The trailing impacts of premium and loss trends on the books of property/casualty reinsurers makes the 2022 outlook for reinsurers rosier than the profit outlook for primary insurers, a Fitch Rating analyst said yesterday.

Longer term, a prolonged period of inflation in which the CPI (consumer price index) is well above analysts’ expectations for a period of two years or more could put some reinsurer credit ratings in jeopardy, Fitch said separately in a written report published later in the day.

During a webinar summarizing Fitch’s insurance outlooks published late last year, James Auden, managing director for North American non-life insurance ratings, compared the improving earnings pictures for both sectors, noting that the P/C insurance sector has garnered a “neutral outlook” from Fitch compared to an “improving outlook” for reinsurers.

Explaining the distinction, Auden said, “We believe reinsurance is lagged in terms of performance and the pricing cycle.” So, even though reinsurers were hit hard by pandemic-related losses and recent catastrophes—”maybe more than primary markets”—Auden said that Fitch thinks there is “a bit more momentum in pricing there and a bit more potential for improvement in performance in 2022” in the reinsurance sector.

Rating agencies like Fitch offer two types of outlooks for segments of the insurance and reinsurance market: sector outlooks and rating outlooks. “Sector outlooks” are “performance-based outlooks or profit expectations” based on operating fundamentals, Fitch representatives have explained to Carrier Management in the past. “Rating outlooks” describe the possibility of near-terms upgrades and downgrades.

Before Auden gave a rundown of the P/C insurance and reinsurance outlooks, Julie Burke, head of North American Insurance Ratings, and Auden started the webinar noting a change in the language of the outlooks the rating firm is publishing for 2022. Instead of words like “positive,” “negative” and “stable,” the 2022 sector outlooks are either “improving,” “neutral” or “deteriorating. And the sector outlook is a general forward-looking assessment of the underlying business conditions for the sector on a one-to- two year horizon. It is assessed relative to 2021 conditions.”

“It’s no longer a rating outlook. It’s more of a true sector, fundamental outlook,” she said.

Primary Insurance ‘Neutral’

“It was a bit of a close call, but we are neutral” for primary insurance, Auden said, explaining factors that favored an improving outlook for U.S. P/C insurers instead included a Fitch forecast of a 97 or better combined ratio in 2022, compared to an estimated 99 for 2021, and continued favorable pricing in commercial lines. On the other hand, earnings improvement could be tempered by possible action by the U.S. Federal Reserve to increase interest rates, a move that would likely impede the continuation of “three great years of investment performance” for insurers, he said. And on the insurance side, catastrophe losses—”always the largest source of volatility in results”—as well as the impact of economic inflation, which “had a big effect on short-tail lines” in 2021, could impact longer-tailed lines as well if they continue, he said.

Auden said the end of the pandemic is also a factor that will impact P/C insurance losses, with a return to normal levels of economic activity leading to potentially higher claims frequency issues in many lines. With courts reopening, litigation activity will likely revert to normal levels, he said, explaining that this means more activity than experienced in 2021.

Longer-Term Reinsurance Credit Outlook

The title of a separate report focused on the reinsurance sector—”Prolonged Inflation Poses a Risk for Reinsurers But a Short-Term CPI Spike Is Manageable”—summed up the thinking of Fitch analysts about the credit profiles of reinsurers looking beyond 2024.

“An inflation rate that significantly exceeds expectations for at least two years in a row is negative for reinsurers’ credit profiles, but a short-term spike, which is Fitch’s base case, is manageable for the industry,” wrote Robert Mazzuoli, a Fitch director, who co-authored the report with Senior Director Brian Schneider.

Currently, CPI rates are reaching multidecade highs in both Europe and the United States. But while Fitch forecasts a 6.4 percent annual CPI increase at end-2021 for the U.S., the base case assumes that it drops to 2.8 percent at end-2022.

The report notes that higher CPI is leading to higher claims inflation in reinsurers’ short-tailed business lines due to rising repair costs for buildings and vehicles. While reinsurance prices are increasing, too, keeping pace will be a struggle if high claims inflation persists, particularly if pricing starts becoming competitive again as it was in recent years.

Prolonged inflation plus a softening market environment could produce margin pressure in short-tailed lines of business and reserve deficiencies in longer-tail lines, “which in more severe cases would weaken reinsurers’ credit profiles,” the report says.

In addition to lasting two years or more, to be a threat to reinsurer credit profiles, elevated CPI would need to have a “knock-on effect on inflation subcategories” that are relevant for reinsurers—repair cost inflation, medical cost inflation, wage inflation or social inflation—and a softening market environment with strong competitive pressure, reducing the ability to re-price treaties appropriately, the report says.

Primary Sector Line by Line

Back at the webinar, Auden gave a line-by-line breakdown of pluses and minuses adding up to a neutral overall sector outlook for U.S. P/C insurance.

Referring to personal auto, he noted that in addition to claim frequencies rising as drivers headed back onto the roads, “this is one of the biggest lines with the supply chain issues,” impacting the physical damage coverage part through rising costs of auto parts and labor costs for repairs. Through the first nine months of 2021, the statutory direct loss ratio was 10 points higher than for the same period in 2020, he said.

There is better news on the commercial lines side, with carriers benefiting from renewal rate increases of 10 percent, on average, over the last seven quarters, Auden said, citing results from market surveys by the Council of Insurance Agents and Brokers.

Also, in commercial lines, workers compensation continues to be the best performing line, but with rates having been flat to slightly down for some time, and the expectation of a similar rate environment in 2022, inflationary trends could fuel a deterioration in performance, he said. “It’s not just general inflation, but in workers comp [there is] medical inflation” to consider as well. “If we see that flare up, that will lead to sharper reductions in performance in workers comp,” Auden said.