Hiscox Stock: Attractive In Ongoing Insurance Hard Market (OTCMKTS:HCXLF)

Insurance Group Hiscox Ltd (OTCPK:HCXLF)(LSE:HSX) has had a strong run lately, but there’s likely still a lot left in the tank. Supported by its solid recent financial performance and its growing retail business, Hiscox is in a strong position to capitalize in the ongoing insurance hard market.

Background

The Bermuda-based insurer is most closely associated with its beginnings as a Lloyd’s underwriter, but the company is much more diversified nowadays. Hiscox underwrites a wide range of personal and commercial insurance risks, with a particular focus on commercial clients, reinsurance, high-value personal lines and specialty markets.

Hiscox operates through three key segments, namely Hiscox Retail, Hiscox London Market, and Hiscox Re & ILS.

Hiscox Retail serves small and medium-sized enterprises (SMEs) in underwriting property and business risks, most notably in professional indemnity and specialist sectors such as technology and media. The segment also sells to private clients, focusing in specialist areas of personal lines, such as high-value homes, fine art and luxury auto insurance. Together, it has 1.6 million retail customers across the USA, UK, the rest of Europe and Asia.

Hiscox London Market specializes in insuring big-ticket items and operates within the Lloyd’s of London market, focusing on areas like property, marine, casualty, energy, cyber, and other complex risks.

Hiscox Re & ILS is the reinsurance division of the Hiscox Group, leveraging expertise in catastrophe risks and other specialized sectors, such as marine and aviation. The segment also includes the performance and fee income from its roles as an alternative investment advisor, which manages capital for third parties through insurance-linked securities.

Stock Near 4-Year High

Rumors of takeover interest, which began to circulate about a month ago, drove the stock to a four-year high in July. Some of those gains have been pared back somewhat in the summer sell-off, though the Lloyd’s of London insurer is still left trading at a 57% premium to its book value.

You may then be surprised to find Hiscox valued at far below its pre-Covid levels. The stock price is still a third lower than its 2019 all-time high, when the price to book value was a whopping 2.6 times. Yet, the operating environment is much more favorable now. Rates have improved significantly after a series of big windstorm losses and a period of high claims inflation.

From an earnings perspective, things are also looking better now. For 2024, analysts currently expect Hiscox to deliver $1.72 in adjusted EPS – which gives the stock a forward P/E of just 9.0.

What’s more, there’s room for the forward P/E ratio to come down further. The decline in interest rate expectations in recent weeks is likely to deliver a short-term boost to its investment return (as lower yields push up bond prices) – and so, the current situation in the fixed-income markets should allow analysts to raise their EPS forecasts.

Combined Ratio

When looking at the combined ratio (that is, the ratio of claim-related losses and operating expenses as a proportion of premiums earned) across the group – we see that Hiscox delivered a combined ratio 85.4% for the first half of 2024. That’s significantly better than the 94.9% combined ratio that it achieved in 2018 and 105.7% for 2019 – during which the stock was trading at significantly higher multiples.

The combined ratio is a key measure of profitability used in the insurance industry. As it does not include investment income, which is widely seen as volatile, it can be a better comparison of the profitability of underwriting between the years and among different insurance companies.

Can The Good Times Last?

History has shown us that these good times won’t last forever. High returns in the industry will eventually lead to excess capital, encouraging increased competition on pricing. Known as the insurance cycle, or the underwriting cycle, the industry periodically oscillates between “hard” and “soft” market phases.

In a hard market, premiums are high and underwriting is strict, which leads to higher profitability. In contrast, a soft market is where there is excess capital deployed, leading to increased competition on pricing and lower profitability.

A surge in the cost of claims is usually the catalyst that precipitates a hard market. This could be driven by a series of major catastrophe losses or higher than expected claims inflation – and we saw both of these factors at play at the end of the last cycle.

In this regard, market conditions may have already peaked. After five years of hardening, insurers are seeing increased competitive pressures; and in some areas, the market is slowly starting to soften again.

Risks

Hiscox is exposed to a multitude of risks. Firstly, there’s the ever-present risk of major catastrophe claims. Natural disasters are increasing in frequency and severity – recent rising rates reflect this, but do they still need to rise further to offset the impact of climate change?

Then there’s the uncertainty over whether higher rates will sufficiently offset claims inflation going forwards. For now, the answer is yes – claims inflation has so far been well below what had been expected. But for how much longer will this hold true? As such, investors need to ask themselves how far and fast they believe insurance markets will soften.

Hiscox’s focus on the premium retail and specialty markets does partially insulate the company, however. The group’s ten-year average combined operating ratio is 94.6%, reflecting its resilience through the insurance cycle.

M&A Attention

Hard market conditions over the past few years has left the insurance industry flush with cash and few places to park its excess capital. Aside from bigger dividend payouts and share buybacks, the timing is ripe for M&A deals. London-based trade publication Insurance Insider reported that Japan’s Sompo Holdings (OTCPK:SMPNY) and Italy’s Assicurazioni Generali (OTCPK:ARZGF) could be interested in making an offer for Hiscox. Although no bid has yet to materialize, the insurer’s position at Lloyds should make it a tempting target for foreign large-cap insurance groups looking to expand its capabilities in the reinsurance and specialty insurance space.

The last hard market saw a number of fellow Lloyd’s insurers become M&A targets for foreign insurance groups. In 2015, Amlin was acquired by the Mitsui Sumitomo Insurance Group, while Catlin was made an offer by XL Group. Then in 2017, Novae Group was taken over by Axis Capital (AXS). Along with Beazley (OTCPK:BZLYF) and Lancashire Holdings (OTCPK:LCSHF), Hiscox is one of the few remaining independently listed Lloyd’s insurers.

The last takeover attempt of Hiscox was when Chubb (NYSE:CB) sought to acquire the company back in 2001. The opportune offer was swiftly rebuffed by management. After its failed takeover bid for Hartford Financial Services Group (HIG), I wonder whether Chubb could return to the fray once again. The US insurer has been making smaller bolt-on acquisitions since then, including for part of Cigna’s Asia-Pacific business and most recently, acquired Healthy Paws, a pet insurance provider. Chubb and Hiscox overlap both geographically and in terms of product market – which could make them a complementary fit.

Management Changes

Two decades on, Hiscox could find itself more amenable to being acquired. Some very long-standing people at the top of the company have since retired, including Bronek Masojada in 2022, after serving 21 years as the group’s chief executive. He was succeeded by Aki Hussain, who previously served as the group’s chief financial officer.

This was followed by chair Robert Childs’ retirement in 2023, after 37 years at the company. He first served as the active underwriter of the company’s Syndicate 33 at Lloyd’s, before becoming the group’s chief underwriting officer in 2005, and finally its chair in 2013. He was replaced by Jonathan Bloomer, who tragically passed away in the sinking of the Bayesian off the coast of Sicily this month.

On August 23, 2024, Hiscox named Colin Keogh to lead as interim chair. He has previously served as senior independent director and chair of the remuneration committee of the company. Keogh has had decades of experience in the financial services industry and was chief executive officer of Close Brothers Group between 2002 and 2009.

Final Thoughts

Between the historically low valuation multiples and the attractive near term earnings outlook, I believe Hiscox has more upside potential. Whether or not a takeover bid materializes, we can be reassured that the stock only trades at a very modest 9.0 times its expected 2024 earnings.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.