As the 2023 hurricane season approaches, the insurance industry is on high alert for the potential losses it might bring. Analysts at Bank of America predict a tough season and advise investors to consider putting their money on reinsurers, rather than primary insurers.
The property and casualty insurance companies have experienced heavy losses over the past few months due to strong winds, hail, tornadoes, and Canadian wildfires. This has led to Bank of America analysts lowering their earnings forecasts for most primary insurers.
Reinsurance companies charge insurers premiums to help cover losses above certain levels, making them more appealing to investors. In the last six months, reinsurance costs for property catastrophe policies have surged due to increasingly severe natural disasters and high inflation. This has resulted in some primary insurers cutting their reinsurance coverage, leaving them to shoulder more catastrophe risk themselves.
This means that if major hurricane damage happens in 2023, primary insurers will likely face a bigger financial hit than in the past few years.
Furthermore, this year, the US has seen a lot of mid-sized catastrophes from March through June. Losses associated with these events are mostly borne by primary insurers because reinsurance coverage usually only kicks in when more severe disasters occur.
It is therefore advisable to consider investing in reinsurers rather than primary insurers. The predictive analysis tells us that it’s time to focus on the reinsurers, who would fare better if a major disaster occurs during the upcoming hurricane season.
Reinsurers Outperform Primary Insurers in 2019
Reinsurer stocks are on the rise, outperforming primary insurers by more than 20 percentage points in 2019. While primary insurers have lost 10.9% year-to-date, a market-weighted index of Arch Capital, AXIS Capital, Everest Re, and RenaissanceRe have gained 9.5%. This outperformance is unusual as the groups have historically tracked each other closely, according to a report.
The BoA analysts believe reinsurers’ stocks still have room to run and recommend that investors consider two big players in the industry: Everest Re and RenaissanceRe. These companies currently trade at only six to seven times the consensus forecast for their 2024 earnings per share. In contrast, primary insurance firms Chubb and Travelers are priced at 10 times their 2024 earnings.
The surge of investment into insurance-linked securities due to low interest rates over the past decade has allowed primary insurers to buy catastrophe coverage at “arguably artificially low prices.” As interest rates climb, reinsurers have gained more market power to price their products as desired. While the Federal Reserve’s rate hikes have paused for now, as long as Treasury yields remain in the 3.5% to 4.5% range or higher, the BoA analysts expect reinsurance pricing to stay elevated, possibly until next year.
Reinsurers’ Balance Sheets and the Summer Trade
As the hurricane season approaches, concerns arise that a major hurricane could cause reinsurers’ balance sheets to suffer significant losses, consequently resulting in a drop of their stocks. Investors may consider the “summer trade” strategy, selling the reinsurers in July or August and buying them back at a lower price in October or November to reap profits.
However, BofA analysts found little evidence to support this strategy by examining the historical performance of the group. Over the past two decades, on average, reinsurer stocks have both appreciated in value and outperformed the S&P 500 during the months of July to October.
Despite this positive track record, investors should approach short-term trades with caution. Success in trading around hurricane fears and seasonal trends requires quick flexibility in being the first to sell, then buy back at an advantageous price.
Moreover, should a major hurricane strike, it would likely instill more fear into the market, prompting primary insurers – many of whom suffered substantial catastrophe losses last year – to seek more reinsurance to prepare for the following year.
In conclusion, while the seasonality of the hurricane season may present opportunities for investors, it is important to tread carefully and be mindful of the potential consequences.
