Risky Business: Insurance Outlook 2025

Ed Martin: I'm Ed Martin, head of Insurance Strategy for Allspring Global Investments. Welcome to SpringTalk. Today, I'm speaking with Matt Cox, who is a senior credit analyst covering the U.S. insurance industry for our fixed income teams.

Matt Cox: Hi, Ed. Thanks for having me. Looking forward to it.

Ed Martin: We both cover the insurance industry—Matt from the perspective of a credit analyst, and I work with our clients who are insurance companies. So, I'm looking forward to comparing notes. Matt, you just got back from two industry conferences this week and heard from management on fourth quarter earnings calls. Has anything surprised you or stood out versus what you expected to hear?

Matt: I would say there weren't a lot of significant surprises, but maybe I'll try to hit on one or two areas for each of the sectors I cover. So, for the P&C (property and casualty) insurers, the positive surprise was probably the most significant one: the limited impact of the recent catastrophes. We had a fair amount of confidence that risk management had improved, but it was pretty impressive to see that we didn't really have any major blowups coming out of either the hurricanes that hit the Southeast last year or the California fires. On the negative side of things in P&C, we did continue to see reserve charges and casualties, so we'll continue to keep an eye on trends in that space. In terms of life insurance, I’ll probably talk about just one trend that's been pretty significant in the sector and that’s the establishment of offshore reinsurance subsidiaries in the life space. Offshore reinsurance is not a new phenomenon for the sector, but it's getting pretty hard to find any life insurance companies that don't have an offshore reinsurance subsidiary. That move has caught the eye of the regulators and certainly was a topic of discussion at the insurance conference that I attended this week. There's a strong consensus view among the insurers that Bermuda is not going to be viewed as problematic, though, because Bermuda does have Solvency II equivalence. And so, they feel that the regulators should be comfortable with that. The area where they're less confident is looking at jurisdictions outside of Bermuda because the regulation there is much less stringent. Finally, just looking at the health insurance companies, the biggest surprise there has been the bipartisan regulatory pressure on the health insurers at this point, whether that comes in the form of scrutiny of the PBMs (pharmacy benefit managers) that are owned by the health insurers or by just looking at things like the House's budget resolution, which has called for some pretty massive cuts to the Medicaid business.

Ed: That's great. Let me ask a few follow-up questions. Let's start with P&C. The property and casualty industry was really in the spotlight earlier in the year because of those horrific fires. It seemed like the insurance industry might be severely impaired, but even the most exposed companies seem to have bounced back. From a credit perspective, how do you assess the strength of the industry, given the recent catastrophes?

Matt: The California fires were obviously a very tragic event and, from an insurance standpoint, had the negative impact of causing a capital hit well before we would typically see this kind of loss. But there is a little bit of a silver lining to it all from a credit perspective. I think these events really demonstrate the resilience of the P&C industry and some of the risk management that's been put in place by the sector. Despite really significant insured losses from the events, I can only think of one P&C insurer from my coverage that’s seen ratings pressure as a result. I think this is a credit to overall risk management and, maybe more specifically, the appropriate use of reinsurance to manage risk.

Ed: After you had a chance to absorb this information, what was our stance on some of those companies that were writing insurance in that area?

Matt: We really kind of stepped away from the media reports and took a little bit more of a measured view from a credit perspective. So, ratings certainly are not everything. We do our own independent evaluation, but it's important to think about how the ratings agencies think about this. There are a lot of factors that go into ratings, but as a general rule, the ratings agencies tend to look past catastrophes unless an insurer really has an outsized loss that would show some weak risk management or if the insurer experiences a decline in their shareholders’ equity that's more than 10% on a rolling 12-month basis. So, even when you look at the 2024 hurricanes and then add the fires on top, I still couldn't get to a number where these insurance companies were at risk of a 10% drop in shareholders' equity. As a result, we made very, very limited adjustments to our exposures at the time of the fires. With that said, we realize these fires have used up a significant portion of these insurers’ catastrophe budgets for the year. We're certainly paying close attention to the comments coming from management, whether it's about capital allocation or risk management—especially as we head toward hurricane season. But I can tell you, I've had conversations with the management teams and really everybody I've talked to says that they're going to make sure they have adequate reinsurance coverage for the rest of the year. So, they're not going to let their risk management fall off just because they had this event early in the year.

Ed: OK, let's turn our attention to the health industry. Many health insurance stocks have been in the doldrums for a while, and it seems like this new regulatory scrutiny adds one more level of uncertainty. What's your outlook for the health industry in 2025?

