It’s been a bad year for insurers.
Lloyd’s of London, the world’s leading insurance market, has just reported a near-ÂŁ700m loss for the first half of 2011. That compares with a ÂŁ628m profit a year ago.
Indeed, this has turned out to be the costliest six-month period in the market’s history. And the outlook for the near future isn’t much better.
So you should avoid shares in Lloyd’s insurers like the plague, right?
Wrong. Now’s the time to buy. Here’s why.
2011 has been an awful year for insurers
Lloyd’s of London started in Edward Lloyd’s coffee house in the City in 1688, and has been providing insurance cover across the globe ever since. It specialises in re-insurance: that’s where insurers spread their risks by selling part of them on to other insurers.
So when the market’s top men start muttering that 2011 is shaping up to be the second-worst year ever for the insurance industry, it’s worth taking note.
Nothing is going right for insurers at the moment. There’s been an unprecedented series of natural disasters – from floods to earthquakes – in Australia, New Zealand, Japan and the US. These have already resulted in claims worth ÂŁ6.7bn landing on underwriters’ desks.
Normally when disasters strike, there’s a silver lining for insurers. They’ll charge more before they take on the same risks again. Higher premiums mean bigger profits. Take 2005, for example. After Hurricane Katrina battered New Orleans, “the market was still reasonably hard” – ie underlying premiums were good – “and there were still profits in the system”, Lloyd’s boss Richard Ward tells the Guardian’s Julia Kollewe.
The trouble is, now the global economy is looking pretty ropey. When most businesses are trying to cut costs, it’s much harder for the industry to push through higher premiums.
Meanwhile, the current havoc in the markets creates another problem for insurers. Their investment income returns aren’t as good as they were.
Here’s how this works: insurance claims usually come in slowly and can often take many years to settle. So until they need to cough up, insurers will invest their premium income.
But because they must make sure there’s enough cash in the kitty when they do have to pay out, they can’t take chances with the money.
So they tend to invest only in relatively low risk assets, such as short–term bonds. But today’s ultra-low interest rates have reduced the cash inflows that insurers need to help pay claims.
All in all, it’s no wonder that the immediate outlook for the industry “will get more and more challenging”, says Ward.
Given all this, you might think that shares in listed Lloyd’s insurers are the last thing you’d want to buy right now. But in fact, now could be just the right time to invest in the sector.
Three reasons to buy Lloyd’s insurers now
Why? First, while many insurance rates remain ‘soft’ – ie they’re flat or dropping – there are some glimmers of hope. The chief financial officers of North American insurers reckon we could be seeing the insurance cycle bottoming out. In a survey by risk management consultants Towers Watson, 74% said they believe that standard property premiums are at the bottom or turning upward. “It does seem we’re approaching a turn in the overall marketplace”, says Bruce Fell at Towers Watson.
Second, over recent months the stock market has been ‘pricing in’ the problems that these Lloyd’s insurers have been facing. The recent market sell–off has pushed prices even lower. And that’s left some of these shares priced at bargain basement levels.
Yet, despite the soft market and recent losses, most Lloyd’s insurers are in pretty good financial nick. Their balance sheets are stuffed with cash and low-risk assets. So much so, that some stocks are now trading on discounts to their net asset value (NAV). In other words, their assets alone are worth more than their market caps. That means the sector could see more takeover bids, as big value investors move to cash in on the great value on offer.
Third – and this is key – the time to buy into insurers is when the premiums ‘cycle’ is nearing an upturn. If you wait until the market is obviously hardening again, you’ll have missed the chance to get in cheaply – share prices will already have gone up.
So what’s the best stock to buy? My favourite is speciality insurer and re-insurer Catlin (LSE: CGL) which is on a forecast p/e ratio for 2012 of six and boasts a tasty 8% prospective yield. Further, it sells on a decent discount to NAV – you can currently buy ÂŁ1 worth of assets for 75p. That sort of value won’t stay around for too long – not even in this market.
Category: Market updates