Davis Funds: “We Expect Chubb (CB) to Grow Decently and Gain Market Share Over Time”

Davis Funds, an investment management firm, published its “Davis Financial Fund” fourth quarter 2020 investor letter – a copy of which can be downloaded here. In the said letter, David Funds discussed the updates on their long-term performance, recent results, and notable changes during the recent period. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.

Davis Funds, in their Q4 2020 investor letter, mentioned Chubb Limited (NYSE: CB) and shared their insights on the company. Chubb Limitedis a Warren, New Jersey-based insurance company that currently has a $71.5 billion market capitalization. Since the beginning of the year, CB delivered a 3.37% return, extending its 12-month gains to 50.20%. As of March 31, 2021, the stock closed at $157.97 per share.

Here is what Davis Funds has to say about Chubb Limited in their Q4 2020 investor letter:

“Chubb is now among the Fund’s largest P&C holdings at 5.2% and illustrates well why we thought there was an opportunity to add to our P&C names. Through September 30, 2020, Chubb had returned −24% for the year, reflecting investors’ fears that (1) the insurance industry would be compelled to cover substantial business interruption claims that were never intended as part of insured’s policies, (2) declining long-term rates would diminish the value of “float” (i.e., customers’ funds that insurers get to hold and invest until claims are paid), and (3) adverse trends (pre-dating the pandemic) in insured loss rates (e.g., rising litigation and settlement costs, increased frequency and severity of catastrophe losses, etc.).

With industry economics already soft, it was only a matter of time before insurance pricing would have to adjust. In fact, P&C pricing had already begun to increase in a number of business lines before COVID hit, and that trend has only increased and broadened since then. Chubb disclosed in Q3 2020 that North American commercial P&C pricing increased by more than 15% in aggregate. Some of the price increase will go to cover rising insurance loss rates, but we certainly do anticipate some dropping into underwriting profit too. Admittedly, some of that increased underwriting profit will itself get offset by a decline in investment income owing to lower interest rates, but that is a “feature,” if you will, of P&C insurance companies. Unlike a bank, where the floor on its deposit funding costs practically speaking is zero, there is in theory no reason underwriting profit cannot increase to offset low interest rates, so it is feasible for its earnings to “normalize” far in advance of an eventual rise in long-term rates.

With respect to the setting of loss reserves, we have always admired Chubb’s conservative approach in establishing cautious initial loss estimates and in recognizing the bad news first. In terms of COVID related losses, Chubb reserved $1.4 billion for customers’ claims in the second quarter, the majority of which were “incurred but not reported” loss estimates for professional and general liability lines that would be the second- and third-order impacts of the virus. Like the banks’ “life-of-loan” reserving described above, Chubb has made an honest effort to put all of COVID’s financial impact behind it.

When we started adding to our position in Chubb this year, it was valued at 1.6x tangible book value, and we expect it has the potential to earn a mid-teens return on capital over time and for it to grow decently and gain market share over time.”

Our calculations show that Chubb Limited (NYSE: CB) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the fourth quarter of 2020, Chubb Limited was in 34 hedge fund portfolios, compared to 45 funds in the third quarter. CB delivered a 3.42% return in the past 3 months.