Zacks Industry Outlook Highlights: RLI, AXA, American Financial Group, CNA Financial and CNO Financial Group

For Immediate Release

Chicago, IL – May 6, 2011 – Today, Zacks Equity Research discusses the Insurance Industry, including RLI Corp. (RLI - Analyst Report), AXA (AXAHY - Snapshot Report), American Financial Group Inc. (AFG - Snapshot Report), CNA Financial Corporation (CNA - Snapshot Report), and CNO Financial Group, Inc. (CNO - Analyst Report).

A synopsis of today’s Industry Outlook is presented below. The full article can be read at http://www.zacks.com/stock/news/52746/Insurance+Industry+Stock+Update+-+May+2011.

After enduring stress with respect to pricing pressure and reduced insured exposure through mid-2009, the overall health of the U.S. insurance industry has improved to some extent in recent quarters. Though the market turmoil forced many companies to take immense write-downs, the worst of the crisis appears to be now behind us.

However, long-lasting soft market conditions, shrinking businesses, a still-high unemployment rate and legislative challenges are threatening insurers’ ability to rebound to the historical growth rate. The industry continues to be challenged by subdued pricing and premium volume growth in a perked up economy as well as a massive health care restructuring.

Though there are signs of economic recovery, its sluggish pace is expected to continue at least through 2011. Also, structural economies of scale have pushed the industry toward consolidation. As a result, inter-segment competition within the industry has reduced. Moving forward, maintaining profitability after complying with regulatory requirements could be a painful task. 

We expect static growth with persistent soft market conditions to result in further consolidation in the industry. Though there are near-term opportunities for insurers, braced by some rapidly growing sectors such as health care and technology, overall industry condition is expected to improve beyond 2011, should the economy turn to growth post-recovery.

Life Insurers

Losses in the investment portfolio and lower income from the variable annuity business will continue to hurt earnings of life insurers. Most life insurers have substantial exposure to commercial real estate-backed loans and securities, which will result in further losses in the coming quarters.

As the industry’s statutory capital levels fell sharply during the recession, life insurance companies will need to optimize their capital levels to address continuing challenges. In the short term, traditional sources of capital are expected to fulfill most of what life insurers need to stay in good shape. However, non-traditional sources of capital will take years to help these strengthen financials.

The underlying trends amid sluggish economic recovery indicate stability of U.S. life insurers over the medium term with respect to credit profile and financial prospects. However, higher-than-average asset losses of life insurers, primarily a result of real estate exposure, will remain a major concern in 2011.

Most importantly, narrowed disposable income owing to high unemployment and huge credit card debt has reduced the ability of Americans to invest in retirement products such as life insurance. On the other hand, interest in cheaper products to cover only their basic risks has increased. So returning to providing basic services should be the primary course of action for life insurers to realize some profit in the near term.

Some life insurers have already gone back to the basics in order to meet demand and escape financial and regulatory difficulties, but taking shelter from the icy winds will not be adequate for thriving. Life insurance companies have to be more proactive to weather the situation.

Health Insurers

The U.S. health care system is significantly dependent on private health insurance, which is the primary source of coverage for most Americans. More than half of U.S. citizens are covered under private health insurance. Unfortunately, these insurance companies utilize a pre-existing exemption clause to control costs and maximize profit.

The historic health care legislation, which was passed by the Congress last year, prevents private insurance companies from using the pre-existing clause, but at the same time brings in 32 million more people under coverage. In total, the health care reform packs 95% Americans under health insurance coverage. Further, according to a new Commonwealth Fund report, 90% of American families live above the federal poverty level and are able to afford health insurance premiums.

While the legislative overhaul brings more regulatory scrutiny for private insurance companies, the net negative effect is far softer than was initially feared. Also, the removal of this uncertainty is a net positive in its own right.
 
Though the reform will provide more cross-selling opportunities for health insurers, their overall profitability will be marred in the long run as the negative impact of Medicare Advantage payment cuts, industry taxes and restrictions on underwriting practices will more than offset the benefits of the 32 million added coverage.

Property & Casualty Insurers

Steep losses in the investment portfolios since the beginning of 2008 have significantly reduced the capital adequacy of most Property & Casualty insurers. The seizure of credit markets and rising concerns over defaults have pushed down bond prices sharply since then, causing significant realized and unrealized capital losses on insurer portfolios. As Property & Casualty insurers hold about two-thirds of the invested assets in the form of bonds, their capacity is highly sensitive to changes in credit market conditions.

While the ongoing recovery in the credit and equity markets is leading to a reduction in unrealized investment losses, the premium rates continue to decline, though at a slower pace.

Reduced financial flexibility and weak underwriting and reserves have further added to insurer woes. The only positive trend visible as of now is a slight improvement in some insurance pricing after continued deterioration for two years since 2008.

However, the Property & Casualty industry endured the recent financial crisis better than the other financial service sectors. Once the economic recovery gains momentum, insurance volume will grow rapidly.

The recent quarters have been witnessing increasing rebound in claims-paying capacity (as measured by policyholders’ surplus), which reflects the industry’s resilience over the prior-years.

Reinsurers

Losses from the investment portfolios of reinsurance companies have gotten worse during the last few quarters. In the second half of 2008, the underwriting profits were severely hurt by Hurricanes Ike and Gustav. However, pricing improved in 2009 and 2010. We expect pricing to remain firm going forward.

With the signs of recovery in the capital market (though still weak by any means), concerns related to reinsurers' ability to access capital markets on reasonable terms have sufficiently eased.

However, diminishing new business and rising expense ratios are major concerns for reinsurers at this point. According to a survey by the Washington-based Reinsurance Association of America (RAA), U.S. reinsurers' premiums decreased and combined ratio deteriorated on a year-over-year basis in 2010. An increased level of price competition among insurers explains the decline in premiums.

For the upcoming quarters, we expect slightly lower favorable reserve development trends, due to lingering concerns about the overall economy.

OPPORTUNITIES

We remain positive on RLI Corp. (RLI - Analyst Report) and AXA (AXAHY - Snapshot Report) with a Zacks #1 Rank (short-term Strong Buy).

Other insurers that we like with a Zacks #2 Rank (short-term Buy) include American Financial Group Inc. (AFG - Snapshot Report), CNA Financial Corporation (CNA - Snapshot Report), CNO Financial Group, Inc. (CNO - Analyst Report), among others.

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Read the full analyst report on RLI

Read the full analyst report on AXAHY

Read the full analyst report on AFG

Read the full analyst report on CNA

Read the full analyst report on CNO