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Property and Casualty insurer Chubb Corp. (CB) is slated to release second quarter earnings on July 21, after the market closes. The current Zacks Consensus Estimate is $1.02 per share for the quarter, projecting a year-over-year decline of 27.8%.

Chubb has consistently outperformed Zacks Consensus Estimates. Over the past four quarters, the average earnings surprise is 12.13%.

First Quarter in Brief

In the first quarter of 2011, Chubb recorded operating earnings of $1.35 per share, beating the Zacks Consensus Estimate of $1.13, on the back of reduced claims costs owing to natural disasters and an increase in premium revenue.

Chubb wrote premiums of $2.86 billion during the first quarter, up 3% from $2.77 billion in the comparable period last year, driven by a strong overseas growth, as well as a positive growth in the United States.

Operating costs and expenses rose 4.9% year over year to $904 million. But its combined loss and expense ratio stood at 93.7%, almost in line with the year-earlier quarter (93.6%).

Losses from worldwide catastrophes totaled $270 million before tax in the first quarter, compared with $344 million in the year-ago quarter. The losses in the first quarter of 2011 emanated primarily from winter storms in the U.S., floods in Australia and earthquakes in New Zealand and Japan.

Looking Forward

With the release of fiscal 2010 earnings, Chubb provided its fiscal 2011 earnings guidance. At that time it, had forecasted operating income per share of $5.35 to $5.75.  The midpoint of the guidance range was 35 cents below the actual operating income per share recorded in 2010. This reflected an expectation of the negative impact of margin deterioration and lower investment yields, which was more than offset by the positive impact of its share repurchase program and lowered expected catastrophe losses.

However, contrary to management’s expectation of low catastrophe (cat) losses with respect to 2010, the first half of 2011 alone experienced exceptionally high cat losses.. The impact of catastrophes translated into 9.5 points of the combined ratio and affected the company’s results by 59 cents per share in the first quarter itself.

Chubb suffered a full-year average cat loss of 5.7 points in 2010, which management viewed as unusually high. However, considering severe cat losses incurred in first quarter 2011, the cat loss drag on 2011 earnings will be starkly higher than management’s full-year average expectation of a drag of 3.5 points on combined ratio. The impact of each percentage point of cat losses on 2011 operating income per share will expectedly be 25 cents, compared with 22 cents incurred in 2010. 

Management did not revise the guidance for first quarter earnings. Instead, it stated that it would revisit its guidance during the release of second quarter results, when the operating conditions for 2011 become clearer.

Chubb is facing a difficult catastrophe environment. The insurers could further suffer if the hurricane season that kicked off June 1 translates into significant losses. According to the estimates by the National Oceanic and Atmospheric Administration and other forecasting groups, 6–10 hurricanes, with 3–6 classified as major hurricanes, are expected this year. On account of all this, we expect management to lower its previous guidance. 

Estimate Revision Trend 

Analysts’ estimate revision trends for the second quarter have been significant over the past month. Over the last 30 days, fifteen out of the 20 analysts covering the stock pulled down their estimates. Furthermore, one analyst has decreased the estimate over the last 7 days. No analysts made an upward revision over those time periods. A similar trend was noticed for fiscal 2011, which saw 17 downgrades (out of 21 analysts) over the last 30 days and 1 downgrade over the past 7 days.

However, we notice an insignificant revision trend for the third quarter, where 2 out of 18 analysts have decreased their estimates over 30 days and 1 over the last 7 days.  The Zacks Consensus Estimate for the third quarter is pegged at $1.36 per share, which translates into a year-over-year deterioration of 19.30%.

Magnitude of Estimate Revisions

The magnitude of revisions has been significant over the past month, with estimates for the second quarter declining from $1.31 to $1.02. However, over the past 7 days, no change in estimates has been seen. For fiscal 2011, 30-day, as well as 7-day old estimates, remained at par with the current level of $5.29 per share.

Our Recommendation

Chubb’s Commercial Insurance (CCI), which represented about 34% of the net written premium in 2010, is recently witnessing a slowly improving market. The segment has been reporting a reversal of trend or stabilization after declining continuously since fourth quarter of 2008.

However, Chubb’s Specialty Insurance business does not look encouraging unlike CCI. Chubb’s Specialty insurance business has been suffering rate reductions over the past several years. The company’s surety, professional liability and personal lines of business are also expected to remain under some pressure as new business pricing stays negative or at low single digits. Combined with the continued discipline in underwriting, these challenges will continue to suppress premiums in the near term. Although there have been some signs that an economic recovery may be underway, the when and how of it remain uncertain. Even if it does occur, premium growth will lag any recovery that takes place, thus pressuring margins.

Chubb’s Personal Insurance is also strengthening gradually based on positive improvements in new business growth in premiums, as well as in-force count levels.

However, the vital thing to look out for in Chubb’s second quarter earnings would be the cat losses details. In May, Chubb revised its second quarter cat loss expectation upwards by approximately $80 million to the range of $250 million to $310 million. Chubb ranked fourth by the size of losses from April-May tornadoes, with the top three positions held by Allstate Corp. (ALL) with $2 billion loss, State Farm with $1.75 billion loss, and Travelers Companies Inc. (TRV) with $1.09 billion loss.

The catastrophe losses, incurred early during the year, will expectedly drain Chubb’s second quarter 2011 earnings by 55–68 cents per share after tax. Huge cat losses can drain insurers’ capital and force them to limit share repurchases and dividend payments. Chubb is otherwise active at share buyback and dividend hike, with its recent annual dividend hike marking its twenty-ninth year of consecutive dividend increase.

Recently, Chubb’s close peer The Travellers Companies announced that it would limit its share repurchase to below $250 million for the second quarter of 2011, which will be almost 3.5 times lower than the repurchases made during second quarter 2010.

However, we believe Chubb’s superior underwriting expertise, strong capital position, prudent investment philosophy, and excellent credit ratings will enable it to generate solid returns in a difficult economic environment and capitalize on business opportunities as they arise.

We carry a “Neutral” recommendation on the stock for now but might revisit our recommendation after second quarter earnings. The stock carries a Zacks #3 Rank, which also translates into a short-term (1-3 months) ‘Hold’ recommendation.

 
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