While substantial uncertainties remain regarding the ultimate damage inflicted by Hurricane Irma, and a worst-case scenario appears to have been avoided, this represents another possible hit for the insurance industry right on the heels of Harvey. However, there are some mitigating factors for our insurance coverage, and we will maintain our fair value estimates and moat ratings for now.
Property-casualty insurance stock prices have fallen meaningfully over the past month due to these hurricanes. In our view, Travelers (TRV) is the best relative option for investors willing to deal with near-term uncertainty over the impact.
In the wake of Hurricane Andrew in 1992, Florida regulators made a number of changes designed to support a healthy homeowners insurance market and maintain affordable rates. In practice, however, these changes achieved the latter goal at the expense of the former, in our view. As a result of the constraints on pricing, national carriers largely exited the state, and the market became dependent on small local insurers and government-backed entities. For instance, Allstate (ALL), which has 9% market share nationally, has only 2% share in Florida. This meaningfully limits the potential for homeowner losses within our coverage, regardless of Irma’s strength, although potential for losses exists in commercial and other personal lines.
The company we cover with the largest share of the homeowners market in Florida is Progressive (PGR), which controls 3% of the market. Progressive acquired ARX, a homeowners provider, in 2015 to improve its ability to bundle and make a move toward more upscale customers. Overall, we are positive on this shift, and it appears to have had a meaningful positive impact on growth in auto lines, an area where we think Progressive enjoys a narrow moat. However, participation in homeowners lines creates a level of volatility that the company has not had to deal with historically. The market awards one of the highest book multiples in the industry to Progressive, owing to its strong and steady returns, and we are curious as to how the market might react if catastrophe losses materially impair near-term results.
Because of the limited presence of national primary carriers in the homeowners market in Florida, we think the biggest industry impact of large privately insured losses would probably be in reinsurance. Reinsurers have faced weak pricing in recent years due to an overabundance of capital and the rise of the catastrophe bond market. In our view, major catastrophe losses could be a catalyst for an industry shakeup and a return to more normalized pricing conditions. For disciplined and well-capitalized reinsurers such as Berkshire Hathaway, the positive impact on pricing should provide a material long-term offset to the near-term losses.
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Brett Horn, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.