Economic strain on insurers is starting to show

Much has been written and said about insurers’ resilience to the tough economic conditions endured by many of the world’s developed markets over the past four years.

While insurers have certainly fared better than banks, they are by no means immune, and the pressure is starting to show.

Ratings agency Standard & Poor’s (S&P) has downgraded AXA’s financial strength rating to A+ from AA- because of worries that tough economic and investment market conditions will inhibit the French insurance group’s ability to grow its profits.

The downgrade closely followed the agency’s decision to put UK insurance group RSA’s A+ financial strength rating on negative outlook. The RSA action, while less severe than AXA’s, was also related to economic conditions. S&P is concerned that low interest rates will weigh on RSA’s capital, which it contends has already fallen to the BBB range.

The RSA announcement is interesting because S&P had only upgraded its rating to A+ in February because of the insurance group’s “strong capitalisation”.

The big picture

It is important to look at the rating actions in context. An A+ rating from S&P is still good, and neither RSA nor AXA are likely to disappear any time soon. Commercial insurance clients only really start to worry when ratings drop below the A range and into triple B territory – and even then they may continue to use the insurer.

The downgrades do show, however, that stress cracks are starting to appear even in Europe’s strongest insurance groups.

The tough economic climate is hitting the industry on all sides. Clients are spending less on insurance, pushing premium income down, and more claims are being made, pushing loss ratios up. More claims on lower premiums means a higher combined ratio.

In years gone by, insurers were able to tolerate higher combined ratios because they were able to make up any underwriting losses through investment income. But interest rates throughout the economic downturn have been low, meaning that insurers can only expect a pittance from their bond-heavy portfolio of invested assets.

Investing too much in higher-yielding, riskier assets is not an option. Insurers need a relatively benign asset portfolio to offset the risks they are taking on the underwriting side of the business. And there are plenty of examples of the catastrophes that result when insurers take too many investment risks.

Companies like AXA and RSA still have plenty of strength and stamina to last out the crisis. They are diverse global companies with large capital bases and plenty of options. But questions must be asked about how long their smaller, weaker rivals will be able to withstand the pressure.