Investment Bank Bearish on Insurers

A favorable loss environment the past few years has served to mask underlying financial issues for property/casualty insurers, a new report from Keefe, Bruyette & Woods contends.

KBW’s 2011 Annual P&C Industry Reserve Review is based on 2010 data for the domestic P&C insurance industry as compiled by A.M. Best. This year, the review notes that Berkshire Hathaway Insurance Group,  Travelers Group, and State Farm Group all recorded the favorable reserve development in 2010, but finds industry reserves as a whole slightly deficient. One large contributor to the sector’s underperformance was the performance of American International Group, which reported $5.1 billion of adverse reserve development in 2010.

“P&C insurers have benefited tremendously from favorable loss reserve development in recent years. Undoubtedly, some companies will continue to book favorable development, boosting earnings,” the report states. “However, we believe most P&C insurers will see a drop-off in the earnings benefit they receive from favorable development, and we expect many companies will even need to take reserve charges in the next couple of years.”

Moreover, the report says weaker investment income in the next few years will put new pressure on insurers to achieve positive underwriting results, no easy task in a soft market that may linger for years to come.  “We believe there will be winners and losers in this underwriting environment,” the report states. “In addition to reviewing a company’s operating performance, we caution investors to carefully consider its balance sheet strength (both on the asset side and the liability side) and the track record of its management team when making investment decisions. When the mask of favorable loss reserve development is removed, these factors may very well determine whether or not the company achieves its targeted earnings.