Insurance Pricing Power
Cyclical Rates & Long-Term Challenges
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The market last week celebrated the July CPI report, which showed annualized inflation at <3% for the first time since 2021, almost certainly heralding a rate cut next month. The report is the latest datapoint signaling success in the ongoing crusade against inflation, and points to broad based slowdowns (and even reversals) in price increases across a wide range of consumer categories. But among the categories with the most stubborn prices, insurance sits near the top: auto insurance rates continued to rise at close to 19% (which I suspect is no surprise to any reader who owns a motor vehicle). The insurance industry has seen tremendous premium growth over the past year, but the vast majority of it has come from rates, not new policies (for example: Allstate posted 14% y/y premium growth in Q2 but just 2% growth in policies in force).
As inflation appears to be coming down to earth, this post examines why insurance rates continue to rise despite lower CPI in other sectors, and what it might mean going forward.
Why insurers have pricing power today
Insurance is a heavily cyclical business, and like most other industries, is also sensitive to macroeconomic shocks. Post-Covid inflation (especially in home/auto repair costs) drove a sharp and abrupt decline in carrier underwriting margin. Disrupted supply chains and labor markets impacted P&C claims costs disproportionately: for example, in the 3 years from June 2020 to June 2023, motor vehicle repair costs rose by >25% and used car/truck prices rose by >47%. Insurers cannot quickly pass this higher cost on to their customers. Because of the regulated nature of admitted insurance markets, carriers face the burden of making the case for higher rates to heavily fragmented and often politicized state regulators. In the worst offending states, carriers may be waiting upwards of a year or longer for approval – bleeding capital or scrambling to churn unprofitable customers in the meantime.
Over the last several quarters, by contrast, cost inflation has abated and carriers are busy implementing their rate increases that were finally approved. The natural result is that insurers now appear to have strong pricing power in a potentially low inflation (but for the moment, still non-recessionary) environment. Combined Ratios and ROE have trended better since last year, and P&C carriers have been on a tear. With Form 13F filings out last week detailing institutional equity holdings, I was again reminded of Berkshire’s big recent bet on Chubb. CB popped 3 months ago when Berkshire announced its $6.7B stake, and Q2 filings show Buffett added to the already huge position. The bullish case is clear and playing out in real-time.
No one expects rates to go up indefinitely – in most lines, rate growth has already decelerated. And insurer stocks can continue to work even if/as rates stabilize, since carrier ROE and multiples hinge on more than just pricing. But there are a handful of signs that the current pricing power might in fact be short-lived.
Ad spend is one such reason. P&C marketing collapsed after 2020 when carrier profitability fell, and is now rapidly springing back as combined ratios improve and carriers target growth. For example, Root spent $65m on Sales & Marketing expense in the first six months of 2024, vs. $10m in the same period a year ago (6.7x); for Allstate, the corresponding figures are $685m vs. $271m in 1H 2023 (2.5x). As carriers return to the market to acquire customers, increased competition could erode underwriting discipline, pressure prices, and push CAC higher.
The increasing politicization of inflation could also pressure insurers. Just last week VP Harris announced that inflation and price gouging would be a cornerstone of her administration’s economic agenda. Given how heavily regulated insurers are, and how visible/painful home & auto policy costs are to Main Street consumers, it does not seem out of the realm of possible that rate filings could face increasing scrutiny going forward. If carriers are approaching peak-cycle profitability, it may put a regulatory target on their backs.
Long-term trends > Short-term cycles
Regardless of how the near/medium-term rate cycle plays out, there are other macro trends at work that are likely to impact long-term carrier profitability. “Social Inflation,” or the trend toward more (and more severe) litigation, is one such risk. Third-party litigation funding has grown by >40% since 2019, and juries increasingly award large liability judgments in favor of plaintiffs as social trust in corporations declines. Another such risk for carriers is climate change, which, as we’ve argued before, is driving elevated losses and uncertainty for insurers. In the regions most affected by these trends (Florida, for example), a growing share of policies is already moving to unsustainable public carriers-of-last-resort as private insurers retreat. It is clear that these structurally worsening risks present challenges for carriers that cannot be solved simply by indefinitely waiting out higher rates.
I believe this points to a secular risk management problem for the industry, despite the near-term pricing power. P&C carriers are flying in a period of long-awaited growth right now, but must identify strategies that last beyond the current cycle. Regardless of how long pricing power lasts, we believe now is a great time to be investing in solutions that enable increased carrier profitability across cycles. While there will be no silver bullet here, it will require non-cyclical solutions to long-term structural challenges. We believe there is immense opportunity (and margin unlock) in areas such as specialty underwriting and claims/expense optimization — categories we are diving into at Equal and will write about in more detail in the coming weeks. Carriers that are able to win on these battlefields will not only reap the greatest rewards during robust markets, but can also steal share and thrive in the eventual downturn.