The Big Reason Your Insurance Is Getting More Expensive

None of that mattered when it came to renewing their homeowners insurance. Though they had done everything right and never filed a claim, they found themselves scrambling to find insurance in a state where costs have soared, insurers have split, and even the state-backed carrier turned them down after balking at the replacement cost of the house. 

“It’s nightmarish because you have no control,” says Voss, 53, CEO of a fintech start-up called Deception and Truth Analysis. 

Florida, while extreme, reflects a national collision between increasingly calamitous weather and the insurance industry. Caught in the middle are homeowners, though investors could benefit as insurers hike prices, lifting revenues and potential profits.

Nationwide, costs are rising as insurers try to price in losses from more frequent and unpredictable storms, wildfires, and other effects of climate change. Inflationary pressures, combined with population growth in susceptible areas, are making insurance costlier for everyone. 

Whether the industry is equipped, long term, to handle it is an open question. Insurers are expanding their preparedness kits, throwing technology at the problem with more predictive analytics and artificial intelligence. Actuarial science, the bedrock of pricing risk, is now a “multifaceted discipline” involving experts from geologists to meteorologists, says Daniel Bauer, chair of the department of risk and insurance at the Wisconsin School of Business. 

One industry strength: financial firepower. Bankrolled by a global financing network and billions in corporate assets, the industry maintains nearly $1 trillion of surplus capital to pay out claims. Moreover, insurance is in a “hard market” where demand is high and competition is thinning out in some major markets—ideal conditions to raise prices, impose stiffer terms, and profit. 

“Simply put, it’s the fact that prices are up and terms and conditions are tighter,” says Juan Andrade, CEO of
Everest Group
(ticker: EG), a reinsurance specialist that is expected to boost net income by 28.6% next year to $2.5 billion, according the consensus forecast. “It’s more conducive for an insurer or reinsurer to do business.”

Barron’s has identified four stocks that could capitalize in this climate:
Allstate
(ALL),
Arch Capital Group
(ACGL),
Ryan Specialty Holdings
(RYAN), and
Guidewire Software
(GWRE). Each has specific growth and stock drivers, and each focuses on a different part of the industry, from front-line coverage (Allstate), to reinsurance (Arch), brokerage services (Ryan), and software (Guidewire).  

The New Insurance Normal

No matter where you live, you’re probably paying more for insurance. Homeowners premiums are averaging $1,700 this year, up 10% since 2022 and 36% since 2018, according to the Insurance Information Institute, a trade group.

Coverage is also getting stingier as insurers tighten terms. Some insurers are placing limits on the age of a home’s roof and are increasing dwelling coverage limits, referring to the maximum amount an insurer will pay to rebuild a home, says Mark Friedlander, director of corporate communications at the institute.

The price hikes reflect inflation in home replacement costs, up 55% from 2019 to 2022. Insurers are also trying to rebuild capital and profits after years of above-average payouts for catastrophe-related claims. Losses from natural disasters covered by insurance reached $120 billion last year, well above average for the prior five years, according to Munich Re, the world’s largest reinsurer. The industry is also still rebuilding from $60 billion of insured losses in 2022 due to Hurricane Ian alone.

Andrade calls Ian a “tipping point,” as reinsurers like Everest used the flood of claims to hike rates sharply on front-line insurers. Reinsurance rates in the U.S. are up 50% versus a year ago, he adds. Reinsurers have also attached stiffer conditions for payouts to insurers, essentially shifting more of the front-line risk to them.  

This year’s hurricane season has been mild—typical in an El Niño year. But weather/climate disasters are picking up. So far, there have been 15 episodes with losses exceeding $1 billion each in the U.S. this year, according to the National Oceanic and Atmospheric Administration, or NOAA. That’s tracking well above the average of eight events a year from 1980 to 2022. 

Insurance brokerage
Aon
(AON) says global insured losses through July 2023 reached $59 billion, near record levels. Bank of America analyst Joshua Shanker recently raised catastrophe loss forecasts across much of the P&C industry, and modestly increased losses to capture quarter-end storm activity.

“Several things surprised us during the first six months of the year, but probably the most important was severe convective storm losses in the United States that were record-breaking,” says Michal Lörinc, head of catastrophe insight at Aon.  

Bad Cycles Rising

Insurance has always been a balancing act of actuarial math and luck. Companies load up on selling policies and build capital in the good years, when losses are low, then pay out massive claims in the bad years when catastrophic losses ramp up. 

