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Quarter-End Insights

Financial Services: A Favorable Outlook for Insurance

Diversified insurance and property-casualty are particularly attractive in a sector that looks slightly undervalued overall.

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  • Markets have created more value in financial services, with the average price/fair value ratio estimate falling to 0.95 across our coverage. We see particular value in diversified insurance (P/FV of 0.91) and property and casualty insurance (P/FV of 0.95).
  • We believe investors often make the mistake of focusing on pricing to formulate their outlook for the P&C insurance industry, as historical results suggest that overall profitability levels are the key driver of insurance stock returns. Pricing increases have restored profitability in the P&C insurance market despite lower investment income. Although we are not necessarily optimistic that pricing will continue to increase, we think P&C insurers can modestly improve profitability going forward.
  • A gradually rising interest-rate environment would be a net positive for P&C insurers, in our view, given the relatively tight spread between rates and inflation. Overall, we think the current environment is conducive to investing in high-quality names.

While recent price increases have improved profitability in P&C insurance, we don't see a strong reason to assume that pricing will continue to improve. In our view, recent pricing increases have largely been driven by lower interest rates. As lower rates pushed down investment income, higher pricing and underwriting income have been necessary to maintain ROEs. Yields on new issues are still generally lower than yields on maturing securities, and investment income remains pressured. We believe interest rates will continue to have a positive impact on pricing in the very near term, but the effect should fade over time, barring a further decline in rates.

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Erin Davis does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.