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Weak Private Auto Results Could Put P&C Industry At A Loss

Downward pressure on premium writings in select commercial lines of business in combination with escalating private-passenger auto loss ratios through the first three quarters of 2016 may lead to slightly higher full-year combined ratios for the U.S. property and casualty industry in the near term, revised S&P Global Market Intelligence projections show.

In an updated analysis based upon disclosures in the Insurance Expense Exhibits of U.S. P&C insurers' annual statements and informed by quarterly statement data, S&P Global Market Intelligence projects the industry's 2016 statutory combined ratio will increase to more than 100.2% from 97.6% in 2015 before improving slightly to 99.1% in 2017 and 98.8% in 2018.

A previous analysis published in July 2016 concluded that the industry's 2016 combined ratio would approach — but remain below — 100% for a fourth consecutive year, followed by modest improvement in 2017 and 2018. Since then, however, certain trends emerged in quarterly data from both top- and bottom-line perspectives that lead to a more cautious near-term outlook for underwriting profitability.

None of them have been more consequential than continued increases in private-passenger auto loss ratios. But slower-than-originally expected premium growth rates in other business lines such as workers’ compensation and the marine lines also may impact certain key statutory income statement metrics.

Auto woes

S&P Global Market Intelligence projected that the private-passenger auto business was in store for one of its most challenging years since the turn of the century in 2016. Quarterly data for the first nine months of 2016 has only served to amplify those concerns.

The private-passenger auto liability direct incurred loss ratio for the first nine months of 2016 increased to 73.3% from 69.4% in the year-earlier period. For the trailing 12 months ended September 30, 2016, the loss ratio climbed to 73.7% from 70.1% during the comparable year-earlier period.

In auto physical damage, which historically is heavily weighted to personal auto, as opposed to commercial auto, business, the direct incurred loss ratio for the first three quarters of 2016 increased to 67.7% from 63.4% in the year-earlier period. The trailing-12- months result of 67.5% for the period ended September 30, 2016, represented a rise from 63.3% on a year-over-year basis.

S&P Global Market Intelligence originally projected that the private-passenger auto liability net loss ratio would increase to 70% in 2016 from 69.1% in 2015 before improving to 68.6% in 2017. Given that the direct results have demonstrated greater-than-expected deterioration from an already elevated level, the revised projections suggest net loss ratios in the private-passenger auto liability line of 72% in 2016 and 70.1% in 2017, with the latter figure assuming improvement off the higher base.

In private-passenger auto physical damage, revised projected net loss ratios of 66.6% in 2016 and 65.3% in 2017 mark increases from levels originally projected of 65.1% and 63.2%, respectively.

Updated U.S. P&C industry combined ratio outlook

Across both lines, the projected net loss ratio increased to 69.8% from 68% for 2016 and to 68.2% from 66.4% for 2017. The projected private-passenger auto combined ratio of 106.9% for 2016 would represent a third-consecutive annual increase, and it marks a jump from an originally projected value of 105.1%.

All else being equal, a one-percentage-point increase or decrease in the projected private-passenger auto net loss ratio for 2016 or 2017 would add or subtract 38 or 39 basis points from the projected P&C industry combined ratios for the respective two years. Given that the newly projected 2016 private-passenger auto loss ratio is 183 basis points higher than the previous projection, the business can be held almost entirely responsible for the 75-basis point increase in the P&C industry-level combined ratio projection for the full year.

Investment relief possibly on the way

The challenges facing the auto business are all the more acute in an environment that continues to be characterized by low investment yields.

Though the 10-year Treasury note closed Dec. 30, 2016, at a yield of 2.45%, up from 1.49% at midyear 2016 and 2.27% at year-end 2015, it will take further improvement for P&C insurers to begin to benefit from higher rates. The P&C industry’s net yield on invested assets for the third quarter of 2016 and the first nine months of the year was a meager 2.98%, down approximately 16 basis points in both cases from the year-earlier period.

The industry's net yield on invested assets held relatively steady in 2015 at 3.19%. The projected net yield on invested assets for full-year 2016 remains at 3.07%.

