Oct. 26 2018 — The federal tax reform President Donald Trump signed into law in December 2017 should help provide for an extended period of P&C industry profitability in 2018 and beyond as companies benefit from the lower corporate tax rate, but the impact is not limited to after-tax profitability. Actions by several prominent European-headquartered insurers to change the way certain of their U.S. business is reinsured materially impacted premium growth rates in the first quarter of 2018 and are likely to affect full-year results.

1 quarter does not a trend make

Historically strong results for the State Farm group in the first quarter
helped drive favorable comparisons in several key measures of underwriting profitability. To the extent the improvement continues for State Farm — the industry’s largest group based on direct premiums written — it could provide an additional tailwind for 2018 and beyond.

While there is a risk of recency bias in reading too much into a single quarter’s worth of data, the industry was already positioned for improved underwriting results in 2018. The second half of 2017 saw elevated catastrophe losses as the United States was hit by three landfall-making hurricanes and an unusual spate of fourth-quarter wildfires in California. Projected results for 2018 and subsequent years, all of which show combined ratios of less than 2017’s total of 103.5%, assume a normal catastrophe load.

Auto repairs in progress

Competition will remain intense in certain non-auto business lines given ample reinsurance capacity, high levels of industry capitalization and a macroeconomic environment that remains characterized by relatively slow growth in gross domestic product. Though modestly higher business volume driven by that economic expansion will help offset downward pressure on premiums, the industry will be challenged to achieve profitable top-line growth.

Trends in litigation will increasingly weigh on underwriting results in several business lines, including professional lines and the Florida homeowners business. They also could lead to greater demand for coverage, particularly for new and emerging risks.

The macro view

A rising federal funds rate and 10-year Treasury yields that have reached seven-year highs bode well for an industry that has long been suffering from low interest rates. And the relief cannot come quickly enough after the industry’s net yield on invested assets slipped to a new low of only 3.03% in 2017. Though projected results provide for increasing yields from that floor, the improvement will still take place gradually and is unlikely in and of itself to materially impact how companies are underwriting business

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The projections reflect various assumptions regarding premiums, losses and expenses. They are a product of a sum-of-the-parts analysis of individual business lines that is informed by third-party macroeconomic forecasts, historical trends and recent market observations that include first-quarter 2017 statutory results and anecdotal commentary about market conditions. Projected results are displayed on a total-filed basis and are not intended for application to individual states, regions or companies. S&P Global Market Intelligence reserves the right to update the projections at any time for any reason.

Aug. 29 2018 — Bankruptcy Summary

Poundworld Retail Ltd (Poundworld) is a discount store operator located in the United Kingdom that on June 11, 2018, while operating around 350 stores, filed for administration in order to work to find a buyer for the chain¹. S&P Global Market Intelligence’s Fundamental Probability of Default (Fundamental PD) increased nearly fivefold from 1.69% (an implied credit score of ‘bb-’²), a level that was better than the median general merchandise store in the U.K., to 10.39% (an implied credit score of ‘ccc+’) between fiscal year (FY) 2015 and FY 2016. To summarize, the increased Fundamental PD is similar to a credit score decline from ‘bb-’ to ‘ccc+’. The following year between FY 2016 and FY 2017, the Fundamental PD increased nearly 72% from 10.39% to 17.84% (an implied credit score of ‘ccc-’).

As of the reporting date November 10, 2016 for the period ending March 31, 2016, 19 months before the company filed for bankruptcy, Poundworld fell into ‘ccc’ range and was unable to recover. Poundworld’s inability to recover was due to competing in an increasingly competitive discount retail environment where there was less foot traffic to traditionally populous town centers and exchange rate pressure due to importing goods while the pound was weaker than the dollar³. This resulted in increasingly narrow margins, higher leverage, and decreasing profitability.

Exhibit 1: Fundamental PD Escalation

Business Description

Poundworld operates a chain of discount department stores in the United Kingdom and sells products through its online shop. It offers food and drinks, cleaning and laundry products, health and beauty products, home products, garden and outdoor supplies, pet care products, electrical products, stationery items, toys, baby products, party and gift products, and leisure time products. Poundworld was founded in 1974 and is based in Normanton, United Kingdom.

Fundamental Probability of Default Analysis

The analysis of S&P Global Market Intelligence’s one-year Fundamental PD reveals Poundworld had consistent implied credit scores in the ‘single b’ range for 10 of its 13 reporting periods from FY 2005 to FY 2017⁴. In the time after FY 2012 the volatility of the implied credit scores increased in response to the volatility of Poundworld’s net income. As recently as FY2015, Poundworld, with a PD of 1.69% (implied credit score of ‘bb-‘), sat in the top half of UK general merchandise stores. However, in FY 2016 the company fell into the worst 25% of its UK peers with a PD of 10.39% (implied credit score of ‘ccc+’), roughly a year and a half before filing for administration. Subsequently, in FY 2017, it approached the worst 10% of its UK peers with a PD of 17.84% (implied credit score of ‘ccc’). This shows a notable escalation in risk, both on an absolute basis and with respect to its peers.

