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In his Industry Overview for the Property/Casualty Industry, Value Line analyst Alan House estimates that insurance losses related to Hurricane Irene will range between $3 billion and $6 billion. That’s a far cry from the $100 billion or so related to Hurricane Katrina. That said, the latter event was largely contained to one relatively small area, while Irene’s impact was felt across a very broad swath of the East Coast.

Katrina’s impact on the property and casualty insurance space was a series of losses, as insurance companies paid claims, but the longer-term impact was increased pricing power across a number of product lines. Irene’s impact is likely to be less severe, with fewer material near-term losses followed by fewer meaningful pricing increases. That said, Irene wasn’t the only major weather event in recent days and pricing power was already starting to pick up for some insurers and markets, so Irene is likely to provide a bolstering effect that could magnify trends that are already in place.

These trends, however, are pushing up against low interest rates, which affect insurers’ investment income. The Federal Reserve has effectively promised to keep interest rates low for the next couple of years—not a good thing for the insurance companies’ portfolios.

Using the VL Page_Quarterly EPS BoxThese trends are important to understand when looking at property and casualty insurers. Examining The Travelers Companies (TRV - Free Value Line Research Report for The Travelers Companies) results can help put numbers behind the words. The company suffered a loss of $0.91 a share in the second quarter of 2011, compared to a profit of $1.39 in the year-earlier period (both of these numbers can be viewed in the Quarterly Earnings box). Although net premiums earned actually advanced 3% in the second quarter, from the prior year, catastrophe-related losses jumped nearly fourfold year to year due to severe tornadoes and hail storms primarily in the Midwest and Southeast regions of the United States.

In fact, management stated that the losses TRV absorbed in the latest quarter were much larger than those incurred during 2005's Hurricane Katrina, a seminal moment for the Insurance industry. The impact of Irene is yet to appear in the company’s numbers, as this event took place after the second quarter ended. Although results are likely to be hampered by insurance claims related to Irene, House doesn’t believe that they will cause significant losses.

Using the VL Page_Historical ArrayA quick examination of the Quarterly Earnings box helps illustrate the thinking, with the second-quarter loss followed by estimates, shown in bold, for the third and fourth quarters. Note that the estimates are in positive territory, but are below the previous year’s tally. That said, full-year results, shown in this box and in the Statistical Array, are for a material earnings drop, year over year.

Looking back to 2005 and Katrina, the Statistical Array clearly shows that earnings were weak in 2005 and 2006. However, a quick look at the top line, Property/Casualty Premiums Earned, shows that the years following that event were good for top-line growth. This is, to a material extent, because of pricing increases made possible by Hurricane Katrina’s severity. Another way to view this is to examine the Loss to Premiums Earned row, where a sizable drop occurs after 2005.

Using the VL Page_Capital StructureSo, while there may be some valid concerns in the near term about catastrophe losses, longer-term, they are likely to benefit Travelers and other such insurers. A prolonged period of low interest rates, however, is unlikely to be a good thing over the long term.

An important source of profits for insurance companies is the money they earn on their investment portfolios. In the case of Travelers, that portfolio consists of almost $63 billion dollars of fixed-income securities and $600 million dollars of equity securities (as of June, 2011). These figures are found in the Financial Position box (this is called the Capital Structure box on most non-insurance company reports). Clearly, interest rates are very important to Travelers’ results, since a few basis points multiplied by $63 billion is a lot of money.

Using the VL Page_GraphIn fact, the Statistical Array shows the insurer’s investment income to total investments (the return on the portfolio), where the impact of the recession, shown as a gray bar in the Graph, can be clearly seen. Returns fall off materially in 2008 and 2009, and recover in 2010. The recovery in 2010 is likely the result of equity gains, as interest rates have remained low for quite some time. House expects returns on the portfolio to be largely flat in 2011 and inch up only slightly in 2012. This is a material hindrance to profitability and is partly the result of the low interest-rate environment.

Although investment income is likely to advance because of growth in the size of the company’s portfolio, higher rates would likely be a bigger benefit. So, while Travelers, and its brethren, may be gaining near-term pricing power with regard to the policies they sell, those gains are being hampered by the low-interest-rate environment. Moreover, these companies need to be adept investors, since rates and bond prices move in opposite directions. So, when rates do finally start to increase, the prices of bonds are likely to fall—which could hurt insurance companies that manage their bond portfolios poorly.

 

At the time of this article's writing, the author did not have positions in any of the companies mentioned.