Progressive Corp PGR

Despite the Interest Rate Tailwind, P&C Insurers Are Overvalued

Higher interest rates have boosted investment income and have had a material positive impact on overall returns for our domestic property-casualty insurance coverage. While insurers with low fixed-income duration have seen the largest impact, the effect has flowed through our coverage. Interest rates and investment income are only part of the story for insurers, but the outlook for underwriting is strong as well, in our view. Following a few years of solid price increases, commercial insurers have seen underwriting margins stabilize at an attractive level. Personal auto insurers have endured some difficulties recently, but strong pricing increases have improved combined ratios. With both sides of the profit picture already strong or improving, we expect our P&C insurers to generate unusually attractive results in the near term. However, we believe the market has overreacted to these tailwinds, and we see our coverage as generally overvalued. Investigating historical underwriting results for a P&C insurance peer group strongly suggests that underwriting results adjust over time to changes in interest rates, and underwriting margins have improved over the past few decades as interest rates fell. If interest rates stay high, we expect underwriting margins will compress, and returns will normalize. Our fair value estimates hinge on the idea that returns for our coverage will ultimately return to a level roughly in line with historical averages. If the industry does mean-revert over the next few years, investors will pay an overly rich price today for most of our coverage.