A new note from Goldman Sachs says that attractive returns within the industry are being driven by a hard market.
The firm said that reinsurers have historically been a low-beta and defensive sector that outperformed in terms of uncertainty. This has continued, it said, as the hard market pricing has started to earn through and the underlying performance starts to improve.
Goldman Sachs wrote: “Our thesis with the reinsurance/LM names is that they are well-placed to benefit from the current tailwind of the pricing cycle, and in the medium term from increased demand for reinsurance protection from climate change. We believe Q3 with a category four Hurricane Ian was an important test for the sector. Indeed, they have all passed the test, in our view, as Hurricane Ian remains an earning, not a capital event, with all reinsurers and LM names reporting in-line/below market expected losses.”
It added: “In our view, this shows the strength of the cycle working through – in past years, a loss of the size of Hurricane Ian would have wiped out underwriting earnings. But today, our Buy rated companies (Munich Re, Hannover Re, Beazley and Hiscox) have reported underlying profit at 9M even with Hurricane Ian and Russia/Ukraine losses. They have also reported strong premium growth and profitability and reiterated FY22 earnings targets (Munich Re and Hannover Re).”
The firm said that reinsurance and the London Market is continuing to see strong rate increases momentum, which is being driven by a strong demand for insurance protection following inflation alongside reduced capital supply.
It added: “This has been further exacerbated by Hurricane Ian, leading to materially higher price increases in 2023. In fact, the market could have increased prices without Hurricane Ian, but it will likely turn the “hardening” market into a “hard” market. As price hardening momentum continues, we believe the underlying profitability and returns will continue, and see scope for sustained share price performance.”
It went on: “Whilst there has been much positive commentary on pricing, investors remain focused on whether pricing fairly reflects both higher claims inflation and a material increase in catastrophe losses from weather events due to climate change. Swiss Re, for example, reported negative PYD for higher inflation. However, we note that inflation is a short-term negative for the sector (driving increasing loss picks and reserve charges – both of which happen immediately), but a medium-term tailwind as it is passed through to pricing (which occurs as the book reprices over the following 12 months and earns through the P&L over the subsequent 12 months).”
Goldman Sachs said that it believed last year and this year will bear the brunt of the short-term impacts of higher inflation, but that the positive impacts will come through next year and going into 2024. This, it said, will be through higher top-line growth and improving margins.
It added: “Indeed, the impact of higher inflation on property prices is one of the key reasons the property insurance market has hardened, increasing demand, with the supply of capital flat to down. This demand / supply imbalance is driving higher pricing, in our view. Hurricane Ian losses will further reduce the industry capital.”
It went on: “Overall, we believe the sector, although trading at peak multiples as a result diminished book values from unrealised losses, looks attractive, and that stocks could regain their historical defensiveness. At this point of the cycle, we would expect the stocks to be trading above peak multiples as they earn peak cycle RoEs.”
