It’s been a rough period for insurers, with Direct Line sending shockwaves through the sector, but this expert believes there’s a handful of stocks worth owning.
Bank of America expects this year will be just as challenging, as property and casualty insurers continue to deal with inflation pressures, weaker house prices dampen protection sales, and cost-of-living strains weigh on savings and asset management flows.
It starts 2023 with “buy” recommendations on five out of the 13 stocks in its coverage, including two Lloyd’s of London insurers who enjoy the benefit of international exposure and a gearing to favourable commercial and reinsurance trends.
As well as Beazley and Hiscox Ltd (LSE:HSX), the other buy recommendations are Prudential, its former UK investments division M&G Ordinary Shares (LSE:MNG) and the savings and retirement business Phoenix Group (LSE:PHNX).
It has neutral ratings on Aviva (LSE:AV.) and Legal & General (LSE:LGEN) and believes that it is too early to buy UK motor insurers such as Admiral (LSE:ADM) and Direct Line (LSE:DLG) despite an improving pricing environment.
Prudential is one of its two sector top picks for the year, based on a price target of 1,475p. Shares have rallied from 800p in October to this week’s 1,300p but the bank sees the Asia-focused insurer recovering more lost ground as it gets a sales boost from the reopening of the Hong Kong border and next month’s arrival of a new chief executive.
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It points out that shares have meaningfully underperformed the European insurance sector and trade at a substantial discount to peer AIA at 11 times 2024 earnings.
Beazley is the other top pick as Bank of America believes the market has under-appreciated the cyber-insurance specialist’s double-digit earnings growth and mid-20s return on equity. Even after a strong year, the bank notes shares are only on six times forecast 2024 earnings.
It added: “In our view, Beazley's underwriting margins are tracking at the best levels since 2016, with significant investment income tailwinds expected.”
Beazley was one of the better performers in 2022, a year that Bank of America said had been a “dreadful” one for the sector after both UK life and property and casualty posted double-digit negative total returns.
And while insurers only marginally underperformed the FTSE All-Share last year, they lagged UK banks for the first time in recent memory.
Bank of America said: “We fear that this trend could continue in 2023 as banks have become a credible investible option after a troublesome decade of recapitalisation, low rates and regulatory/political challenges.”
Only four insurers delivered double-digit positive total returns last year, three of which were Lloyd’s insurers, and the other was Aviva after a big capital return in the year.
The bank expects most life insurers to grow their dividends in forthcoming annual results, although some property and casualty insurers may be forced into cuts after a challenging year.
It adds: “Yield has been a key attraction for the insurance sector for many years, but recent increases in bond yields mean competition for capital has increased. The relative appeal of a 6% yield has lessened. With growth moderate for most insurers, this weakens the sector's relative investment appeal even if the operational performance is as strong as ever.”
Direct Line shocked investors last week when it pulled its dividend for 2022, blaming a near doubling in weather claims on previous expectations alongside a further increase in motor claims inflation and lower value of investments in commercial property.
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The Churchill business had one of the highest dividend yields on the London market at around 10%, having set aside £199 million to pay last year’s final award of 15.1p a share.
Bank of America expects companies in Direct Line’s sector to confirm a more constructive outlook given improving market discipline and hardening premiums into the end of 2022. The claims inflation outlook, however, is less certain and more volatile, but data points suggest early signs of moderation.
It said: “We expect insurers to seek to close the gap between pricing and claims inflation over 2023, which will likely be a transition year. However, the earnings recovery could be pushed into 2024.”
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