Insurers’ good fortune may need more than a capital idea

Insurers have demonstrated resilience over the past several years. However, have insurers been “lucky” or have they worked hard to secure their good fortune? Perhaps it’s a bit of both.

Over the past several years, S&P Global Ratings has been consistently identifying emerging threats to the insurance sector that could negatively impact credit quality. These threats include:

• disruption from new technologies; cyber security;
• an evolving regulatory or accounting landscape;
• stubbornly low interest rates and the weight they put on investment yields;
• increased catastrophe losses; and pricing pressures due to the abundance of capital, to name a few.

These are all themes that emerged again at the 34th Annual Insurance Conference, which was held on June 6–7 in New York City.

Notwithstanding all these legitimate threats, rating activity in this sector has been muted over the past several years. In fact, many rated insurance companies are sitting on historically high levels of capital. Some of the strength and stability that insurers have demonstrated can certainly be attributed to strong leadership and active risk management, including good underwriting discipline and the optimization of data analytics.

Related: How funding, innovation and collaboration changed insurance

Luck plays a role

It would be shortsighted, however, to not acknowledge that luck has played a role in the success of this sector as well. We don’t mean luck in the sense that management teams are making uninformed bets with their product offerings and leaving it entirely to chance, or that they are unaware of the risks they are assuming. However, as we consider some of the major events in the history of this sector that have weighed on capital and credit quality, such as asbestos, 9/11, Hurricane Katrina and the Great Recession, insurers have enjoyed what could be characterized as “a lucky run,” emerging relatively unscathed over the past decade.

In addition to the prolonged absence of any meaningful capital event, the U.S. economy is in the midst of completing its ninth consecutive year of growth, albeit at a less compelling annual growth rate than previous recoveries. Furthermore, and perhaps more impactful, in a search for yield fueled by the sustained low interest rate environment, alternative capital has flooded into the insurance sector. This has served as a boost to the industry in multiple aspects.

On the life insurance side, M&A activity has increased, as alternative capital has allowed several of our rated life insurers to divest less-desirable, underperforming legacy liabilities more easily. For example, VOYA has announced plans to divest its closed block variable annuity business to an Apollo-led investor consortium, and Hartford has announced plans to divest its Talcott Resolution business to a Cornell Capital-led group of investors. Transactions like these are allowing life insurance companies to free up capital to pursue more attractive liabilities, such as pension risk transfers.

On the property-casualty insurance side, while the abundancy of alternative capital has weighed a bit on pricing, many insurers and reinsurers took advantage of the presence of alternative capital to purchase reinsurance or retrocession last year, which served many of them quite well during what turned out to be the most active catastrophe season in more than 10 years. Furthermore, there was some concern that one rough catastrophe season might be enough to deter alternative capital, but at this point, it appears it is here to stay. We believe this generally bodes well for our rated insurers.

Related: Reinsurers turn sexy as suitors see disaster-scarred targets

Limited positive ratings movement

While capital levels continue to build and emerging risks have not affected the majority of our ratings, there also has been very limited positive rating movement in recent years. There are a few factors we can point to that support this. First, building more and more capital can only do so much to improve credit quality, particularly given the fact that our average ratings are comfortably in investment-grade territory.

We look to the performance of the underlying business (profitability and stability) as a means to differentiate once ratings reach a level that fully reflects the benefits of capital, as we view strong operational performance as a key to sustained strong capital.

Related: Fixing America’s disaster risk financing problem

Pressures on profitability (low interest rates and pricing pressures for example) have weighed on the sector broadly, but we expect that with interest rates finally picking up some momentum, there will increasingly be an opportunity for insurers to demonstrate the strength of their business models versus peers.

More importantly, we do believe that some of the longer term, emerging risks in the insurance sector (that is, disruption from new technologies) are legitimate threats, particularly those associated with improving the customer experience and converging supply chain dynamics. These emerging risks will present the need for insurers to innovate and perhaps partner with some of the emerging InsurTech players if they wish to maintain their strong value proposition, and high investment grade ratings.

Related: ‘Alternative’ market players are here to stay

Ben Bubeck, managing director with S&P Global Ratings, is head of the U.S. and Canada Financial Services, Sovereign, and International Public Finance Ratings Department. He can be reached at ben.bubeck@spglobal.com.