Last year, it was all about Covid and the pandemic’s impact on all facets of the business, including BI, shifting workplace practices, and safety standards. As a result, every carrier was scrambling towards a solution to the mountain of problems caused by Covid.
This quarter, conversations are shifting slowly. Chubb’s call highlighted some of the themes common among carriers this earnings season.
Natural catastrophes: CEO Evan Greenberg called attention to the rising frequency and severity of natural catastrophes, noting not only that storms, wildfires and floods are getting worse, but also that impacts are being amplified by “increasingly vulnerable infrastructure”, as well as increasing insured values of properties at risk.
During its earnings call, W.R. Berkley also focused on the same subject, arguing that, given cats are increasing in frequency and severity, analysts should no longer exclude them from loss ratios.
The increased wildfire risk has been a significant factor in Chubb’s decreasing exposure in California. Management noted that the state of California is preventing carriers from charging adequate pricing for wildfire risk given elevated loss activity, making business there less sustainable.
Chubb was the largest commercial lines insurer in California in 2020, with 5.6% of market share. Its reduction in exposure in the state will open up opportunities for those remaining to increase their market share, including current second-largest insurer Travelers (5.3%), if they don’t follow Chubb’s lead to scale back writings in a challenging geography.
The drawback from California is reminiscent of national carriers fleeing Florida. And if the inadequate pricing we have seen in Florida is mirrored in California, Chubb's decision will likely pay off.
Rate in excess of trend: Greenberg also paid particular attention to rate movements, noting slight moderations as Travelers did during its call. Rates were up 12%, down from 14% in Q2. A robust rate environment this quarter supported growth and margin expansion for commercial carriers, including Chubb.
While rates are still in excess of trend, moderating rates may signal a (still distant) close to the hard market. Management predicted the firm would continue to achieve rate in excess of trend for “some time to come”.
At the current pace of rate moderation, rate increases are likely to last until 2023. This may not be enough time for commercial carriers to reposition themselves in all lines. Additionally, time will tell if this growth works out or the industry looks back and regrets pushing the growth accelerator this hard.
Inflation and economic outlook: Shared among all carriers this quarter is attention on the risk of sustained inflation and its potential effect on the economic outlook. As we’ve previously noted, inflation could play a more prominent role for casualty carriers, given the long-tailed nature of that business.
Chubb noted they are taking the trends into consideration, but as CEO Evan Greenberg said during the call, “if you worry, don’t be in the casualty business”.
While short-term margin expansion seems likely given the rate-on-rate, a slowing economy and intensifying loss cost inflation would quickly put the brakes on further expansion. We remain quite cautious on the low level of concern the industry has shown when discussing overall inflation, social inflation and stagflation.
International footprint: Another point Chubb management highlighted was the firm’s recent international expansion. Chubb recently announced the acquisition of the East Asian accident & health and life business from Cigna, rebalancing its line-of-business and geographic distribution and expanding its international footprint. The acquisition better positions Chubb for a softening pricing cycle.
The discussions listed above came with a report of strong quarterly results. The firm reported operating EPS of $2.64, 22% higher than the Street consensus and 32% higher than Q3 2020.
Top-line growth outpaced peers again at 17% YoY net written premium growth. As we’ve previously noted, the Ace-Chubb combination in 2015 was pitched as a growth story that would require three to five years to emerge, and the company is finally delivering.
The combined ratio also improved nearly 2pts YoY, with the expense ratio getting the majority of the improvement. Management noted the expense ratio benefit partly resulted from commission rates coming down as rates increase.
Below we take a closer look at the P&C operations.
Commercial lines: Incrementally lower underlying loss ratio
The commercial segment had solid top-line growth, resulting from rate increases, strong retention and new business growth.
The firm’s commercial lines underlying loss ratio dipped to 62.3% from 63.8% in the third quarter of 2020, a 1.5pt improvement YoY. While this is impressive, it is not unique to the firm, with other carriers also reporting underlying loss ratio increases, due in part to rates and exposure growth. One of Chubb’s main competitors, Travelers, similarly improved its business insurance segment underlying loss ratio from 63.5% to 59.7%.
Given solid rate improvement, the question arises as to why there is a lack of significant margin improvement following rate action.
The chart above details the firm’s declining underlying loss ratio compared to its moderating but still increasing rate rises. Both the decline in underlying loss ratio and slowly moderating rate increases point to continued margin expansion. Unfortunately, historically the property-casualty industry has done a poor job in predicting trends in longer-tail lines.
