One of my main roles as an investor was trying to assess the difference between what companies said and what they were actually telling you with their actions.
Company scripts for investor calls rarely directly answered your questions. I had to read between the lines or listen for what was not said to get the real information.
But just like a poker player, most CEOs have their tells. You can observe through their decisions what they are actually thinking.
So I thought I’d share my recent observations around some industry headlines to give you my take on what message companies are really sending with their actions.
Several companies have talked up the need to hold the line on casualty reinsurance pricing, most notably Swiss Re.
While this may sound reassuring, it immediately sets off alarms for me. There is only one reason reinsurers find sudden discipline around their casualty book.
It’s not because expected returns have fallen below their benchmark or because they have raised their hurdle rate or because they would rather deploy more capital to the hard cat market.
It’s certainly not because of interest rates. Higher yields mean they can afford to write at higher combined ratios.
So what’s really going on? Reinsurers are genuinely worried about adverse loss development on the pre-Covid book.
We’ve seen signs that the 15-19 accident years are developing poorly and they are likely the canary in the coal mine. Swiss did top up casualty reserves in their last earnings and several smaller players have encountered challenges.
So, the pain is real, but it hasn’t shown up in a big way yet. Why? Because everyone is scared to go to the front of the confessional line and see their stock blasted.
But if you can instead talk up casualty pricing, then that greases the skids. You at least have something positive to talk about when you eventually take the medicine.
If casualty re pricing is strong at 1/1, we may even see some confessions with year end earnings reports.
But it feels like 2024 is going to be the year of reserve additions – and not just for reinsurers. If the reinsurers are seeing it, then surely their cedants have seen it too and are waiting for the right time to drop the bomb.
Don’t get me wrong. It’s good that the reinsurers are finally chasing price. They need it. But the way insurance works is we will see the pain in results before we see the benefit.
Primaries Buying More Cat Cover
Average annual worldwide cat losses have doubled over the last ten years. Yet, insurers have been slow to increase their cat load expectation or retentions before reinsurance.
One reason is because cat cover was cheap for most of the past ten years, so insurers took advantage through deals like cheap, low layer aggregate covers.
When the market hardened this year, those covers went away and insurers had to decide whether to pay up to replace them or take higher retentions. Most chose the latter.
Now, logically, insurers should have understood retentions needed to move higher. After all, if average losses have doubled, retentions should approximately double (not necessarily but close enough) over time.
However, most insurers, as I recall, had flat to slightly up retentions for much of the past ten years. That means they should be paying a lot more for their reinsurance, not less.
When prices went up this year, the common reaction was to buy more up top (because of higher expected losses and it costs less) but to keep spend down by cutting those lower layers and increasing retention.
Unfortunately, many learned this year that strategy resulted in a lot more volatility than their shareholders expected.
Now, word is, many are looking to buy low layers again. Why would they do this if it is now more expensive and their capital base is larger than ten years ago?
Shouldn’t they be able to tolerate the higher volatility of frequency losses? In theory, yes, but there is something else going on.
They weren’t charging enough gross for the risk. That cheap reinsurance that existed for so long let them get lazy on their own pricing.
Now that they have to pay a fair price for reinsurance, they are scrambling to fix their primary rates. Until they do, they would rather pay for expensive reinsurance than run the risk net.
You’ll know pricing is adequate when the insurers decide they are comfortable with higher retentions that they should have planned for years ago.
Brokers Buying Bank Agencies
There’s been a recent shift of insurance brokers buying up bank-owned agencies. Gallagher has bought several and it’s widely expected Truist will sell the remainder of theirs.
This makes sense from the bank’s perspective. They can cash out at fat multiples for businesses they have realized aren’t strategic.
But why would the large brokers buy them? After all, bank owned agents have less growth and are harder to consolidate.
Furthermore, once the bank sheds ownership, what incentive do they have to refer clients? Local agents surely know this and will aggressively try to poach clients. Thus, there is significant risk of revenue leakage.
So what are the brokers trying to tell us? They have run out of traditional acquisition candidates and are lowering their standards.
Yet, they are still paying peak multiples for lower quality opportunities. This is not a good combination!
We are likely in the later innings of the broker rollup game and the risk of deals gone bad is rising. Brokers would be better off reducing their acquisition activity and paying large dividends to shareholders instead.
I’m sure I can come up with some more examples to add to the list but I’ll leave it at these three. When you see insurers acting in a certain way, it is always a good idea to consider whether their real motives agree with their stated motives.