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Inside in Full: Q1 earnings preview: Are we there yet?

In his 2005 film about a family road trip, Ice Cube, playing the protagonist, is stuck in an SUV with two pretentious children and their mother who he seeks to impress...

Throughout the movie, the kids, whose aim is to question the relationship, indulge in shenanigans including repeating the titular phrase “Are we there yet”?

To be honest, the movie was too hammy for our liking. But as we head into first-quarter earnings, we feel a bit like the kids in that movie.

A year or so ago, the industry – primarily commercial insurers – discussed the expectation of meaningful margin improvement from pricing, as well as the potential benefit to investment income from changes in interest rate.

Beyond commercial lines, personal auto was also supposed to be reacting well to loss costs, and reinsurers were tightening the capital availability spigot.

One year later, we are still saying: “Are we there yet?”

But rather than getting clearer, the picture has only gotten more muddled, with multiple events influencing this earnings season. These range from several items that could impact insurance companies’ balance sheets and investments, such as the SVB crisis, to emerging issues surrounding commercial real estate.

Beyond the balance sheet items the macro discussion including the Fed’s next move and its impact on the sector will also be front and center.

This earnings season will bring continued conversation on these topics, as well as the direction of loss cost inflation. Our recent reserve analysis showed the industry taking down reserves for recent accident years, and if economic trends turn, this could prove premature.

We had barely ended the fourth-quarter earnings season when we were hit with the news of SVB bank heading to a crisis and eventually failing.

These factors led us to publish a few recent deep dives on the banking collapse and potential contagion for insurers, as well as covering investment strategies. Those pieces gave us the following key takeaways:

(a) Over the past decade there has been a noticeable shift away from one-to five-year investments, and into five-to-10-year ones. However, this trend has fully reversed with the shifting economy.

(b) Real estate investment has been on the rise but is still less than 1% of average investment holdings

(c) Insurer investment in troubled banks is minimal relative to their equity

(d) The biggest concern is the effect the banking sector’s troubles might have on capital availability and the macroeconomic effects of further Fed action

The charts below give some additional insight into these points.

First, we can see that the majority of insurer investments are in bonds, with some movement into stocks in recent years as market conditions shifted.

  

 

Though the primary investment is in bonds, the concentration in the collapsed banks, or other potentially endangered regional banks is minimal, as shown below.

  

 

Another area of concern is real estate, and commercial real estate in particular. The chart below shows these investments. While the majority of carriers have increased their holdings in this area over the time period shown, the overall proportion of investment is less than 1% and has actually shrunk relative to the total portfolio.

  

 

So, while we can safely say most insurers are/were not invested enough in the corporate debt of the collapsed and endangered banks or real estate to fundamentally move the needle with any one event, the environment that precipitated the collapse will still be a factor in near-term success or struggles, depending on how effectively the companies adapt.

Beyond balance sheet items, this quarter was once again active in terms of US and global catastrophe losses which will weigh on the sector.

These factors have, of course, affected analyst consensus for earnings. While we will get the actual numbers in the coming weeks, it is interesting to see how the expectation for this quarter’s earnings and the full year has shifted over time.

The chart below shows these numbers for insurers as well as the S&P 500 as a point of comparison. Note how general expectations have slid down for the S&P, while insurers have largely stayed above (a trend we had seen in 2022 as well). In fact, the full year 2023 insurer estimates have only shifted down about 2% vs. the 12% fall for the S&P.

  

 

However, the recent pre-announcements of The Hartford and Progressive were significantly under consensus, and if other carriers follow in the same vein, we are likely to see that even these downward moves were too optimistic.

On a price to forward earnings basis, insurers are trading at 14.9x earnings while the S&P is trading at 18.9x. This could lead one to believe that insurance stocks are cheap on a relative basis. However, we would caution on that thought process as estimates could trend down further.

The calendar below shows a schedule of the P&C earnings schedule as announced so far.

