Earnings reports for 3Q14 reveal shifting fortunes for insurers. But it’s unclear whether investors will find recent short-term performance gains sufficient incentive to bid up anyone’s stock price.
Personal lines underwriters saw earnings gains of 230 bps this quarter, compared with a downturn of 300 bps on the part of reinsurers. Standard commercial lines came in a close second at 200 bps, while specialty underwriting dropped 20 bps according to figures issued by industry watchers Keefe, Bruyette & Woods.
Personal lines underwriters benefitted from a variety of factors. While competition for the hearts and minds of consumers remains intense, the scale required to play in the personal lines market is an obstacle to entry for new outside capital. Also underwriters of personal lines tend to maintain fairly rigorous actuarial discipline. This is especially true in markets such as auto, where underwriting rules are subject to increasingly granular risk projection formulas based on broad, empirically validated data inputs that range from vehicle safety features to customer credit scores.
Reinsurance, in stark contrast, has become highly subject to capital incursion and can be much more opaque from an actuarial perspective. That said, some reinsurers have demonstrated an ability to more effectively manage rates, loss inflation and reserves than their competitors. KB&W’s 3Q14 report specifically cites ACE, AXIS Capital Holdings, Greenlight Capital RE, Validus Holdings and XL Group as “overperformers” in its model portfolio of reinsurance underwriters.
“Overperformers” in the rest of KB&W’s model portfolio as of 3Q14 include Donegal Group, United Insurance Holdings and Hartford Financial Services.
Of course, P&C underwriters’ margins have benefitted from a relative absence of catastrophic losses this year. That’s not something that’s likely to impress investors, who are acutely aware that insurers’ fortunes could readily swing in the other direction where such exposures are concerned. “Hindsight is never a compelling reason to invest,” notes Vincent DeAugustino, the report’s lead author.
Loss inflation is also a problem for underwriters of workers compensation, since healthcare costs continue to rise—and should do so for the foreseeable future despite any claims to the contrary made by proponents of the Affordable Care Act.
Investors looking for earnings-per-share growth will therefore be hard-pressed to find underwriters that can maintain a healthy pace of rate increases without alienating customers in a competitive market, while avoiding out-of-projection losses and maintaining adequate capital reserves. Harder yet to find will be companies that don’t already have these positive attributes factored into their stock price.
“With the way insurers’ stocks have been running up with the rest of the market, there may be a sense that valuation are becoming full,” DeAugustino says. “That may lead investors to re-balance their portfolios in 2015.”
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