Home and Auto Insurance Got Wacky. What’s Next?

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We have seen in the last 5 years over $100 billion per year in catastrophe losses. There are a lot of meteorologists prognosticating this year that it's going to be worse than ever. And the storm season kind of starts in late June and it goes through September. So we're about to go into the jaws right now.

Jaws sounds bad, I have to say. Welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Andrew Kligerman. He's an analyst at TD Cowen covering the insurance business, which has been in upheaval. We'll hear in a moment from Andrew and another analyst about what's next for that business and what to make of the stocks. Listening in is our audio producer, Jackson Jaws Cantrell. Hi, Jackson.

I hope that nickname sticks. It's pretty cool.

It's not a bad one. You don't get to pick your own nicknames. You'll get stuck with one much worse. That's how it works. We have a listener question, right? You want to jump right into that?

Yeah, we have Javier from Alabama.

Great.

My question for you today pertains to the best use of money I've been saving in an individual brokerage account for several years. I have about $75,000 invested in the stock market and will be graduating from medical school next May. When I graduate, I'd like to buy a house, and these funds would basically be my only way to make a down payment. What do you think I should consider, and what are the pros and cons of using what is effectively my life savings for a down payment on a home versus keeping it invested in the stock market while I save for a down payment with my new income?

Thank you, Javier. It's an excellent question. We've talked about this in the past. What's next for house prices? Basically, I'm going to do what they do in politics, which is I'm not going to directly answer that question. I'm going to answer something that I kind of want to talk about anyway. If this were a hurricane, the eye of the storm would not pass directly over your question, but your question would be in the outer bands of this storm. I'll come to why in a moment, but for now, let me just say, first of all, congratulations on graduating medical school. Congratulations on your early savings, $75,000. That's an accomplishment. I don't know a lot about what life is like right after medical school, but Jackson does. Jackson has a wife who's been going through it. And Jackson, you can, you can end up in different places, right? You move around a bunch. Yeah. Fair to say?

Residency, maybe a fellowship, maybe a job somewhere else, maybe moving back to where your family lives. There's a lot of moving involved.

Right. And a few things that I want you to keep in mind. I don't want you to think of missing out on buying a house based on what has been happening recently with prices. Prices have been running up quickly. That is not the typical experience for houses over long time periods. As I've said in the past, houses are not special magical things. They're sticks and stones and labor. They tend to rise over time at the rate of inflation. Stocks over time tend to go up by something more than the rate of inflation because stocks are businesses, and businesses are things that turn sticks and stones and labor into something more valuable— profits. Also, when people buy houses, they tend to overconsume housing. And what I mean by that is when you get an apartment, you tend to get just the space you need to live. When you buy a house, you tend to buy more space than you need. You get yourself a big house. And that means you're paying a lot of ongoing carrying expenses of the house. You have taxes, you have insurance, you have maintenance and so forth. Those costs can add up. So don't underestimate how much you need to have in the bank still as a homeowner. $75,000 might be around where you want to be in cash earning, let's say 5%, where you can get your hands on it quickly if you need it in an emergency as a homeowner. Now, homeownership can be great, and it's particularly useful as a forced savings program, right? You have to pay off your mortgage over time, and you build up equity in this thing that's increasing in value anyhow. And before you know it, you're surprised in just how much house you own years into the future. I'd have to know a lot more about your particular circumstances, Javier, to say whether this is the right move now. And housing is highly localized. It's not just the region of the country you live in, it's your particular street that you're looking at and that particular house. But broadly speaking, I'm thinking maybe there's no great urgency in your case. Now, I've been thinking a lot about something that could affect house prices down the road, and that's what's happening with insurance. Let me come back to that. Jackson, I was talking to you recently about the quick trip I made to Houston, and this is not about going to Pappardelle's and eating fried alligator for the first time. And this is not about driving past a billboard that said, rent the machine gun and go into the place. And it turns out there's— if you give the guy your address and your name, then you can literally just shoot a fully automatic M16. You got to pay for the ammo. It's quite expensive and it goes quickly. Here's my impression of an M16. $20, $20, $20, $20. Wait a second, what happened? Anyhow, not about that, but about the storm.

