Risks to fundamentals in the non-life insurance and reinsurance sector are “skewed to the downside” according to analysts from Bernstein, but still the stock market has not yet priced in the fact that many companies are destined to deliver lower returns across the cycle in future.
In their latest report, analysts from Bernstein question whether investors are really aware of the downside faced by the non-life sector, particularly reinsurance, and whether the potential for re/insurers to face permanently lower returns has been priced into their shares or not.
The analysts, led by Josh Stirling, believe that value for investors is becoming harder to find in the shares of non-life insurers and reinsurers.
“Though the stocks may perform well on a relative basis if the risk-off trade is dominant, if we look to the fundamentals of the business, we think risks for the non-life insurance group are skewed to the downside,” the report explains.
The analysts note that historically the simplest way for investors to profit from investing in non-life insurance or reinsurance stocks has been to time it with the cycle and invest when pricing was on the up.
But with pricing now down for four or more consecutive years in reinsurance and increasingly pressured in non-life commercial and specialty insurance, while many talk about the cycle being permanently altered (or even dead) thanks to the entry of capacity from ILS players and the capital markets, those days of riding a wave of price rises may be over.
In reinsurance “the pain continued at the 1/1 renewals” the analysts explained, adding that already thinly priced property catastrophe risks saw further price declines, while non-catastrophe business also softened further.
Importantly, the analysts note ongoing pressure on terms and conditions, including in multi-year casualty treaties, which they say was “once anathema to underwriters.” The fact terms are being expanded in lines where previously it was thought to be unwise or even downright dangerous could be cause for caution.
Bernstein’s analysts agree with the premise that many reinsurance firms will no longer be able to meet their cost-of-capital, while pricing remains at current levels. With new capital continuing to enter the space this pressured environment looks set to persist and reinsurance returns may remain below the cost-of-capital of a traditional player, particularly those less-diversified firms.
“With lower barriers to entry for new capital in this secularly changed market, we think the market has not recognized the lower cross-cycle returns these stocks will likely deliver going forward,” the analysts warn investors.
The warning signs have been evident for some years now, but for the majority of investors in reinsurance company shares it seems there could still be a shock to come, as the realisation that returns are not going to bounce back quickly becomes apparent.
When that fact is realised and if the softening persists and has structurally changed the shape of the reinsurance market cycle, investors could begin to vote with their money and some companies may see share prices suffer, while others, particularly the diversified, or those operating a more total-return type approach, may benefit.
For the moment excess capital and the lack of catastrophe losses continue to help reinsurers to report adequate results each quarter and that could continue for some quarters to come. However; “We do not think it is likely these tailwinds will persist indefinitely,” Bernstein says.
Any type of catalyst that impacts performance could result in pressure on stocks in the sector, as investors finally get to see whose results are more resilient to shocks than others. At that time share prices will have to reflect how the cycle reacts, and if it has been permanently changed by the entry of lower cost capital from the ILS sector and capital markets, the only way to price many non-life re/insurance shares will be down.
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