What a hard market means for insurance stocks

Severe weather is creating a hardening insurance market in Canada and the U.S., giving providers pricing power that could help stocks outperform, says Natalie Taylor, vice-president and portfolio manager at CIBC Asset Management.

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Storms in the U.S.—including Hurricane Maria in 2017, which devastated Puerto Rico, and California’s Camp Fire last year—cost insurers more than $200 billion, Taylor said in a May 24 interview. The 2016 wildfires in Fort McMurray, Alta., and flooding this year in the eastern provinces have led to large claims in Canada.

The weather has “significantly reduced the supply of capital in the system,” said Taylor, creating the early stages of a hardening price market for property and casualty (P&C) insurance. Weather and catastrophes often dictate the direction of the cycle, she said.

“Periods of relatively few catastrophes can result in excess capital. But, similarly, a higher frequency of catastrophes can wipe out sizeable amounts of capital, leading to pricing power.”

Insurers’ earnings calls with analysts suggest that pricing started to firm up in the first quarter of this year, she said, with price increases of mid single digits to mid teens ranging across multiple product lines.

The last hard market for insurers followed the Sept. 11, 2001 attacks and lasted until 2003, said Taylor, who works on the CIBC Dividend Income Fund.

“If we use this period as a case study, we can see that pricing spikes may be double digits on the commercial side and can last for periods of 12 to 24 months before profitability is restored across the industry and the cycle starts again,” she said.

“Companies that are able to take advantage of this environment are rewarded.”

Insurers’ price-to-book multiples expanded from about 1.3x to 2x during the last hard market, Taylor said, with commensurate increases in profitability and return on equity.

“P&C insurance stocks have outperformed the index on average by 7% across the last three hard markets,” she said. “We also believe that M&A is likely to pick up in a firming market as challenged participants look for exits.”

Taylor said the change in cycle has been coming for some time, as the margin earned on policies has been eroding since 2013.

Prior to that, a period of lower losses contributed to excess capital building up in the system, as did a wave of third-party capital moving to the insurance industry as investors sought to diversify away from market risk following the global financial crisis, she said.

The excess capital was competing for a finite amount of insurable risk, increasing competition, Taylor said. This led to undisciplined underwriting, compressed margins and falling profits. “That’s really reached a head now and we’ve seen the inflection point to more of a firming price market.”

Canada’s largest P&C insurers, Intact and Fairfax, showed restraint in the undisciplined market, Taylor said.

“As such, they should have excess capacity to underwrite policies in this favourable pricing environment,” she said.

“Intact is primarily exposed to Canada, which we believe has seen greater pricing firming than other regions. Fairfax is more geographically diverse as well as across different business lines—including reinsurance, where pricing is a little bit less robust currently.”

Intact Financial Corp.’s stock has performed well in recent months, trading around $122 this week after opening the year just below $100. Its price-to-book ratio was around 2.4 this week, according to Bloomberg.

Fairfax Financial Holdings Ltd. was trading around $650 this week after opening the year just above $600. It peaked above $655 in February but dipped below $600 in March. Its price-to-book ratio was around 1.1 this week, according to Bloomberg.

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