Sunday, January 16, 2005
Insurance boom over
Investors need to understand the industry a company operates in. What drives profits and turnover? Does the industry have a long-term future? What are the risks to earnings?
In his magnum opus One Up on Wall Street, legendary fund manager Peter Lynch pigeon-holes companies into six categories: slow growers, stalwarts, fast growers, cyclicals, turnarounds and asset plays. This week, several announcements highlighted the insurers as cyclicals, which Lynch defines as:
a cyclical is a company whose sales and profits rise and fall in regular if not completely predictable fashion. In a growth industry, business just keeps expanding, but in a cyclical it expands and contracts, then expands and contracts again... [share price] charts of the cyclicals look like the polygraphs of liar, or the maps of the Alps, as opposed to the maps of Delaware you get with the get with the slow growers
Obviously, the challenge for the investor is to anticipate the up-leg of the cycle and bail out at a profit before earnings begin to decline. But how does an investor judge the present wherabouts in the cycle?
One of the best ways to get your bearings is to read the trading statements and other stock market announcements from the sector. Though my insurance holding, Chaucer, has made no anouncement on trading thus far in 2005, rivals Wellington Underwriting, Amlin and insurance broker Admiral all gave their barometer reading from the industry.
On 7th January, Wellington reported a fall in the prices being achieved for it's insurance products:
Underwriting conditions have remained favourable during 2004. Overall, rates have decreased 5% which is in line with our expectations. In some classes of business, rate pressures have eased as the result of industry losses sustained from the Hurricanes Charley, Frances, Ivan and Jeanne. Rates in other lines, particularly US property, remain under pressure.
Wellington's announcement sounded the opening bars of the insurance industry's lamenting on facing a period of falling revenue. Three days later, Amlin reported similar news on current trading:
The average renewal rate reduction for the 2004 year was 4%, weighted across premium by business class...Overall, this 2005 renewal period for Amlin has been satisfactory with premium volume of £168 million written to date, only 4% down on the previous period. International property catastrophe and other large property risks have come under some pressure but US catastrophe reinsurance renewals have seen only small reductions in rates. This is encouraging given that the principal renewals of programmes impacted by the hurricane and typhoon losses are later in the year.
but Amlin reassured investors this year's figures for the industry would be extraordinarily depressed due to losses incurred in the wake of the Atlantic hurricane season:
2004 was the costliest year on record for natural catastrophes. Current industry estimates place the insurance cost at approximately $40 billion.
On the 12th, Admiral piped up with their industry prognosis,
Admiral believes premium rates in the overall market drifted down by around 3% during 2004, but our conversion data suggests the decreases were more focussed on the lower premium segments which are not part of Admiral's core market. Following a small increase in rates in the second half of 2004, Admiral's own rates finished the year roughly 2% below the level at the start of the year.
The industry has clearly signalled to the market that the top of the cycle has passed. But how much further will insurance rates continue to fall? Will insurance remain a profitable industry until rates start to increase again and what are the implications for share prices in the sector?
The Lloyd's insurance market, which includes Wellington, Amlin and my sector investment, Chaucer, has a notorious reputation for destroying shareholder value in the down-leg of the cycle as insurers compete for Pyrrhic victory in writing insurance at what transpires to be unprofitable rates. Management comment from the sector has for months reiterated the need for discipline in the business. At current price levels, the market is assuming the insurers will continue to write insurance like lemmings until profitability falls off the cliff. But while the shares have such strong asset backing in cash, bonds and equities of aggregate value almost equal to market capitalisation - I'd be showing the level folly of a lemming to sell now.
The Artful Dodger
In his magnum opus One Up on Wall Street, legendary fund manager Peter Lynch pigeon-holes companies into six categories: slow growers, stalwarts, fast growers, cyclicals, turnarounds and asset plays. This week, several announcements highlighted the insurers as cyclicals, which Lynch defines as:
a cyclical is a company whose sales and profits rise and fall in regular if not completely predictable fashion. In a growth industry, business just keeps expanding, but in a cyclical it expands and contracts, then expands and contracts again... [share price] charts of the cyclicals look like the polygraphs of liar, or the maps of the Alps, as opposed to the maps of Delaware you get with the get with the slow growers
Obviously, the challenge for the investor is to anticipate the up-leg of the cycle and bail out at a profit before earnings begin to decline. But how does an investor judge the present wherabouts in the cycle?
One of the best ways to get your bearings is to read the trading statements and other stock market announcements from the sector. Though my insurance holding, Chaucer, has made no anouncement on trading thus far in 2005, rivals Wellington Underwriting, Amlin and insurance broker Admiral all gave their barometer reading from the industry.
On 7th January, Wellington reported a fall in the prices being achieved for it's insurance products:
Underwriting conditions have remained favourable during 2004. Overall, rates have decreased 5% which is in line with our expectations. In some classes of business, rate pressures have eased as the result of industry losses sustained from the Hurricanes Charley, Frances, Ivan and Jeanne. Rates in other lines, particularly US property, remain under pressure.
Wellington's announcement sounded the opening bars of the insurance industry's lamenting on facing a period of falling revenue. Three days later, Amlin reported similar news on current trading:
The average renewal rate reduction for the 2004 year was 4%, weighted across premium by business class...Overall, this 2005 renewal period for Amlin has been satisfactory with premium volume of £168 million written to date, only 4% down on the previous period. International property catastrophe and other large property risks have come under some pressure but US catastrophe reinsurance renewals have seen only small reductions in rates. This is encouraging given that the principal renewals of programmes impacted by the hurricane and typhoon losses are later in the year.
but Amlin reassured investors this year's figures for the industry would be extraordinarily depressed due to losses incurred in the wake of the Atlantic hurricane season:
2004 was the costliest year on record for natural catastrophes. Current industry estimates place the insurance cost at approximately $40 billion.
On the 12th, Admiral piped up with their industry prognosis,
Admiral believes premium rates in the overall market drifted down by around 3% during 2004, but our conversion data suggests the decreases were more focussed on the lower premium segments which are not part of Admiral's core market. Following a small increase in rates in the second half of 2004, Admiral's own rates finished the year roughly 2% below the level at the start of the year.
The industry has clearly signalled to the market that the top of the cycle has passed. But how much further will insurance rates continue to fall? Will insurance remain a profitable industry until rates start to increase again and what are the implications for share prices in the sector?
The Lloyd's insurance market, which includes Wellington, Amlin and my sector investment, Chaucer, has a notorious reputation for destroying shareholder value in the down-leg of the cycle as insurers compete for Pyrrhic victory in writing insurance at what transpires to be unprofitable rates. Management comment from the sector has for months reiterated the need for discipline in the business. At current price levels, the market is assuming the insurers will continue to write insurance like lemmings until profitability falls off the cliff. But while the shares have such strong asset backing in cash, bonds and equities of aggregate value almost equal to market capitalisation - I'd be showing the level folly of a lemming to sell now.
The Artful Dodger
Comments:
Post a Comment
