Fitch: US P&C Firms Capital Adequate to Handle Equity Volatility
Fitch Ratings analysis reveals that US property and casualty insurers can broadly withstand more significant deterioration in global equity market conditions while maintaining capital positions consistent with current ratings.
US P&C insurance companies traditionally allocate a percentage of invested assets to common stocks, which may boost long-run returns, but are also a source of capital volatility. Recent equity market declines and continuing volatility raise questions regarding insurers' capital strength, given their exposures to equity investments.
At year-end 2014, unaffiliated common stock investments represented 18% of P/C industry statutory invested assets and 37% of policyholders' surplus. Concentrations of equity investments in firms' investment portfolios vary widely across individual insurers, with several organizations maintaining a larger long-term asset allocation weighting to common equities or alternative investments with underlying equity exposures.
P/C insurers with the largest exposure to equities (based on year-end 2014 statutory financial statements) are Markel Corp. and National Indemnity Co. (Berkshire Hathaway), with their equity investments representing over 80% of statutory surplus, followed by FM Global (71%), State Farm Mutual Insurance Group (68%), and Cincinnati Financial Corp. (68%). See chart here for a list of equity investment exposures for other large U.S. insurers.
In 2008 a 38% decline in the S&P 500 led to an average 20% decline in surplus for the above five companies, versus an industry aggregate decline of 12%. The declines in 2008 reflected underwriting losses as well as negative investment returns.
In a stress test applying a 35% after-tax haircut on the equity holdings for a group of large US insurers, Markel, Berkshire Hathaway and FM Global could face a 20% decline (or more) in policyholders' surplus. Several other companies could show a decline in surplus of 15%-to-20% in this scenario. A large percentage of companies would experience a more manageable loss of less than 10% of surplus.
Hedge fund reinsurers Greenlight Capital Re, Ltd. (GLRE) and Third Point Reinsurance Ltd. (TPRE) rank among publicly traded insurers with the largest exposure to equity investments relative to shareholders' equity. Estimating the effect of broader stock market declines on these entities is difficult due to the use of more intricate trading strategies that include long/short equity positions and greater use of derivative instruments. Both GLRE and TPRE reported a loss on their investment portfolio of more than 5% for the month of August 2015.
Insurers with above-average equity investment exposures typically maintain capitalization and leverage profiles consistent with 'AA' or better insurer financial strength rating guidelines under Fitch's insurance sector credit factors. In the event of a sharp equity market decline, a primary focus of rating decisions would center on the companies' ability to maintain capital ratios within established rating triggers in rating announcements and reports.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Douglas M. Pawlowski, CFA
Matthew Noll, CFA
Financial Institutions Fitch Wire
+1 212 908-0652
Alyssa Castelli, New York, +1 212-908-0540