Morningstar’s Top Two Picks in EU Insurers
As new accounting standards further strain insurance firms throughout Europe, Morningstar’s analysts say these two companies have the muscle to outperform.
The Covid-19 pandemic pummeled several sectors and industries across the world, but personal-line property and casualty insurers were generally not in that unhappy group. While claims in life and health insurance rose as the virus spread, companies insuring living spaces, autos, and other property enjoyed a sharp drop in claims – and record profits. Simply people stuck at home experienced far fewer accidents, burglaries, water leaks, and other claim-generating tribulations. This effect occurred in the US, but it was especially pronounced in many European countries where lockdowns were even more restrictive.
Unfortunately, these high earnings quickly evaporated as the pandemic waned, and the short-lived prosperity for scores of European insurers gave way to a drastic fall. A recent Morningstar report examined the ongoing consequences of this dramatic reversal, both for these EU insurers and their (existing or potential) investors.
End of the “golden period”
The end of quarantines signaled a hasty death knell to the boom times of 2020 and 2021 for personal-line property and casualty insurers in the Eurozone, or their “golden period,” as the Morningstar report puts it. In 2022, Europeans raced out of their homes with vigor – and the bedevilments of crime, injury, and sporadic bad luck promptly flooded back into their lives, making insurance claims soar to new levels. Additionally, a bump in severe weather events in Europe made matters worse for both policyholders and insurers. As the profits of many firms dried up, investors fled, driving valuations and share prices down.
Strapped, struggling, and pessimistic
In the second half of the 2023, according to the Morningstar report, European property and casualty insurers find themselves strapped and struggling in a post-pandemic world with greater volatility, the double-edged swords of high inflation and interest rates, and perhaps most impactfully, the burdens of a new accounting law (IFRS-17) that came into force on January 1, 2023.
These factors are converging to create a grim environment with uncertain futures for several companies, many of which have taken on sizable debt after being flush with cash perhaps just 18 months ago. “The profitability of personal-line insurers has been on a rollercoaster over the last few years as firms have gone from experiencing some of the best operating conditions in years to some of the worst,” the report notes.
Importantly, the Morningstar analysts note that the harsh new landscape is also giving a few select firms powerful advantages.
Think capital and moats
With the playing field now dramatically changed for European property and casualty insurers, they’re facing new realities that will likely determine their fate. One of the most important consequences? They are far more sensitive to the strength of their balance sheets than in the before times – and this a boon to investors seeking reliable info (more on this momentarily). The Morningstar report asserts that the new conditions are decidedly favoring insurance companies with two key attributes: strong liquid reserves and a “competitive shield” against rivals – through services or other factors.
“We believe the best-capitalized insurers are going to be winners in the new environment because they can withstand greater investment and underwriting stresses...while still maintaining [critical] investments and, in some cases, carving out a moat,” the report’s authors state.
As for the specific winners, the analysts point to Admiral (ADM) and, secondly, among European reinsurers, Hannover Re (HNR1) as two standouts for investors to watch (selected from dozens of companies compared or analyzed in detail in the report).
Why balance sheets matter more now
Admiral’s robust balance sheet is a key attribute in helping the company vault to the top of Morningstar’s list. While scores of EU insurers now have severely weakened balance sheets due to the mandates and changes coming from the most potent regulatory pressures (such as Solvency II, an EU framework enacted in 2016 that requires insurance firms to have adequate capital, and the aforementioned IFRS-17, or International Financial Reporting Standard 17, which compels these firms to use accounting methods that provide more transparency into their financial condition), Admiral’s balance sheet actually gained strength after enduring these new stress tests.
Morningstar’s analysts argue that this gives the company an even more critical advantage over other firms than it had seemed previously – amid other positives that make Admiral’s stock a solid contender for institutional portfolios. “With its partnerships and technology, this is a company that continues to be focused on, and able to deliver, growth over the long term,” the report adds.
By ensuring sufficient cash reserves and improving transparency, the combination of the Solvency II framework and the recent introduction of IFRS-17 is a game-changer for investors seeking to gauge the risks and opportunities among EU insurers, according to the report. It notes:
[Previous frameworks and accounting laws] have led to overinflated and underinflated balance sheets, which has made it difficult for analysts and investors to assess [their] economic value. Ushering in new accounting standards will change that dynamic...[As a result,] the balance sheets of European insurers will better reflect economic value.
[More specifically,] the new accounting standards mean that in the future all insurers’ balance sheets will be a lot less volatile and will reflect economic values better because assets and liabilities will be discounted...This makes sensitivity analysis of balance sheets...much more relevant.”
Certainly, the enactment of IFSR-17 is not a welcome development for a subset of Eurozone insurance companies struggling in the post-pandemic market, as increased transparency into to their financial situations is likely among the last things they desire. But other firms, such as Morningstar’s top pick among reinsurers – Hannover Re – are using the new mandates as an opportunity to improve their processes, infrastructure, and capabilities. The report states:
Hannover Re is strengthening its competitive position even through the transition to IFSR 17...While most insurers are concerned about the implementation of a new accounting change...Hannover Re has taken a straightforward approach to accounting choices and...has also aimed to improve the quality of the business, [taking] the opportunity to upgrade its actuarial and finance systems, merge all its core databases into two, and improve the granularity of data underwriters can use.
Looking ahead – and watching out
With the earnings bonanza of the pandemic long gone, claims still extremely high, losses from severe weather events likely to rise, debt pressures increasing, Europe in a technical recession with vital economies (such as Germany) facing troubling downturns, the adversities for personal-line property and casualty insurers in the EU remain daunting. Many may not survive over the next two years, even if they were doing quite well just a short time ago. Others could become mired in compliance issues and conflicts.
For investors, takeaway from Morningstar’s report is clear: The new playing field makes it more imperative to look for European insurers that have ample capital to absorb economic shocks and sudden market swings, continue investing in their ongoing operations, and keep paying dividends to shareholders. Fortunately for investors, synergies in the pairing Solvency II and IFRS-17 are making it much easier to accurately assess an insurer’s financial health. Further, among the companies that pass muster, those that can also leverage a significant competitive advantage – creating a moat against challengers – have a much stronger likelihood of remaining top portfolio contenders for the long term.