Insurers beat forecasts on strong fundamentals

The glut of reinsurance capital has disrupted parts of the industry, but the insurance industry as a whole continues to post strong results. Nick Martin takes a look at third quarter earnings.

Nick MartinNick Martin is the Co-Manager of the Polar Capital Global Insurance Fund which currently invests in excess of USD 500m in insurance equities. On October 31 2015 the fund's top five holdings were Arch Capital (7.82%), ACE (7.22%), Marsh & McLennan (6.07%), Markel (5.60%) and Alleghany (5.11%).

Third quarter results from most public (re)insurers exceeded analyst expectations due to strong insurance fundamentals and a favourable loss environment. The year to date numbers set the stage for a strong full year 2015. There was a little noise from the Tianjin loss with the largest exposures as expected ending up with the large European reinsurers who have had a long term presence in Asia. Most companies pointed to the higher than normal uncertainty in reserving this loss. The official end of the Atlantic hurricane season has now passed and the east coast of America has once again emerged unscathed. This has been the tenth consecutive year with no hurricanes making landfall, a new record.

Managements on their earnings calls noted stable market conditions in the third quarter. After four years of rising prices most US primary insurance companies are now generating good underwriting margins across their portfolios. There are pockets of weak performance notably commercial auto which has seen a higher frequency of losses and as a result rates are currently increasing at mid to high single digit levels. In profitable classes of business rate increases are generally tracking claims inflation keeping margins strong. With interest rates likely to remain low there is little to suggest any change in the strong pricing discipline being shown by the market. Within personal lines more companies pointed to the increasing frequency in US auto due to an improving economy and cheap fuel prices. Previously both Allstate and GEICO (part of Berkshire Hathaway) reported elevated loss trends but this quarter they were joined by, amongst others, Progressive and Hartford in highlighting the higher claims trend. We are now likely to see mid to high single digit rate increases in US personal auto until loss ratios improve providing opportunities for some.

Whilst M&A did not dominate the earnings calls in the way it did for the second quarter there is a clear expectation that consolidation will continue. The benefits of diversification and scale will likely become even more prominent under the Solvency II regime which comes into force on 1 January.

Whilst it was good quarter for the underwriters, the markets are becoming more challenging for the insurance brokers. The Dowling & Partners US broker public composite reported organic growth of c.2% which was below expectations. Whilst primary brokerage has been growing organically for most companies at 2-3% per annum in recent years growth in reinsurance broking is becoming ever more difficult. Primary insurance companies continue to retain more risk and reinsurance pricing has continued to decline with the slowing pace of declines little consolation. It is not surprising to see a number of the larger brokers taking action to address these headwinds. Aon recently announced a number of initiatives. “Aon Client Treaty” will pre-place a share of its London market book with several Lloyd’s underwriters led by XL Catlin, whilst its new “Aon Carrier Link” platform is expected to lead to more new business coming into the Lloyd’s market.

This quarter also saw the final conference calls from two of the industry’s most respected CEOs, Bill Berkley and Jay Fishman. Both have made an outstanding contribution to our industry and their companies, WR Berkley and Travelers respectively, make excellent case studies of how to succeed in the property casualty insurance industry over the long term. We have owned stock in both companies for many years which has been very rewarding. Despite these changes at the top the two CEO’s leave their respective businesses in great shape and the future for both remains bright.

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Posted: Monday, December 7th, 2015