Image Source: NASA Goddard Space Flight Center. NASA Sees Irma Strengthen to a Category 5 Hurricane. This visible light image of Hurricane Irma was captured by NOAA’s GOES East satellite as it strengthened to a Category 5 hurricane in the Central Atlantic Ocean on Sept. 5 at 7:45 a.m. EDT (1145 UTC). NASA and NOAA satellites have been providing valuable satellite imagery to forecasters at the National Hurricane Center, and revealed that Hurricane Irma has strengthened to a Category 5 hurricane on Sept. 5 around 8 a.m. EDT (1200 UTC). Credits: NASA/NOAA GOES Project.
Hurricane season 2017 has not been kind to insurers.
By Brian Nelson, CFA
What a disaster-of-a-hurricane-season 2017 is shaping up to be. Our hearts and thoughts go out to the people of Texas and Florida in the wake of such disasters, Hurricane Harvey and now Hurricane Irma, the latter a Category 5. We wish our friends in Houston and Miami a safe and speedy recovery.
Readers of Valuentum’s work know that we’re not too fond of the insurance business model, as underwriting profits can quickly be eroded by exogenous events and returns on premiums (“float”) are still based on investments that are tied to market activity. Some insurers have fantastic track records pricing risk appropriately, but substantial underwriting uncertainty remains and insurance is largely a commodity business with meaningful pricing pressures on certain lines (reinsurance premiums are estimated to have fallen 40% in the past 10 years or so). Another key driver behind an insurer’s business model is its investment returns on the float, but an investor may instead prefer to identify his or her own investments that meet his/her circumstances and criteria than rely on an insurer’s investment committee for such diligence.
Of course, there can always be exceptions: Warren Buffett, the Oracle of Omaha, and Berkshire Hathaway (BRK.A, BRK.B); hedge fund guru David Einhorn and Greenlight Re (GLRE); and Dan Loeb and Third Point Re (TPRE) are three insurers investors might like (we like Berkshire the best), but there are hundreds of public insurers and not nearly as many investors that can be relied upon to generate abnormally positive investment returns year after year over sustained periods of time. The “reinsurance business isn’t what it used to be,” and at the end of the day, the float is only as good as the investment committee behind it. For Buffett, it has resulted in a massive fortune; others may not be as “lucky” though. Even Buffett has sold stakes in Swiss Re (SSREF, SSREY) and Munich Re more recently.
Product pricing pressures driven by increased competition in a largely-commoditized space, the risky nature of the underwriting business in general, and the increasing lack of opportunities to invest the float in a near-negative interest rate environment and frothy US stock market make for an ominous near-term outlook for insurers–especially reinsurers, and especially in the wake of Hurricane Harvey and Hurricane Irma. Hurricane Katrina, which overwhelmed New Orleans in 2005, is estimated to have been the costliest hurricane in history, but some are already estimating Hurricane Harvey could be even costlier. The governor of Texas, for one, estimates that Hurricane Harvey could require up to $180 billion in relief spending, and Hurricane Irma could be equally as troublesome.
The stocks of a number of property and casualty (P&C) insurers with heavy exposure to Florida have been selling off aggressively, companies such as Universal Insurance (UVE), Federated National (FNHC), Heritage Insurance (HRTG), United Insurance (UIHC), HCI Group (HCI), among others. Seeking Alpha has also reported that larger insurers have been under pressure, too, including Travelers (TRV), Allstate (ALL), Chubb (CB), Cincinnati Financial (CINF), W.R. Berkley (WRB), Progressive (PGR), and 1347 Property (PIH). Reinsurers, already facing an industry maelstrom, are selling off, too, namely Everest Re (RE), Renaissance Re (RNR), Aspen (AHL), Axis Capital (AXS), XL Group (XL) and Reinsurance Group of America (RGA), among others. The top 3 insurance ETFs, by assets under management, are the SPDR S&P Insurance ETF (KIE), iShares US Insurance ETF (IAK), and the PowerShares KBW Property & Casualty Insurance Portfolio (KBWP). Since August 4, the SPDR S&P Insurance ETF has fallen nearly 6%, while the other two have performed similarly.
Home improvement retailers–Home Depot (HD) and Lowes (LOW)–engineering and construction (E&C) firms, and other building materials stocks may get a boost from hurricane-related rebuilding, and environmental service companies may get some extra work from the clean-up, but we don’t think betting on the weather is a way to achieve better risk-adjusted long-term returns, so we only mention such ideas in passing. The fallout from Hurricanes Harvey and Irma has yet to be finalized, but the market is certainly not acting to kindly to those holding the risk, the insurers. Regardless, we hope the economies of Houston and Miami bounce back like we know they can, and we hope those impacted by the devastation can quickly rebuild in every aspect of their lives.
Building Materials: DEL, EXP, KOP, LPX, MAS, MHK, MLI, MLM, OC, RYN, TILE, USG, VMC
Engineering & Construction: ACM, CBI, EME, FLR, GVA, JEC, KBR, LAYN, MDR, PWR
Environmental Services: CLH, CVA, CWST, DAR, ECOL, RSG, SRCL, WCN, WM