Projections for 2017 through 2020 contemplate annual net yields on invested assets in the low-3% range, but those may prove overly conservative particularly for the out years should the rally in Treasury yields continue. The third-party macroeconomic projections that underpin the P&C industry projections do not yet reflect a higher level of growth in gross domestic product that would favor higher interest rates.

Top-line pressure

S&P Global Market Intelligence's outlook continues to be premised, in part, upon the notion that the industry will continue to exhibit disciplined underwriting as the challenging investing climate increases the importance of underwriting profitability from a bottom-line perspective.

But even though the 2016 and 2017 projections for growth in direct premiums written at the industry level of approximately 3.7% and 3.6%, respectively, are only marginally below those previously estimated, there were more material changes present in the top-line outlook for several key lines.

The updated projections contemplate faster growth in direct premiums written in private-passenger auto liability, but slower expansion in workers' comp and the combination of the ocean and inland marine lines based on sluggishness evident through the first three quarters of 2016.

S&P Global Market Intelligence now projects 2016 growth in personal lines direct premiums written of 5.4%, up from 5.2% as originally projected, to reflect the revised private-passenger auto outlook. In the commercial lines, meanwhile, the revised projection for direct premiums written growth of 1.9% marks a decline from 2.3% as previously forecast.

Private-passenger auto liability direct premiums written expanded by nearly 6.8% during the first three quarters of 2016 as compared with growth of 3.4% in the year-earlier period. For the trailing-12-month period ended Sept. 30, 2016, the growth rate of 6.1% compared favorably to the year-earlier result of 3.6%. The revised full-year 2016 projection for direct premiums written growth in the line of 5.4% marks an increase from an original projection of expansion at a 3.8% rate.

A continued push by carriers to implement rate increases in response to elevated loss ratios likely has contributed to the higher levels of written premium. S&P Global Market Intelligence's RateWatch application shows a cumulative approved private-passenger auto liability rate change of 7.2% in 2016 from the states from which data is available, up from 5.2% in 2015.

Workers' comp direct premiums written increased by only 1.7% during the first three quarters of 2016 and 2.4% during the trailing-12-month period ended September 30, 2016. The growth rates in the respective year-earlier periods were 6.2% and 5.8%.

While private-passenger auto rates have been on the rise in response to higher losses, the opposite has occurred in the workers' comp business, which is coming off one of its strongest calendar years in recent memory from an underwriting profitability perspective.

The National Council on Compensation Insurance reported in a November 30, 2016 presentation that voluntary market filings for the 2016-2017 filing season in which it requested a rate or loss-cost change of less than 0% outnumbered those in which it requested a change of 0% or greater by a count of 29 to 1. The requested changes ranged from a decline of 14.7% in West Virginia to an increase of 1.3% in Hawaii.

Those figures exclude what the NCCI classifies as "law-only filings," which generally involve requested rate increases or decreases to reflect changes in law from legislative or judicial activity. Primary among those was the 14.5% rate increase in the state of Florida that largely reflected the expected cost impact of the Florida Supreme Court's April 2016 decision in Marvin Castellanos v. Next Door Co. et al, which eliminated statutory caps on claimant attorney fees in certain circumstances.

The NCCI originally filed in May 2016 for a rate increase of 17.1% to take effect August 1, 2016, for new, renewal and in-force policies. Its revised filing as approved by the Florida Office of Insurance Regulation was scheduled to take effect December 1, 2016, though it is subject to legal challenge.

The original 2016 projections anticipated some benefit from the proposed rate increase in Florida, which ranked as the No. 6 state for workers’ comp direct premiums written (or No. 4 when excluding the impact of business produced by entities classified as state funds)

Limitations and caveats

Historical data and projections reflect the U.S. P&C industry as consolidated by S&P Global Market Intelligence, excluding companies under coverage as state funds or residual markets as well as select other entities.

Quarterly statement data differs in a number of material respects from annual statement results. The insurance expense exhibit and reserving information on Schedule P are only included in annual statements. Line-of-business-level disclosures in quarterly statements are limited to data regarding premiums written and earned and losses incurred on a direct basis.

