Flavors of Insurance, Part III (Personal Lines)

If someone wants to drive a car or take out a secured loan, personal lines insurance typically needs to be bought to protect the interests of other drivers, and lenders, respectively.

Personal lines coverages are simpler in their form, in that they typically renew annually. Commissions are smaller than for life products. Reserves divide into two classes, those for the premium paid but not yet earned, and those for claims incurred. Incurred claims fall into two categories: those reported to the company, and an estimate of those incurred but not yet reported to the company [IBNR].

Personal lines insurers have two sources of profit, underwriting and investment income. The track record of the industry has been less than stellar. Most companies over the past fifteen years have lost money on underwriting and made money on investments. In general, the best managed, and most profitable personal lines writers give up sales growth in order to have an underwriting profit.

This has been less true of homeowners’ insurance, where personal lines writers have consistently lost money on underwriting. Part of the reason for that is homeowners is often treated as a poor stepchild to auto insurance, and only used to generate additional automobile premium.

Performance of the personal lines insurers over the past ten years reflects the relatively hard market through 1997, with strong investment performance through 1999 not getting reflected in stock prices. Money was flowing away to technology stocks. In March of 2000, the next hard market began, and the stocks personal lines insurers rebounded, despite relatively poor performance in the investment markets.

At present, the personal lines insurers are entering phase 1 of the underwriting cycle. Premium rates are trending flat in automobile, and rising in the low single-digit percents for homeowners, but the increases are slowing. Valuations are not excessive, so there should not be a major selloff, unless premium rates soften dramatically. We expect premiums to remain flat for a while, so personal lines stocks should perform at roughly the rate of the return on equity for now.

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Bringing it to the Present

We are back to Phase 1 of the underwriting cycle.  There have been no big disasters, God-given or man-made to deplete surplus, for a long time.

My view is that the personal insurers should always trade at a premium to the commercial insurers because they are safer.  It is always easier to run a short-tail company than a long-tail company.  At present, that relationship is normal.

Personal lines companies have a tailwind in that the zeitgeist has policymakers taking actions to prevent accidents — graduated licensing, anti-drunk driving, making cars safer for drivers even it creates more cars that get totaled, while passengers survive better.

Valuations are reasonable-to-cheap in aggregate here, and the same is true of the life sector.  I am overweight insurers by a factor of six, relative to their weight in the indexes.  They comprise all of my exposure to financials.

Full disclosure: long ALL, SAFT