline in the market value of bond holdings, which negatively affected AOCI, a component of shareholders' equity. Another contributing factor was share repurchases, which continued through the first half at a pace similar to 2021, which was a very active year as companies resumed their programs following the pandemic. One benefit of rising rates in our capital model is the reserve discount adjustment for the time value of money, which provides a partial offset to reduced shareholders' equity. The decline in investment portfolios will also reduce the amount of capital required to support asset risk, but this benefit will be offset by higher required capital as premium volume and technical reserves continue to increase.
Given the further rise in interest rates through the third quarter, we anticipate another significant decline in bond portfolio valuations and shareholders' equity. We also note that interest rates have continued to increase, so we expect further capital deterioration in the fourth quarter. Bond market indices are suffering their worst year in decades, and although there may be a partial recovery over the next two to three years, we do not expect all the unrealized losses in insurers' bond portfolios to be reversed. The amortization of unrealized losses to par is expected to contribute only modestly to a recovery in valuations over our projection period as most of the losses are on longer dated bonds. In addition, some insurers are selling securities to reinvest the proceeds in higher yielding securities, converting unrealized losses in realized ones.
Higher Inflation And Supply Chain Disruptions Weigh On Underwriting Results
Reported GAAP earnings have been reduced by realized and unrealized capital losses on equity holdings, which flow through the income statement. Personal lines writers have had a sharp deterioration in their underwriting results because of the impact of higher inflation and supply chain disruptions on the cost of car parts, building materials, and labor. The sharp increase in inflation and higher claims litigation costs is also leading some insurers to strengthen prior year loss reserves. An elevated level of convective storm losses and, more recently, losses from Hurricane Ian, have also depressed underwriting performance. Fortunately, commercial lines pricing and underwriting results remained strong, partially mitigating the deterioration in personal lines for multiline insurers.
We anticipate that the combination of a relatively high proportion of Hurricane Ian losses being ceded to reinsurers, some property catastrophe reinsurers withdrawing market capacity, and higher inflation will increase the cost of renewing reinsurance programs next year and may lead some primary insurers to increase their net catastrophe retentions, which could raise their capital requirements.
As insurers report their third quarter results, we will be updating our assessment of capital and earnings, as measured by S&P Global Ratings' proprietary insurance capital model. As part of this process, we will be revising our earnings forecast for our projection period (2023-2025) and our expectations for capital management activities. Our view of capitalization is prospective and will be based on the forecasted level of capital adequacy at the end our projection period.
This report does not constitute a rating action.
| Primary Credit Analysts: | John Iten, Princeton + 1 (212) 438 1757; john.iten@spglobal.com |
| Brian Suozzo, New York 1 (212) 438 0525; brian.suozzo@spglobal.com | |
| Taoufik Gharib, New York + 1 (212) 438 7253; taoufik.gharib@spglobal.com | |
| Secondary Contacts: | Simon Ashworth, London + 44 20 7176 7243; simon.ashworth@spglobal.com |
| Lawrence A Wilkinson, New York + 1 (212) 438 1882; lawrence.wilkinson@spglobal.com |
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