In a research note issued this morning, JMP Securities equity analyst Matthew Carletti commented that geopolitics and inflation will weigh on Q1 results but pricing remains strong.
“1Q22 results will likely paint a mixed picture as geopolitical issues (Russia/Ukraine), modest catastrophe losses, and a high level of mark-to-market losses on the back of higher interest rates will negatively impact reported EPS and book value growth, offset by strong top-line growth and improving underlying core accident year loss ratios from the continued favorable pricing environment,” Carletti said.
“We would describe the [pricing] cycle as approaching the seventh inning stretch. However, our recent meetings in Bermuda revealed that the moderation in the pace of rate increases observed in late 2021 has seemingly abated, leading us to wonder if this cycle may go into extra innings”
JMP Securities equity analyst Matthew Carletti
The analyst said that catastrophe activity was “relatively mild” in the first quarter, with a busy international picture and a less active domestic backdrop consisting of some convective storm activity late in the quarter.
“While not a natural catastrophe, the Russia/Ukraine conflict will likely generate a significant amount of insured losses when all is said and done, but due to the niche nature of the exposed lines of business (eg, aviation war, trade credit, political violence) the losses are unlikely to be evenly distributed and the timing by which companies will record the losses remains unclear (we expect some in 1Q, but likely more as 2022 progresses),” Carletti said.
Interest rates on the upswing
The significant rise in interest rates from relative long-term lows should drive some of the largest mark-to-market headwinds on book values seen in recent memory, Carletti said. He expects investor focus to remain squarely upon the pricing cycle and continued pandemic-related economic uncertainty.
“While pricing is firmly in improving territory nearly across the board, we would describe the cycle as approaching the seventh inning stretch,” Carletti said. “However, our recent meetings in Bermuda revealed that the moderation in the pace of rate increases observed in late 2021 has seemingly abated, leading us to wonder if this cycle may go into extra innings.”
Adverse loss cost trends from the reopening of the economy and supply chain and labor issues are causing the abatement of rate increases.
Carletti expects management commentary to be broadly supportive of continued pricing in excess of loss cost trends in most commercial lines, implying more accident year loss ratio improvement likely in coming quarters.
The analyst also expects the excess and surplus lines markets will continue to exhibit some of the strongest growth and margin improvement trends within the commercial lines sector for the foreseeable future
Against the backdrop of rising interest rates, JMP recommends that in the near term investors focus on companies that are less leveraged to investment income and more driven by underwriting results. Carletti said these include Arch Capital, Chubb, HCI, Palomar and The Hanover.
Underlying margin improvement to continue
Carletti’s preview of the Q1 earnings season follows comments from other analysts.
Last week Wells Fargo analyst Elyse Greenspan said her top picks include Chubb and WR Berkley “where we expect strong pricing to continue to benefit margins”.
She added that Wells Fargo also likes the “brokers that benefit from an improving economy and our top idea is AJG (while we are the most cautious on WTW)”.
Insurance brokers’ growth is “slowing but at decent levels”, Greenspan said, with the analyst looking for organic growth of +5.8 percent for the group excluding BRP and Ryan Specialty Group, which would be below the 8.4 percent recorded in Q4.
Wells Fargo estimates Q1 insured cat losses of around $12bn driven by global events including the European windstorms, Japanese earthquake, and Australia floods, while losses should be lower than normal in the US.
“Rising interest rates and weak equity markets performance should pressure book value growth; typically-lagged alternative investment income should mostly reflect positive 4Q21 results”
Keefe Bruyette & Woods equity analyst Meyer Shields
“Away from cats and Russia/Ukraine, we expect commercial lines insurers to continue to see underlying margin improvement (and point to a still strong pricing environment), while personal lines insurers are still seeing a loss trend that exceeds pricing levels, and reinsurers should benefit from stronger growth in casualty lines, while we think most will remain cautious on the mid-year renewals in Florida,” Greenspan said.
Meyer Shields, analyst at Keefe Bruyette & Woods, last week also issued a Q1 preview in which he suggested most reinsurers’ and commercial underwriters’ core combined ratios should improve on earned rate increases, while personal auto insurers’ results should include very limited earned rate increases and rapidly rising claim costs.
“Rising interest rates and weak equity markets performance should pressure book value growth; typically-lagged alternative investment income should mostly reflect positive 4Q21 results,” said Shields.
KBW expects about $10bn of global natural catastrophe losses, while Russian/Ukrainian losses’ likely-contested coverage status, particularly for aviation, implies manageable booked Q1 losses, predominantly for Lloyd’s insurers and their reinsurers.
For reinsurers, Shields expects manageable Q1 catastrophe and Russian/Ukrainian losses, with core loss ratios otherwise broadly declining year over year.
KBW’s top quarterly picks are personal insurer Palomar, specialty insurers American Financial Group, CNA, and RLI, Bermudians Axis Capital and Everest Re, and brokers BRP and Ryan Specialty Group.
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