Matt: The health insurance business went through a pretty challenging year last year. And a lot of that was driven by Medicare Advantage that was seeing some elevated claims, and then later in the year, those challenges moved to the Medicaid business. The insurers have pretty consistently indicated that the states seem to understand the issues. They seem to be receptive to making the appropriate changes, but there is a bit of a timing mismatch between when those elevated claims tend to happen and when the states approve the necessary rate increases. So, it sounds like that mismatch is likely to continue through the first half of 2025, but we should see some improvement coming in the second half of the year. Despite the improvement, though, in underwriting results that we're expecting for next year, I tend to think it's going to be tough for spreads in health insurance bonds to outperform the credit index, just given the regulatory overhang that's out there. The insurer-owned PBMs seem to be in the crosshairs for both Republicans and Democrats. It's one of the few times that you can actually see the Republicans and Democrats agreeing with each other. And then, the Republicans’ House budget resolution included $880 billion in Medicaid cuts. I assume that number is going to come down and probably come down pretty significantly from that level, but given that high starting point, it's pretty fair to assume that Medicaid is really viewed as a primary source of funding for the planned tax cuts. So, the Medicaid cuts will not fall solely on the shoulders of the health insurers, but there's going to be some impact. Then, to go along with that, we've also got the health exchanges. That's another area where I think the Trump administration is going to take a look. They may look to cut those subsidies on those exchanges completely, or more likely, they may make just some dramatic reductions in the subsidies.

Ed: And does that affect some insurers more than others?

Matt: It does. There are certain insurance companies that are almost exclusively government focused so they're going to be in the crosshairs more. There are others that are almost exclusively commercial so for the commercial insurers, they should be relatively insulated from these issues. And, honestly, they also have been insulated a bit from the pressures of the past year. They're going to be on better footing. Those that are more diversified will also be on better footing, but those that are really focused in the government sector, they're going to feel the biggest impact.

Ed: You mentioned regulation. In the U.S., there's been a lot of activity on the regulatory front, but a lot of it's focused on insurance company investments. What do you see there from the perspective of a credit analyst when you look at companies?

Matt: So, I'll start by saying, nothing has been finalized at this point, but the trend is definitely pointing toward certain changes from the NAIC (National Association of Insurance Commissioners). From our perspective, these changes should generally be a nonevent. So, just stepping back, unrelated to the potential NAIC changes, we have purposely limited our exposure to the insurance companies that have sizable investments in some of the lower-rated tranches of asset classes, such as CLOs (collateralized loan obligations), that are kind of in the crosshairs. The companies that we've spoken to that we invest in do not expect to have any significant impact from these potential changes. For the companies that do have investments in some of the lower-rated tranches of CLOs and such, they're probably going to need to make some changes to their investment portfolio or face higher RBC (risk-based capital) charges, which will then have an impact on their RBC ratios.

Ed: Now, a lot of our clients are focused on their general account assets. When we looked at 2023, we saw certain companies turning over their portfolio a lot to try to increase yields, and yields have stayed higher in 2024. What are you hearing from companies about their investment portfolios?

Matt: In terms of the investment trends, I would say that there really has been one main theme that's dominated the investment conversation and that's to move into private credit. That's not just with the insurers that have private equity relationships. It's really happening across the board at this point. So, the challenge here is not all private credit is created equally. There's a component of private credit that has been around for decades and it's been tested through economic cycles. For this more traditional private credit, you're not necessarily sacrificing in terms of credit risk, but you are getting paid to take on liquidity risk. So, that liquidity risk makes asset liability management very important because if you get in a situation where you need to sell, it's much more difficult to sell private credit than it is to sell public credit. For some of the newer forms of private credit, these investments haven't necessarily been tested through a cycle, so there's a bit more uncertainty in terms of how they would perform in a more challenging investment environment. I think that's where there's a bit more concern at this point for the ratings agencies and for the regulators.

Ed: Yeah. We'll be taking a close look at insurance company investments when those annual statements come out in a few weeks. Final question for you: What do you hear about M&A (mergers and acquisitions) in insurance at these conferences and when talking to management?

Matt: I had a chance to get some pretty good insight on M&A earlier this week at the conference where it wasn't just coming from companies—it was actually coming from some of the individuals that facilitate some of these transactions. I would say that in terms of traditional M&A, the main sources are going to be first in the insurance brokerage space. Insurance brokerage has been a place where there's been quite a bit of M&A activity just in the last year and I don't expect that to subside anytime in the future. I think we're going to see some pretty good activity in that space. The other place that's going to be active is actually in cross-border M&A. This may be a little bit surprising, but it's more of the U.S. companies being acquired. The Japanese insurers seem to be very interested in overseas M&A because of some changes to the regulatory regime. From the U.S. life insurers’ standpoint, they're really more interested in buying and selling certain parts of the business or insurance blocks. And then, in terms of U.S. P&C companies, they're really internally focused at this point. There doesn't seem to be much of an M&A appetite really in any areas right now.

Ed: Thank you, Matt, for being with us here today and sharing all your insights.

Matt: Thanks for having me, Ed. It's been a pleasure.

Ed: And for our audience, thank you for joining us on SpringTalk.

Announcer: Visit allspringglobal.com to receive more market insights and investment perspectives from Allspring Global Investments. To hear the latest from our thought leaders on the ever-changing investment landscape, you can subscribe to the program on Apple Podcasts, Spotify, or wherever you get your podcasts. Thank you for listening and joining us on the road to investing elevated.