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Industry Outlook

Looking beyond the implications of the uncertainty surrounding the interest rate hike, it is market softening that characterizes the Property & Casualty (P&C) insurance industry. In order to retain renewals and secure new business, carriers are aggressively reducing rates and making the market advantageous for buyers.

The softening was evident right through 2015 and continued in the first half of 2016. Pricing primarily remained soft in the areas of commercial property, workers' compensation, general liability and business interruption. On the other hand, the commercial auto line has been witnessing an increase in rates.

By its very nature, a soft market causes lower underwriting profitability for carriers, as they prioritize market share gain over making more from premiums to exist in the market.

With the increasing appetite of carriers, their willingness to negotiate on terms and conditions, and enhanced capital strength, the market is likely to remain highly competitive in the quarter ahead.

However, greater demand for insurance, particularly following the emergence new insurable risks including cyber threat and endemic disease, will keep the business of P&C insurers afloat.

Is Rate Hike Uncertainty Too Much of a Concern?

P&C insurers are less sensitive to Fed interest rates than life insurers, but the sensitivity has both positive and negative directions. Whether the upside offsets the downside is yet to be seen, as there hasn’t been any palpable progress on the rate hike front so far.

A rising rate environment would boost investment earnings of P&C insurers that have been declining in a prolonged low-rate environment.       

However, the key downside is a significant amount of bonds in P&C insurers’ portfolio losing value if rates are hiked steadily (which is unlikely though). P&C insurers’ extreme sensitivity to asset inflation will aggravate the situation. And this could ultimately result in capital volatility.

In other words, the value of the properties insured by carriers will appreciate with an improving real estate market, increasing their potential liabilities from claims. This may outpace the rising yields on bonds they added to their portfolios for covering the claims. In fact, the bonds in their portfolios will lose value with rising interest rates.          

Addressing this concern would require P&C insurers taking more risk to meet the rising liabilities from claims. And this would eventually increase their costs.

Fundamentals Look Reassuring

In addition to the continuation of a soft market environment, slowing reinsurance renewals across most lines due to less significant catastrophe in recent years should keep P&C insurers’ bottom lines stressed.

However, ample underwriting capacity, a strong liquidity profile and evolving coverage opportunity should help the carriers stand tall.

Concerns related to weak capital levels are now things of the past, as the industry’s capital position has been building up on the back of improved earnings and policyholders' surpluses. The industry has also been witnessing continued inflow of alternative capital (which is one of the reasons for market softening). High capital levels on the other hand are positioning the industry to perform well.

Further, better preparation to withstand catastrophe losses should translate into higher underwriting profits and a lower combined ratio in the upcoming quarters. Conservative investment strategies should also work in favor.

As P&C 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. With the credit market showing resilience and almost no possibility of a sudden spike in interest rates, insurers are likely to incur lesser realized and unrealized capital losses in the quarters ahead.   
Moreover, insurance volume is expected to expand going forward with economic recovery. With improved employment in the private sector and recovery, though uneven, in the housing markets, a number of carriers have seen growth in insurance sales in recent quarters.

Though competition is cropping up both within the primary lines of the P&C space and with reinsurers’ expansion, proactive transformational measures, including adoption of technology solutions, will give a competitive advantage.

Also, for more enthusiasm in renewals and to meet evolving demands of policyholders, insurers are in the process of product reframing and innovation. This should help them expand their customer base for products that will offer higher margins.
The emerging risks related to cyber threats are also giving P&C insurers scope to capitalize on. This segment, though relatively small in size, has been witnessing continued growth in premium and policy count.  

How to Play the Industry

The likely continuation of the buyer’s market will typically hold insurers back from flourishing. In fact, stiff competition and reducing premium rates may pose significant challenges to bottom-line growth for some carriers. As such, staying away from stocks with an unfavorable Zacks Rank should be the right strategy.

We strongly suggest staying away from or getting rid of stocks with a Zacks Rank #5 (Strong Sell) including White Mountains Insurance Group, Ltd. , State Auto Financial Corp. (STFC - Snapshot Report) and Mercury General Corp. (MCY - Snapshot Report) .  

However, there are plenty of reasons to be optimistic about U.S. P&C insurers’ long-term prospects. The industry has been undertaking several structural changes that will make underwriting and pricing schemes even more attractive to consumers. If one can look past the near-term clouds over the industry, buying some P&C insurance stocks based on a favorable Zacks Rank would be a prudent decision now.

We particularly recommend Allied World Assurance Co Holdings, AG. (AWH - Snapshot Report) and National Interstate Corp. (NATL - Snapshot Report) with a Zacks Rank #1 (Strong Buy).

Stocks in our U.S. P&C insurance universe with a Zacks Rank #2 (Buy) currently include Cincinnati Financial Corp. (CINF - Analyst Report) , First American Financial Corp. (FAF - Snapshot Report) and ProAssurance Corp. (PRA - Analyst Report) .

Check out our latest U.S. Insurance Industry Outlook for more on the current state of affairs in the overall insurance market.

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