Social inflation: Insurers turn adversity into opportunity

As social inflation propels claim costs higher, a headwind for some insurance providers, Fidelity's Fahim Razzaque is investing in those that can turn this dynamic into a competitive advantage.

• As societal shifts lead to increased litigation, higher jury awards and larger settlements, Fidelity Portfolio Manager Fahim Razzaque is paying close attention to which insurance firms are uniquely positioned to not only adapt but thrive in this environment.
• "The higher cost of legal verdicts is driven in part by the general public's desire to help the 'little guy' at the expense of big corporations and insurance companies," according to Razzaque, who manages Fidelity^® Select Insurance Portfolio. "Consequently, awards handed out by juries have skyrocketed."
• For example, he explains that only 10 or 20 years ago, someone injured at work who sued their employer might have been awarded $2 million, whereas today that figure could balloon to $200 million or more.
• Social inflation — the term coined by the insurance industry to describe the rising cost of insurance claims beyond the prevailing rate of inflation — has become an increasing driver of both property & casualty insurance claim costs, but also profitability, says Razzaque.
• As an investor, his approach to navigating social inflation is to own high-quality companies that he believes can benefit from increased pricing, have appropriate reserves for losses and exhibit reasonable valuations.
• Razzaque notes that while social inflation has been evident for many years, its impact on insurers has increased significantly over the past several years, making it one the biggest trends he's following in the insurance industry.
• In managing the portfolio more broadly, he relies on bottom-up, fundamental research, supported by Fidelity's global financials team, to find insurance firms generating high and sustainable returns on equity, given these businesses' unique underwriting, distribution and scale advantages. He also prefers to own companies with strong organic reinvestment opportunities that can drive faster earnings-per-share growth.
• Social inflation has both negative and positive implications for insurance firms, primarily among P&C insurers, Razzaque points out.
• He underscores that higher insurance premiums clearly are unwelcome news for policyholders in an environment where inflation is elevated seemingly everywhere you turn.
• P&C providers, on the other hand, are essentially intermediaries that pass on the higher cost of paying claims, says Razzaque. Still, when those costs do rise, insurance carriers initially must absorb them, which can be challenging, particularly for those whose pricing didn't anticipate the uptick.
• "This is not necessarily bad news for all insurers, however, because over the long term, many of them are able to raise premium rates to adjust for higher claim costs, effectively 'socializing' losses across the population and getting paid a percentage of it," Razzaque highlights.
• Firms such as Hartford Financial Services Group, Travelers and Chubb — top fund holdings as of July 31 — fall squarely in that category.
• "All three are well-managed companies that have managed through the past year without any major negative surprises, so they look well-positioned to capitalize on the impact of social inflation as it reshapes the property & casualty landscape," Razzaque concludes.