Undervalued property-casualty insurance stocks should perform better in the near future, an investment bank predicted yesterday.

Bear Stearns property-casualty analyst David Small said the bank was upgrading the sector from Market Underweight to Market Weight based on valuation.

He noted that the p-c sector has underperformed the S&P 500 by 920 basis points since the beginning of the year “even as the industry has posted the best underwriting results in nearly 60 years and companies in the Bear Stearns P&C Insurance Index grew book value on average of 14 percent.”

The reinsurance subsector, according to Mr. Small, appears to be the cheapest, and “already appears to be pricing in the impact of the recent Florida legislation and another active hurricane season,” he wrote.

Mr. Small said small- and mid-cap commercial insurers remain the only stocks that are expensive, with the current valuation gap between small- and large-cap stocks at record levels.

“It seems investors believe that the small companies will be able to more nimbly navigate” through the current cycle of falling insurance rates, he wrote.

The analyst expressed skepticism that small-cap companies are acquisition targets, “given the spotty acquisition history of the industry.”

Bear Stearns doesn't see p-c stocks hitting the valleys of the 1999-2000 period. “In the late '90s investors rightly believed the balance sheet was overstated given reserve deficiencies,” he wrote. “At this point investors should be more comfortable with reported book value and are more likely to see reserve releases.”

Mr. Small said the upgrade is based for the most part on current valuation. “We believe insurance pricing will continue to soften for the foreseeable future, preventing multiple expansions.”

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