Nonetheless, the company noted it has not dismissed the effects that the closed court systems have had on casualty lines.
We and all the whole industry we've been saying for over 1.5 years now that, obviously, with courts closed, dockets full, it has a delay in the processing or final adjudication of casualty-related claims… we don't believe that's a change of the trends. And so therefore, as I said earlier, we remain with a 6% trend factor, and the paid will ultimately come through
This trend has also been reflected in the company’s paid-to-incurred ratios below. The paid-to-incurred ratio illustrates if the estimated reserves have been paid. Typically, most reported claims are paid out fairly quickly (with carriers often realizing they hadn’t reserved enough for claims). But Chubb has had the opposite since the pandemic – that claims the company is aware of have not yet been settled.
On a company-wide basis, Chubb reported the paid-to-incurred ratio for the first nine months of 2021 was 76%, up slightly from 2020's 73% but still below historical norms.
The chart below shows the industry’s ratio also declined overall, in part a result of closed courts. Chubb’s ratio suggests the same pattern may hold in 2021 for peers as well.
Personal lines: Business mix allows Chubb to evade market woes
While Chubb commands 5.4% of the US market share and the top rank for commercial lines, the firm’s personal lines presence is less emphasized. Chubb only holds 1.1% of the total personal lines market share and is the 15th-largest player in the personal lines space.
Equating to around 20% of premiums, Chubb’s personal lines business mix differs from peers given its high-net-worth profile, and its significant majority skew to homeowners. This quarter, the firm’s underlying loss ratio increased only 1.7pts from 49.1% to 50.7%, outperforming peers.
Other carriers, such as Travelers, have reported more significant movement, with Traveler’s underlying loss ratio increasing 6.5pts YoY (from 62.3% in Q3 2020 to 68.8% in Q3 2021). Carriers have pointed to personal lines being damaged by inflation in both car and home construction materials. For example, the ongoing semiconductor supply chain crisis and rising lumber prices have kept severity costs high, while frequency has had increases thanks to an active catastrophe season.
Chubb also noted the impacts of inflation on homeowners, but that it had less effect on commercial lines.
Right now, in short-tail, there is evidence of inflation in the homeowners line and has been for some time. But not so much in commercial property paid losses. But given labor costs and commodity prices and supply chain problems and scarcity of materials, we expect costs to rise
The firm's loss ratio may also have been more stable because high-net-worth customers theoretically translate into better driving (just as credit scores correlate with driver behavior) and can better avoid rush hours/late-night shifts when there are typically more accidents.
The company did register heavy catastrophe losses of $397mn vs. $305mn from Q3 2020. Recall, 2020’s third quarter included losses from above-average hurricane activity, including Isaias, Laura, and Sally, plus the Derecho windstorm and West Coast wildfires.
However, the quarter was lower than the third quarter of 2017’s record with hurricanes Harvey, Irma, and Maria, as well as a wildfire season that destroyed more than 10,000 buildings in California alone.
Crop: Top-line growth driven by commodity pricing
Chubb is one of the largest crop insurers, writing through Ace P&C Insurance Co. and Agri General Insurance Co. While there’s no incentive to buy earlier, growers must purchase crop insurance ahead of spring planting and primarily tend to purchase corn and soy (the largest crops) during Q3, making the premiums concentrated in the third quarter.
Management noted that the year-over-year increase was largely a result of commodity pricing. For example, between February and October, futures for corn, soybeans, and wheat were up 18.5%, 1.5%, and 16.9%, respectively.
We're up significantly year-over-year in our spring crops. Corn and beans [prices] were up 18% and 29%, respectively. And we had another record year in terms of policy count acquisition growth and new acreage plan to be produced
The combined ratio for the segment materially improved, down 7.7pts from 93.3% to 85.6%.
Overseas general: Tracking US trends
The overseas general segment (nearly a third of premiums) also had strong growth in the quarter, with net written premiums up 16% YoY. Management noted that this is a result of an awakening economy and strong rates (15%). Last quarter, management had noted that commercial business internationally had recorded cumulative rate increases of roughly 35%.
We anticipate seeing further improvement in the underlying loss ratios as rates are earned over time, and the results are tracking with the US’s post-Covid recovery.
In summary, although we anticipated a more considerable improvement in underlying loss trends given the cumulative rates, Chubb is reaping the benefits of the favorable market, with strong but moderating pricing trends, expense benefits and steady loss trends.
The company has been able to sustain strong growth despite operating the largest book in the commercial lines space. In addition, its recent acquisition will better position it to manage a softening market.