Chubb Ltd

Like its peers, Chubb has been generating strong returns recently thanks to industry tailwinds on both the underwriting and investment sides. That remained the case in the second quarter, but lower growth suggests tailwinds could be starting to ebb.

Why it matters: Chubb generated an adjusted annualized return on equity of 21% in the quarter, in line with recent results but meaningfully above its historical average. Underwriting results benefited from relatively mild catastrophe losses, but the underlying combined ratio for property and casualty operations (which excludes catastrophe losses and reserve development) held basically level at 82.2%, compared with 82.1% in the previous quarter and 82.3% last year. Net investment income increased 12% year over year. While the company likely still has the ability to roll fixed-income investments into higher yields, investment income growth at this point is coming mainly from higher balances.

The bottom line: We will maintain our $297 fair value estimate for the narrow-moat company. We see the shares as overvalued. While we appreciate current industry tailwinds, we think the market is extrapolating this favorable period too far into the future, resulting in industry valuations that are stretched from a long-term perspective. We believe weaker pricing will be the primary catalyst for a move back to more normalized returns and see signs that this is starting to occur in certain lines. To that point, net written premium growth continued to slow in the quarter, with premiums for P&C operations up only 1% year over year on a constant-currency basis. US commercial was down 2%, with the company continuing to pull back in certain property lines due to weaker pricing. Management noted that this weakness may be spreading into some casualty lines.

We are increasing our fair value estimate to $314 per share from $297 due to the time value of money since our last update and some adjustments to our assumptions. Our fair value estimate is equivalent to 1.7 and 2.4 times year-end 2025 book value and book value excluding goodwill and accumulated other comprehensive income, respectively.

We forecast a 4% compound annual growth rate for net earned premiums through our projection period. The company's international operations do modestly boost its long-term growth prospects, but we believe Chubb's size will make it difficult to dramatically outstrip industry growth over time. Additionally, we think weaker industry pricing will be a bit of a headwind for Chubb and its peers going forward.

We expect the combined ratio to average 91% throughout our projection period, in line with the company's 91% average since the Chubb merger. We think recent pricing increases will allow the company to continue to generate relatively strong underwriting margins in the near term. However, we expect industry combined ratios to creep up over time, as we expect higher interest rates and investment income will reduce the need to generate strong underwriting profits. Our projections include one large catastrophe loss year in the back half of our projection period to incorporate the inherent volatility of the lines Chubb underwrites.

These combined trends should continue to drive strong returns in the near term. The net effect of our forecast is an average return on equity (adjusted to exclude intangible assets and AOCI) of 18% over the projection period. However, by the end of our projection period, returns have fallen back to a level in line with the company's average since the Chubb merger.

We use a cost of equity of 8.9% in our valuation.

In general, insurers do not benefit from favorable competitive positions. Industry competition is fierce, and the products are essentially commodities. Furthermore, most participants do not know their cost of goods sold for a number of years, allowing them to underprice policies without knowing it. Firms are encouraged to chase growth without regard for profitability, a cycle that repeats itself as competitors are forced to match artificially low prices or risk losing business.

Despite the fact that Chubb is a large, diversified insurer, we think its underlying business is moaty. ACE's and Chubb’s legacy businesses centered on commercial lines, but they served different segments. ACE historically focused on serving large, global clients. Often, these companies have risks that do not fit nicely into one country or one particular policy line. To service complex accounts, an insurance company must be able to match these unique and diverse risks with an equally diversified global network. Since its formation in 1985, ACE built a franchise with operations in more than 50 countries, and in so doing, carved out a strong position in this niche. Few have such a footprint, and ACE consequently benefited from strong relationships with many members of the Fortune 1000.

Chubb historically served middle-market commercial clients. While competitive barriers are lower in this area, we think Chubb’s middle-market business is moaty, as the company is an entrenched leader in the space. Further, the business contains a large portion of lines that we would consider specialty—for instance, its executive liability and surety business.

The personal lines business also primarily comes from the old Chubb business. We think that building a moat in personal lines is a lot tougher than in commercial lines, given the standardized nature of most personal policies. However, Chubb primarily targets high-net-worth individuals. Because of the high value of their assets and their sometimes unique nature (such as yachts or fine art), insurance companies require assessments on the current value of their property, which increases policyholder duration and lowers acquisition costs. Furthermore, individual exposures are large, so an insurer needs substantial size for the law of large numbers to hold, which limits the number of carriers that can successfully operate in this area. Finally, Chubb's international presence is a plus in this line, as high-net-worth individuals often have insurable assets spread across multiple countries. Thus, its personal lines are a unique example of a niche noncommercial line, in our view.

While we don’t believe the combined company’s smaller lines necessarily have moats, they have been solid performers, and the commercial and personal segments account for about 75% of premiums. As such, we believe a Narrow Morningstar Economic Moat Rating is appropriate for the firm as a whole. In the years since the merger, Chubb's combined ratio has averaged 91%, which is one of the best results in the P&C insurance industry.

Chubb is one of the few companies with global footprint large enough to service multinational corporations. Its network has created a barrier to entry for potential competitors.

Chubb is a large insurer with leading positions in the most moaty areas of the P&C insurance industry.

Chubb's international operations benefit from stronger growth opportunities.

Large corporations often have substantial bargaining power, which may hurt Chubb when negotiating on premium pricing.

While near-term results will likely remain strong, returns are likely to come under pressure over time.

We think Chubb's life insurance operations are dilutive to the company's moat, and we don't see a valid strategic connection with its core P&C operations.