Reduced reliance on reinsurance and increased emphasis on new products and the secondary market may help insurers cope with next year's expected drop in municipal bond volume, a new report from Standard & Poor's says.
The report, which appeared in yesterday's issue of Creditweek Municipal, says another strategy might be more aggressive pricing and underwriting, but warned that course would hurt the industry.
Standard & Poor's said new-issue volume is expected to drop to between $160 billion and $170 billion from this year's projected $225 billion.
"For bond insurers, the decline in volume may be even more precipitous," said Richard P. Smith, a senior vice president and author of the report.
That is because refundings, 38% of which were insured during the first 10 months of 1992, are expected to decline significantly as interest rates rise and the candidate pool for insurance shrinks.
"There is a concern that some insurers will be pressured to avoid showing a significant drop in written premiums," Standard & Poor's said, especially from equity owners focused on growth or from management itself.
"The most obvious way to garner as much of the business as possible is to price aggressively," the report says, noting that premium rates have not increased in the past few years despite an environment of decreased competition that argues for higher rates.
"It should have been a time for the insurers to try to raise premium rates, but the decline in interest rates and yield spreads may have quashed the opportunity," the report says. "In the more competitive environment envisioned for 1993. the challenge will be to keep premium rates from falling" and weakening insurers' long-range earnings potential.
David H. Elliott, president and chief executive officer of Municipal Bond Investors Assurance Corp., said pressures to show constantly increasing growth are unlikely to be great enough to alter basic business strategies in the industry. Bond insurers' revenues generally are not damaged by year-to-year volume declines because premiums are earned over the course of several decades.
If you take a long-term perspective, you should be "totally indifferent" to what happens in any given year, Elliott said.
But Ann C. Stern, president and chief executive officer of Financial Guaranty Insurance Co., agreed the coming leaner volume years will test the industry's resolve.
"There will be a real temptation not to show a significant drop-off to written premiums, and the question is do we have the courage to show that," Stern said. "Will our publicly held competitors view a decline in volume as something that is a black mark against them, or will they focus on return on equity?"
Stern added that adequate pricing remains vital, because refundings are almost certain to fall off in coming years as interest rates rise. That means insurers can no longer count on the "ball-out effect" of refundings, which compensate for inadequate pricing on the original deal, she said.
Robert J. Genader, an executive vice president at AMBAC Indemnity Corp.. said there are already built-in protections against letting premiums fall. If insurers do not price to get an adequate return, for example, the rating agencies will insist on higher capital reserves, he said.
Genader also said there is a chance, given credit deterioration among several major issuers and an increased emphasis on lowering risk for investors, that insured penetration may decline less than the market as a whole.
"While the market may decline in the macro, insured volume may actually hold up," Genader said.
In addition to warning against cutting premiums, Standard & Poor's also blasted the strategy of lowering underwriting standards to write more business, calling it "fraught with peril and destined to fail."
But the report pointed out that the industry is aware such a practice would be looked on unfavorably by the rating agency, which would notice immediately through its issue-by-issue shadow rating processes. "Therefore, Standard & Poor's does not expect insurers to lower underwriting standards in an attempt to generate a higher volume of business," the report says.
On the positive side, the report says new products and increased activity in the asset-backed and secondary markets are likely to help insurers offset declines in volume, as long as they are complementary to existing business lines.
AMBAC, which wrote the first secondary market policy in 1983, agrees the secondary market "will be more appreciated" as new issues decline, Genader said.
Ceding less business to reinsurers is also an attractive way to offset declines in premiums written and decrease exposure to certain foreign reinsurers that have seen rating downgrades in recent years, Standard & Poor's said.