I’m back from last week’s NYSSA Insurance Conference where I listened to 16 presentations from a cross-section of small- and mid-cap insurance companies. It was a great opportunity to spend time with corporate and investor friends, both at the conference and socially.
Since my return, I continued to listen to fourth-quarter conference calls and read some of the related research as I mull the investor relations implications of what appears to be a shift in investor thinking on the insurance sector.
What is Changing?
From what I’ve seen and heard, I believe that insurance-sector investors are concluding that the pricing cycle has been “broken” and that a broad-based insurance-sector recovery is unlikely in the next few years.
Investors who have decided the cycle is broken can be expected to move their primary focus away from attempting to determine the timing of sector changes. They are more likely to focus on determining which companies have the business model to survive (and prosper) with pricing at current levels. They will be most interested in the characteristics that distinguish each company and on how management will achieve improved return on equity and growth in book value through its own actions and choices.
Regardless, for investor relations purposes, it doesn’t matter if the pricing cycle is really broken or not, what matters is investor perceptions and related information needs. (And whether the cycle is actually broken is well outside the purview of this blog.)
Why Did I Come to This Conclusion?
I have two primary reasons for drawing this conclusion, one of which is pretty straightforward — I’ve started to see words such as “the pricing cycle no longer exists” in research reports.
But more importantly, and more subtly, I am hearing a strikingly different tone in the questions that investors are asking of managements this year, in particular at the NYSSA conference when compared with last year. In my view, investors are clearly signaling a higher level of interest in specific business strategies and outcomes and much less interest in management’s thinking about the insurance pricing environment and other macro trends, with the possible exception of M&A pricing.
Last year, the general tone was, “At some point, the tide will turn and probably lift all the ships. Can you help us figure out when the tide will start to rise and whether or not your company is ‘seaworthy’ enough to benefit?”
This year, the tone seems to be, “We’ve given up expecting the tide to turn. Can you help us figure out what you are doing to make your ship even more seaworthy than it has been and how can we measure the improvement?”
(About five months ago, I reported that fewer questions were being asked about the pricing environment at the KBW Insurance Conference. I think the investors now have moved beyond the pessimism I observed at that time to considering a new paradigm.)
What are the Investor Relations Implications?
If investor perceptions of the property casualty sector have changed, the investor communications effort will need to shift to answering the “value driver” questions.
Investors can be expected to have a heightened interest in how a business strategy will make the company better, what operational metrics management will use to assess implementation and when management expects to see the strategy contribute to reported results.
I also will point out that insurance investors have always been interested in these topics, what I am observing is a shift in mindset and emphasis.
Go With the Flow
Insurance companies don’t need to declare the cycle dead to leverage this heightened interest in business strategy. Instead, companies simply can take a modestly different approach to their communications while continuing to strive for increased transparency (both of which should yield benefits under any circumstances).
I recommend that a company’s pricing-driven opportunities be placed in the context of the potential contribution to return on equity of other business initiatives, quantifying how all of its plans could affect premium leverage and/or the underwriting margin. The discussion might cover:
- Strategies to leverage available premium capacity (e.g., new territories or acquisitions), accompanied by appropriate discussion of financial strength
- Strategies to enhance short- (e.g., claims handling efficiency) and long-term (e.g., actuarial/reserving risk) underwriting profitability,
- Strategies to improve operating efficiency (e.g., investment in technology)
- Strategies to manage expenses
When implemented, this approach means less time is spent on the organization’s record relative to past cycles (and vs. peers). More time is spent on describing and quantifying the potential value of actions specific to the company and its current situation.
While every insurance company is different, here is a sample for consideration:
An insurer would describe a strategy to improve policyholder retention in a line of business through a series of specific operational activities, such as better claims service. In that discussion, the company would draw the connection between improved retention rates and lower expenses, looking at expenses (or the expense ratio) by age of account. The discussion might end by measuring how every percentage point shift in the retention ratio could improve underwriting profitability by a specified amount, presuming flat premiums.
After the analysis of ways to enhance the contribution of insurance operations to return on equity, discussion would turn to a similar analysis of the potential contribution of the investment strategies.
As I’ve written in the past, I believe the simplest way to shape a compelling value driver analysis is to use the property casualty insurance return on equity model as an outline. But there are other effective ways to break down a business strategy to illustrate a company’s potential; those alternatives may be more appropriate for some carriers.
Insurance investors bring a sophisticated understanding of the sector to the table. The conclusions they draw from their analysis of a company and their interactions with management drive valuation, and there is strong evidence that better information can lead to better valuation.
I encourage taking into consideration that investor views of the sector may be changing. As a result, their information needs may be shifting. Insurance companies that respond in a timely fashion have the potential to benefit.
Finally, as discussed in many earlier posts, I continue to encourage transparency and the disclosure of good information on a quarterly basis. Providing investors with the data to support management’s contentions bolsters credibility.