Lancashire buoyed by hardening rates

Investing in an insurer might not seem like such a safe move against the backdrop of the global financial crisis. But, with mounting evidence that the insurance cycle has turned solidly upwards, such caution could leave investors missing a potentially lucrative opportunity.

Oddly, that improving market outlook reflects the impact of the hefty pay-outs that insurers were forced to make last year, largely from hurricanes Gustav and Ike. Indeed, according to reinsurance giant Swiss Re, the two storms cost the global insurance market a total of £24bn (£15bn). Moreover, grim financial conditions have also meant chunky losses for insurers' investment portfolios. Certainly, those events have been bad news for underwriters' earnings in the short term. However, such conditions have also forced insurers to start hiking premium rates in order to rebuild reserves. And Bermudan-based insurer, Lancashire, looks especially well placed to take advantage of that improving rating environment.

Indeed, Lancashire's focus - on property, marine or energy risk - leaves the group exposed to a good measure of those hurricane-related business classes which are experiencing the heftiest rate increases. When rival Hiscox reported first-quarter figures this month, for instance, it revealed that rates for US hurricane exposed business had risen by between 10 per cent and 50 per cent over the last year. That solid rating picture was further confirmed with Lancashire's first-quarter figures this month. “The market is now extremely active, with rates rising strongly year-on-year,” said chief executive Richard Brindle.

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Lancashire also reported an 81.2 per cent combined ratio (of claims to premiums) with its first-quarter figures, indicating that the group is decently profitable at the underwriting level. According to broker Numis Securities, that drops to a sector-beating 53 per cent after adjusting for the hit to earnings from last year's hurricanes. Indeed, Lancashire was hit relatively harder by those storms than its peers and, last month, management reported that hurricane Ike-related losses would be $39.8m higher than the $150.8m hit announced with the full-year figures. Still, Lancashire remains one of the most profitable underwriters in the sector, and Numis Securities expects a combined ratio of just 69.3 per cent for 2009. In contrast, rivals in the Lloyd's market are typically expected to achieve combined ratios for 2009 that are more than 10 percentage points higher than that.

The group's investment portfolio has weathered the global financial storm relatively well, too. During a period when such rivals as Chaucer, Catlin, Beazley or Hiscox have suffered often hefty investment book losses, Lancashire reported a decent enough 4.6 per cent annualised investment return with its first-quarter figures; little changed on the return reported at this stage last year. And the book remains focused on low risk assets - nearly 68 per cent of the portfolio is invested in fixed income products, with the remainder in cash.

However, Lancashire - which joined the Alternative Investment Market (Aim) in 2005 and then moved to the main market in March - has yet to begin making regular dividend payments. The board has said that it may introduce a divided in 2009 and Numis Securities is forecasting a 15p dividend this year. But some uncertainly over the introduction of regular dividends must remain at a time when all insurers need capital to fund growth in the midst of a hardening market. Still, Lancashire doesn't look especially capital-constrained and, unlike such rivals as Catlin, Chaucer or Beazley, it has not needed to tap shareholders for more funds. "As things stand right now, we believe we are carrying the appropriate level of capital," said chief financial officer Neil McConachie, with the group's full-year figures.