Reserve shortfalls and deteriorating loss ratios will impact negatively on auto insurance stocks, an investment bank predicted today.
The Chicago-based investment bank of Cochran Caronia Waller changed its outlook on auto insurance stocks to negative based on its analysis of 2006 reserves.
The report asserted that the underwriting cycle will take its toll on the profitability of auto insurers.
Among the reports highlights:
o While 2006 reserves are redundant, they are less so than the previous year.
o Excess reserves from the strong part of the underwriting cycle (2002-2005) are mainly exhausted.
"We expect auto loss ratios to rise by 300 to 500 basis points over the next two years," the report said.
Favorable reserve releases will likely slow or go away and future accident-year loss ratios should begin to rise. "An historic review shows that current loss patterns are similar, although somewhat muted compared to those experienced before loss ratios inflected in 1999," the report said.
Higher loss ratios will translate into returns on equity that will move from 20 percent to 15 percent over the next two years and a resulting contraction in trading multiples.
The report commented on three companies.
It reduced Allstate's rating from Outperform to Market Perform and removed the company from focus list predicated on an expected rise in auto loss ratio resulting in a return on equity decrease to 15 percent.
The Safeco rating was reduced from Market Perform to Underperform due to a reserve study showing 2007 should be negatively impact by a lower level of reserve releases than 2006. In addition, the report said overall reversion in auto sector trends have a greater impact on this company as the market to book is relatively high given the expected ROE.
Progressive, the report said, continues with a Market Perform rating because it remains ahead of the curve in recognizing losses, has a huge amount of excess capital, and the stock has already experienced significant multiple compression.
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