  

 

 

In general, the major themes we expect by sector are:

Commercial: Recent carrier commentary suggests the pricing cycle has extended, with no real sign of slowing. We will look for updates on this trend and insight into how this is affecting margins, and how these increases are balancing against loss costs and social inflation. Continuing the discussion from Q4, we expect carriers to comment on the hardening property market as well.

Specialty: The recent stamping data has shown some slowdown in surplus lines premium growth but it is still meaningfully up vs. pre-pandemic results. It remains to be seen if the publicly-traded cohort continues to exhibit this trend or shows some signs of slowing down.

Regionals: We expect to hear comments on the loss cost environment and regional insurers’ focus on the small and middle market. Strategically, hard market environments of the past have also positively impacted these players, as overflow business from nationals has gone to them. That said, it remains to be seen if they take their foot off the accelerator on risk/reward.

Personal: Personal lines carriers are likely to comment on their rate increases and how those rises should counteract loss cost inflation. Recent Progressive monthly results and The Hartford’s pre-announcement demonstrate that we are not out of the woods yet.

Reinsurance: Reinsurers have been seeing favorable pricing due to a supply/demand mismatch. However, various broker reports indicate that April 1 pricing has eased from January 1. The focus from here is going to move from the Japanese/APAC renewals at April 1 to the important Florida and Gulf renewals at June 1, July 1 and if there has been any softening in the stance on capital deployment.

Brokers: Overall, this sector will benefit from the continued commercial pricing cycle and inflation. We also expect part of the cohort, namely AJ Gallagher and Aon, will likely benefit from January 1 reinsurance renewals. We will be looking for commentary on the macro environment, both for insight into how it will change brokers’ capital strategy in the near-term, as well as the effects they are seeing for their carrier partners.

We expand on these ideas below.

Commercial will continue to benefit from the pricing cycle, but some may suffer from cat losses

The recent quarters, and even years, have been uncertain for carriers, with an increasingly complex macroenvironment making the future unclear. The commercial sector, however, has benefitted from increased exposure, pricing, and from consistent reserve releases over the past few years. However, the margin thesis from expotential rate improvement hasn’t really played out as anticipated.

These factors should generally lead to another strong quarter from this cohort, but The Hartford pre-announcement reminds us to keep a cautious stance. We will briefly cover the large commercial segment, as well as the sub-segments of specialty and regionals.

The chart below shows the large commercial cohort’s consensus estimates at the beginning of the year vs. the present. (We have removed The Hartford as it announced, and these numbers are no longer helpful). Two are up and two are down, but only Travelers is a material shift. We would note the trend of surprise shown below as well, though of course past performance is not an indicator of the future.

  

 

The Hartford’s EPS was a significant negative surprise, but it is important to note that the drivers were personal lines-related and will therefore not affect the commercial cohort uniformly. We would be looking for Travelers to have the most exposure to these same risks.

While catastrophes and other factors have put pressure on these carriers, one positive for the commercial sector has been the pricing cycle. By all accounts, the trend should have petered out by now, but in last quarters’ earnings we heard from a number of companies that the numbers were continuing to come in strong.

The chart below shows how this has played out. We can see the hardening property trend, and even workers comp, which lags behind, has still had some improvement.

  

 

On the coming earnings calls, we will be looking for additional commentary on pricing by line, including drivers and guidance for the coming quarters.

With the discussion on pricing vs. loss cost trends likely to remain the most important topic, we are reiterating our reserve analysis from earlier this month.

The chart below shows the reserve releases by segment. Note the benefit from workers’ comp and all-other lines (this includes special property, financial and mortgage guaranty) doing the heavy lifting, while being partially offset by adverse development from private auto liability and other liability-occurrence.

  

 

It will be interesting to see if this quarter yields more reserve releases, or if the companies become increasingly conservative as the economic outlook gets hazier.

