Credit outlook for the North America insurance industry mostly stable: Standard & Poor’s

A resilient economy in the United States is shielding North American credit conditions from increasing risks, while the credit outlook for the insurance industry being stable, notes a briefing issued Tuesday by Standard & Poor’s.

The report is based on S&P credit conditions committees that meet quarterly to review macroeconomic conditions in four regions, including North America.

“The world’s biggest economy seems to be on the path of sustainable growth, even after a slight contraction in the first three months of the year,” the briefing notes. “The continuing expansion of the U.S. economy and still favourable financing conditions should support stable North American credit conditions for the remainder of the year,” it states, but adds “the region is facing increasing risks, among them the potential for credit markets to become more volatile.”

Citing a Greek exit from the Eurozone, a default by Puerto Rico and the increasingly volatile Chinese stock market, “nevertheless, we currently view these risks as manageable and don’t expect them to disrupt the flow of credit to North America’s economies,” S&P reports.

With regard to North American insurance trends, “our assessments of insurer’s business conditions and their credit outlook are mostly satisfactory and stable, respectively,” the briefing states. “The group’s credit quality remains strong overall, with potential for upward and downward movement in the mortgage and reinsurance sectors, respectively.”

Looking specifically at reinsurers, the briefing states current business conditions (for the next 12 months) are weak, business conditions outlook (for the next 12 months) is somewhat weaker, and the sector outlook is stable to negative.

“We believe competitive pressures will remain heightened for reinsurers, and we don’t expect that the recent spate of consolidation will alleviate that burden,” the briefing notes. “In fact, we believe this trend toward greater scale highlights how hard it will be for management teams to defend their market positions. Premium rates for reinsurance contracts have continued to decline with no relief in sight.”

With regard to property and casualty, the briefing states current business conditions are satisfactory, there is no change in business conditions outlook, and the sector outlook is stable.

S&P reports insurers have seen premiums soften following a period of hardening rates that began in mid-2011. “Nevertheless, we believe that their pricing is adequate,” the briefing states. “The strong dollar is causing some foreign-exchange losses, but these have not been material yet, and insurers have been matching their local assets and liabilities. Low inflation has also been good news for p&c insurers because it reduces concerns regarding their adverse reserve development,” S&P explains.

That said, the briefing notes that inflation must be closely watched because higher prices can inflate claim costs faster than p&c insurers can update their premium rates. “Higher inflation that accompanies increased interest rates may also affect asset valuations. We, therefore, believe that inflation represents a medium-to-high risk for the P/C insurance industry, especially to longer-tailed lines of business such as general liability and workers’ compensation.”

Other findings in the report include the following:

• resilient private spending is returning the U.S. to sustainable growth, while large consumer debt burdens and struggling energy markets are impairing Canada’s recovery;

• U.S. banks will need to manoeuvre around an evolving regulatory environment, as well as competitive pressures that could loosen underwriting standards and, over time, lead to higher loan losses; and

• still struggling with a strong dollar, U.S. non-financial companies are pursuing mergers and acquisitions to find new revenue sources.

“Because most sectors are seeing limited potential for organic revenue growth due to the U.S.’s nominal GDP growth prospects, mergers and acquisitions (M&A) continue to be a popular alternative given the continued favourable financing conditions,” notes the briefing.

“With the ability to improve margins through ongoing cost reductions facing diminishing returns, companies are increasingly turning to potential synergistic acquisitions in order to increase their revenues. As such, we anticipate robust M&A activity for the remainder of 2015 with companies ‘purchasing revenue streams’ and then quickly eliminating cost redundancies in order to increase their revenue and margins,” S&P adds.

“The sharp drop in oil prices (and the cost of gasoline) – while not a happy story for the borrowers that we rate in that industry – is a net positive for the economy because it puts more cash in consumers’ wallets,” the report states. “We expect paychecks to continue climbing gradually this year as the job market tightens further, encouraging more consumer spending.”

In Canada, “economic recovery has stalled for the first time since 2011, as the country’s real GDP declined by 0.6% in first-quarter 2015. As expected, sharply lower oil prices reduced business investment, increased unemployment, and cut workers’ income in the country’s oil-producing regions. Consumers reacted by reining in their spending, notably by purchasing fewer motor vehicles, and saving more,” the briefing notes.

“Consumer spending should rebound going forward as the severe winter weather in the first quarter likely reduced consumers’ willingness to shop. However, we think that concerns about job security (especially in Canada’s oil-producing regions) and, more generally, the large consumer debt burdens across the country will limit the growth in consumer spending to just 2.1% in 2015 (down from 2.7% last year),” S&P adds.

The company’s real GDP growth scenarios for Canada (forecast) are as follows:

• baseline forecast: 2015 – 1.8%, 2016 – 2.3%, 2017 – 2.5%;

• upside scenario: 2015 – 2.3%; 2016 – 2.9%, 2017 – 2.8%; and

• downside scenario: 2015 – 0.4%, 2016 ¬ 1.0%, 2017 ¬ 1.5%.

The briefing notes that S&P credit conditions committees are monitoring the following top North America regional risks:

• contagion from Puerto Rico’s debt problems that leads to credit market volatility and a broader repricing of risk for U.S. municipal debt – risk level is moderate while risk trend is increasing; and

• a contraction in consumer wealth from a sharp housing market correction that leads Canada back into a recession – risk level is moderate while risk trend is increasing.