The Fundamental PD as of August 16, 2017 for the reporting period ended March 31, 2017 (FY 2017) highlights business and financial risk were significant problems for the company with vulnerable and highly leveraged scores, respectively. The most noteworthy factors contributing to the increased PD were total revenue, profit margin (net income to total revenue), a ratio of how much of every dollar earned is kept within the company, and current liabilities to net worth, a measure of how leveraged the company is/how much debt is used to finance the business. Poundworld experienced a revenue growth rate decline of 57.15% between FY 2015 and FY 2016 from 22.32% to 9.56% with a subsequent decline of 40.88% ultimately ending with a profit margin of 5.65% by FY 2017. As revenue growth for Poundworld slowed, the company became exceedingly leveraged. The average current liability to net worth ratio between FY 2013 and FY 2017 was an extraordinary 667%, signaling the company was unable to pay off debt obligations that were due within a year. In addition to the increasing leverage, Poundworld was battling diminishing profit margins until they eventually became negative, with an average profit margin of -0.02% between FY 2013 and FY 2017. Poundworld’s illiquid position made the company particularly vulnerable to the other operating expenses which totaled approximately £9MM in FY 2016 and FY 2017, which only carried the company closer to the brink of bankruptcy.

^{Source: S&P Global Market Intelligence as of July 19, 2018. For illustrative purposes only.
Note: Current Liabilities to Net Worth ratio in FY 2017 is actually -1317%, but the model assumes the worst possible profile and assigns the value of 10842%}

^{Source: S&P Global Market Intelligence as of July 19, 2018. For illustrative purposes only.}

^{1 Unless otherwise noted, all information sourced from the S&P Capital IQ platform as of July 24, 2018.
2 S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD scores from the credit ratings used by S&P Global Ratings.
3 Source: Financial Times, Poundworld files for bankruptcy, as published on June 11, 2018. https://www.ft.com/content/5f00154e-6d54-11e8-852d-d8b934ff5ffa
4 Source: S&P Capital IQ platform as of July 24, 2018.}

Aug. 28 2018 — Despite a wealth of conceptual applications for blockchain, U.S. insurers do not appear as engaged with the technology as their counterparts overseas. But if initiatives in Europe and Asia prove successful, U.S. insurers may plunge more deeply into the blockchain waters.

There is no shortage of thought experiments around how blockchain — and distributed ledger technology more broadly — will revolutionize the insurance industry. These include smart contracts, fraud detection, claims prevention, proof of insurance and product authentication. Insurers overseas have made significant progress with blockchain technology, including a consumer application for flight delay insurance and a commercial platform for marine insurance. But activity on the part of U.S. insurers is less apparent.

Conference calls provide a useful barometer for a company's interest in blockchain, as they indicate that executives are thinking about it. When startups try to introduce new technology, one of the common hurdles they cite is a lack of commitment from those with decision-making power at incumbent institutions.

When we published research in April on how U.S. financial services companies are using blockchain, we found roughly 40 transcripts since the start of 2015 from publicly traded U.S. banks that mentioned "blockchain," versus only three from insurance underwriters. Publicly traded banks greatly outnumber insurers in the U.S. But insurers also lagged broker/dealers and asset managers in terms of transcripts, and those sectors each have fewer publicly traded companies than insurance. For this piece, we expanded our transcript analysis to include global insurers, which offered a wealth of information. Many more European insurers discussed their projects than companies in other regions, despite there being about half as many publicly traded insurers in Europe as in the U.S. and Canada region.

One project that caught our attention in the European market was Axa's Fizzy. The flight insurance product uses smart contracts written to the Ethereum blockchain and automatically pays a claim if a passenger's flight is delayed more than two hours. Axa launched Fizzy in September 2017 and at the time offered coverage for only a few routes a day. As of mid-June 2018, Axa had expanded the app to 5% of worldwide routes. But merely the fact that it launched is noteworthy, as many projects from other companies, both in and outside the insurance realm, remain in proof-of-concept mode.

Ping is king

While European insurers collectively discussed blockchain on the most number of conference calls, Chinese insurer Ping An Insurance (Group) Co. of China Ltd. took the top spot in our ranking of individual insurers.

Ping An considers blockchain one of its five core technologies, as executives mentioned during an investor day in November 2017; the others are biometrics, big data, artificial intelligence and cloud computing. One of its main initiatives was the creation of a blockchain-as-a-service platform, which provides services to small and medium-sized enterprises that want access to the latest technology.

Come together

While they might not be as forthcoming about their internal projects, a number of U.S. insurers have discussed their membership in consortium initiatives. One of these is The Institutes RiskBlock Alliance, or RiskBlock for short, which works with underwriters and brokers to develop blockchain applications specifically for the insurance industry. Europe is also home to a consortium that has been generating buzz: Zurich-based B3i. Short for Blockchain Insurance Industry Initiative, B3i began as an industry collaboration but in March announced that it was becoming an actual legal entity, incorporating itself as B3i Services AG.

The bottom line

While it is possible that U.S. insurers are more secretive about their blockchain plans than other industries, they are more likely taking a wait-and-see approach. The fact that insurers in other areas of the world are experimenting with the technology and even launching apps supports this assessment.

Right now seems like a make-or-break moment for distributed ledger technology, as projects across multiple industries are going from proof-of-concept to live implementations. Perhaps if those bear fruit it will compel U.S. insurers to further embrace the technology.