You said you felt like Pharaoh in the Ten Commandments.

I wrote that in Barron's Magazine this week, the scene with the plagues, right? Because I got to Houston and on my first night there, there was a freak storm. This was not a hurricane that came in off the water where they give you a lot of warning beforehand and they tell you don't go out. This showed up all of a sudden. And it had 100-mile-an-hour winds and it took down trees and structures. It blew windows out of high-rise buildings. A million people lost power. It was nuts and damaging for the city of Houston and surrounding areas.

Wow.

You're probably relieved to come back home.

Well, funny you should mention that. I live in the lower Hudson Valley, just north of New York City, and it is not an area known for, natural disasters. And I got back home and there was hail the size of, I don't want to say, not quite ping pong balls. It was about the size of quarters in my little town. It's a very local storm and it just shredded leaves on trees. It made like this, this kind of green puree all over the streets and it brought down branches. And it wasn't, it wasn't nearly on the scale of what I experienced in Houston. This was a little local thing. It didn't do a lot of damage., but it was crazy for me to see this blanket of ice balls on my yard and all around our town. And it's going on June. And speaking of June, June 1st marks the official start of the Atlantic hurricane season. It runs through November. And NOAA, that is the— what does it stand for, Jackson?

Quickly, quickly. The National Old Association of Astrologers.

National Oceanic and Atmospheric Administration. Thank you. They say this is going to be a record year for hurricanes, and they say that in part because of record high ocean temperatures. Okay, so weather is getting weird. These storms are not just following me wherever I go. 18 states were unprofitable last year in the home insurance business., and that is causing insurance companies to, first of all, quickly jack up rates. I looked at my own home insurance policy. I, it's something that I should be reviewing every year, but you know, I get busy and I don't pay attention and it gets paid automatically, so I don't notice. But my homeowner's insurance is up 70% over 3 years. When I was in Houston, there was a woman who worked at the hotel. She said, yeah, the storm had badly damaged her roof., and she said she wasn't sure if the insurance company was gonna pay for it. She said because she hadn't been able to find coverage from a private carrier, so she was forced to fall back on the state insurance company, and the, the state insurance company was kind of skimpy in the things it would pay for. And that is a common story. There's a rapidly rising number of people around the country who find that private insurance companies have fled their area. They don't think that business is good there, and the only choice they have left is a state provider. And that gets me wondering, Javier, and this is more of answering your question with a question, which they say is rude, but here goes anyway. What happens if home insurance just gets endlessly more expensive? If it becomes a much bigger carrying cost of owning a home than people anticipated? That's already happening in some high-risk areas. I won't say that the cost of my insurance has really changed the calculus on whether I want to own my home. But in some parts of the country, that's happening. It just makes me think that if something doesn't change quickly, it could affect house prices, right? Couldn't it affect house demand if people like right now they say, well, I'm going to buy this house, I'm going to have to pay a certain amount in property taxes. You definitely factor that in when you buy a house. You do not think generally about what the cost of your homeowner's insurance will be, but maybe you will in the future. So all of that left me wanting to learn more about the insurance business and what the companies providing the insurance make of all this. I reached out to Andrew Kligerman, who covers insurance for TD Cowen. I asked him about the volatile financial results we've seen in recent years from a company like Allstate. I was looking at Allstate at some financials the other day, and I saw that they had been earning a lot of money, and then they went through what looks like a couple of bad years on the profit line. One was negative and one was minimal. And now it looks like Wall Street expects them to return to healthy profits. And maybe the stock kind of followed along with that pattern a little bit.

What's happened there that explains that? Pre-COVID, everything's fine. COVID hits in 2020, nobody's driving. Personal lines companies are minting money, particularly in auto insurance. No accidents, no accidents if no one's on the road. Nobody's on the road, nobody's driving, it's beautiful. But everybody's still paying. They're all paying. And then they actually had some refunds, Jack. So it was kind of interesting, but it was still like uber profitable. Now we get to 2021, things are fine in the beginning of the year and people start driving. And what they didn't anticipate was frequency would pick all the way back up, or not all the way, but, but significant. And then the severity of the accidents was much greater because the, you know, there still weren't as many cars on the road. And loss cost inflation kicked in. We were heading into a, not only on an economic level, but social inflation. So the two forms of inflation were thrusting upward in a big way.

