“People like to live in dangerous places.” Why climate change will boost insurance stocks
Written by Michael Brash
Weather disasters motivate people and businesses to buy more insurance. So demand rises while capacity shrinks.
If you notice a lot of extreme weather events, you’re right. It’s not just media hype as climate change deniers would have you believe. There have been a record number of severe storms this year so far.
As of the end of August, the United States had been hit by 23 climate disasters large enough to cause $1 billion or more in damage. This was more than the number recorded for any full year since 1980, according to the National Oceanic and Atmospheric Administration.
Localized pop-up storms, known as “severe convective storms,” caused $38 billion in insured losses in the first half of 2023 alone. This shattered the previous record of $33 billion in the first half of 2011, notes Aon Analytics, a division of insurance company Aon (AON). Severe convective storm losses increased 9% annually from 1990 to 2022.
“Climate change is real,” said Greg Lucraft, an equity analyst who covers the insurance sector for T. Rowe Price. “It’s causing storms to form faster and more intensely. This is happening now nationally. Severe convective storms are happening everywhere.”
While expensive catastrophes hurt in the near term, higher payouts have two positive effects for insurers.
Because climate change and other factors are driving claims up, insurers around the world will pay $133 billion annually in catastrophe loss claims over the next few years, predicts research firm Verisk, which analyzes insurance industry trends. This is up from an average of $101 billion per year over the past five years, and $70 billion per year over the five years before that.
You might think these trends are terrible for insurance companies that offer property and casualty coverage. But in the twisted world of insurance, just the opposite is true. While costly catastrophes hurt in the near term, the payouts have two positive effects for insurers.
First, capacity. By consuming capital, large payments take insurance capacity out of the market. As weather forecasting becomes more difficult, some insurance companies are moving away from property and casualty insurance. Large losses also drive out irrational insurers and discourage new entrants. All of these trends reduce capacity.
Secondly, demand. Weather disasters motivate people and businesses to buy more insurance. So, demand rises, while capacity shrinks.
Combined, these trends are boosting prices, creating what is known as a “hard market” in the industry. The result is increased profitability at insurance companies – making it a play on climate change.
Climate change is not the only trend in favor of insurance companies. Higher inflation means property is more valuable and repairs cost more, so insurance payouts rise.
Moreover, people are moving to places more vulnerable to weather-related losses, such as Florida, the Sun Belt states, and Texas. “People like to live in places that are dangerous from a climate perspective,” Lucraft said. “The most beautiful and expensive places are places near water and in the forest.” “If you start building high-value homes in Miami and a hurricane hits, the hurricane is more expensive because it hits where the value is. This has nothing to do with climate change.”
In fact, Aon Analytics blames most of the increase in insured losses on increased exposure in high-risk areas and inflating real estate costs – not climate change. But this may not be accurate, says insurance company RenaissanceRe Holdings (RNR).
“Our scientists believe weather events are influenced by a range of slowly evolving factors,” noted Kevin O’Donnell, CEO of RenaissanceRe. These factors include “boosting energy in the system due to climate change,” he added.
The bottom line is that all of these trends, including climate change, are collectively creating significant pricing power in the insurance sector. In the past five years, property and casualty insurance rates have doubled, Lucraft said. Now, expect more of the same.
“Insurance losses to the industry in 2023 will likely exceed $100 billion again,” O’Donnell said. “This puts further pressure on reinsurance demand. At the same time, we have seen very little new capital in the system.” Taken together, these trends “should create a healthy pricing tension,” he said.
Insurers also benefit from rising bond yields.
Pricing power is not the only source of earnings growth. Insurance companies also benefit from rising bond yields, as they invest their returns in fixed income.
“Insurers this year are delivering the best results I have seen in 20 years of following this sector,” Lucraft said. Big picture, analysts expect 47% earnings growth among property and casualty insurers next year, according to Yardeni Research.
“You’ve got at least a one-year view into an uncertain earnings environment when the likelihood of a recession is increasing,” Lucraft said. Despite these trends, insurers are trading at some of their lowest valuations in a decade, he added.
Here are three insurance companies that look like good investments because they are taking advantage of these trends. The first two are Locraft favorites at T. Rowe Price. The third comes from the superior fund managers of Marshfield Focused Opportunities Fund (MRFOX MRFOX).
1. Chubb (CB): This Swiss-based insurance company is one of the largest in the industry. Net written premiums rose 9.1% year over year in the third quarter, to $13.1 billion. Property and casualty insurance premiums increased by 8.4%. Net income per share rose 49% to $13.79, although some of that came from the purchase of Chinese insurer Huatai.
“We had a great quarter, contributing to great year-to-date results,” said CEO Evan Greenberg. “We are confident in our ability to continue to grow revenues and operating profits globally, which in turn will increase earnings per share.” Investment income grew by 34% to reach $1.4 billion.
“Chubb and its peers have seen a positive trend in underlying underwriting profitability, similar to the period following September 11,” says Morningstar analyst Brett Horn. “Highly disciplined operators like Chubb are in a position to earn a very attractive return.”
2. RenaissanceRe Holdings: Bermuda-based RenaissanceRe Holdings said it is “one of the top five reinsurers, but is particularly good at property and casualty reinsurance.”
Year-to-date, net premiums written for property catastrophe insurance are up 40%. Investment income in the third quarter rose 109% to $329.1 million, despite exposure to large weather events such as Hurricane Idalia, which struck Florida last August. Because of the price increases, “disaster activity has had a much less impact on us than in previous years,” CEO O’Donnell said.
Arch Capital Group (CGL): Like famous investor Warren Buffett, smart underwriters know when to back away from underwriting because rates are too low. Arch Capital is great at this, say Elise Hoffman and Chris Niemczewski, who manage the Marshfield Concentrated Opportunity Fund. This is one of the reasons why Arch Capital is their largest position, at more than 10% of their portfolio. “Property casualty insurance companies live or die by how disciplined they are,” Niemczewski said. “You can only lean into a hard market if you get out of a soft market.”
Arch Capital took over years ago during a weak part of the insurance cycle, so it now has the potential to grow quickly. Gross written premiums rose 17% in the third quarter to $4.5 billion. Property and casualty insurance premiums rose 26% over last year to $3 billion. Earnings per share were $1.88 versus two years ago.
Arch Capital expects “hard market” pricing power to support healthy gains again in 2024. “The current tough market looks like a baseball game,” CEO Mark Grandison said. “We know there are only nine innings, but we have no idea how long those innings will last.”
Michael Brash is a MarketWatch columnist. At the time of publication, he had no positions in any of the stocks mentioned in this column. Brush publishes a stock newsletter called Brush Up on Stocks. Follow him on Xmbrushstocks
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11-23-11 1020 EDT
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