Another trend we hope to hear more about is the relative outperformance of specialty players. In recent quarters, the gap has widened between these two groups, but recent stamping data shows a slowdown that may mean they have benefited less from current pricing than vanilla commercials.

The chart below shows specialty consensus estimates shift as well as historical trends which reflect a mixed bag over time.

  

 

For the regional cohort, we will be looking for commentary on how these macro factors are affecting the small and middle market space. We mentioned in our last reserving piece that we are holding off on naming this a hard market yet, but it is worth noting that in the past, hard market environments have helped this group as business from large commercials spills over to the smaller players.

The chart below shows that the view is generally trending upwards for regionals, and in this sub-group, all of the adjustments are material rather than just a small tick up or down.

  

 

Personal lines results will likely be weighed down by pressure on loss costs and catastrophes

We may have seen the preview of personal lines earnings in the form of Progressive’s March announcement stating adverse development. Given that Progressive is a leader in the personal lines space, and finds itself in the enviable corner of value creation, it is likely that the news it is sharing will also be shared by competitors.

We’ll also be looking out for news on exposure to catastrophes, given the higher-than-usual volume of events in the quarter. Another hot topic would be regulation, specifically in Florida where cases have ticked upward ahead of recent legislation effective dates. It remains to be seen if this is more of an isolated event, or if this is another leg of the continuing loss cost challenge.

The following table lays out EPS estimates, and also includes prior quarters’ surprise percentages. It shows that the estimates have trended down significantly for insurers since the end of 2022.

  

 

In addition to these issues, we are likely to hear continued conversation on increased loss costs and rate action.

The graph below was shared on our recent note on insurance-related CPI metrics. It shows personal auto premium inflation against loss cost inflation. We see that premium growth has recently surpassed loss cost growth on a three-month rolling basis.

  

 

Personal lines insurers have had a difficult few years battling loss cost inflation and catastrophes.

The following charts show that inflation is still very much a problem that personal lines insurers are dealing with, primarily through aggressive rate increases, across the country.

  

 

In addition to the loss cost components shown above, used car pricing appears to be reversing trend and seeing price increases.

In the chart below, the Manheim used vehicle value index indicates that used car prices are back on the rise, now only -2.4% on a year-over-year basis (Last month it was -7% YoY; two months ago it was -12.8%).

  

 

High used vehicle values combined with high loss cost components will keep insurers’ rates moving higher with likely tightening of underwriting guidelines and reduction in exposures.

Our analysis of rate changes for both personal auto and homeowners’ is shown below.

The following graph shows personal auto rate filings by month, as well as a 6-month moving average. We are showing 15+ years of data to highlight the historically high levels of rate change in the market.

  

 

The entire industry is taking increasingly aggressive rate action.

We see a similar story with homeowners’ filings, although homeowners’ rates did not plunge during the Covid crisis.

  

 

Lastly, taking a look at Florida, in general, imminent legislation changes seem to result in a spike of cases against insurers prior to those laws going into effect.

The following chart shows Florida court cases against insurers against the effective dates of bills that will benefit insurers against predatory legal actors.

  

 

Both SB 2A and HB 837 see spikes leading up into the laws going into effect. The situation in Florida, with regard to insurers’ health and the state’s catastrophe fund is challenging, so we’ll see how much these laws will help P&C insurers.

Reinsurers remain in control of pricing, though reports indicate rates eased for April 1 renewals

Overall, reinsurers are reluctant to deploy significantly more capital, and they are largely in control of terms and pricing. Broker reports state that April 1 prices are “easing”, but the supply and demand balance is still, as Aon described it, “delicately poised”.

Cedants are largely taking higher retentions, more co-participation, and moving to lower return periods, though PMLs remain elevated. If a recession were to hit, this would likely put further pressure on reinsurance spend.