One difference now: The “bad cycles” may be longer due to more extreme weather and population growth in danger zones like Florida. And it’s unclear if actuarial science and climate forecasting can keep up with “100-year floods” and other rare events happening more frequently. 

Southern California, for instance, hasn’t experienced a storm of Hilary’s magnitude in 84 years. In Hawaii, the Maui blaze was fanned by winds from a hurricane churning hundreds of miles to the south, while drought contributed to the severity of the fires. 

Industry executives say their models are being updated to assess rising risks, such as wildfires, as the planet warms. “U.S. wildfire is an increasingly significant peril, and we’re going to have to turn more attention to how it is modeled,” says Kirsten Mitchell-Wallace, director of portfolio risk management at Lloyd’s of London, the world’s oldest insurance marketplace.

At Aon, a key priority is developing more predictive models for “secondary perils” such as severe convective storms, winter storms, and wildfires, says Megan Hart, a managing director at the firm. “The models haven’t been mature for those perils, because so much focus has been placed on hurricanes and earthquakes,” she says.  

Still, some analysts express skepticism, partly because there is no historical precedent with large-enough sample sizes of data to feed into the computers. “Actuarial science is very good at using the past to predict the broadly similar future. It’s much less good at predictions in a period of flux,” says Meyer Shields, an analyst at Keefe, Bruyette & Woods.

Everest’s Andrade calls the tech investment an “arms race.” In his four years as CEO, Everest has tripled its spending on technology. “The theory is, if you don’t do it, you will get what is called ‘adverse selection,’ where you are left holding the bag with the worst risks at the worst price,” he says. 

For homeowners, one bit of reassurance is that the industry has stocked up on capital to pay rising claims. According to the Insurance institute, U.S. P&C companies had $990 billion in capital at year-end 2022, down slightly from 2021, when the surplus topped $1 trillion for the first time, but up from $891 billion in 2019. 

“The health [of the industry] is fine from a capital perspective,” says Paul Newsome, an analyst with Piper Sandler who has “Overweight” ratings on several insurers. 

Capital buffers aside, some giant insurers have fallen short of consensus estimates as catastrophe losses picked up.
Travelers
(TRV) reported a $14 million net loss in the second quarter as catastrophe losses doubled from a year earlier to $1.5 billion; the company lost 6.5 cents for every dollar in premiums. Allstate also racked up a net loss for the quarter with catastrophe losses of $2.7 billion, up from $1.1 billion a year earlier.

The profit outlook could improve as higher premiums flow to the bottom line. “Pricing is a leading indicator for future profitability, and pricing right now is accelerating in commercial lines, auto, and homeowners insurance,” says C. Gregory Peters, an analyst with Raymond James.

Prices for U.S. property insurance look especially strong. Prices were up 19% year over year in the second quarter, accelerating from a 17% annualized gain in the first quarter, according to the Marsh Pricing Index. Prices have now risen for 23 consecutive quarters.

One bright spot for investors: Reinsurer stocks are holding up, partly because the companies have managed to unload risks and raise prices, pushing down their “loss ratios” (the lower the better for profits). Shanker, of BofA, sees strong demand for reinsurance in 2024, especially from Florida, a big buyer through its state-backed hurricane catastrophe fund. Florida “probably didn’t buy as much as they need,” he says. Many primary insurers are also likely to buy more reinsurance for 2024, he adds.  

Peril and Profits 

Allstate has been a disaster stock of its own this year, down 22%. In homeowners insurance, the company said catastrophe losses were “substantially” above the 15-year average in the second quarter, resulting in an underwriting loss of $1.3 billion. The firm said it lost $678 million in auto insurance. For the full year, Allstate is on track to report a net loss of $689 million, based on consensus estimates. Its overall profitability on insurance, measured by its “combined ratio,” is forecast at 106.5% for the year. A ratio above 100% indicates an insurer is paying more in claims than it is taking in through premiums, implying an operating loss.

All those sound like reasons to avoid the shares, but KBW’s Shields sees “a light at the end of the tunnel” for the stock, which recently traded near $105. His price target is $148. “Allstate’s results have been very poor,” he concedes. But the auto business is expected to recover as the company pushes through large premium increases and gets a tailwind from softer inflation on repair costs. Allstate is also paring back on unprofitable states like California, where the insurer has stopped writing new homeowners policies.