As such, this analysis seeks to balance learnings from the limited information contained in quarterly statements with the more complete set of data available from 2015 annual statements. Various anecdotal information obtained from publicly available events and documents such as earnings conference calls, investor presentations and select third-party research also contributes to the outlook.

In addition, there are a number of variables not reflected in the projections that could materially impact results for 2016 and future years.

In the fourth quarter of 2015, for example, American International Group Inc. announced a significant charge  to increase loss reserves for prior accident years in certain key lines of business that dramatically impacted industry-level underwriting performance in general liability and workers' comp. Other P&C insurers have taken large reserve charges in the fourth quarters of previous years.

Noise associated with the limits of statutory data has also materially impacted full-year results in certain calendar years, particularly as it pertains to the offshoring or onshoring of portfolios of losses and loss adjustment expenses where existing business either flowed into or out of the scope of the statutory data.

The historical results for 2014 and 2015 which are part of the baseline on which the projections are formed have been adjusted to account for the impact of three such transactions that took effect during that two-year period. As noted above, reserve development statistics for the first three quarters of 2016 have been materially impacted by the nature of certain intercompany transactions involving U.S. and non-U.S. subsidiaries of Allianz Group.

The forthcoming inauguration of President-Elect Donald Trump and the change in the political landscape that is expected to result from Republican control of the legislative and executive branches of the federal government may affect P&C insurers’ income statements, particularly given expectations that Congress will pursue corporate tax reform. Given the speculative nature of the prospective timing and contents of such legislation, however, the projections have not been revised to incorporate lower effective tax rates.

The transition of power also could introduce the potential for variability that could impact P&C insurers in ways that are not currently foreseen. Significant and unexpected rallies in the equity market and 10-year bond yields took place in the aftermath of the election.

The potential for natural catastrophes to impact results is less speculative but no less uncertain on a year-by-year basis. Munich Re recently reported that insured natural catastrophe losses increased to approximately $50 billion in 2016 from $32 billion in 2015 and the 10-year average of $45 billion. Swiss Re Ltd. put the 2016 figure at $49 billion, up from $37 billion in 2015.

Hurricane Matthew was the largest individual U.S. insured loss during the year. Although Swiss Re estimated that insured losses in the Caribbean and United States related to the storm topped $4 billion, that figure is well short of values put out by risk-modelling firms of upwards of $30 billion prior to the time it made landfall, based on potential paths under consideration at the time.

Since the projections exclude results reported by residual markets, it is possible that the historical data does not fully capture the insured losses associated with natural catastrophes and it is difficult to predict whether or to what extent future losses of the kind will fall inside or outside of the scope of the analysis.

For Hurricane Matthew, for example, the Florida Office of Insurance reported  that the more than 56,000 claims had been closed and paid by the industry through Jan. 6. Citizens Property Insurance Corp., which is under coverage as a residual market, reported the receipt of more than 3,200 Matthew-related claims as of November 7, 2016.

From a macroeconomic perspective, the projections assume future fed funds rates and 10-year Treasury yields based on a monthly survey of more than 60 economists conducted by The Wall Street Journal as of December 2016 supplemented by data points from the Congressional Budget Office's annual outlook as most recently revised in August 2016. S&P Global Market Intelligence does not forecast changes in interest rates or macroeconomic indicators and aims to project what the P&C industry will look like if the future holds what most economic observers expect.

Historical data is current as of January 11, 2017, and it is subject to change upon the receipt of new and/or amended information. The outlook is also subject to change, based on adjustments to the consensus expectations for interest rates, unemployment and economic growth.

The projections can be updated or revised at any time as developments warrant, particularly if material changes occur, including, but not limited to, changes in the macroeconomic climate, material natural catastrophes, key judicial developments and extraordinary earnings reports. S&P Global Market Intelligence intends to make periodic updates as circumstances warrant.

For a more complete discussion of the methodology employed and the limitations associated with it, please see the 2016 U.S. P&C Insurance Market Report.

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