October 23rd, 2017

Industry in investor “sweet spot” – GC@BB Commentary

Posted at 3:15 AM ET

richard-hewitt-smiling-smRichard Hewitt, Head of Business Intelligence, EMEA

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  • Insurers bucking standard competitive cycle response
  • Current dynamics look set to continue for long term in spite of recent catastrophe losses
  • Investor appeal will remain strong

The insurance industry is currently in an investor ’sweet spot’ and can maintain that position for a long time if insurers drive efficiency measures and focus on capital optimization in response to current market dynamics, believes Richard Hewitt, Head of Business Intelligence, Guy Carpenter.

“We are seeing a very different market response to the current competitive phase of the cycle,” says Hewitt. “Previous cycles were classically driven by supply and demand. Amidst harder markets, insurers de-risked portfolios and hiked prices, margins improved, retained earnings grew and excess capital built up. With an increasing appetite for growth, the focus shifted to growing the top line as insurers acquired new customers, cut prices and conditions, and pursued mergers and acquisitions. A price war ensued - margins fell, profits collapsed to losses and capital was destroyed. This is not happening this time.”

According to Hewitt, four factors are contributing to this development. “First, the impact of cat losses on the core operating ratio (CoR) has dropped from a long-term average of three points to below two points (1). Although this trend will be tested by 2017’s catastrophe losses, the sector is strongly capitalized and for most European insurers these are easily manageable earnings events that pose little threat to ordinary dividends and buybacks, in fact they could be fillip for increasing demand for commercial lines cover. Second, we are witnessing strong reserve releases driven primarily by low inflation/deflation pressures. Third, increasingly impactful cost-efficiency measures are being deployed and fourth, smarter reinsurance buying is occurring along with better capital optimization. We are seeing an improved and hopefully stronger industry emerge.”

And there is little sign of the current state of play altering significantly. “I just don’t believe that the scale of the 2017 catastrophes is sufficient to alter the sector’s fundamentals. If inflation behaves and insurers continue to push ahead with cost-reduction efforts (given current cost ratios there is still plenty to be done) and investors reward them for high dividends and share buybacks over growth, then I would expect this current phase to continue for a long time. We’re in a ‘Goldilocks’ state - there’s plenty of warm porridge still in the bowl and the bears are nowhere in sight.”

Hewitt says that, “In addition to potential market-altering catastrophic events, the insurance industry also faces long-term threats from large, financially powerful new entrants disrupting the market on a massive scale through price discounting and innovation. Higher bond yields and spreads due to the normalization of monetary policies could also be a factor if they lead to accelerating price competition. And, of course, inflation remains a key concern, as it could severely impact reserve releases and send them into reverse.”

Despite 2017’s large scale catastrophes, Hewitt believes the market’s investor appeal will remain strong. “The industry is currently in a sweet spot and there is a lot more it can do to keep this running. Current valuations are still favorable for investors. Dividend growth and capital management actions can continue to drive the sector forward, rather than the returns and growth that might have done so in the past. Insurers today are better positioned with investors than they have been for a very long time.”

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Note:

1.  Based on Guy Carpenter composite of top 10 European insurers’ results

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