Given the inherent unpredictability of accidents and natural catastrophes it may seem odd that general insurance stocks have delivered some of the most consistent income streams in recent years. In a post-financial crisis era of ultra-low interest rates – one that has extended well beyond many investors’ expectations – assets offering income and yield have become scarce.
Yet the sector is battling rising claims costs and competition, which has pushed up combined operating ratios – claims costs as a proportion of premium income – during the past 18 months. Those pressures have continued into the first quarter of this year, leading analysts to forecast a reduction in earnings for some insurers this year and next, which has also led to a cut to dividend expectations.
The market can be broadly split into two camps: personal line insurers offering motor and home insurance; and those that are part of the Lloyd’s of London specialist market. For the former, premium rates have lagged claims inflation, as competition has intensified. For one, Hastings (HSTG) – whose shares have underperformed most of its rivals during the past 12 months – elevated claims, market competition and third-party property damage costs witnessed during the first quarter led management to warn that its full-year loss ratio was likely to move to the higher end of the 75-79 per cent range. That was despite continued gains in the UK private car insurance market, taking its share to 7.6 per cent.
Given that many personal line stocks have a policy to pay out a ratio of earnings – Direct Line (DLG) aside – the reduction in their income prospects has been largely due to profits being squeezed, says Investec’s Ben Cohen. “There’s also some pressure from some of the customer loyalty work that the Financial Conduct Authority (FCA) has been doing,” he adds.
However, the cyclicality of insurance premium pricing means lower stock valuations may present a buying opportunity. “For braver investors who are confident that at some point motor pricing will turn, then the current market may provide an opportunity,” Mr Cohen says.
Despite Hastings’ recent warning, Mr Cohen says it is the only insurance stock that he has placed a ‘buy’ rating on because of the group’s operational cost efficiency. The fact that the group distributes a very high proportion of business via the price comparison market may also stand it in good stead in the wake of the FCA’s decision to tackle so-called ‘loyalty premiums’ charged by insurers. “Customers should have been less loyal [meaning there is] less repricing to do,” he says.
Expansion or returns?
For specialists such as Hiscox (HSX), Lancashire (LRE) and Beazley (BEZ), which have access to the Lloyd’s of London insurance market, rising claims costs have been due to increased natural catastrophes. Some of those costs have crept into the first quarter of this year, forcing Beazley to strengthen reserves in some areas of its short-tail business, particularly in relation to typhoon Jebi, which struck areas including Japan and Taiwan last year. Losses associated with that event have risen to more than double initial industry estimates at up to $12bn (£9.3bn), according to insurance industry data company PCS.
That has led many Lloyd’s insurers to review their product lines and cut back those that are not profitable. Hiscox reported just 3.3 per cent growth in gross premiums during the first quarter, far behind the 20 per cent rise at the same time last year. That was partly due to a pullback in unprofitable liability insurance for US executives.
Lloyd’s safety valve
The good news is that premium prices have started to harden, as claims have risen. The Lloyd’s market acts as a “safety valve” for insurers, says Polar Capital’s global insurance fund manager Nick Martin. Increased stress may cause some insurers to review their underwriting appetite, freeing up capacity, something UK-listed insurers could take advantage of. “If US insurers are in stress…they may want to reduce catastrophe exposure and there [could be] a lack of capital in the US to absorb demand,” Mr Martin says.
Increased capacity could result in more Lloyd’s insurers utilising capital on their balance sheets to underwrite more risk globally. “Lancashire has been sitting on its hands during the past few years and earning respectable returns for shareholders,” says Mr Martin. However, that could change if growth opportunities emerge. “Earnings can be more volatile than other industries, particularly if you’ve got some catastrophe-type exposure in your portfolio,” he adds.
However, for providers such as Hastings, focusing on UK car and motor insurance markets means they have greater ability to return capital to shareholders via share buybacks or dividends. “There’s not a lot of long-term growth opportunities and not a lot of capital intensity in terms of what they’re doing,” Mr Cohen says.
