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Low Q2 Cats Mask Continued Worsening Of Fundamentals

|About: Marsh & McLennan Companies, Inc. (MMC), Includes: AHL, AON

Low levels of catastrophe losses flattered second quarter results at risk carriers, as market conditions continued to apply upward pressure to core loss ratios amid softening reserve releases

Most carriers registered an improved headline underwriting performance year-on-year, as a modest cat quarter followed a heavy one in the corresponding period last year, with 14 of 18 companies also besting analysts' forecasts.

Nine of the 14 beat consensus estimates by 10 percent or more, with these outperformers spread across Bermuda, the US, London and the global reinsurers.

Nevertheless, their share price performance was highly mixed, with more losers than winners and the first day of post-results trading not clearly correlated with earnings relative to consensus.

The second quarter of 2016 was a highly active period for cats with over $9bn of losses, according to Aon Benfield, as the Fort McMurray wildfires coincided with a major quake in Kumamoto, Japan and a less costly seismic event in Ecuador.

These events left most of the Bermudians with a cat ratio in the 10-15 percent range and inflicted damage elsewhere too.

But this time around cat losses were more modest, with the majority of claims coming from severe weather events in Colorado and Texas that will have been more heavily retained in the primary market.

This brought the losses for the Bermudians down to the 3-7 percent range, buoying earnings.

Warnings signs on underlying profitability continued in the period as the most active months of the Atlantic hurricane season approach, but to date the reserving issues seen in recent quarters have not been evident.

While Q4 2016 and Q1 this year saw reserve hits at companies including AIG, RLI, Allied World and The Hanover - as well as a string of charges relating to the Ogden rate change - the early second quarter reporters have told a story of gradual deterioration.

The Insurance Insider's Bermuda composite - the only group to have fully reported to date - benefited from 5.4 percentage points of reserve releases, down from 6.2 points in the prior-year period.

The same picture looks to be emerging in London, where Hiscox's reserve releases as a proportion of earned premiums slid from 12.5 percent to 10.3 percent, with Lancashire fully 7.0 points worse off in another quarter of big releases and Beazley broadly flat.

In the US, Markel released marginally more reserves, but Travelers had around a third less, with WR Berkley releasing nothing a year after its back-book took 1.0 point off its combined ratio.

Most companies were forced to absorb a deterioration in their accident year ex-cat loss ratios as rate decreases continue to earn through and loss-cost inflation - a frequent theme on earnings calls - picks up.

RenaissanceRe's core loss ratio took on 7.4 points to reach 49.0 percent, while Arch's P&C business recorded a 4.0 point increase to 68.9 percent.

The global reinsurers were also hurting, with Everest Re 4.1 points worse year-on-year and Scor 1.1 points weaker, as two of the three US specialty insurers also experienced core loss inflation.

And over in London, Hiscox surprised analysts with a 4.6 point underlying loss ratio increase, while Beazley's was up by 1.5 points.

With core loss ratios trending upwards and no means of controlling cat losses, there was evidence again that carriers were looking to bear down on costs.

Among the carriers, there was a negative trading bias as investors digested the Q2 numbers.

Aspen was predictably punished, with its share price down 5.9 percent in its first day of post-results trading. Its earnings were less than 50 percent of consensus estimates, with a breakeven combined ratio and operating return on equity of only 4.0 percent.

But some other carriers that were ahead of consensus or in line suffered sell-offs too, with a deteriorating core loss ratio one possible connecting thread.

Arch was down 4.5 percent on the 4.0 point jump in its core loss ratio, with Everest Re's 4.1 point rise driving the shares 1.6 percent lower. XL Catlin, meanwhile, was 6.7 percent weaker despite topping consensus estimates by 9 percent, as its core loss ratio took on 1.6 points to breach the 60 percent threshold.

Gains were more muted, but The Hartford and RLI - victims of reserve strengthening in past quarters - outperformed to secure share price increases of 3.6 percent and 3.5 percent respectively, while Validus pushed on despite the headwinds of the broader Bermudian market to advance by 2.6 percent.

First-half returns for the London market players softened but remained at healthy levels, with Hiscox and Lancashire in low double-digit territory while Beazley was again in the high teens.

However, the results are unlikely to be representative of the broader market - which is struggling and in mid-single-digit territory - given that all three London-listed companies are in the top quartile in terms of performance.

The brokers that have reported to date - Marsh & McLennan Companies (MMC), AJ Gallagher and Brown & Brown - all ended their first day of trading after their results disclosures in positive territory. Each set of results were broadly in line with forecasts.

AJ Gallagher was the only one of the three to post higher organic growth and an improved margin for the quarter, as its underlying growth advanced from 2.7 percent in Q1 to 4.2 percent.

MMC's operating margin expanded by 110 basis points to hit 27.9 percent, but its organic growth for broking narrowed from 5 percent to 2 percent, just below a full-year growth target range of 3-5 percent.

Brown & Brown saw its Ebitdac margins squeezed by 120 basis points to 33.5 percent, and also suffered a 2.0 point slowdown in organic growth to 1.6 percent.