For Immediate Release
Chicago, IL - Jan 02, 2018 - Today, Zacks Equity Research discusses the Industry: Insurance, Part 3, including XL Group LtdXL , Hallmark Financial ServicesHALL , Alleghany CorporationY and CNA Financial CorporationCNA .
Industry: Insurance, Part 3
It is expected that 2017 will be one of the costliest years for U.S. insured catastrophe losses, but a strong capital base, efficient risk management and ample earnings capacity should help Property & Casualty (P&C) insurers absorb the losses. However, the carriers' futures still look bleak with persistent industry concerns. What's worse, the rising rate environment is also not expected to lend any major support.
The key factor that might hurt P&C insurers' financials is lack of pricing power. While insurers are pricing their policies to address perils in the disaster-prone areas, overall market softening prevails in both commercial and personal lines.
However, personal auto insurers that have raised premium rates to deal with increasing accident frequency and severity trends are on the mend. An expected stabilization of frequency trends with increasing adoption of accident avoidance technologies should lead to better underwriting results for auto insurers in the quarters ahead.
In terms of interest rates, P&C insurers typically don't benefit significantly from a rising rate environment, as their business models are not too sensitive to interest rates. But, although P&C insurers could not benefit from the gradually rising interest rates over the past two years, the Fed's latest rate hike and a likely acceleration of the pace going forward might translate to some advantage for the industry.
However, increasing demand for P&C insurance with overall economic growth perhaps attracted investors' attention lately, helping this segment perform close to the broader market. The Zacks P&C Insurance Industry has gained 17.8% since the beginning of the year compared with the S&P 500's rally of 20.2%.
This rally may not last long with the likely downside gradually fading investors' optimism.
On the other hand, while a strong job market and increasing disposable income will lead to more car and home purchases and thus increase insurable exposure, the rising rate environment may make these less affordable.
Why Little to No Benefit Expected from Rate Hike
P&C insurers' financials are less sensitive to interest rates than life insurers, as the large financial portfolios managed by these carriers are designed to be fairly conservative. Meaning, they keep the required fund on hand to cover claims that they typically face faster than life insurers. Due to this, they depend significantly on short-term Treasury bills.
For P&C insurers, the interest rate sensitivity has both positive and negative directions. Whether the upside offsets the downside is yet to be seen. This will become clear when either the magnitude or the pace of rate hike increases.
Higher rates would boost P&C insurers' investment income that declined substantially in the prolonged low-rate environment. However, the key downside is a significant amount of bonds in P&C insurers' portfolio losing value if rates are hiked steadily and sizably.
P&C insurers' extreme sensitivity to asset inflation will aggravate the situation. In other words, the value of the properties insured by carriers will appreciate with an improving real estate market, increasing their potential liabilities from claims. This may outpace the rising yields on bonds they added to their portfolios for covering the claims. In fact, the bonds in their portfolios will lose value with rising interest rates and could ultimately result in capital volatility.
Addressing this concern would require P&C insurers to add more risky assets to their investment portfolios to meet the rising liabilities from claims. This would eventually increase their costs.
Market Softening to Keep Top Line Under Pressure
Looking beyond the implications of a relatively sluggish pace of rate hike so far, it is market softening that burdens the P&C insurance industry. In order to retain renewals and secure new business, carriers are aggressively reducing rates and making the market buyer-friendly. While the recent severe catastrophes will lead to an increase in premiums in some areas, the overall recovery in prices is not expected to be visible any time soon thanks to the ample supply of capital.
The softening was evident right through 2015 and has continued so far this year. Pricing is primarily soft in the areas of commercial property, workers' compensation, general liability and business interruption.
By its very nature, a soft market causes lower underwriting profitability for carriers, as they prioritize market share gain over making more from premiums to survive.
While greater demand for insurance (particularly with the emergence new insurable risks including cyber threat) will keep the business of P&C insurers afloat, their willingness to negotiate on policy terms and ample capital strength will intensify the competition for market share in the quarters ahead.
Sluggish Recovery Might Continue
Increasing frequency and severity of natural catastrophes give P&C insurers the scope to bump up pricing. Also, these might lead to an accelerated pace of policy renewals.
Moreover, ample underwriting capacity, a strong liquidity profile and evolving coverage opportunity should help P&C carriers keep growing.
Concerns related to weak capital levels are now things of the past, as the industry's capital position has been building up with earnings growth and policyholders' surpluses. The industry has also been witnessing continued inflow of alternative capital (which is one of the reasons for market softening).
As P&C insurers hold about two-thirds of their invested assets in the form of bonds, their capacity is highly sensitive to changes in credit market conditions. With the credit market showing resilience and limited possibility of a sudden spike in interest rates, insurers are likely to incur lesser realized and unrealized capital losses in the quarters ahead.
Competition is heating up both within the primary lines of the P&C space and with the expansion of reinsurers. However, we expect proactive transformational measures, including the adoption of technology solutions, to bring competitive advantages.
Also, for more enthusiasm in renewals and to meet the evolving demands of policyholders, insurers are in the process of product reframing and innovation. This should help them expand their customer base for products that will offer higher margins.
The emerging risks related to cyber threats are also giving P&C insurers scope to capitalize on. This segment, though relatively small in size, has been witnessing continued growth in premium and policy count.
How to Play the Industry
The absence of any significant support from the interest rate environment and the likely continuation of the soft market will hold P&C insurers back from showing any measurable progress in the near term. In fact, stiff competition may pose significant challenges to bottom-line growth for some carriers. As such, avoiding stocks with an unfavorable Zacks Rank should be the right strategy.
We strongly suggest staying away from or getting rid of the following bottom-ranked stocks:
XL Group Ltd : This Zacks Rank #5 (Strong Sell) stock has lost 4.9% year to date versus the S&P 500's gain of 20.2%. The stock's Zacks Consensus Estimate for the current year earnings has been revised significantly downward over the last 60 days.
Hallmark Financial Services : A 50% downward revision in the Zacks Consensus Estimate for the current year over the last 60 days precipitated a Zacks Rank #5 for this stock as well. The stock has lost 6.8% since the beginning of the year.
However, as there are some reasons to be optimistic about P&C insurers' growth potential, buying some stocks from the space based on a favorable Zacks Rank would be a prudent decision now.
Here are a couple of top-ranked P&C insurance stocks you may want to consider:
Alleghany Corporation : A substantial upward revision in the Zacks Consensus Estimate for the current year over the last 60 days lead to a Zacks Rank #1 (Strong Buy) for this stock. However, the price of this stock has plunged nearly 4% since the beginning of the year. You can see the complete list of today's Zacks #1 Rank stocks here .
CNA Financial Corporation : This Zacks Rank #1 stock has gained nearly 27% year to date. However, its Zacks Consensus Estimate for the current year has been revised 3.4% upward over the last 60 days.
Check out our latest U.S. Insurance Stock Outlook for more on the current state of affairs in the overall insurance market.
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