Best’s Special Report: U.S. Property/Casualty Insurers’ Leverage Ratios Elevated Due to Capital Declines
- January 24, 2023 08:24 AM (EST)
Oldwick //BestWire// - A confluence of factors, including rising interest rates, increased unrealized losses and declines in capital has led to leverage ratios ticking up among U.S. property/casualty (P/C) insurance companies, according to a new AM Best special report.
The Best’s Special Report, “U.S. P/C Insurers’ Leverage Ratios Remain Elevated Due to Declines in Capital,” states that the P/C industry’s aggregate leverage ratio climbed from 19.5% to 23% in the third quarter of 2022 from year-end 2021. Nearly every company saw an increase in their debt to capital ratios in 2022 from year-end 2021 despite most reducing their long-term debt obligations. For the 42 publicly traded P/C companies followed for this study, most kept their appetites for long-term debt in check in 2022, and instead are focused on strengthening and making enterprise risk management (ERM), strong corporate governance, and stress testing capabilities integral to their operations.
“The rising interest rate environment is not only impacting the investing and operating environments for U.S. insurers, but it is also leading to a more cautious approach to capital-raising via debt issuance,” said Helen Andersen, financial analyst, AM Best. “Macro-economic challenges such as inflation and capital markets volatility will likely hamper profitability compared with prior years. However, the shorter duration of bond portfolios may benefit P/C insurers in the rising rate environment because insurers can reinvest proceeds of maturing bonds at the current higher rates.”
According to the report, capital at many companies have notably declined on a GAAP basis. At year-end 2021, nearly one-quarter of invested assets in the P/C industry were allocated to equities, which dropped nearly three percentage points by the third quarter of 2022, driven partially by the stock market downturn, resulting in unrealized losses. Additionally, losses through the third quarter of 2022 have turned the interest coverage ratio negative in aggregate.
The ability to service financial obligations over time is a function of an organization’s ability to generate earnings from operations and maintain adequate capitalization. Uncertainty about the direction and pace of interest rate changes further demonstrates the need for a strong asset-liability matching program and routine rigorous stress testing of insurers’ portfolios. Losses may pressure insurers needing to service financial obligations, but average liquidity across publicly traded P/C companies remains very high despite a decline through third-quarter 2022. Given that the industry follows a hold-to-maturity investment strategy, the unrealized losses and hit to capital only become permanent if companies sell their long-term debt at current discounted market value prices—which is unlikely for those insurers with adequate liquidity and cash flow.
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=328217 .
AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City.