This is an update to my earlier discussion of P&C pricing to reflect the new data points we received during earnings this week.
The good news is pricing will continue to get better. The bad news is it will get better because losses continue to get worse. The net impact will be disappointing earnings.
The Good News
Aside from some cautious notes out of Brown & Brown (the brokers always say pricing isn’t as robust as the carriers), there was continued optimism out of Travelers, Berkley, and Chubb this week. Pure rate at Travelers increased to 3.6% from 2.3% in Q1. Chubb said rates increased from 5% to 7%. In general, pricing was described as accelerating and spreading to more lines.
The Bad News
The continued momentum on pricing though was overshadowed by Traveler’s commentary on loss pressure. Travelers revised its loss picks up in commercial auto (CA) and general liability (GL). This is after revising the auto as recently as Q4. Additionally, reserves flipped to adverse in both CA and now for GL as well. This is particularly discouraging, though shouldn’t be surprising.
What comes next?
The real concern is whether this is Travelers getting ahead of the curve or just the beginning of increased margin pressure. Typically, it is the beginning. With all the concerns about GL at the industry level, it is hard to imagine Travelers totally put it behind them with one quarterly adjustment.
Notably, the 1/2 point change to the run rate margin is only 1.5% on GL & CA (they are ~30% of total business insurance). That doesn’t suggest a kitchen sink true up. If anything, it may only be reflecting resetting the base for the adverse reserves experienced.
Investors who are expecting improving margins from pricing are likely to be disappointed. First, it’s unclear that pricing is even exceeding “normalized” loss costs. We have had a long period where the 3-4% companies typically quote has proven to be very conservative. Now, it is probably right or even light. 4-5% pricing is only keeping up with the new loss pressure.
However, as Travelers has shown, the base margin needs to be level set. That could easily be 2-3% of loss ratio for most companies, if not more. There will also be a temptation among companies to put away a little more IBNR on new business.
The way things likely play out is a point of pricing will go to higher IBNR levels, the rest offsets new loss trend, and the rebasing process comes straight out of margins. Next, add a likely deterioration in reserve releases and you have a recipe for lower earnings. Oh, and let’s not forget, interest rates are lower than budget too.
The good news is this deteriorating performance will drive more pricing. It does make for a bumpy ride though.
Is This a Traveler’s Issue?
Unlikely. Everyone is seeing the same pressures. Travelers was just honest enough to admit it first. Recall my three rules for why bad news emerges slowly.
- Companies know more than investors.
- Companies only raise price in response to bad news (known or pending).
- Nobody wants to admit to bad news first!
Kudos to Travelers for being willing to be among the first. However, as I said, I don’t think they’ve taken all their pain yet, because, if you go first, you want to only go a little. There is no benefit to fully confessing while everyone else is still in full denial. It creates misperceptions that you’re the only one with the problem (“why isn’t anyone else seeing this?”). Better to go a little at a time.
Should we issue an IANS alert?
Clearly. Recall, IANS is when companies are aware of a pending problem but don’t have enough data to quantify it, so they delay acknowledging it rather than be proactive. The commercial auto issue has been ongoing for more than five years now. Yet, it continues to only gets acknowledged a little bit at a time. The GL pressures have been building the last couple years. There was certainly enough known that companies could have added to IBNR at YE18. Most chose not to. They’d rather wait for the actuaries to see it in the numbers. This will take years. In the meantime, they write more underpriced business.
So yes, I’m bullish on continued pricing. I’m also bullish that we will have more disappointing earnings reports as the year progresses, especially in Q4. As far as being bullish on the stocks? Well, I’m out of that business, but I’ll observe that the stocks are up as much as 40% on the year. That tells you something about whether expectations for the future are high or low.