The end result of the debate over the U.S. debt crisis will have serious impacts on the insurance industry. With the credit quality of the U.S. imperiled by the current impasse over raising the debt ceiling, "insurance companies are facing increased overall risk on their balance sheets," states A.M. Best in an article by the Insurance Journal.
A.M. Best recently announced the findings of stress testing it performed using its proprietary Capital model, Best’s Capital Adequacy Ratio (BCAR), which examined what impact a U.S. sovereign downgrade would have on the portfolios and financial strength of U.S. insurance companies.
One key finding from the Best review is that "insurers will have to reexamine their underwriting leverage, which they may not be able to maintain at historical levels without adversely impacting their financial strength."
Best argues that since insurers are "large-scale investors in U.S. Treasuries and government-backed instruments, they would experience a larger impact from a decline in the credit quality of the U.S. government than many other industries because of the asset leverage insurers hold."
Therefore, while Best said it "expects a compromise to be worked out to raise the debt ceiling, the probability of a U.S. sovereign downgrade is no longer negligible." Confidence in America’s economic strength has obviously taken a huge hit internationally and therefore the risk inherent in virtually all investments has increased.
Insurance is the practice of risk avoidance, so the debt crisis putting insurers in this precarious position, is not something the industry takes lightly. Thus the concern is well-founded over the tightening of property and casualty underwriting practices.
Property and Casualty Sector
Robert Hartwig, Presdient of the Insurance Information Institute Inc., has said there is "zero probability the United States will default on its debt," and therefore have minimal impact on the Property/ Casualty insurance sector. Hartwig’s comments were made to business insurance.com.
Mr. Hartwig said while there has been a "lot of confusion about what's going on Europe, the U.S. is not Greece." He said revenue flowing into the U.S. Treasury in August will greatly exceed what is needed to make the interest payments on existing debt.
Life Insurance Sector
Best added that while a sovereign downgrade would not, on its own, have a significant impact on the financial strength ratings of insurance companies with adequate liquidity, the situation bears consideration, especially by life insurers.
"The life insurance industry is clearly more adversely impacted than the property/casualty because of its exposure to investment risk through higher asset leverage. In addition to the larger impact to the life industry in this stress test, there are other significant issues the life industry would face (disintermediation, liquidity, etc.).
In addition to the larger impact to the life industry in this stress test, there are other significant issues the life industry would face (disintermediation, liquidity, etc.), A.M. Best reports.”
Best also argues that usually when an economic crisis occurs, "a global flight to quality would cause portfolios to shift away from emerging market assets toward high credit quality assets in the developed world – traditionally to the 'guaranteed safety' of sovereign debt." However in the current situation "of downgraded European countries and a negative outlook on U.S. debt, that is not the case."
