OLDWICK, N.J.--(BUSINESS WIRE)--During the latter part of 2016 and through early 2017, the U.S. economy has shown signs of improving health, and the optimism reflected in the equity market gains has been accompanied by initial signs that prevailing interest rates are finally increasing to a level that may augment investment returns. Should this improvement prove sustainable, it would elevate the United States out of the low interest rate doldrums that have persisted for several years.
The latest Best’s Special Report, titled, “Balance Sheet Debt and Financial Leverage Decline for Publicly Traded P/C Companies,” states that this low interest rate environment, combined with the high level of competition in the property/casualty (P/C) insurance marketplace and weakening cash flow over the last several years, has prompted P/C insurers to examine their use of capital rather than chase underpriced business with minimal “float.” Furthermore, it has led insurers to utilize debt issuances to lower the cost of capital, facilitate product or geographic expansion efforts, raise capital for strategic acquisitions and fortify their balance sheets by replacing higher-cost debt with lower-cost alternatives.
P/C insurers continue to utilize debt financing for various strategic reasons. Based on a compilation of 42 publicly traded P/C insurers, aggregate financial leverage encompassing both long-term and short-term debt issuances has actually plateaued in recent years, after declining noticeably to around 25% at year-end 2012, from almost 50% at the beginning of 2009. This decline corresponds to the years immediately following the financial crisis. The aggregate debt-to-capital ratio has fluctuated modestly within the 22% to 25% range since the beginning of 2013.
While the decline in financial leverage for P/C companies in the aggregate has helped keep interest coverage manageable, any potential global macroeconomic instability could have a ripple effect on the P/C industry. This could present a distinct challenge to P/C insurers looking to sustain the generally favorable underwriting and operating results that have been generated over the past few years. Any appreciable degree of operating margin compression will compel P/C companies to focus even more on the need to fine tune their capital and remain dedicated to core operating strategies. That will generate the best opportunities to withstand market uncertainty and effectively balance financial leverage with the ability to fund debt payment obligations from internally generated bottom line profits. Although stock market indexes hit record highs late in 2016, the P/C industry continues to maintain very manageable common stock leverage and is somewhat insulated should some degree of market correction be forthcoming in 2017. The lower degree of long-term debt on P/C company balance sheets in comparison to debt levels just prior to the 2008 financial crisis should help offset the impact from any further increase in interest rates.
To access a copy of this report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=259289.
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