Commentary: Shares of Insurers Pause After Recent Gains—What Direction Now’

By | August 13, 2001

In the short term, it’s extremely difficult to predict whether a stock will go up or down. The many factors involved are open to widely varied interpretations. Trends in a given sector can be spotted over time, but it’s purely hypothetical whether they’ll continue in the same direction. Market analysts, using the same data, often reach differing conclusions. Wall Street’s current enchantment with insurance stocks may well end tomorrow, or it may continue, depending on general economic conditions and specific industry factors.

Robert Hartwig, vice president and chief economist at the Insurance Information Institute, notes that, “P/C stocks gained 43.4 percent last year compared to a slide of 9.1 percent in the S&P 500 and 39.3 percent on the NASDAQ. Prior to their comeback last year, the prices of many insurer stocks were at their lowest levels in years.” Over the last year, Standard & Poor’s Insurance Index has varied between $613.39 and $864.72. At the beginning of August it was around $749, down about 5 percent this year compared to a 7-percent decline in the S&P 500 Index.

Measuring the ups and downs in value against broader market indices only shows how Wall Street feels about the insurance industry’s stocks and bonds generally—it says little about individual companies. While share values are mostly higher than they were at the end of 1999, an individual examination shows that some companies did a lot better than others, while a
few—Reliance, HIH and Independent—vanished into bankruptcy.

The term “insurance industry” itself is broad enough to be something of a misnomer. Insurers invest in real estate, bonds, equities, swaps, ART’s and other industries—AIG owns the world’s largest commercial aircraft leasing business; AXA owns a half dozen winemakers. Nor does it help to break them down along traditional property/casualty-life/health lines, as most companies do business in all these areas, plus provide “financial services.” Allstate is the second largest p/c insurer and thirteenth largest life insurer in the U.S.

Both direct and indirect events influence share values. Natural disasters or long-tail liabilities like asbestos obviously have a direct influence on a p/c insurer’s earnings, as the number and amount of claims increase. This eventually drags down share prices.

Indirect events also have an impact. As an example: the safest investment should be life companies. Their extensive use of actuarial expertise, the growing sophistication of their products and their use of advanced probability models, would seem to make it impossible for any decently managed life insurer to lose money. However, as the competition requires pricing their products with very little margin, most of their earnings have to come from investments, and like any investor, they can be wrong.

One look at the disasters among Japanese life companies shows how. Set returns on policies too high, bank on the prospect that your investment income will cover them, then pay too much for the investments, and watch them decrease in value; boom, you’re bankrupt.

Particular circumstances within the industry also play a part in determining share values. For years, cutthroat competition for market share and excessive capacity drove down insurance and reinsurance rates, depressing share prices. Then things began to change. Reinsurance markets are firming. Commercial premiums are rising. More rigorous underwriting standards are being applied to risks. As a result loss ratios are improving, less money has to go into reserves, making more available for investment, earnings are higher, and, amazing thing, the value of most insurance stocks has been rising.

These changes in fundamentals have substantially improved many companies’ bottom lines and ultimately their share values. Rising premiums in commercial lines and reinsurance have helped companies like ACE rise to its current value of $34 a share, off its high of $43.9375 last November, but well above its $26.1250 low last summer. Rival XL also has seen its share price raise from around $52 a share to over $75.

Rising premiums and expanding life sales also helped increase the value of personal lines companies. Despite market weakness, Allstate’s shares were up more than 50 percent at the end of June to $44, near its December high of $45.90, but they have recently declined to around $34 at the beginning of August.

A company’s P/E ratio—basically how many times what it earns (or is expected to earn) per share does it cost to buy one—is a standard valuation measure. It’s most useful for industries with steady income streams and fixed investments in plant and equipment. It’s less helpful in evaluating insurance companies, as other factors like market position, capitalization, financial ratings, return on equity and loss ratios are more significant. AIG’s recent P/E ratio was around 35, AXA’s was about 16 and ING’s was only 5.5. While ING’s probably not a bad investment, that P/E ratio reflects a lot of one-time-only earnings contributions—one of those pesky “other factors.”

A company’s quarterly earnings reports usually have the most immediate affect on its share price. AIG’s shares, for example, rose throughout most of last year on reports of earnings increases, which registered 12 percent growth at $11.5 billion. For a while its shares traded at over $100, making it the biggest financial/insurance company in the world in terms of shareholder equity, ahead of even Citibank/Travelers.

Recent reports, however, have shown more modest gains as the U.S. economy slows and analysts factor in the costs involved in acquiring American General. Partially as a result, AIG’s shares closed recently at $82.45. Its huge equity capital, around $200 billion, is primarily due to the fact that it has 2.33 billion outstanding shares, 2.24 billion of which float. This doesn’t really mean anything for its present valuation; however, it may influence long term prospects, as its capitalization makes it easier to raise money—a fancy way of saying that “the rich get richer.”

Most insurance stocks have been good investments over the last year and a half. “While some investors have taken profits in the wake of the industry’s phenomenal performance on Wall Street last year, insurer stock valuations have managed to hold their own and continue to outperform the S&P 500 and NASDAQ,” Hartwig stated. “Over the past 52 weeks, the performance gap is extraordinary.”

The biggest factor presently weighing on Wall Street is the downturn in the U.S. economy, which shows signs of spreading to Europe and the rest of the world. Share values of insurance stocks have declined, but if the economy improves and the fundamentals continue to remain strong, the sector could weather the current crisis pretty well.

From This Issue

Insurance Journal West August 13, 2001
August 13, 2001
Insurance Journal West Magazine

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