The inverse views of underwriters and investors

While recent years have made it very clear that the insurance and reinsurance market pricing cycle continues to respond to factors including loss activity, capital availability and broader macro-economic pressures on the industry, investors and underwriters tend to hold inverse views on the market opportunity in both soft and hard market cycles.

This fact was highlighted by equity analysts from investment bank Jefferies recently, who believe that it at least partly explains why some insurance and reinsurance company stocks are trading at multiples that don’t really reflect the potential investment opportunity.

Jefferies analyst team believe that public market investors in particular have an inverse view on the market right now, compared to underwriters.

While underwriters may see opportunity in a commercial insurance and reinsurance market that has been hardening quickly, investors may only be able to think about the performance of those underwriting companies through recent years.

“When underwriters are positive on pricing following a period of losses, investors tend to focus on the cost of the claims,” Jefferies analyst team explained.

Adding that conversely to this, “When Underwriters are cautious on pricing, investor sentiment is often positive.”

This is because periods where the market is considered soft often drive improved profits for underwriting insurance and reinsurance companies, meaning they can deliver outsized special capital returns to their investors.

While this may be thought of as inverse thinking, it could also be thought of as a lag, as investors want to see the profits of an opportunity before deploying capital into it, where as underwriters need the capital to be able to take maximum advantage of the opportunity in a hardening market.

Which in the past has applied to the insurance-linked securities (ILS) market as well.

Among traditional insurance and reinsurance companies it could also be said that this shows a lack of profitability through most of the cycle, with only the few very benign years resulting in capital returns of an outsized nature, while even average loss years see those drying up.

Of course, we’ve had a hurricane drought that persisted for close to a decade, which was followed by a period of hyperactive hurricane seasons, driving elevated losses.

After this we’ve had the COVID-19 pandemic, which has dented re/insurer profits and now Russia’s invasion of Ukraine to drive additional fear into re/insurers.

But, it’s true that right now the underwriting opportunity is as good as it’s been for many years.

We see this in catastrophe bonds and ILS with the highest spreads seen in a decade, implying more profitable portfolios of cat bond and ILS assets can be constructed for investors.

At the same time, those portfolios are generally moving up in the reinsurance tower, so attaching higher-up, while also having more beneficial to the investor terms and conditions as well.

All of which makes the opportunity really attractive right now, underscored by re/insurers pulling-back from some areas of the market that ILS investors tend to target their returns from.

The inverse nature of investor and underwriter views can read-across to investor and ILS fund managers as well, although the ILS market is motivated by serving its investors and stays very close to them, cultivating their relationships, as without them it has no business model, where re/insurers can often be a few steps more removed from their ultimate equity-holders.

Which means ILS fund managers have the opportunity to develop relationships with their investors to help them understand when the opportunity is at its best, as seen with some recent infusions of capital to certain ILS fund strategies (albeit these are relatively small).

So, while ILS investors continue to be a in a bit of a holding pattern, following the consecutive challenging loss years, we do expect conversations on how to take advantage of the underwriting opportunity are well-underway with their ILS fund managers and it’s possible we’ll see a pick-up of inflows to the ILS sector as a result, with the end of year potentially a time when capital flows may improve.

Of course, that will all come down to how the intervening months go, whether we see any significant hurricane losses, and whether ILS fund managers can demonstrate that the opportunity is benefiting returns and their efforts to improve their portfolios are going to pay off.