TUESDAY, NOVEMBER 18, 2008
INVESTORS' SOAPBOX AM
AIG May Influence Sector Pricing Rebound
KeyBanc says the firm's rivals claim that AIG prices too aggressively.
KeyBanc Capital Markets
WE BELIEVE THE PROPERTY/CASUALTY insurance industry is unique in the ability to make lemonade out lemons, or to put it another way, the worse the results, the better the potential for an improving-rate environment.
Third-quarter 2008 was one of the most brutal earnings seasons for the property/casualty insurance industry in recent memory. Earnings disappointments were the norm during the quarter. Catastrophes and soft pricing impaired underwriting profits, and investment losses drove book values lower. As a consequence, capacity as measured by shareholders' equity, declined 15.9% through the nine months of 2008.
The good news is that a reduction in capacity is the catalyst for a pricing-cycle recovery. We believe a turn in the pricing cycle for the property/casualty industry has been accelerated as a result of the disastrous results the industry reported in third-quarter 2008. We therefore forecast an increase in property/casualty insurance prices will occur during 2009 rather than 2010 as many observers had pontificated prior to third-quarter results.
We believe some insurers are better positioned to benefit from an earlier than expected pricing turn. Our choice of stocks that are particularly well-positioned to benefit from price increases in 2009 include: Progressive (ticker PGR) (rated at Buy with a $16 price target); Meadowbrook Insurance Group (MIG) (rated at Buy, $9 price target); HCC Insurance Holdings (HCC) (rated at Buy, $30 price target); and Harleysville Insurance Group (HGIC) (rated at Buy, $38.50 price target).
Almost every insurer expressed [during conference calls] the need to raise prices. We were most influenced by industry participants that have the resources and market share to be price leaders. Many insurers in leadership positions were more vocal than most in a declaration to the investing community that the current pricing conditions could not stand and that even if the insurer is alone in the effort, the prices have to be raised.
We believe third-quarter and nine-months 2008 results provided a plethora of evidence supporting price increases beginning with the 2009 reinsurance renewal season. Price-raising by 2009 is sooner than we had originally expected. We believe the change to a sense of urgency to raise prices among the insurers is reflective of the damage that catastrophes and investment losses have wrought on the property/casualty industry.
The economy is the first concern. The economic slowdown, especially given the expectation for a severe slow down, could limit the impact of higher prices as demand may decline at a faster pace than prices are able to increase. Financially strapped customers might choose to cut back on coverage to offset the higher insurance costs.
The second factor is American International Group (AIG) and how the insurer will behave in the market. AIG representatives are adamant that the pricing behavior of AIG has remained appropriate despite financial pressures that might encourage price discounting.
However, all of AIG's competitors have been consistent in their criticism of AIG's pricing behavior. We believe AIG's size and reputation positions the company to be a significant influence on pricing in the overall market. In our opinion, if AIG continues to price business aggressively as the company's competitors and agents claim, the size and the rapidity of price increases for the overall property/casualty insurance market may be delayed.
We have analyzed the third-quarter 2008 industry data to confirm the industry's conditions of investment loss, underwriting loss and inadequate pricing have resulted in a meaningful decline in capacity sufficient to serve as a catalyst for higher prices in 2009.
--Elizabeth C. Malone, CFA
--Ed Imsirovic
--Mark Aydin
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