Zurich tipped as ‘major beneficiary’ of commercial lines pricing upturn

Analysts have tipped Zurich as a “major beneficiary” of the pricing upturn as the equity analysis firm Jeffries reports that pricing in commercial lines has accelerated to +18 percent in North America and +12 percent in EMEA.

However, the analysts said the group has cautiously set its casualty loss picks higher, despite not reporting a material hit from social inflation, which was viewed as “reassuringly prudent”.

But the Jeffreis analysts added: “Nevertheless, our enthusiasm for Zurich's outlook is tempered by the Z-ECM ratio of 102 percent, prompting us to cut the excess capital from our valuation.”

The Z-ECM ratio is Zurich’s Economic Capital Model, which informs the group's capital management policy. It measures the amount of financial resources available to cover the capital needed to meet all policyholders claims.

The analysts said that one of the concerns they had coming into the H1 2020 results, was around Zurch being conservative on its long-tail lines. They thought Zurich might report materially lower reserve releases, compensating for the lack of reserve strengthening at the 2019 full year results, unlike AXA, Allianz and Swiss Re.

“However, our fears proved unfounded, with reserving relatively stable at 1.5 percent pts and management confident that price rises were exceeding claims inflation.”

Jeffries pointed to Zurich’s management statement that said claims inflation trends hadn't materially deteriorated since the first quarter 2020, although for prudence Zurich had opted to raise its estimated loss figures.

“In worker's compensation, management also appeared confident, leading us to expect that this tailwind will last longer than we previously anticipated. All of this derisks the reserving position in our view, allowing for a lower risk premium to be applied to the stock.”

The analysts were “pleased” to see commercial lines prices accelerating. “Although we were already optimistic about rising commercial lines pricing, these have accelerated faster than expected. In Q2 2020, Zurich North America experienced rate changes of +18 percent up from +12 percent in Q1, while in EMEA rates rose by +12 percent from +6 percent in Q1. In addition, terms and conditions are also improving, suggesting that normalised margins should improve more than the amount implied by rate rises. As one of the world's largest commercial insurers (alongside Chubb, AIG, QBE and AXA), this is a material tailwind for Zurich, where 61 percent of non-life and 36.9 percent of group earnings are in commercial.”

But Jeffries analysts reiterated that there was one area of disappointment - the Z-ECM ratio. It had not improved from 101 percent in Q1, rising to 102 percent in Q2. This is “largely because bond yields remain at their lows”, they said.

“In this regard, we suspect that consensus had been hoping for some improvement, reflecting the recovery in financial markets. Though such a low Z-ECM ratio may appear alarming, we note that as this is Zurich's own measure, calibrated to a AA- credit rating, falling below 100 percent is not the same risk that falling below the 100% threshold for Solvency II or Swiss Solvency Test would be. Nevertheless, this does mean that Zurich is at its target capitalisation, limiting near term dividends and capital returns.”