Global reinsurance broker Guy Carpenter recently reported that between 2014 and 2017, the property and casualty (P&C) industry in the US grew its collective capital position from US$686 billion to US$767 billion, at a 3.8% compound annual growth rate.
This expansion in capital, outlined in the broker’s 2018 Risk Benchmarks Research, was achieved during a period when the normalized return profile of the P&C underwriting business was considered to be below the cost of capital.
According to the reinsurer, the expansion of industry balance sheets could be a sign that insurers expect favorable conditions - such as improved pricing and organic growth opportunities as new perils emerge - and they want capital ready to pounce on those opportunities. On the other hand, building up capital cushions could be a sign that carriers are wary of challenges on the horizon, such as rising interest rates, increases in loss severity and frequency, and reserve deficiencies.
“There’s probably a fairly level mix between opportunism and conservatism,” commented Charles Sebaski, head of North American business intelligence at Guy Carpenter. “When you look at what’s transpiring regarding new risks [like cyber] and pricing improvements, these things could certainly be beneficial for the industry.
“However, we would consider the industry as a whole to be quite conservative by nature, and there are some warning signs on the horizon like rising interest rates, rising inflation and increasing claims severity – all of which might coincide with that conservatism and lead to carriers holding on to an additional capital buffer.”
The trend toward higher equity allocation provides carriers with “opportunities for greater returns” on those assets, while also potentially “introducing risks on a statutory accounting basis” to their balance sheets, explained Blake Berman, senior vice president, strategic advisory at Guy Carpenter.
“This [re-evaluation of industry asset strategies] is definitely coinciding with a changing interest rate environment,” Berman commented. “The industry allocation to equities has increased steadily since 2010. If you mark 2010 as a low point, the proportion of equities as a part of total invested assets increased by nearly 50% by 2017, and the level of equities as a percentage of total assets has reached its highest level since 2001.”
According to Guy Carpenter’s 2018 Risk Benchmark Research, the largest asset class held by most carriers are fixed income investments and interest rate sensitive securities such as mortgage backed securities. If interest rates experience a sudden spike, this could adversely impact the value of those assets. Furthermore, interest rates normally track alongside inflation. If inflation rises, this could pose challenges for long-tail liability reserves, making it prudent for carriers to save additional capital and liquidity as a buffer.
“There’s been a continual re-evaluation of asset strategies for carriers since the credit crisis [starting in 2007] and since the prolonged period of low interest rates,” Sebaski told Insurance Business. “Carriers have faced challenges replacing and replicating the yield they used to achieve from a fixed income portfolio because new money yields have persistently been below the run-off or existing yields of portfolios. The industry as a whole has been looking for ways to replace that income, with many opting for higher allocation into equities and alternative private equity.”
The US is slowly seeing some upward movement in the interest rate yield curve. The Federal Reserve System approved three interest rate increases in 2018 and is forecasting some more upward movement this year. Sebaski explained that as the yield curve normalizes, insurers’ allocation towards equity is also likely “to stabilize.”
