Earnings season for insurers kick off again in just a few weeks and investors will have a lot to discuss. The biggest question on property and casualty (P&C) investors' minds is the formula shown below. As all mathematics majors know (and maybe some graduates in finance as well), this equation is the second derivative.
So, what is the 'second derivative?' The first derivative is simply the rate of change in pricing. In the insurance industry right now, premiums are increasing (so the first derivative of the premium is positive). However, the rate of that increase is no longer going up. In fact, for every survey FactSet tracks, and every large U.S.-based commercial insurer, the price increases have slowed (a.k.a. the second derivative turned negative).
What Does This Mean for Insurers?
Investors in P&C insurance stocks have been consumed by increasing premium rates for almost four years now. Driving the firming rate environment has been multiple years of back-to-back above-average catastrophe losses, rising 'social inflation' (increasing jury awards, a more aggressive plaintiffs' bar, the emergence of litigation finance, etc.), and lower-for-longer interest rates. Specifically, premium rate increases started in late 2017 with a whisper of just 0.5% and rose-at least for The Chubb Corporation's North American commercial accounts-to as high as 16.5% in the fourth quarter of 2020. However, premium rates ticked down by two percentage points to 14.5% last quarter.
Thus, investors began to worry-despite loss cost inflation still only about 5.5%, according to Evan Greenberg, Chairman, CEO, and President of Chubb, Ltd.-that margins would begin dropping sooner than they had modeled.
This led investors to sell. Despite the nice earnings beat and good overall report for Q1 2021, Chubb's stock dropped 1.5% on the day of its earnings report. This was the first time since April 2020 that the stock dropped on its earnings report.
Similarly, W.R. Berkley Corporation reported a solid earnings beat of 33% (operating earnings of $1.08 vs. FactSet consensus of $0.81) with core margin improvement and growth better than expected-at least what analysts surveyed by FactSet were predicting. Yet the stock was essentially flat on the day following its after-the-market-close earnings announcement.
Travelers Companies Inc. announced excellent results as well with a 15% operating earnings beat compared to consensus, yet the stock was also essentially flat. Why? Here again, the second derivative turned negative for the first time since 2018. This despite Alan Schnitzer, CEO and President of Travelers saying, 'we expect that overall pricing and pure rate, for that matter, will continue to be at levels that result in expanding margins…for a while now.'
Comparing Prices Across Insurers
The chart below compares pricing data provided by a select group of predominantly commercial lines insurance carriers. Often too much focus is placed on the 'headline' rate number and it is important to note when comparing companies that not all reported pricing figures are created equal.
For example, account size matters. An insurer who is more weighted towards larger commercial accounts typically sees a greater magnitude of rate change relative to smaller accounts which tend to be 'stickier' or more inelastic.
Differences in geographic concentrations are also a significant consideration as riskier exposures (e.g., coastal territories) require higher pricing (all else being equal) because the insurer is more likely to see claims from hurricanes.
Of course, differences in business and product mix can also meaningfully influence rate comparisons. Data from the Council of Insurance Agents and Brokers (CIAB) shows that rates in most major commercial lines are decelerating, with the exception of workers' compensation.
Another consideration when comparing insurance rates is what type of 'paper' the insurer is using-admitted vs non-admitted (also known as excess and surplus lines business). An insurer primarily writing on admitted paper, i.e., using industry-standard forms and rates, will likely report lower rate increases than a company weighted more towards non-admitted business. Insurers may choose to write business on a non-admitted basis if their client's risk is comparatively more complex and/or has riskier exposures since writing on a non-admitted basis gives the insurer freedom of rate and form.
Consistent with data reported by commercial lines predominant insurers, the commercial pricing surveys that FactSet tracks also show a deceleration in price increases.
So, where do we go from here? P&C pricing trends, especially in U.S. domestic commercial lines, are heavily influenced by catastrophes, be they man-made or natural. We'll call 2020's pandemic man-made, though, nevertheless, it caused a spike of 5-10% in commercial pricing domestically.
As we enter the peak of hurricane season in a few weeks, we'll get a clearer view of overall U.S. and international pricing trends. However, assuming a 'normal' wind season, we would expect commercial pricing trends to continue their slow downward trend. That is, the second derivative will stay negative for some time to come.
Aaron Woomer contributed to this article.
FactSet Research Systems Inc. published this content on 21 June 2021 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 21 June 2021 14:08:03 UTC.