I remember that the price of cars really jumped up, so that made the cost of repairs go up and there were more lawsuits on auto accidents or, or more severe.

Oh, big time. In, in fact, in fact, you brought up a point that I should have brought up, which was just, you Used car prices at one point were up over 40%. And with the other inflationary factors, used car parts, labor, you name it, it was just really bad. And with personal lines in particular, you get some of this in commercial, but it's really key in commercial, personal lines. The regulators have to approve raising your prices. So there we are in 2021, the regulators are slow. California up until 2023, I think they had over a 2-year moratorium on rate increases. So you couldn't even get an increase in California. So these companies were bleeding money back half of '21, worse in '22. Pretty much equally bad in '23, but started to turn the corner at the end of '23 because the regulators were giving price.

Maybe it works similar to like the utility business. You have to make some kind of a rate case. You have to, you have to lay out a case to your regulator and say, here's why we need more money. And then they take a while to consider it and it takes them a while to come back to you.

That's spot on.

That is spot on. And is, and is there something similar going on in homeowners insurance?

It's, it's exactly the same. And in fact, it's, it's, it's still Many, many homeowners carriers are not out of the woods yet with that because climate change has been extremely difficult and the regulators have been very slow to increase rates. So you've seen companies like Nationwide leave California. Allstate has kind of shut it down in California in terms of writing new business. So that, that line is actually now more problematic than auto. As auto turns the corner, we think homeowners will next year.

But it's been problematic. Thank you, Andrew Jackson. Do you think everybody knows the basics about how the insurance business works, about how they make money, how you can size them up as an investor?

You see how much money they're bringing in and subtract the money they're paying out and pocket the rest.

That's pretty much exactly it. They have, they have something called the combined ratio. And the combined ratio tells you the portion of premiums that you're paying out both in losses, uh, on claims and in your own expenses just to run the business. And if your combined ratio is safely below 100%, then you are profitable as an insurer. There's one other important thing, which is that you collect the premiums, a lot of time passes before you have to pay that money out as claims, and you get to use the money during that time. You get to invest it, so you earn an investment return on the cash. And bond yields are higher right now, and that bodes well for the income portion of the return that these companies can earn going forward. Sometimes insurance companies have to run a loss for a year when claims are particularly bad. Then they go to their regulators, they say, we need to charge higher prices to be profitable again. Those price increases stick, and if claims go back to normal, profits return. That's what's happening with Allstate, only it's been greatly exaggerated by the price increases for cars that we saw during the pandemic. But Allstate was just approved for a 30% price increase in California, for a 20% increase in New Jersey, and 14.6% in New York. Insurance companies have a pretty strong case with regulators when they are unprofitable. The case goes like this: we are going to leave if business doesn't get better, and you will be stuck providing this insurance yourself. Regulators tend to say, Okay, you can raise prices. You heard Andrew mention social inflation. That's a weird term. What does that sound like, Jackson?

Social— sounds like people talking about inflation more.

Oh, I was going to say a balloon party, but yeah, I guess social inflation is an insurance industry euphemism for liability judgments gone wild. There was an analysis cited by Travelers. It said that so-called nuclear verdicts— those are ones that are over $10 million— they increased by 35% between the years 2015 and 2020. Travelers says the public has grown numb to the numbers. It says that sentiment toward big companies among jurors has fallen. It says that tort reform has shifted into reverse. And the plaintiffs have sharpened their tactics. I spoke recently about that with Mike Zaremski. He's an insurance analyst at BMO Capital Markets. You mentioned about some trends that are behind the increase in litigation. What are those trends and are they going to continue?

