According to Travelers (TRV) CEO Jay Fishman, the property and casualty (P&C) insurance cycle is a thing of the past. Many analysts, on the other hand, frequently mention the cycle as a headwind, and a reason to avoid the industry. So the questions come up: 1) is there a cycle, and 2) is it turning?
Jay Fishman's Version
From the Travelers 3Q 2011 earnings conference call transcript, here is Mr. Fishman responding to a question on the P&C cycle:
No, sir. In fact, if you go through the comments here today, you won't actually hear the words market or market cycle in anybody's commentary. We decided a year ago -- as I've said, and you've heard us speak about this in other meetings and in our investor days. We're much more skeptical that the amplitude of the cyclicality that many of us grew up in, in this business remains. For a whole host of substances systemic reasons, we just don't think it exists in the same way anymore. And we made the decision a year ago, if you recall, that regardless of whether a red light went on somewhere that was going to declare a cycle turn that we were going to attempt to take our destiny in our own hands and move our own pricing.
Renewal Rates Are Increasing
Reviewing company presentations on the 3rd quarter, many of them are mentioning the ability to raise rates in commercial lines. Here's a selection of excerpts:
We are delighted that our net premiums -- net written premiums grew 8% in the quarter, 10% in Commercial and 6% in Specialty. Exposure growth for the quarter was positive for both Commercial and Specialty. We are seeing additional audit premiums in Commercial as opposed to return premiums a year ago.
Rates were slightly positive in Specialty for the second quarter in a row and Commercial rates continue their climb for the fourth consecutive quarter.
We're also pleased with the continued firming in the market. It's best evidenced by the 4% rate increase we achieved in the third quarter in our standard commercial business, while maintaining strong retention levels.
From The Hartford's (HIG) 3Q Earnings Press Release:
P&C Commercial written premiums increased 7% from the third quarter of 2010, reflecting renewal written price increases, strong retention and increased exposures.
The Cycle is Alive and Well (and Turning)
From the foregoing, it is evident that the management of various companies is seeing the same thing. There are forces at work, not the least of which is the low interest rates that many observers have listed as a negative for the industry.
A company that is writing business and accepting premiums today in order to pay losses five years down the road will naturally plan to invest the premiums received until they are required to pay the expected losses. The lower the expected safe rate of return, the higher the premiums that will be required.
Catastrophes have been above average all year. While that does temporarily depress profits, it also leads to higher rates and greater pricing power, as companies play catch up on the affected property lines.
Insurance companies are trading at discounts to historical pricing levels on many common metrics, to include P/E and P/B. Management, looking at this situation, finds that creating value is a no brainer - it can buy back shares for less than book value. CB and TRV have done well on this basis, and they can hardly be expected to squander their excess capital by cutting rates below breakeven and then making it up on increased volume.
Some of the weaker members of the industry have finally had enough poor performance to convince them to raise rates. CNA would fall into this category. American International Group (AIG), always a fierce competitor, has had some issues around profitability and at some point has to make money in order to pay back its loans from Treasury.
A Walk Down Memory Lane
Back in the early seventies, computers were still in their infancy, and the flow of data to management was nowhere near as detailed as it is today, and most of it was well after the fact. This resulted in sudden reversals of policy, as up to date information would reveal previous underpricing. Management would send down a directive - raise all General Liability premiums by 25% - no exceptions. Of course exceptions would be made, but the overall effect was fairly impressive, especially when every other company in the industry was doing the same thing.
Then within a few short years the pendulum would swing to the other extreme. I can still remember my friend Herb clutching his chest and declaiming "they cut the heart out of the rate!"
The point is, with modern data capabilities, management can track pricing much more accurately, and is able to tweak it as needed, rather than resort to draconian pronouncements.
The P&C cycle should not be regarded as a current headwind, or as a reason not to invest in the industry. Many companies in the industry are profitable, and still trading at discounts to historical valuations.
I think Fishman is correct, that the cycle is less severe than it was twenty or thirty years ago. That makes the industry much more attractive as an investment. And in spite of the severity of the financial crisis, the better run P&C insurance companies cruised through the turbulence with aplomb.
Finally, the companies are seeing increased exposures and audit premiums - signs of economic growth and a plus for equity markets generally.