The simplest definition of a regional insurer is a company that operates in specific states and specific classes, leaning into the customer and agent servicing theme.
The focus is generally more on small/middle market accounts, allowing these companies to build a stickier book of business which keeps the larger nationals from encroaching.
For the purposes of this piece, we will focus on Selective Insurance Group, The Hanover Group, Cincinnati Financial and Donegal Group.
Although regionals have existed for a long time, one of the defining moments for them came after the 9/11 tragedy, during the subsequent market hardening. The hardening allowed regionals to expand and transform into what are known today as super-regionals.
This growth has come with its own challenges, and only over the past decade or so have the regionals struck the right balance, with the relationship aspect being backed by the necessary technology. The priorities from here will likely be two-fold: continue to focus on the small and middle market; and navigate the loss-cost environment.
The chart below shows the shift in valuation for the regional group which, aided by a degree of takeout speculation built into their valuation, has started to outperform the larger nationals.
The fixed expense structure makes it somewhat difficult for the larger nationals to step down and fight it out at the smaller end of the market, helping regionals hold onto their corner of the market.
This small/middle end of the market has proven lucrative, as regionals have continued to drill deeper and expand over time. As this execution strategy results in stable ROEs and value creation this space will also prove consolidation-worthy, as seen in the past.
Regionals have also continued to lean into a commercial/specialty mix as shown in the chart below. The personal auto space remains competitive, and a full-scale dive into telematics would result in a substantial capital outlay with an unclear path to being a real differentiator compared with established players.
The current macro and pricing environment is proving a bit uneven for commercial-predominant insurers.
The greater the specialty and E&S portion of the business mix, the better the ability to pursue rate increases. Further, one needs to take a step back and think about the impact of exposure on different market segments.
The smaller end of the market might be more stable over time, but the exposure impact will be bigger for nationals due to their book being spread across multiple classes. Since exposure behaves like rate, the impact of earned pricing over time will also have a longer tail associated with it. Consequently, the regionals must be careful in managing pricing vs. loss-cost trends as we head towards a potential inflection point.
On loss-cost trends, this quarter’s earnings have been more favorable for the larger players. In fact, two of the regional players, Donegal and Cincinnati Financial, included adverse loss-cost and inflation trends in their numbers. With less of a buffer on the earned rate side, any quick uptick in loss-cost trends must be carefully accounted for.
In terms of value creation, Cincinnati, Selective and The Hanover screen well. As broader commercial pricing slows, and companies looking to deploy excess capital look at options beyond the usual, many of these names will likely show up as having many admirers.
The note below looks at these three points in detail.
Firstly, exposure has provided a bigger initial lift to nationals, so earned impact is different.
One of the bigger surprises going into second quarter was the stability of rates shown by the pricing surveys. This was confirmed when the actual reporting commenced with larger national continuing to print double digit rates (including exposure shift).
The table below shows pricing and/or rate (as defined by each carrier), predominantly for the commercial lines for some of the relevant larger nationals and regionals.
Admittedly, the data is a bit spotty and not always clearly defined. That said, rate momentum has clearly benefited the larger names on both a renewal and an exposure basis as the economy has rebounded, and nationals have aggressively pursued rate. We would particularly note the several double-digit numbers seen at the specialty and larger nationals vs. the regionals who only have sporadic double-digit rate changes.
As the rate momentum for the industry wanes, regionals will have to watch the loss-cost trend closely and its impact since they have lesser wiggle room on earned pricing over time.
Secondly, loss-cost trends for the industry have been stable, but the first signs of reversal are here.
The chart below looks at the median loss ratio for regionals for both commercial and personal lines segments.
The pivot and re-underwriting effort in personal lines has helped regionals turn their books around, and yet recent quarters have seen negative surprises.
Even on the commercial lines side, the gap between the industry and regionals, which had expanded, has now stalled as shown in the chart. On Chubb’s and other commercial predominant insurers’ conference calls, there was renewed focus on a shift in loss-cost trends from here. If the loss-cost trends shift faster than anticipated, the pressure might be on the regionals since the nationals and the specialty players have been compounding double-digit rate over time.
Taking a step back, with the regionals showing more noise from catastrophe losses and inflation-related loss development, they need to be laser-focused as we head towards an uncertain loss climate with the slow reopening of the court system and the recent interest rate shifts changing the loss-cost assumptions for setting reserves.
Thirdly, as the broader cycle shifts, consolidation will be back on the front burner.
Traditionally consolidation picks up during a softer market since there are fewer organic opportunities in the marketplace.
Although there is some consolidation speculation built into these insurers’ stocks, with the uncertain market environment we haven’t seen an uptick in dealmaking yet. Additionally, with pricing remaining in a good spot, a majority of insurers are focused on organic growth.
The chart below shows the value creation CAGR for the group on a five-year and a 10-year basis. If the same analysis were done for the period 2000-2010, several regionals would rank at the bottom of the list!
In the past, regionals have featured in meaningful consolidation. The table below shows select regional and specialty acquisitions over the years (it excludes reinsurers and international acquisitions). Note the multiples for Ohio Casualty and Harleysville. With the present crop of regionals’ performance in a much more stable place than it was a decade or so ago, any interest will likely be at a decent premium to current multiples.
In summary, it’s all about executing on the present strategy and navigating the market from here in the face of an uncertain loss-cost climate. Regionals will likely continue to plug away on slowly expanding their small market share in the vast middle-market space. It is only a matter of time until suitors will come knocking on their doors as we head towards a softer pricing cycle over the next few years.