Advertising spend. You know, if you're a lawyer, especially with the rise of social media, you can be more surgical, quantitative in how you're targeting folks versus just doing kind of blanket, the, you know, the ads you see on the highway or the airwaves or whatnot. And so that's been great for the legal industry in terms of more efficiently getting an ROI, return on investment on your spend and increasing your spend. The other part that's not as big as that, but as a driving force is your— the US and Australia and parts of Europe have allowed third-party investors. So anyone out there, institutions, high-net-worth individuals, to basically offer money to lawyers. And so they have someone else's money too. They're more inclined to not, uh, settle as, as fast as they, as they used to, or just do a much more comprehensive due diligence in terms of as they present their case, uh, ultimately to a jury and/or judge.

Thank you, Mike. Mike made the point that inflation is not necessarily bad for the insurance industry. I mean, the insurance company's not out there causing the weather or causing the damage. They are able to eventually adjust their prices. It gets a little trickier when we talk about homeowner's insurance and weather uncertainty, but it also gets simpler if we're talking about publicly traded insurance brokers. Those are companies that get paid for their advice. They don't have the same underwriting exposure that insurers have. And that, I suppose, takes us to some stock recommendations.

Hey, Jaws, how about we take a quick break here and we come back with the stocks?

Glad to hear the nickname sticking. Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you.

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Welcome back, Jackson. I just a moment ago read something on the internet that I think will change everything for you. It's from the American Kennel Club. Oh no. It says there has yet to be any scientific research on why dogs love belly rubs. Dr. Stanley Coren, Professor Emeritus of Psychology at the University of British Columbia and author of How to Speak Dog, believes it's simply another way of socially connecting with your pet. Here's a quote: For some dogs, a belly rub is simply a variant of being petted. It's a form of social contact. The fur on the belly is usually less dense and softer, so the sense of being touched is less muted. Well, that's a fine theory, Dr. Coren, but as we've just read, there has yet to be any scientific research.

And Jackson, This is where you come in. What does this have to do with insurance?

Nothing, but there could be a big grant from the state of California for you to— you need a lot of dogs and money and time, and you could look into this subject. I'm just saying you could become the world's foremost expert on the subject, a smart guy like you. Maybe we should get back to insurance companies and the stocks. Earlier, I used the example of Allstate. That's a company that was approaching earnings of $50 a share early in the COVID 19 pandemic when roads emptied, people weren't driving, and there were very few claims. Then it turned unprofitable in 2022. Then it won all those big rate increases from states, and now Wall Street expects it to once again approach earnings of $15 a share this year, rising over the following 2 years to more than $20 per share. So about 70% of the analysts who cover Allstate say to buy shares. Not everyone is bullish, of course. Elise Greenspan at Wells Fargo Securities views Progressive as better positioned than Allstate to win market share. Progressive was an early leader in something called telematics. That's where insurance companies will give you a smartphone app or some other device to put in your car, and they track your data as a driver. And the deal is you can get lower insurance rates if you allow them to do that. So customers get discounts and the insurer is able to fine-tune how much it charges for coverage. That's been great for Progressive. It had a much smoother earnings ride than Allstate in recent years. It's been a much better long-term stock performer. Now Allstate and other insurers have gotten in on the telematics business. Mike from BMO calls telematics one way that customers who are really hurting on their car insurance bill can try to get a better deal. I also mentioned insurance brokers. Here's Andrew on why he likes them and one of his picks.

I love the brokers, Jack. Why? Because when claims come in and they're really bad, insurance companies have to raise prices. Commissions and fees are typically a fixed percent of the dollars that the carriers take in. So imagine prices are going up The insurance carriers are hurting, but the brokers aren't hurting because they don't pay claims. And the one we really love there is Aon because for a variety of reasons, their organic revenue growth has been slow. I think it's going to come back strong. They did an acquisition of a middle markets company called NFP. I think that's going to be a big accretive contributor, not only to operating EPS, but also to revenue growth. So I think you're going to see this company really see a nice pickup in not only revenue but margin. And they're a bit undervalued. People are a bit nervous. They're at a discount to Marsh and some of the other players.

It's about time that someone on this podcast professed their love of insurance brokers, and you've done it. And I picture some of them blushing right now while they're listening to this.

So only an insurance guy would say something that ridiculous. But I do love that group, man.

It is awesome. Mike at BMO likes a couple of insurance brokers too, Arthur J. Gallagher and Brown Brown. He also likes a midsize insurer called Cincinnati Financial.

