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Natalie Taylor, CIBC Asset Management, vice-president and portfolio manager.

We do believe that we are in the early innings of a hardening price market for the property and casualty insurance industry. Recently, commentary on company conference calls suggest that pricing started to firm in the first quarter of 2019. And the magnitude of rate increases ranges across a number of different product lines with pricing increasing kind of mid single digits to mid teens at the present moment.

So, this has been in the making for some time. Combined ratios or the margin earned on policies, has been eroding since 2013. Prior to this period, excess capital was building in the system, and this was really from two sources. The first was from lower losses. We went through a period of lower catastrophes and that allowed excess capital to build up in the system. And secondly, there was third-party capital chasing the insurance industry because of what was believed to be uncorrelated risks as investors were looking to diversify away from market risk post the global financial crisis.

So, this excess capital built up in the system and was competing for a finite amount of insurable risk, and when there is an excess amount of capital in the system, this tends to increase competition and erode underwriting discipline for some time. Prior to the price hardening, we were seeing the impact of that undisciplined underwriting as profitability declined and margins compressed. And that’s really reached a head now and we’ve seen the inflection point to more of a firming price market.

Weather impacts or catastrophes, as they’re referred to often in the industry, dictate the direction of the cycle typically. So, for example, periods of relatively few catastrophes can result in excess capital but, similarly, a higher frequency of catastrophes can wipe out sizeable amounts of capital, leading to pricing power. So, what we’re seeing today is the higher frequencies and severity of storms in 2017 in the U.S., and additional disasters shortly thereafter in 2018, including Camp Fire out in California, were extremely costly—in excess about $200 billion for insurers. And that has significantly reduced the supply of capital in the system and is causing some pricing power now. In Canada, the effect of the Fort McMurray fires, and flooding in Calgary and Toronto, and what we’re seeing out east is also leading to a hardening market here as well.

Intact and Fairfax are the largest publicly traded property and causality insurance companies in Canada and each represents about 1% of the TSX index. They’re generally thought to be disciplined underwriters which have shown restraint in the period of the undisciplined market we’ve just come through. So as such, they should have excess capacity to underwrite policies in this favourable pricing environment.

Intact is primarily exposed to Canada, which we believe has seen greater pricing firming than other regions. Fairfax is more geographically diverse, as well as across different business lines, including reinsurance where pricing is a little bit less robust currently.

And beyond Intact and Fairfax, the P&C industry in Canada is fairly fragmented, with a number of foreign-owned subsidiaries, mutuals and also bank-owned entities.

It’s been nearly 20 years since the last hard market in the insurance industry, and that was 2001 to the 2003 period. So, it’s immediately following 9/11. If we use this period as a case study we can see that pricing spikes may be double digits on the commercial side and can last for periods of 12 to 24 months before profitability is restored across the industry and the cycle starts again.

Companies that are able to take advantage of this environment are rewarded. The last hard market saw price-to-book multiples for insurers expand from about 1.3x to about 2x commensurate with an increase in profitability and ROE. P&C insurance stocks have outperformed the index on an average by 7% across the last three hard markets.

We also believe that M&A is likely to pick up in a firming market as challenged participants look for exits.

CIBC Dividend Income Fund
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