MANY PROPERTY AND CASUALTY INSURers are likely to see triple-digit growth in earnings this year, as they recover from weather-related catastrophes that pum meled profits in 2005. Their shares, too, have rebounded nicely in recent months from the beating they took last fall, al though more gains lie ahead, particularly for the industry's biggest players.
In July, we suggested that investors load up on P&C a.nd reinsurance stocks, notwithstanding predictions from weather experts that nine or more hurri canes, including at least five with roof lifting winds of 111 to 130 miles per hour, would batter the Caribbean and U.S. this fall ("Fair Weather's Friend," July 10, 2006). That forecast, as well as last year's devastating storms, including Katrina, Wilma and Rita, had led most investors to dump the group last fall, leaving many stocks temptingly cheap.
Because the insur ers bled so much money in 2005, state regulators allowed them to hike rates sharply and increase de ductibles to build reserves. A more benign season, we reasoned, would cause industry earnings and stock prices to rise.
Lo and behold, the 2006 hurricane season proved to be one of the mildest on record, with just five storms, none of which made landfall in the U.S. While strong storm systems have dumped rain on areas like western Washington state, none had an impact comparable to the 15 hurricanes that roared ashore last year, causing $58.7 billion of damage across nine states.
Analysts are split on the prospects for the stocks in 2007. Mark Lane of Chicago's William Blair says he's neutral on the insur ers because most of their shares now are fairly priced, and he considers this year's mild season a one-time event.
Because competition for other lines of business is placing pressure on premiums, he predicts the group's earnings overall will be flat. Bigger companies, such as ACE (ticker: ACE), still have some upside, he says.
Rohan Pai and Alain Karaoglan at Deutsche Bank still like the group, and see return on equity increasing to 18% to 20%, assuming an average rate of catastrophes. That could translate into share-price increases of 25% to 30%. The analysts contend insurers will be able to charge higher premiums in 2007, because almost everyone assumes '06 was a fluke and that future hurricanes will be more frequent and severe.
If the consensus is wrong again, how ever, and next year proves to be mild, "in 2008, there will be significant de creases in the pricing of insurance and reinsurance, because everyone will ques tion whether the assumption of in creased frequency and severity was valid," says Karaoglan.
Although the stocks have run up, the pair still likes Aspen Insurance (AHL), Endurance Specialty (ENH) and Axis Capital (AXS), as well as Montpelier Re (MRH) and RenaissanceRe (RNR). Says Karaoglan, "RenaissanceRe is already up 30% this year, but over a long period of time, it's the best reinsurance company, and should do well."
RenaissanceRe currently trades for 58.80; the analysts have a price target of 65, which would represent a gain of more than 10%.
Earnings for the three quarters be tween now and the next hurricane season should be excellent for the P&C companies - but that assumes that there .' are no major earthquakes. "That's the thing that worries us most, because we haven't had one in a while," Karaoglan says. 'We don't know the impact an earth quake would have on the insurance compa nies."
Perhaps, then, investors ought to treat the insurance rally like good weather. Enjoy it while it lasts.
-JIM McTAGUE
