U.S. P&C insurer profits challenged by investment prospects: Fitch Ratings

Declining investment yields are among the most considerable operating challenges facing property and casualty insurers in the United States heading into 2016, credit ratings and research firm Fitch Ratings said on Wednesday.

Yields in insurers’ investments “fell again in 2015 and will likely fall further in 2016 unless long-term rates meaningfully rise,” Fitch Ratings said in a press release.

Still, Fitch maintains a stable outlook on the U.S. P&C sector in part due to strong capitalization from lighter-than-average catastrophe events. However, the industry’s revenue production is dogged by premium rate competition in most segments and limited revenue growth in a still-recovering economy, Fitch said. These factors, combined with weak investment yields, mean that P&C profits will be under pressure in 2016.

Declining interest rates have steadily eroded portfolio investment yields in high-quality, fixed-income securities for years. In aggregate, the industry’s statutory portfolio yield (investment income/average invested assets) has declined by 140 base points (bps) over the last decade to 3.2% at year-end 2014. Lower investment yields mean there is greater pressure to produce underwriting profits to generate an adequate return on capital, the release added.

An analysis of statutory bond portfolios for a group of large insurers that represent over 60% of industry fixed-income holdings shows that the coupon rate of maturing bonds in 2015 and 2016 is 4%, Fitch said.

The U.S. Federal Reserve’s recent increase of the Fed Funds target rate, and anticipation of further increases in 2016, may promote some stabilization of portfolio yields, Fitch suggested. However, how rate hikes affect credit fundamentals and the longer end of the yield curve is yet to be determined. It is also uncertain how new issue yields in the investment-grade corporate and municipal bond markets, favoured by P&C insurers, will react to future Federal Reserve actions.

“P/C insurers’ total investment return is unlikely to meaningfully rebound in the near term as any upward interest rate movement will reduce values of fixed income holdings,” Fitch concluded. “Outsized equity returns that could offset the effect are not likely, given current market valuations and still mixed economic fundamentals.”