Two winter storms swept across the United States in mid-February, leaving a path of destruction along the way. They traveled as far south as Texas and even reached some parts of Mexico. The storms broke records for snowfall in many regions, caused wide-scale power outages, froze pipes, and even affected supply chains.
In addition to the human toll, the extreme weather hit insurance companies, too. Those insurers with property insurance lines in that region have seen an uptick in claims this year, weighing down earnings as a result. Insurers including Lemonade (LMND -1.25%), Progressive (PGR 0.01%), and Loews (L 1.12%) all saw larger-than-expected losses on their property insurance lines in the quarter. Not only that, but Progressive saw larger losses on its property line of coverage again in April, this time related to extreme weather events in Texas, Oklahoma, and Alabama.
These extreme weather events have affected property insurers for years now, and have led what experts call a hardening insurance market. Here's some perspective on how these insurers deal with these events, and what this means for them going forward.
A year's worth of claims from Lemonade
In the first quarter, Lemonade reported a net loss ratio of 120%. The net loss ratio is a profitability metric used in the insurance industry, and it's a measure of incurred losses divided by collected premiums. The company's loss ratio was significantly higher than the 72% posted in the same quarter last year, and damage from the winter storms was so bad that Lemonade said a year's worth of claims were made in the first few days following the freeze in Texas.
Other insurers felt some pain from these weather events in the quarter as well. Loews and The Hanover Group saw an uptick in combined ratio -- a similar metric to loss ratio that measures incurred losses plus expenses divided by collected premiums -- to 98.1% and 98.8%, respectively. These companies saw loss ratios of 67.2% and 66.3%, not nearly as big a hit as Lemonade took.
Progressive posted a solid 89.3% combined ratio and a 68.3% loss ratio in the quarter. However, in the company's April earnings report, it reported a combined ratio of 96%, which is on the higher side for an insurer that has kept its annual combined ratio under 96% for the past 20 years.
The company's personal line of coverage was fine, with a combined ratio of 94.6%. However, its property line of coverage was hit hard, posting at a combined ratio of 149.9% during the month. The company cited extreme weather, which included thunderstorms, hail, and tornadoes hitting the Texas, Oklahoma, and Alabama region of the U.S., as the cause. The higher combined ratio for the month of April had investors squirming in their seats, and in the four days following the company's release of its April numbers, the stock dropped 7%.
Here's why insurers can weather the storm
The past few years have been tough for insurers. Increased weather catastrophes combined with the COVID-19 pandemic caused increased payouts for insurers across the industry. As a result, the insurance market has experienced a "hardening" of the market. A hard insurance market can be seen in insurers tightening underwriting standards, increasing premiums, and limiting coverage options in response to larger payouts and tighter margins.
Despite the hardening environment, insurers have weathered the storm thanks to reinsurance policies. Reinsurance helps protect insurance companies against excess losses that could cause them to go under. Effectively, reinsurance policies help put a lid on the maximum amount a company can lose.
Lemonade CEO Daniel Schreiber said the company's extensive reinsurance programs worked exactly as promised. The company has what is called a proportional reinsurance contract, where it pays 75% of written premiums to reinsurers. As a result of this agreement, the company ceded $55.6 million of its $75.8 million in net earned premiums in the period, causing revenues to decline 10% in the first quarter. Despite a year's worth of claims in a single week, the company's EBITDA guidance for the remainder of the year hasn't changed much. That's the power of risk management with reinsurance policies.
Reinsurers felt pressure from the winter storms but navigated the situation well. RenaissanceRe Holdings said the winter storms had an estimated net negative impact of $180 million, leading to an underwriting loss in the quarter of $36 million and a combined ratio of 103%. Everest Re, another reinsurer, announced a $250 million loss from the events, but still posted a profitable period with a combined ratio of 98%.
While reinsurers felt the pressure, they managed to keep their risk in check. However, if unexpected weather events continue to happen, reinsurers will be pressured to reduce their risk exposure -- which might make their policies unavailable or more expensive for insurers like Lemonade. As a result, insurers may have to underwrite fewer policies or increase the risk they are willing to take on. And if the insurer is forced to pay higher rates for policies, profitability would take a hit in the short-term, and higher costs would passed on to customers in the long term -- all classic signs of a hardening insurance market.
Two great insurance stocks to add for different reasons
Progressive has achieved stellar combined ratios for 20 years. This is a great sign, but as investors it's important to keep an eye out for elevated combined ratios that span across multiple quarters. One-time weather events cause spikes in these ratios -- that's the nature of the industry. But a combined ratio that is steadily rising is indicative of something more concerning for the long-term health of the company.
For Lemonade, its high valuation and high growth potential bring with it higher volatility and increased scrutiny from investors. The company has a solid reinsurance program in place to take care of black swan events like those winter storms in Texas. It did see an elevated gross loss ratio in the first quarter, but the point is the same as with Progressive. Keep an eye on this metric and be on guard if conditions don't improve.
Despite being in the same industry, Progressive and Lemonade are great stocks that could serve completely different purposes for your portfolio. Progressive is established with a history of solid underwriting and stable growth. Meanwhile, Lemonade is the new kid on the block leveraging insurance technology and is attempting to disrupt the industry, and could be huge if it succeeds.