Catastrophe losses are the wild card—more elevated losses would punish profits. While that’s unpredictable, Allstate is pledging to control expenses and zero in on profitable markets. Analysts expect the combined ratio to decline to 97.1 in 2024 and 94.9 in 2025. UBS analyst Brian Meredith, who has a Buy rating on the stock, sees Allstate at an “inflection point.” Shares trade at just nine times estimated 2024 earnings, a slight discount to rivals. Meredith has a price target of $145 on the stock.

Arch Capital is a specialty insurer in areas like energy, marine, and aviation, along with niches such as professional liability and cyber-insurance. The firm took in $12.6 billion in net premiums for the 12 months that ended in June, with about half in reinsurance and 9% in mortgage coverage. Reinsurance has been a huge growth driver, surging from $1.4 billion in 2018 to $6.1 billion in net premiums a year. The company says it is seeing strong growth in property catastrophe premiums, and it looks quite profitable overall, with a healthy combined ratio of 81.9%.

“Right now P&C—the insurance and the reinsurance—is really well positioned,” says JMP Securities analyst Matthew Carletti, who sees Arch Capital stock hitting $90 from recent prices around $75. “They’re doing exactly what you’d expect for an industry leader: When times are good, they’re leaning in and writing more business.” 

At $90, the stock would trade at 2.1 times forward book value and 12 times estimated 2024 earnings, according to Carletti. That’s above historical averages for the stock, and a premium to rivals. But Carletti argues the valuation is warranted due to “consistently strong operating results.” Arch, he adds, “stands to be one of the biggest beneficiaries of a hardening P&C pricing cycle, given its depth and breadth of global distribution and underwriting expertise.”

Ryan Specialty is an insurance broker focused on “excess and surplus” lines—things that standard carriers don’t provide, such as customized plans, niche insurance, and workers’ compensation. CEO Patrick Ryan, who previously ran Aon, launched the firm in 2010; today it’s the second-largest wholesale P&C broker, with an estimated $2.1 billion in sales this year. The company says it’s getting a lift from demand for catastrophe/disaster coverage, cybersecurity insurance, and “social inflation,” reflecting an increase in litigation cost and insurance fraud.

“A lot of business they write is effectively tailored and bespoke to the actual risks,” says William Blair analyst Adam Klauber, who recommends the stock. “As the world becomes more complex, the trend we’re seeing is much more growth in these specialized markets.” 

Ryan could lift revenue 18% to $2.4 billion in 2024, according to consensus estimates, generating a 22% gain in earnings per share to $1.68. That kind of growth doesn’t come cheap; the stock trades at a price/earnings ratio of 17 times earnings, a premium compared with its broker peers. William Blair doesn’t publish price targets. The stock recently traded around $46.

Guidewire Software is a tech play on the P&C industry: It’s the leading provider of software to P&C insurers, enabling functions such as claims management and billing.

In late June, Stifel analyst J. Parker Lane upgraded the stock to Buy with a price target of $85, on the expectation that sales will gain momentum as the company transitions from on-premise to cloud-based software. “Guidewire has really gotten its act together when it comes to this cloud transition,” he says, seeing the company at a “tipping point.”

Guidewire’s growth, while slowing, still looks impressive, with subscription and support revenue expected to grow at a 24% rate through 2024. Total revenue is pushing above $1 billion annually, and profits are starting to materialize, estimated at $0.83 a share next year, excluding stock option expenses. That isn’t much for an $80 stock; based on consensus forecasts, shares trade at a hefty 96 P/E ratio. 

The long-term bull case is that, for all its tech investments in forecasting and actuarial modeling, insurers still need to modernize plenty of functions and integrate new technology, says Lane. “A lot of tech investments will cycle through these businesses over the next decade or so,” he says. “Guidewire is very well positioned to capitalize on that trend.”

Meanwhile, in Florida, Voss and Jacobson are bracing for the next storm. NOAA is now calling for up to 11 hurricanes this year, expecting “an above-normal level of activity.” One positive for the couple is that they finally found insurance—at a cost of $13,000, up from their previous annual rate of $4,900. When the next storm hits, they plan to grab their hurricane kit—including a solar-powered radio, headlamps, life preservers, and dry food—and ride it out. Much like the insurance industry.

Write to Lauren Foster at [email protected]