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The turmoil in the financial markets created a highly challenging environment for the U.S. insurance industry, forcing many companies to take immense write-downs. In 2010, the overall situation has improved to a great extent and the worst of the crisis appears to be now behind us.
However, the soft market conditions along with legislative changes remain a chief cause for concern for the overall industry at this point. Though there are signs of economic recovery, the trend of sluggish pace is expected to continue at least through the remainder of 2010. Also, structural economies of scale have pushed the industry toward consolidation.
While enormous financial support from the government helped rescue AIG (AIG - Analyst Report) from collapse, many other firms remained under tremendous pressure or have fallen by the wayside. Competition within the segments of the industry has reduced, which is consolidating through mergers and acquisitions. This has increased market shares of the largest firms.
We expect static growth with persistent soft market conditions and an ongoing market crisis, resulting in further consolidation in the industry. However, we expect the overall condition to improve in 2011, should the economy turn to growth, post-recovery.
Continued 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, some companies were trying to raise capital through the Troubled Assets Relief Program (TARP). In May 2009, the Treasury approved six life insurers for capital infusion under TARP. Hartford Financial Services Group Inc. (HIG - Analyst Report) and Lincoln Financial Group (LNC - Analyst Report) received federal aid. The other four insurers, Prudential Financial (PRU - Analyst Report), Principal Financial Group (PFG - Analyst Report), Allstate Corporation (ALL - Analyst Report) and Ameriprise Financial (AMP - Analyst Report) decided against accepting bailout funds.
Following its accumulation of $3.05 billion funds from new securities, Hartford Financial Services has already repaid the entire $3.4 billion of bailout money in Apr 2010. Lincoln Financial is also expected to repay the bailout money by the end of 2010.
The U.S. health care system is significantly dependent on private health insurance, which is the primary source of coverage for most Americans. Approximately 58% of Americans have private health insurance. Unfortunately, these insurance companies utilize a pre-existing exemption clause in order to control costs and maximize profit.
The newly passed historic healthcare legislation prevents private insurance companies from using the pre-existing condition clause, but at the same time brings in more than 30 million additional people under coverage. While the legislative overhaul brings more regulatory scrutiny into this space, the net negative effect is far more muted than was initially feared. Also, the removal of this uncertainty is a net positive in its own right.
Property & Casualty Insurers
Major catastrophe losses in 2008 have resulted in significant deterioration of companies' underwriting results. Steep losses in the investment portfolios since the beginning of 2008 have significantly reduced the capital adequacy of most insurers.
During 2009, the seizure of credit markets and rising concerns over defaults have pushed down bond prices sharply, causing significant realized and unrealized capital losses on insurer portfolios. Holding two-thirds of the invested assets in the form of bonds, the capacity of the Property & Casualty insurers is highly sensitive to changes in credit market conditions.
While a modest recovery of credit and equity markets may lead to a reduction in the unrealized investment losses in the upcoming quarters, the premium rates continued to decline, though at a slower pace.
Reduced financial flexibility and weak underwriting and reserves have further added to their woes. The only positive trend visible as of now is a slight improvement in some insurance pricing after continued deterioration during the last couple of years.
Losses from the investment portfolios of reinsurance companies have surged during the last few quarters. In the second half of 2008, the underwriting profits were severely hurt by Hurricanes Ike and Gustav. However, the pricing improved as of 2009 and is expected to remain firm going forward.
With the signs of recovery in the capital market (though still weak by any means), the concerns related to reinsurers' ability to access the capital markets on reasonable terms has sufficiently mellowed. Considering this fact, along with the relative improvement in macroeconomic conditions and better financial performance of reinsurance companies, Fitch Ratings revised its outlook on the global reinsurance industry to stable from negative in Nov 2009.
The rating agency has also cited that the reinsurance sector's credit quality is less sensitive to macroeconomic factors than that of many other financial services sectors. The agency noted that asset values of reinsurers have been improving markedly. However, we expect slightly lower favorable reserve development trends in the upcoming quarters, as there are lingering concerns about the overall economy.
We remain positive on life and mortgage insurer Genworth Financial Inc. (GNW - Analyst Report) with a Zacks #2 Rank (Buy) as its capital bolstering initiatives, introduction of high-margin products, distribution expansion, improved pricing and strict underwriting standards augur well going forward.
Other insurers that we like with a Zacks #2 Rank include American Physicians Capital, Inc. , Hallmark Financial Services Inc. (HALL), Infinity Property and Casualty Corp. (IPCC - Snapshot Report), Nymagic Inc. and United America Indemnity, Ltd .
We expect continued pressure on investment portfolios and lower income from the variable annuity business will restrict the earnings growth rate of life insurers. Also, reduced financial flexibility and weak underwriting will hurt earnings of Property & Casualty Insurers.
There are currently a number of stocks with a Zacks #5 Rank (Strong Sell) including China Life Insurance Co. Ltd. (LFC), Amerisafe, Inc. (AMSF), Zenith National Insurance Corp. (ZNT), AmTrust Financial Services, Inc. (AFSI), Harleysville Group Inc. (HGIC).