Balance Sheets Matter in Insurance; Admiral and Hannover Re Our Top Picks

We believe balance sheets have been an underappreciated element in insurance, and that prior accounting rules and economic conditions have left property and casualty-orientated insurers in unenviable positions. Even before the coronavirus pandemic, as interest rates remained low, traditional reinsurance capital became elevated as the fall in interest rates led to rises in the value of fixed-income assets. Couple this with the rise of alternative capital as pension funds and hedge funds sought to diversify their returns into an asset class with little correlation to financial markets, and reinsurance capital available for deployment increased to new heights. That meant the pressure on pricing increased as the number of claims related to climate change rose.

After personal-line insurers experienced some of the best underwriting conditions they had in years during the pandemic because the global population could not travel, more recently they’ve been challenged by rising inflation and this has resulted in elevated levels of claims. However, as inflation hit personal-line insurers, it has also led to rising interest rates and decreases in the present value of fixed-income assets. For reinsurers, for whom we believe capital supply/demand is important, that has meant lower capital supply and a greater ability to increase prices, something they’ve needed to do for a long time. The reduction in capital supply within the market has been enhanced by the new accounting framework International Financial Reporting Standards 17 as liabilities have risen with increased prudence and future profits. Therefore, this has resulted in a further reduction in capital supply. After we stress-tested balance sheets, Admiral is our top pick as the firm has one of the most resilient balance sheets in personal lines. We rely on moats within reinsurance and prefer Hannover Re HNR1 as most reinsurers look reasonably capitalized, but those with good investment track records tend to outperform.