It has actually been, you know, slightly negatively impacted in the more recent year by higher than expected inflation levels. When that happens, they raise— they're raising pricing. They're also kind of adding more reserves to their cookie jar, right? So reserves is cost of goods sold because no insurer ever knows their exact cost of goods sold, right? You true it up every day based on the the number and severity of the claims that come in the door, right? It actually, you know, probably overestimating its cost of goods sold on a go-forward basis. And when you overestimate your cost of goods sold, that means there's more earnings than expected that accrue ultimately to shareholders.

Thank you, Mike. We've been talking up until now about personal insurance, home and auto, but of course there's also commercial insurance bought by everyone from the dry cleaner to a global corporation. The timing of that business cycle has been a little different. Andrew says that industry had a reckoning with costs and losses back before the pandemic, and now it is as profitable as he has ever seen it.

He likes two stocks there. So there are two names in commercial that we like. One is the Hartford. This is an iconic company that is best in class in small commercial insurance. And the reason I love small commercial is we talked about social inflation. The bullseye is on the large corporation. Hartford has some of that, but a relatively small amount, and they're the best in class in small commercial. They have a wonderful employee benefits business and they have a personal lines business which we think will get to target profitability next year. And all the while they're trading at a bit of a discount to AIG, Travelers, Chubb. Arch Capital has a division that writes E&S business. I think that's going to grow nicely for them. They've got a reinsurance business that's been really capitalizing on, on the firm pricing there, and they're a company that is not wedded to anything. So in other words, if pricing gets weak, they're more than happy to walk away and buy back stock.

Andrew mentioned E&S, or excess and surplus insurance. That's where You have something you want covered and regular carriers won't touch it. And so there are specialty companies that will write you insurance, and regulators tend to give them a freer hand in doing that. Jackson, what's an example of something that you would want insurance coverage for as a business, but that a typical company might not want to go near? I was thinking about bungee jumping from blimps.

Is this overactive volcanoes?

Can I assume that that'll cost you extra? If you're like me and you've been shocked by a look at a recent insurance bill and how much costs have gone up, you're wondering when the price increases are going to at least slow. I asked Mike at BMO Capital and he says they're likely to slow faster for auto coverage than for homeowners coverage. With cars, you had this big bout of inflation and it has subsided somewhat. With houses, you also had price inflation, you also had repair inflation. It's hard to find skilled workers to do those repairs. And you have the added wrinkle of storms. Mike says the weather trend is really not most people's friend. That's difficult for consumers. Investors should just keep in mind that the car insurance market is a lot larger than the homeowner's insurance market. So many of the stocks that we're talking about have more exposure to car insurance and of the two businesses, that's the less uncertain one at the moment.

Here's Andrew on that. Not a situation where there's a proportionate outsized homeowners exposure in my, in my space, in the publicly traded space.

It's just not— it's just not as big of a deal as auto insurance.

It's— I know. Yeah. In terms of what they write, proportionate exposure on their income statement and balance sheet. It's just not— I mean, it's massive in, you know, in terms of what the amount they write is, but in the amount on their proportionate balance sheets, it's just not that.

Sure.

You know, everybody's got a— just about everybody has a car. Not everybody has a house. Some people have a house and they have 2 cars or 3 cars. And by the way, the cars move. So, so, so bad things can happen to the cars more so than the houses. Maybe.

I don't know. I'm guessing it feels like It feels like Jack's houses are moving too with what's going on.

Thank you, Andrew and Mike. And I want to thank soon-to-be Dr. Javier from Alabama. I know you're going to do great whether you buy that house or keep growing the $75,000. Thank you all for listening. If you have a question you'd like answered on the podcast, I can't really help you with that. But if you have a question you'd like nearly answered in a tangential way, like we did for our friend Javier, just go ahead and tape it on your phone. Use the voice memo app and send it to jack.hough@barons.com. Jackson Cantrell is our producer. You can follow the podcast on Apple Podcasts, Spotify, YouTube, wherever you listen, and you can write a review on Apple. We'd love to hear from you.

See you next week. Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you.

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