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Insurance sector remains on solid credit footing

| January 25, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Standard & Poor’s hosted a conference in NYC to discuss the insurance sector as broken-up into the four main segments: P&C, Reinsurance, US Health Insurance and Life Insurance. The key take-away in our view is that insurance companies have generally done well coming out of a low-rate environment and into high-loss years with still-strong credit fundamentals.

  • Property & Casualty (P&C) has survived two successive years of the biggest loss and occurrence from natural disasters, yet has strong capital and liquidity, which has been supportive of ratings. Capital levels have been built up on strong earnings and limited share buy-backs, which is due to the high price/book of many P&C companies. Earnings have been driven higher on better investment income, which is largely focused in NAIC Level 1 & Level 2 holdings (investment grade debt). Higher interest rates should also help to improve revenues in the coming quarters. S&P has actually revised its rate-hike estimate to two hikes from three in 2019. Lastly, higher pricing is expected to also help the P&C companies, though only modestly as pricing may not increase in reaction to losses in 2017-2018 at the same level that was seen in prior era.
  • Reinsurance also beset by large cat losses in 2017 & 2018 has been held back in pricing increase partially due to a competitive landscape. As of January 2019 pricing is only up 3% from the year-earlier period, which on its own may not pay for another big-claims year like the two before it. S&P is also concerned with the cost of capital for reinsurers, as this sector may not earn its effective cost of capital with projected ROE for 2019 in the 5-6% area. Underwriting is clearly helping these companies, as S&P points to the combined ratio for reinsurers for the 9M18 period as being down to 93.9% from 113% in the year-earlier period. S&P thinks the CR will be closer to 98-99% in FY19.
  • Health Insurance is viewed as stable by S&P due to favorable business conditions and minimal legislative agenda on the horizon. This however helps offset concerns with what has been a very active M&A push with health insurers with non-insurance consumer companies. This may also bring more policy risk and the rise of more legal challenges.
  • Life Insurance epitomize the “high capital / strong earnings” model for insurers, and suits these companies well coming into a higher interest rate environment. Sales of investment products into variable annuity products has picked-up in the 9M18 period vs the year-earlier period partially as these providers have improved pricing and hedging risks. However the NAIC is expected to have rule changes for capital charges and reserve levels for variable annuities as of 2020. Nevertheless, S&P has stable or positive outlooks on over 90% of the rated life insurance segment, which highlights the solid credit support of this business.

Citigroup fixed income investor call had zero tough questions; boring is good

Almost as a sure sign that the SIFI banks are rock-solid, or the fixed income investor community is asleep at the wheel, there was no challenge to Citi management on the FI call hosted Jan 24th. There was an interesting market reaction to the statement management made with regard to the unsavory LIBOR replacement terms in the Citigroup preferred indentures. The market bid-up the Citigroup preferred securities following the call simply on the claim that Citigroup is evaluating how to best cure the problem and will most likely take the broadly used substitution terms stated by peers. Currently there is no fix to the problem for investors of these notes, as the replacement language has said that if LIBOR is not quoted, then the reset rate will go back to the original level at the time of the issuance of the notes. This concern has been addressed many times in the past and expectations are that Citigroup will adopt the Street convention or else risk the ire of its bondholders who hold not only the preferred securities, but also the unsecured corporate bonds. So why the big price move on more clearly stated intentions? Part of the discount for Citigroup preferred notes is also a technical matter, in that Citigroup issued far more in this part of the cap structure in recent years vs peers because Citi started with no preferreds coming out of the financial crisis. Citi took the dubious steps to convert legacy preferred notes into common equity in the crisis, so getting to its current level of financial strength is all the more impressive.

As highlighted in the Bank/Finance 2019 Outlook piece in late December, the best preferred play remains in the high-reset, near-term callable notes. Citigroup has some of the highest floating resets, which makes their complex all the more appealing.

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