Selling bonds and buying equities will boost stock market, analysts say
The insurance sector is the litmus test which will signal the recovery of worldwide stock markets, according to an investment expert.
Insurers' attempts to repair their balance sheets will be key to stock market recoveries, said Schroders chief investment officer Mark Pignatelli.
Insurance companies had been caught out by declining investment returns because they had "loaded up" with bonds, which managers had seen as low-risk, Pignatelli said.
"The real trigger for this very unusual past two-year period was that bonds and equities started to behave differently," he said.
Investments fell in value as the industry incurred huge losses.
Pignatelli said low insurance share valuations showed that investors were no longer looking at profit and loss figures, but paying attention mainly to the strength of the balance sheet.
The insurance sector would lead a wider stock market recovery when it regained enough strength to sell its bonds and start buying back into equities.
"The about turn-will come when insurance companies lead the stock market recovery with a huge sell-off of bonds and the return of equities," he said.
Thomas Hess, chief economist and head of economic research and consulting at Swiss Re, said non-life insurers were better placed than life insurers to rebuild capital bases.
Overall, European insurers had lost 25% to 30% of their equity in recent years, he said.
He forecast that insurers would continue to cut their exposure to risk through tighter terms and conditions and higher limits, and to stock markets.
Capital raising would continue and alternative risk transfer would rise in importance, with more captives and securitisation.
Finite reinsurance would be temporarily hit, but reinsurance generally would be more attractive.
He forecast that the non-life sector would recover through 2003 to 2005.
"Premium growth will be in the 3% to 5% range per year, mainly driven by further price improvements and tighter terms and conditions.
Profitability would improve as a result.
But he warned: "Little can be expected from investment results in 2003. Profitable technical underwriting is what is needed."
But if the insurance sector is going to lead the markets out of the bear phase, what signs are there of impending share price rises within the sector?
William Hawkins, insurance analyst at Fox-Pitt, Kelton, Swiss Re's investment bank, gave a downbeat outlook for insurance stocks in 2003.
He too favoured European non-life over the life sector, but said there were still question marks over the need for extra reserving.
Hawkins said the potential downside risk of equity markets falling back to September levels was worse than the potential upside if markets recovered.
Describing 2002 as the "recovery that never happened", he said that reserve charges and weak equity markets had together kept insurers' price to earnings ratios relatively flat.
The poor outlook for investments and rising losses on prior years would keep reinsurance prices rising into 2004.
He concluded: "Only the property and casualty market offers pricing power that in the shorter term is non-correlated to the financial markets: the pricing of risk.
"However, most quoted primaries are still suffering from the run-off of the past cycle.
"While reinsurers also suffer from negative run-off, the quoted European market offers [in general] strong balance sheets to leverage the upside."
But he ended on a note of caution, raising the prospect of further need to reserve against asbestosis and other losses.