Insurance giant, Travelers, has issued $1.55 billion of catastrophe bonds since 2007 to help reduce its hedging costs. Veteran insurance investor, Nick Martin, finds that while reinsurance rates have fallen dramatically in recent years, the underlying economics of the insurance business are holding up well.
Nick Martin is the Co-Manager of the Polar Capital Global Insurance Fund which currently invests in excess of USD 500m in insurance equities. This quarter he looks at the US insurance sector bellwether, Travelers, and finds that the fundamentals of the insurance market are in rude health.
Travelers is a longtime supporter of the ILS market. Its 2012 and 2013 bonds currently provide it with $550 of indemnity protection. The 2012 bond is due to roll off next year so they could be returning to the market in 2015.
The 3Q earnings season in the US is behind us and, in most cases, companies produced good results. The ultimate long term driver of stock prices, book value growth, is likely to be up double digits this year. As always there was the relentless focus by Wall Street analysts on market conditions and what is happening to insurance rates. The continued decline in property catastrophe reinsurance pricing is well documented but there is more debate on the direction of rates for bread and butter commercial insurance bought on Main Street. Comments made by the well respected Travelers are carefully analysed.
Travelers has seen its rate rises on its Business Insurance book fall from an annual rise of 6-8% per annum a year ago to 3-4%. Some bearish commentators extrapolate this believing we are moving down the well trodden road to inevitable rate declines. However it is too myopic to focus purely on rate changes. You cannot speak of rate changes without at the same time looking at how many accounts you are retaining. Retention for Travelers and many peers remains high historically. This suggests a disciplined market where after four years of rate rises and the restoration of good underwriting margins there is no longer justification for indiscriminate rate rises. Where rate is needed, carriers are able to get it. Travelers continues to get double digit rate rises on its worst performing accounts.
With better underwriting margins analysts are sometimes confused as to why more management teams are not pushing for more growth. Travelers explains that growth is a result of its underwriters winning account by account, where the pricing of each risk is different, and cannot and should not be achieved by some directive from senior management. Volume is vanity and profit is sanity. What matters ultimately for shareholders is per share value creation. Travelers themselves are a great case study. In 2006 their market capitalisation was just over $31 billion. Since then shareholders have received back 97% of this through dividends and share buybacks. Travelers' share count has over halved. Today Travelers' market capitalisation is around $33bn, a small increase from 8 years ago. Although the company is roughly the same size today as then it has created significant value for its shareholders (c.12% per annum compounded through book value and dividend growth). Management are not interested in market capitalisation, the absolute level of premium or other such growth orientated metrics. It is all about per share value creation.
I believe our industry is far more disciplined today than in the past and that is due to the focus on per share value creation adopted by Travelers and many others. This has yet to be fully recognised by Wall Street with the valuation of the property casualty industry modest relative to its earnings power and history. You cannot say that about many sectors following the strong performance of the US stock market in recent years. Therein lies the opportunity.
More information on the Global Insurance Fund and other Polar Capital Funds can be found at www.polarcapital.co.uk
All opinions and estimates in this report constitute the best judgement of Polar Capital as of the date hereof, but are subject to change without notice, and do not necessarily represent the views of Polar Capital. Shares in the fund should only be purchased by professional investors.
Posted: Monday, November 17th, 2014