The possible reversal of the persisting low interest rate environment and modest strengthening of the key economic indicators – employment, real estate, GDP and stock market – should help insurers witness accelerated recovery in 2015. Moreover, an already strong liquidity profile, conservative product design and evolving coverage opportunity should lead the industry to an upside.
Following a slowdown in Q1, which saw an 8.7% earnings decline on 0.6% revenue drop, the insurance industry witnessed a recovery in the next two quarters, keeping pace with the broader finance sector. Earnings growth in Q2 and Q3 came in at 0.1% and 6.1% on revenue growth of 5.5% and 6.6%, respectively. With no major headwind cropping up in Q4 and most of the factors remaining favorable, the growth trend is likely to continue.
While the pace of premium rate increase remained subdued due to the still low interest rate environment, momentum is due shortly as the rate hike seems imminent. However, fundamental challenges – such as weak underwriting gains and low investment yields – and heightened market competition might continue to mar profitability to some extent.
No matter what, the ongoing reserve development will keep supporting insurers’ financials. Also, increasing demand from economically recuperating American households should place insurers in a favorable pricing cycle.
A lot depends on catastrophe losses too. Following two below-normal seasons in a row, the 2015 Atlantic hurricane season, spanning from Jun 1 to Nov 30, is again expected to keep catastrophe losses modest. This should lead to recovery in underwriting and a lower combined ratio for Property & Casualty (P&C) insurers. Moreover, the possibility of lower catastrophe losses will keep lowering premium rates.
Time to Rethink Regulation?
Apparently, a safe and sleepy business nature keeps U.S. insurers out of federal regulations, which could have marred business expansion. But the industry is yet to be strongly braced by the advantages of operating under state-run regulations. Instead, decentralized regulation and consumer protection make the industry susceptible to insolvency.
Now, the changing nature of business – more like banks in terms of liabilities – perhaps calls for federal oversight. Though the necessity for a regulatory revamp has been strongly felt after witnessing the success of banks, this will delve another blow to the tottering industry.
A provision of the 2010 Dodd-Frank Act requires setting minimum capital and leverage standards on insurance companies as well, but these are yet to be implemented by U.S. lawmakers, who are considering the distinct business fundamentals unlike banks. But the industry, which accounts for 7% of GDP in terms of insurance premiums paid each year, is not likely to be relieved of Federal Reserve control for very long.
Zacks Industry Rank
Within the Zacks Industry classification, insurers are broadly grouped in the Finance sector (one of 16 Zacks sectors) and are further sub-divided into five industries at the expanded level: P&C, Multiline, Accident & Health, Life and Brokers. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.
We rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.
As a guideline, the outlook for industries with Zacks Industry Rank #88 and lower is 'Positive,' between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.'
The Zacks Industry Rank for Property & Casualty is #31, Multiline is #70, Life is #76, Brokers is #97 and Accident & Health is #114.
Earnings Trends
The Insurance industry, which is the medium level (or M-level) component of the broader Finance sector, witnessed Q3 earnings beat ratio (percentage of companies coming out with positive surprises) of 77.3%, while the revenue beat ratio was 68.2%.
The broader Finance sector showed a recovery from Q2 in terms of growth. The sector witnessed year-over-year earnings growth of 3.8% compared with 0.9% in the prior quarter. Revenues however witnessed a 10.7% decline compared with 2.4% increase in the prior quarter. For Q4 and FY14, the sector is expected to witness earnings growth of 0.3% and 16.2%, respectively. Revenues are expected to decline 4.8% in Q4 but increase 2.8% in FY14.
However, the sector’s Q3 beat ratios for earnings and revenues were impressive at 70.4% and 63%, respectively. For a detailed look at the earnings trend for this sector and others, please read our latest Earnings Trends report.
Bottom Line
Looking at the broader trends, the overall health of the industry, which endured significant pricing pressure and reduced insured exposure since the latest recession, has recently improved on a stepped-up macro economy. Moreover, learning from past experiences, insurers are now resorting to expense saving measures.
If insurers manage to overcome the short-term resistance that may be holding back premium rate increase, they should ultimately witness margin expansion. Also, in the absence of federal regulation, insurers can take on new challenges with the ample capital that they now have.
That said, though the market condition isn’t soft anymore, reasonable hardening is not expected at least in the near term. Moreover, lack of real employment growth and legislative challenges will continue to restrict insurers’ ability to return to the historical growth rate.
How to Play Insurance Sector
Given the expected upturn of the sector, it could be a prudent idea to bet on a few insurance stocks that still look cheap but carry a favorable Zacks Rank. We have handpicked 5 such stocks here:
- Universal Insurance Holdings Inc. (NYSE:UVE) is a Fort Lauderdale, FL-based P&C insurer. This Zacks Rank #1 (Strong Buy) stocks currently trades at a forward P/E of 9.8x.
- West Des Moines, Iowa-based life insurer American Equity Investment Life Holding Co. (NYSE:AEL) currently holds a Zacks Rank #2 (Buy) and trades at a forward (F1) P/E of 12x.
- Based in Radnor, PA, Lincoln National Corporation (NYSE:LNC) is in multiple insurance and retirement businesses. This Zacks Rank #2 stock currently trades at a forward P/E of 8.6x.
- AmTrust Financial Services, Inc. (NASDAQ:AFSI) is a NY-based P&C insurer which carries a Zacks Rank #2. It currently trades at a forward P/E of 9.6x.
Northbrook, IL-based The Allstate Corporation (NYSE:ALL) Allstate Corporation (NYSE:ALL) provides personal property and casualty insurance, life insurance, and retirement and investment products. It holds a Zacks Rank #2 and trades at a forward P/E of 11.9x.