Including insurance stocks in an investment portfolio can be advantageous. The insurance industry offers enduring potential returns in various economic climates. Thus, for those worried about some potential stormy skies ahead, this is a common landing place for many investors.
However, various risks tied to climate change (increases in wildfires, hurricanes, and other natural disasters) may be changing the calculus for this sector. A number of insurance companies are exiting weather-prone states such as California and Florida, creating the potential for insurance deserts. This, in turn, could significantly impact certain housing markets.
With that, insurance rates will likely rise to meet these increased future costs. Yet, one must wonder if the insurance sector is growing too risky, given the risk of rising claims relative to premium revenue for top property insurance companies. Here are three I think investors should be cautious with right now.
Insurance leader Allstate (NYSE:ALL) is often a top choice for investors looking at this broader sector. The company provides a range of insurance services, with a focus on home and auto insurance, in the U.S. and Canada.
Allstate is one of the insurers that has decided to pull coverage from high-risk markets. Whether this means the company will simply concede profitable market share to competitors, or is dodging a bullet, remains to be seen. However, investors don’t seem to be very bullish on the company’s outlook, with ALL stock trading at just 5.8-times free cash flow. That’s considerably below the sector median of 7.7-times.
The company is diversified and does have a better relative valuation than the other names on this list. However, I think Allstate is a stock that’s not worth the risk, and could be a value trap even at these enticing levels.
Progressive Corp (PGR)
You’re likely acquainted with Progressive (NYSE:PGR), the second-largest U.S. car insurer. Amid this year’s decline, it’s a viable rebound contender. As with peers, rising expenses have impacted the firm. Escalating repair costs, pricier tech parts, and labor challenges have pressured auto insurers, hampering underwriting profits.
Progressive’s Q2 earnings report was disappointing, causing a 13% share drop. The company noted unfavorable reserve development due to auto products. Despite short-term challenges, PGR’s captive customers through mandatory auto insurance in most states is an advantage. The increasingly perilous road conditions, exacerbated by the pandemic, make insurance essential. Given potential Federal Reserve impact, Progressive remains a sensible choice.
If the broader environment takes a turn for the worse, Progressive’s financials put the company in one of the worst positions of its peers, in my view.
Prudential Financial (PRU)
Prudential Financial (NYSE:PRU) faces turbulence despite a decent Q1. Second-half performance concerns arise as Q1’s 12.5% decline in assets under management hints at future challenges.
Prudential faces a significant risk due to its substantial CMBS portfolio, vulnerable to a commercial real estate market downturn. Predicted value drop could affect its financial stability, leading to a complex future of challenges and opportunities.
In Q2, Prudential’s net income was $511 million, a significant rebound from a $1.01 billion loss last year. Group Insurance achieved record operating earnings. Prudential might not gain like other stocks, but its stable dividend yield surpasses 5%. With that in mind, I’d caution investors about PRU stock appearing as a dividend trap at these levels. It’s one I’m avoiding right now for this reason.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.