Ania Aldrich is an analyst for the Cambiar Opportunity Fund. An earlier version said she worked on a different Cambiar fund.
In the hunt for COVID-19 plays, investors have fallen head over heels for “work-at-home” stocks and companies in vaccines and therapies.
This makes sense. But smart investors are looking beyond the classic virus beneficiaries to snap up an unusual lot of COVID-19 stocks — insurers
Unlike favored virus stocks like Zoom Video
insurers won’t directly benefit from the virus. Quite the opposite. It looks like they are going to get hit hard by business interruption claims, meddling politicians who want to “socialize” virus-related losses, and a prolonged slowdown that could cripple demand.
But here’s the catch: Investors are overly worried about these concerns. These false fears have driven insurers down to really attractive levels.
While Nasdaq Composite
hits new highs and the S&P 500
and Dow Jones Industrial Average
get closer to their own records, many insurers are down 30% or more year to date. Insurers typically trade at around 1.2 times book value, but they’ve been knocked down to the 0.8 range. The relative performance of Berkshire Hathaway
to the S&P 500 is around a 19-year low.
Despite this terrible performance, underlying industry trends that many investors don’t recognize are about to drive outsized profits at insurers for years.
“This is one of the best buying opportunities I have ever seen, and I have been covering the group since 1998,” says Greg Locraft, an equity analyst for T. Rowe Price. “Don’t worry too much about the individual names. Just get money on the table.”
We’ll get to six names in a second. But first let’s look at the three main reasons why insurers look very really here.
1. Insiders are buying big time
One of the key themes I look for at my stock newsletter Brush Up on Stocks is broad, sector-wide buying by corporate insiders. That’s clearly the case with insurers.
There’s been very large (in many cases $1 million worth or more per company) insider buying at about a dozen insurance companies in the past several weeks. It’s happening across the space, from life insurance and annuity companies to workers’ compensation, home mortgage and auto insurance companies.
The biggest buying has been happening at property and casualty insurers and insurance brokers. They’re the ones that will benefit most by the favorable COVID-19-related trends. So we will focus on those as suggested stocks to consider.
2. The insurance market is turning in favor of the insurers
Insurance company investing calls for a twisted logic: Bad is good. And it looks like things are getting really bad (good) right now. Here’s why.
On top of all the weird storms and wildfires this year, insurers are going to get hit with large COVID-19 related claims. All these claims will cost them money — or capital. In this business, capital is capacity because to write insurance you need money on hand to back potential claims. Whenever capacity declines in an industry, this creates shortages that drive up prices. Those higher prices will be great for insurers and their investors in the coming years.
“The best time to invest in insurers is when they get hit with a lot of losses,” says Ania Aldrich, an analyst for the Cambiar Opportunity Fund
Big losses also drive out irrational underwriters and discourage new entrants which also curtails supply, points out Chris Davis, who co-manages the Davis Financial Fund
Meanwhile, all the uncertainty around COVID-19 and the weak economy makes managers and people in general more insecure. So they want more insurance. “People value insurance after they feel a loss,” says T. Rowe Price’s Locraft. “They are going to buy more insurance, and pay more for it.” All of this creates favorable pricing trends for insurers, a dynamic known in the industry as a “hard” market.”
“You have classic hard market emerging in property and casualty insurance, and it is the first hard market since 2001,” says Locraft. “That is why insurance insiders are buying. They know it. They see it. And they’re buying it.”
Insiders who were recently buying confirm this. “We expect that market pricing will continue to remain strong, to allow the industry to absorb the higher losses that are expected to emerge from this pandemic,” Axis Capital Holdings
CEO Albert Benchimol said in his company’s most recent earnings call.
3. Investors are worried about false issues
First, concerns are high that a wave of lawsuits will force insurers to pay companies for COVID-19 downtime. But this is unlikely. Most business interruption policies include exemptions for pandemics, viruses and bacteria. Payouts also require actual physical damage to property.
One way around this might be to claim that COVID-19 caused “damage” by being present on the surfaces of restaurant tables, office desks and factory equipment. But this probably won’t work. “How do you put COVID in the building when it was shut, and the virus dies in 48 hours? I don’t know,” says Greg. “If it breaks bad, it will be really bad. But my view is they are fine.”
For the second false fear, investors worry there’s a risk that state politicians will pass laws forcing insurers to pay out for virus-related business downtime, even though policies obviate this. This also seems like it will go nowhere. Indeed, politicians in several states are already backing off.
“The politicians will figure out this would be very unprecedented, and they will destabilize the sector if they force insurers to pay for these damages,” says Aldrich at Cambiar Investors.
Here’s how Benchimol at Axis puts it: If states crippled the industry with forced payouts, who will cover damages from the next big hurricane to hit Miami? No one, unless the insurance industry itself gets bailed out, which would sort of defeat the purpose of making them pay.
Finally, investors are worried about prolonged weak demand for insurance and sustained low returns on investments at insurance companies, given low bond yields, because of an extended sluggish economy.
But if like me, you believe that the huge dollops of stimulus will make the economy rebound nicely, then interest rates and business demand for insurance will follow suit. “The yield curve is steepening and the economy is getting better. And inflationary pressures may build which would make interest rates go higher,” says Todd Lowenstein, an equity strategist at The Private Bank division of Union Bank.
Favored insurance companies
To profit from the bullish insurance sector trends shaping up, consider the following names. Many of them pay decent dividend yields which look secure. In property and casualty, insiders have recently been big buyers at Axis Capital, Selective Insurance Group
and State Auto Financial
Also consider “creative” underwriters like Markel
which are good at coming up with customized specialty lines of insurance for things like classic cars, horse stables and summer camps, says Davis.
Finally, insurance brokers and consultants thrive in a “hard” market where prices and insurance demand go up — like right now. These are fee-based businesses with a decent amount of recurring revenue. Here Davis likes AON
and insiders do, too.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested AXS, SIGI, STFC and AON in his stock newsletter Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School. Follow Brush on Twitter @mbrushstocks.