As the 2023 hurricane season commences, it’s time to consider the financial implications of extreme weather conditions, and the industries that may suffer the most. With a tumultuous few months already in the books, marked by heavy rain, strong winds, hail, tornadoes, and Canadian wildfires, the insurance sector is preparing for the worst.
Turning to Reinsurers
Bank of America analysts predict that earnings for most property and casualty insurance companies will decline during this hurricane season. As a result, investors may want to shift attention to reinsurers as they invest in the potential losses above a designated threshold, deemed too risky for primary insurers to absorb alone. This option provides a more secure alternative in case of disaster.
Tipping the Scales in Favor of Reinsurance
Over the past six months, the cost of reinsurance for property catastrophe policies has surged. The escalation in costs is due largely to increasingly severe natural disasters and high inflation rates. As a result, primary insurers are grappling with having to cut their reinsurance coverage and bear more catastrophic risk. If a major hurricane strikes in 2023, primary insurers will likely experience a greater financial blow than in previous years.
Primary Insurers at Risk
The US has witnessed a tsunami of mid-sized catastrophes from March through June of this year. The losses tied to these events primarily impact the primary insurers rather than reinsurers. Reinsurers coverage typically only takes effect when major disasters occur, so Insurance companies have no recourse to recuperate their losses from current disasters.
It may be time to rethink your investment strategy this hurricane season. While primary insurers may not be able to withstand another major event, reinsurers may provide an effective safeguard at a time when mother nature seems intent on testing the limits of our industry—prepare ahead of time and stay safe.
Reinsurers and Primary Insurers: A Shift in Performance
In a surprising twist, U.S.-listed reinsurers have outperformed primary insurers by more than 20 percentage points so far this year, according to a recent report. The market-weighted index of Arch Capital, AXIS Capital, Everest Re, and RenaissanceRe has gained 9.5%, while the index of Allstate, Chubb, The Hartford, Travelers, and W.R. Berkley has lost 10.9% over the same period.
This divergence from their usual close performance has led analysts to predict that reinsurer stocks have more room to grow. Everest Re and RenaissanceRe, two major industry players, are currently priced at only six to seven times the consensus forecast for their 2024 earnings per share, whereas primary insurance firms Chubb and Travelers are priced at 10 times their 2024 earnings.
However, this shift can be traced back to the past decade of low interest rates, which led to a surge of investment into insurance-linked securities that competed against reinsurers for catastrophe coverage. This allowed primary insurers to buy protection at an “arguably artificially low price” and led to a significant impact on the performance and pricing of reinsurers.
Recent rate hikes by the Federal Reserve have given reinsurers more power in pricing their products at desired levels. While the Fed’s rate hikes have paused for now, as long as Treasury yields remain in the 3.5% to 4.5% range or higher, analysts predict that reinsurance pricing will stay elevated through next year.
All in all, it seems that reinsurers are on the rise and expected to perform well compared to primary insurers going forward.
Hurricane Season Not a Threat to Reinsurer Stocks
As hurricane season approaches and fears of major storms increase, there have been concerns about how the losses suffered by reinsurers will impact their balance sheets and stock prices. However, recent analysis suggests that investors need not be overly concerned.
According to analysts from Bank of America, there is little evidence to support the so-called “summer trade” strategy, which involves selling reinsurer stocks at the start of the hurricane season and buying them back later when prices have dropped. In fact, historical data from the past two decades shows that on average, reinsurer stocks have actually appreciated in value and outperformed the S&P 500 from July to October.
While short-term trades based on hurricane fears and seasonal trends may be possible, analysts warn that they require a level of nimbleness and agility that most investors do not possess. Instead, investors should be cautious and focus on the long-term prospects of the companies in question.
In the event of a major hurricane, primary insurers are likely to buy more reinsurance to prepare for future losses. This could actually lead to increased demand and higher prices for reinsurers.
Overall, while hurricane season may bring uncertainty and volatility to the market, it is not necessarily a threat to the stability of reinsurer stocks. As always, investors should exercise caution and stay focused on their long-term goals.