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Earnings misses cloud P&C outlook

A benign first half of the year for major catastrophes had led to high expectations from investors going into the Q2 earnings season, despite increasing awareness of the pressures facing the P&C sector amid waning insurance pricing momentum and a fast softening reinsurance market.

But with more than half of the US and Bermudian companies that have reported to date revealing earnings misses, equity analysts have been forced to reassess their view on individual companies and the broader sector as share prices tumbled.

According to Nomura's Cliff Gallant, investors in P&C stocks had expected what was seen as a benign cat quarter to drive strong results.

"Instead, smaller weather events, slowing reserve releases, light investment income, and weakening premium volumes have driven what has turned out to be a generally dismal season.

"We broadly expect similar results in coming quarters and highlight that we are low on the Street for 2015 earnings per share estimates for the sector's bellwether stocks, [Travelers and Chubb]," he wrote in a 1 August note.

Gallant said he expects a soft market across the board in 2014, with rates already having deteriorated in reinsurance and pricing momentum topping out in most insurance lines.

"The stocks were strong performers through 2013; however, given our concerns about pricing trends, we believe that valuations are at risk," he concluded.

The comments followed research by Bernstein analyst Josh Stirling, who has lowered his expectations for stocks and called an end to margin expansion in the sector.

Although it was higher than expected cat and non-cat losses that drove earnings misses at Travelers and Chubb, volatility of that nature can be overlooked by investors quarter-to-quarter if the fundamentals of the business point to a healthy outlook and potential for earnings expansion.

But underperforming underwriting in Q2 was coupled with further evidence that pricing momentum is slowing in the US P&C insurance sector.

Indeed, the latest survey from The Council of Insurance Agents & Brokers pointed to a 0.5 percent average rate decrease in the second quarter for US commercial insurance, as slowing rate increases in previous quarters turned to softening.

Shares in Chubb and Travelers fell 6 percent and 5 percent respectively through July following disappointing Q2 misses and a gloomier outlook on rates, while The Hartford has seen its shares trade off by a similar amount as it reported higher than expected asbestos and environmental reserve charges.

Among the major US P&C players only Allstate outperformed, and was rewarded accordingly as it traded up post-results.

Ace and XL were also notable exceptions as they impressed investors with strong earnings beats.

But for most Bermudians - including the clutch of remaining property cat specialists - results were disappointing.

And for RenaissanceRe and Montpelier Re, the punishment for significant earnings misses was to have their stocks downgraded by equity analysts.

Acknowledged property cat market leader RenaissanceRe saw its stock trade down after releasing results that underperformed Wall Street forecasts and included a 33 percent fall in its top line.

Bernstein's Stirling downgraded the reinsurer to sell as he argued that the stock was too expensive in light of its declining earnings power.

The research firm lowered its 2015 earnings estimate for the reinsurer by 20 percent after it missed analysts' second quarter forecasts.

Stirling said that he believed pricing pressure would continue and drive returns on equity below 10 percent for firms such as RenRe.

Stirling described RenaissanceRe as the "premier franchise" in the catastrophe reinsurance industry, long recognised by the market as the "smartest guys in the room".

"Nevertheless, just as at less distinguished peers, the company is facing continuing pricing headwinds from the relentless march of alternative capital, and this quarter even with RenRe's brand, sophistication, and time-tested approach, their ability to protect their franchise is not assured," he said.

Meanwhile, Deutsche Bank analyst Josh Shanker has downgraded Montpelier Re shares from buy - based on a target price of 1.1x stated book - to hold following "disappointing" results.

"We had been operating under the assumption that a) book value is understated and b) Montpelier management had a greater appetite for retiring common shares below book than following cat risk downward.

"By not shrinking, Montpelier is indicating to us that our thesis was incorrect. We do not believe an essentially monoline company willing to operate under a business-as-usual standard should trade at a premium to book valuation in this market environment," he explained.

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