All Primary Insurance Rating Outlooks Now Negative, S&P Says

New York-based Standard & Poor’s changed its rating outlook for personal lines insurers to negative late last week, indicating that ratings downgrades are expected to outpace upgrades over the next 12-to-18 months.

The rating agency also expects the industry overall to record an underwriting loss for 2008, with a property-casualty combined ratio in the 103-104 range for the year, a rating analyst said yesterday.

During a conference call, S&P Director John Iten, explaining the sector outlook revision, said there has been a dramatic change in the distribution of individual outlooks for personal lines insurers rated by S&P. As of mid-November, 26 percent of personal lines insurers now have a negative outlook attached to their ratings, compared to 2007, when no personal lines insurer ratings carried a negative outlook, he said.

Weak operating performance stemming from deteriorating underwriting results and poor investment performance partially explain the individual changes, he noted.

On the underwriting front, he said that while the entire property-casualty industry combined ratio is 105.6, according to a report released by the Insurance Services Office this week, the combined ratio for personal lines insurers is likely one or two points worse.

The negative outlook for personal lines now matches S&P’s outlook for commercial lines, Mr. Iten said during the conference call. He explained that the negative outlook for commercial lines has been in place since August.

While he listed a string of concerns that prompted the August outlook change, Mr. Iten noted some “good news” on the commercial lines side.

Public surveys have showed “a slight moderation in price declines in the third quarter and there is anecdotal evidence that this has continued in the fourth quarter,” he said.

“It’s still too early to call a turn in the commercial underwriting cycle,” he warned, however, explaining why S&P is maintaining the negative commercial outlook. Prior to the August revision, this outlook had been stable since June 2005.

Since November, S&P has downgraded seven commercial lines while upgrading four, with three of the downgrades coming in December. “So the ratings trend clearly has been negative,” Mr. Iten observed.

The distribution of ratings outlooks—“the best indicator of future ratings actions” has moved from 7 percent negative in 2007 to 30 percent negative in 2008.

While the sector outlook reflects ongoing concerns about pricing, as well as third-quarter catastrophe losses, lower investment income and a very substantial increase in unrealized capital losses, Mr. Iten said S&P’s primary concern has been the rapid deterioration in underwriting profitability.

“The pricing cycle has been unfavorable since 2004, and by August we believed that prices had fallen to the point that we really believed that the sector’s underwriting results, which had been favorable for three years, would turn into underwriting losses starting in 2009.”

In light of the recent ISO report, that timetable has been accelerated by this year’s hurricane losses, he said. He predicted the industry will report a combined ratio of 103-104 for the year.

Underwriting results for some companies could be reduced “to the point that operating performance no longer supports current ratings,” Mr. Iten said.

Other factors that could push down ratings for some commercial insurers include:

• Realized and unrealized losses on equities and fixed income investments, which have reduced capital, in some cases below levels contemplated in current ratings

• Capital market constraints making it difficult to raise capital through debt and equity issuance

On the other hand, positive factors include the capital adequacy for most commercial insurers, which was strong leading into 2008, as well as the strength of their reserve positions, which was adequate or somewhat redundant.

Echoing some of the negative comments he made about commercial lines during his discussion of the personal lines sector, Mr. Iten said weak operating performance and reduced financial flexibility prompted last week’s outlook change for auto and homeowners insurers.

Capital positions of personal insurers have been drained away by cat losses, mainly funded by primary insurers rather than reinsurers and by declines in asset value.

While S&P is seeing signs of a turnaround to higher pricing in personal auto, the economic downturn is having an adverse impact. “Fewer car sales [and] fewer houses being sold mean fewer policies being sold,” he said.

The only p-c segment for which S&P maintains a stable outlook is the global reinsurance sector, said Laline Carvalho, also a director. She explained that reinsurers have maintained better pricing discipline and have better enterprise risk management and limited asset exposure to the subprime crisis due to conservative investment postures.