AI, Sentiment and the Insurance Sector
A sentiment analyst says you need to know what insurance investors are feeling.
These are not ordinary times. The COVID-19 pandemic has impacted all market sectors. The insurance sector did not escape the ensuing turbulence.
The shifts in insurance sector stock prices provide a key lesson for observers: that market sentiment is a major factor in moving prices for all sectors.
Consider, for example, how the insurance sector experienced the COVID-19 crises.
Fear and Relief
At first, several fears emerged. In particular, there were fears of business Interruption; increased litigation claims; and reduction in demand for insurance. Let’s not forget to add the increased volatility and general economic uncertainty that emerged. Here’s how one property and casualty (P&C) insurer, RLI, characterized the possible impact of COVID-19:
Certain risks and uncertainties are inherent to our day-to-day operations. Adverse changes in the economy could lower demand for our insurance products or negatively impact our investment results, both of which could have an adverse effect on the revenue and profitability of our operations. The COVID-19 pandemic may continue to result in significant disruptions in economic activity and financial markets. The cumulative effects of any public health outbreak could reduce demand for our insurance policies, result in increased level of losses, settlement expenses or other operating costs, reduce the market value of invested assets held by the Company or negatively impact the fair value of our goodwill.
Many of these initial fears, however justified, were mitigated and offset, indicating that COVID-19 was not totally negative in its financial impact.
More recently, according to the COVID Coverage Litigation Tracker, liability fears at P&C insurers have receded as courts have ruled that. unless there were actually physical losses, COVID-19 losses were not covered under current disaster loss policies.
In some cases, reduced economic activity benefited insurance companies.
Here’ s what Dan Frey, the chief financial officer at another P&C insurer, Travelers Companies, said during an earnings call:
More than offsetting those losses were lower levels of auto claims and to a lesser extent, fewer non-COVID workers’ comp and [general liability] claims due to lower levels of economic activity. The net impact of the COVID environment on the consolidated underlying combined ratio amounted to a benefit of about 2 points, mostly in personal insurance.
Of course, these examples involves P&C issuers, not life, health and annuity issuers, but the same principles apply to how sentiment can affect the stocks of publicly traded life, health and annuity issuers.
The Great Expectation Engine
Caught in the grip of pandemic uncertainty, asset managers and investment specialists are challenged to separate the signal from the noise.
The stock market is the great expectation engine, always processing emotions. It digests negative and positive sentiments, as well as any offsetting factors. It dynamically converts sentiments into price action.
But quantifying the emotions and tracking market sentiment as a factor is very difficult for any individual, or for insurance company managers or producers who want to understand trends in company stock prices.
A Patient Reader
One way for an individual investors to analyze the impact of sentiment is to use new sentiment detection tools that rely on artificial intelligence strategies fueled by machine learning processes.
An AI/machine learning system can scan millions of relevant investor documents and score sentiment in real-time.
This is important, because sentiment often leads price. By tracking how changes in sentiment compare with changes in a stock’s price, important shifts can be detected.
This turned out to be true for the insurance sector.
In the following chart, created by a system using AI-based algorithms, we can see a line representing Insurance Sector Sentiment compared with a line reflecting the price of a basket of insurance company stocks. The stock basket includes shares from AIG, MetLife, Prudential Financial and Prudential PLC of the United Kingdom, along with shares from nine P&C insurers and brokers.
On March 23. 2020, the insurance basket hit a low of 92.23.
By April 9, 2020, the insurance basket price bounced up to 123.34.
Looking at price action alone, it appeared that bearish conditions were over. But, importantly, when we add sentiment as a measure, things look a bit different. In fact, sentiment remained in a downward trend, indicating that the bounce up in basket price was likely to face bearish headwinds. Actually, the basket sentiment bottomed out on May 10, 2020 — at 68.23%.
Note, that from that point, on as sentiment rose, the insurance basket price went on to experience higher lows and, as sentiment kept rising, it finally broke through, on Feb. 11, 2021, at 148.96, climbing back up to the pre-pandemic insurance basket high of 148.36 that was recorded on March 4, 2020. The insurance basket has trended higher since then, supported by a rising investment sentiment as measured by the AI system.
The take-away for those who follow the insurance sector, including those who work with or manage insurance companies, is that sentiment is a powerful factor in assessing price direction and whether bullish or bearish conditions are persisting.
As the pandemic evolves, and as new fears of inflation arise, tracking sentiment about insurance companies and the industry can provide an unprecedented level of insight into what’s really happening.