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Macro factors to colour 2017 industry outlook

The first year of Donald Trump's presidency promises to be a mixed bag for the US insurance industry.

The long-running but slow-paced US economic expansion appears to be picking up steam and inflation could ratchet up as a result. Fanned by Trump's election, the US dollar has reached levels not seen in over a decade.

The US Federal Reserve has indicated it may accelerate interest rate increases, spurring hopes for eventual improvements in investment income for insurers, but also putting pressure on valuations as longer-dated holdings are marked down as prices fall.

Often, macro factors are less of a concern than company or market-specific issues when gauging the outlook for industry players, according to Janney analysts Robert Glasspiegel and Larry Greenberg. But not always.

"As this past year showed dramatically, getting the macro call right matters," they wrote in a note last week.

In a recent note JP Morgan analyst Sarah DeWitt said she expected the P&C insurance sector to benefit from consistent profitability in 2017 and for investors to receive optionality on M&A.

"Additionally, we think the sector could benefit from a broader rotation into financials following a Republican sweep during the US elections and potential reductions in US corporate tax rates," she said.

In the US, brokers are best positioned to gain from an improving economy and stronger inflation, DeWitt added.

Tax cuts

This year, US tax rates may drop if the Republican-led Congress can overcome Democratic resistance to help President Trump make good on his campaign promises to cut corporate levies. A reduction from the current 35 percent rate is likely to fall straight to the bottom line for many carriers.

Broker Brown & Brown could see its effective tax rate of 39 percent drop by more than half, Barclays analysts led by Jay Gelb wrote in a note last week.

Other P&C insurers and brokers paying an effective tax rate of at least 30 percent would also benefit substantially from a potential reduction, such as Allstate and Progressive.

For those with deferred tax liabilities such as Berkshire Hathaway, a cut in the corporate tax rate to 15 percent - as Trump has proposed - or even to a more likely 20-25 percent would produce a book value gain. AJ Gallagher's earnings could also be boosted by as much as 6 percent if the tax rate drops.

Meanwhile, those with deferred tax assets, such as The Hartford and AIG, could see a more muted benefit or even a decline in their book value, absent other factors, Barclays went on.

And (re)insurers domiciled in Bermuda or other non-US locations, including Arch Capital, Chubb, XL Group, Validus and Everest Re, hardly stand to benefit at all. Brokers domiciled in the UK such as Willis Towers Watson and Aon are also unlikely to see a material gain.

M&A activity

The prospective policy shift under a new administration could lead to further M&A transactions, Willis Re said in a report earlier this month. The broker forecast a heightened pace of deal activity in 2017 as companies react to changes that will tilt the balance away from the offshore operating model.

In Europe, Solvency II continues to affect capital structures and risk choices, Willis Re added. The new fiscal regulatory regime is also a factor in generating M&A activity.

Globally, despite heightened interest in potentially disruptive technologies such as blockchain and the development of peer-to-peer financial models, InsurTech has not yet exerted much tangible influence on the industry. But many companies are paying attention to technological developments.

Meanwhile, analysts at Barclays pointed to overcapacity in the reinsurance sector, weak pricing in commercial markets, modest at best investment income, slowing reserve releases and deteriorating underwriting results as the factors which could fuel M&A activity.

Likely targets may include Lloyd's insurers, some Bermudians and smaller US specialty carriers, with potential buyers including Asian investors, Bermuda-based reinsurers and Canadian pension funds.

Interest rates

Elsewhere, investment benefits from higher interest rates may be overridden in the short term by mark-to-market losses on current holdings, according to JP Morgan's DeWitt.

"Each 100bps rise in interest rates equates to about a 6 percent impact to book value on average for the companies we cover and a 200bps increase in the return on equity on average over roughly three years," she wrote.

Travelers, Arch and XL could take the biggest fourth-quarter hits, she said, while Progressive and Validus may record the smallest impacts.

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