David Merkel has an analysis out on insurance stocks. By the way, I deeply respect anyone willing to put original analysis out on the web, as David does frequently. That’s the stuff that drives the blogosphere.
His understanding is way broader than mine on theis business. He begins by dismissing Title and Credit insurers are no longer relevant stand-alone categories, which is great because I know nothing about them. He spends a few minutes on life and health insurers, which I also know nothing about.
I’m a P&C guy and haven’t had any training or experience in anything else. One thing Merkel didn’t get to is the P&C cycle. The best way of talking about this is through his graphs.
You can clearly see how tough it is for that group of insurers to break out past the 1.0 BV line. The market is very skeptical of the profits of those on the right side of the line.
Insurance is a cyclical business and right now we’re approaching the trough. The typical company below 1.0 BV and to the right of the line is probably only performing so well because they are releasing redundant reserves from prior years (translation: business a few years ago is proving more profitable than predicted, so offsets poor results today). Can’t go on forever.
The offshore businesses have a similar problem but the scale of the y axis obscures things a little bit. Almost all of these companies are below the 1.0 BV and the ROE band is shifted out. They’re more profitable and lower-value. Weird!
My gut feel for why this is has to do with the breakdown of business mix. Most insurance companies do two things: they originate/distribute insurance risk and they keep insurance risk. The first business is much more valuable than the second because the infrastructure of distribution is valuable.
Contrast this with reinsurers, who only hold insurance risk and probably dominate this offshore group. Their barriers to entry are super low (three guys, an office in Bermuda and a rolodex full of Reinsurance Brokers!). New entrants are kept away by the spectre of measly profits.
I was still in the reinsurance nursery for the last market turn. I’m looking forward to seeing that it’s like.