For Immediate Release
Chicago, IL – August 24, 2017 – Today, Zacks Equity Research discusses the Industry: Insurance, Part 3, including Aspen Insurance Holdings Limited (NYSE: (AHL - Free Report) – Free Report), ProAssurance Corporation (NYSE: (PRA - Free Report) – Free Report), Markel Corporation (NYSE: (MKL - Free Report) – Free Report) and Atlas Financial Holdings, Inc. (NASDAQ: (AFH - Free Report) – Free Report).
Industry: Insurance, Part 3
Property & Casualty (P&C) insurers typically don’t benefit significantly from a rising rate environment, as their business models are not too sensitive to interest rates. While the market was expecting some benefits for P&C insurers with the interest rates gradually rising over the past two years, the magnitude was not favorable. While there is almost no support from a relatively range-bound interest rate environment, this industry segment is struggling with a number of headwinds, particularly the continuation of market softening.
However, increasing demand for P&C insurance with overall economic growth perhaps attracted investors’ attention lately, helping this segment outperform the broader market. The Zacks P&C Insurance Industry has gained 8.8% since the beginning of the year compared with the S&P 500’s rally of 8.5%.
This rally may not last long, however, with the likely downside gradually fading investors’ optimism. In fact, any unfavorable outcome of the recent disagreement among Fed officials over how quickly to raise rates and the impact of industry headwinds on P&C insurers’ financial results will make investors rethink.
The key concerns that might hurt P&C insurers’ financials are lack of pricing power and a low-yield investment environment. Persistent market softening is evident in both commercial and personal lines.
On the other hand, while an improving job market and increasing disposable income will lead to more car and home purchases and thus increase insurable exposure, the rising rate environment may offset this benefit by making these less affordable.
Zacks Industry Rank Indicates Gloom
This 51-company group has been witnessing significant downward revision in earnings estimates lately and thus carries a Zacks Industry Rank of #203, which places it at the bottom 21% of the 250-plus Zacks industries. Our back-testing shows that the top 50% of the Zacks ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Why the Interest Rate Environment May Not Turn Out Favorable
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 has yet to be seen, as there hasn’t been any measurable progress on the rate hike front so far.
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 (which is unlikely).
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 Hurting Profitability
Looking beyond the implications of relatively range-bound interest rates, it is market softening that characterizes 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.
The softening was evident right through 2015 and has continued so far this year. Pricing primarily remains 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 enhanced capital strength will intensify the competition for market share in the quarters ahead.
P&C Industry Should Witness Some (Slow) Growth
In addition to the continuation of a soft market environment, slowing reinsurance renewals across most lines due to moderate catastrophe in the past few years have been curbing P&C insurers’ bottom-line growth. However, the pace of policy renewals might accelerate in the near term, as the trend of natural catastrophes is increasing lately.
However, ample underwriting capacity, a strong liquidity profile and evolving coverage opportunity should help these 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 almost no 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 cropping 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 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 buyers’ market will hold insurers back from showing any measurable progress in the near term. In fact, stiff competition and reducing premium rates 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:
Aspen Insurance Holdings Limited (NYSE: AHL – Free Report): This Zacks Rank #5 (Strong Sell) stock has lost 15% year to date versus the S&P 500’s gain of 8.5%. The stock’s Zacks Consensus Estimate for the current year earnings has been revised 13.4% downward over the past 30 days.
ProAssurance Corporation (NYSE: PRA – Free Report): A 9% downward revision in the Zacks Consensus Estimate for the current year over the past 30 days precipitated a Zacks Rank #5 for this stock as well. The stock has lost 3.1% 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:
Markel Corporation (NYSE: MKL – Free Report): A 16.6% upward revision in the Zacks Consensus Estimate for the current year over the past 60 days lead to a Zacks Rank #1 (Strong Buy) for this stock. The price of this stock surged more than 16% since the beginning of the year. You can see the complete list of today’s Zacks #1 Rank stocks here.
Atlas Financial Holdings, Inc. (NASDAQ: AFH – Free Report): This Zacks Rank #1 stock has lost 11% year to date. However, its Zacks Consensus Estimate for the current year has been revised 4.5% upward over the past 30 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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