The following is the reinsurers’ Q1 EPS table. Given the favorable conditions, it is the only P&C sub-sector where EPS trend is up for the group. However, part of this is also attributable to these carriers shifting to a hybrid model, allowing for better capital allocation to the hardening sectors.

  

 

The following chart gives a rate-on-line proxy as shared by Gallagher Re using its proprietary index. The data starts in 1990 and goes through April 1 2023 treaties.

  

 

As we see from broker reports, rates are going up across all reinsurance treaty types.

The April 1 treaties are dominated by Japanese business. Rates are increasing in the Asia Pacific area as well, with casualty increasing more than the US.

Moving on to US property in the table below, ceding commissions (pro rata commission) are effectively making quota share treaties more expensive by 0% to 6%; the second two columns show that excess-of-loss treaties are seeing a 20% to 100% increase depending on losses; catastrophe treaties (last two columns) are seeing 30% to 100% increases, again depending on last year’s losses.

It is notable to see ~25% to 35% minimum increase on reinsurance spend for programs comparable to last year.

  

 

On the casualty side, rates are not increasing as dramatically. The chart below shows casualty rate movements on a global basis. Focusing on the US, quota shares are becoming a bit more expensive (0% to 2%), followed by excess-of-loss at 0% to 15%, depending on last year’s losses.

  

 

While we will be watching for the carriers’ individual results for their April 1 renewals, the more interesting point for us will be commentary regarding the upcoming June 1 renewals.

Brokers will have strong results, with a boost for some from Q1 reinsurance renewals

Brokers have been going through a super-cycle over the course of the past couple of years, driven by strong pricing, as well as increases in exposure and inflation. Though the trend looked to be slowing down steadily since the Q1 2022 peak, Q4 was something of a surprise, with the decline slowing or even reversing for several companies.

Based on recent guidance, we expect a continued reversal of the trend this quarter for the cohort overall, as the record reinsurance renewals hit the Q1 numbers, and the boosting effects of inflation linger. However, it remains to be seen if this will be a blip or a true continuation of the super-cycle.

The chart below shows consensus estimate revisions for the cohort.

  

 

Despite strong performance in the sector and the extended pricing cycle, the trend for the cohort as a whole is generally downward. Note that the changes for the larger brokers are fairly small, however.

The chart below shows the brokers’ organic revenue since 2020. The shift in the trend in Q4 2022 is clear in the rightmost data point, particularly with Gallagher. As mentioned earlier, brokers that are more heavily involved in reinsurance (Aon, Gallagher and Marsh McLennan) will likely have a material tailwind this quarter from January 1 renewals.

  

 

Outside the performance of this sector, one of the things we will be looking for is commentary on the macro environment post-SVB.

Brokers have an advantage when it comes to perspective, seeing things not only from their own vantage point, but also seeing first hand the effects for clients and a broad range of carriers’ partners. We will be interested to hear what these companies have to say about how headwinds might affect their capital strategy, as well as what effects they are seeing in the industry on a larger scale.

In summary, this quarter’s earnings season will see a number of influencing factors, including how opposing forces of inflation and pricing interact with interest rates, the banking collapse, and above-average cats.

Commercial lines will benefit from the extended pricing cycle, reserve releases, and exposure, but the impact of the recent storms is a wild card. We will also look towards underlying margin improvement as earned rate comes in.

Personal auto loss cost factors had begun to improve, but Progressive and The Hartford’s pre-announcements show that we are not out of the woods yet. We’ll be looking to get details indicating whether this a blip or the start of another down cycle.

Reinsurance will benefit from strong pricing, but we will be looking for a slowing from Q4’s pricing peak, and a forward look on Florida renewals.

Brokers will likely have strong results, propelled by the commercial pricing cycle and inflation, and by the Q1 reinsurance renewals.

 

 

Inside P&C provides unparalleled market intelligence on the entire US P&C market – from small commercial and personal lines right through to reinsurance and Bermuda. Redeem your complimentary 14-day trial for more premium content from Inside P&C.

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