I recently wrote about Assurant (AIZ), an insurer trading at substantial discount to book value. In this article, I will discuss another insurance company trading at a compelling valuation. Reinsurance Group of America (RGA) is one of the largest life reinsurers in the world. This well managed reinsurance company has over the last 10 years grown book value at a 12% CAGR, net premiums at a 16% CAGR and per share operating income at a 15% CAGR while averaging ROE of 13%. Despite this, it is trading at historically low P/BV (excluding AOCI) and P/E ratios. This presents an opportunity to invest in a company with consistent earnings at a 29% discount to fair value. This represents a potential return on investment of 40% at the current share price of $53.04.
The three factors that I consider most important when evaluating a company for potential investment are moat, management and valuation. Does the company have a sustainable competitive advantage? Is management experienced, ethical and effective as measured by ROE and growth in book value? Is the current valuation low enough to provide a margin of safety and sufficient return on investment? I believe RGA meets all three criteria.
Unlike the competitive individual life insurance industry, life reinsurance is an oligopoly with six or seven large companies dominating the industry. These include Munich RE, Swiss RE and General RE, which is owned by Berkshire Hathaway (BRK.B). As a result, pricing is less competitive and more rational than in the life insurance industry. RGA is typically in the top three in market share in the countries in which it has operations and was #1 in the U.S. with 26% market share in 2010. RGA's competitive moat is provided by its excellent customer service and innovation, both of which have contributed to its strong reputation and brand. Ultimately, RGA's moat is the result of management's acumen and ability to execute its business strategies.
RGA has won numerous industry awards for customer service and innovation in the reinsurance industry. Six of the fourteen executives are actuaries, including the CEO and the Chief Risk Officer. It's typically a good sign when the leadership of a company is held to a professional code of ethics and is capable of understanding the job functions that make the company profitable. This has contributed to RGA's long track record of superior performance. ROE has averaged 13% since 2001. Maintaining high ROE while growing net premiums at 16% CAGR and operating earnings per share by 15% CAGR since 2001 speaks to the ability of RGA's management to execute.
At $53.04/share as of 12/28/12, RGA trades at a P/B excluding AOCI of 0.85 and a P/E ratio of 6.53. This is inline with the P&C catastrophe reinsurance industry that typical trades at a discount due to catastrophe risks. RGA's business is very stable, being tied to mortality rates and not exposed to comparable swings in claims and earnings. As a result of its less volatile earnings and more predictable risks, RGA deserves to trade at a premium to book value. The following table shows a range of share prices starting with the current P/B and P/E multiples and rising to the historic average multiples. Book value and EPS are taken from the RGA website.
P/B (BV $62.05/sh)
P/E (EPS $8.12 ttm)
I believe that RGA deserves to trade at its historic multiples to book value and EPS. With a fair value of $74.46/share, the current $53.04 price represents a 29% margin of safety. If the stock reverts to trading at the historical P/B of 1.20x, the potential return from the current share price of $53.04 is 40%.
Other Items of Note
RGA has excellent financial strength ratings from A.M. Best (A+) and S&P (AA-). After a period of building out or purchasing operations in new markets, the company now has a presence in all markets in which it intends to operate. Management has noted the significant opportunity going forward in China and India, whose life reinsurance markets are just beginning to come into existence. The company is targeting a 50/50 mix of U.S./international business with net premiums doubling within five years.
The persistent low interest rate environment is a significant concern for most insurance companies. However, RGA's business is far less sensitive to interest rates, instead relying on profitable underwriting which is most affected by mortality rates. Management estimated lower interest rates would impact earnings by no more than $0.15/share annually in the 2012 investor day presentation. In addition to potential capital appreciation, the company has increased quarterly dividends from $0.09/share in 2009 to $0.24/share in the 3Q 2012. The current payout ratio is 12%, indicating earnings can support significant dividend increases.
With a strong moat, excellent management and cheap valuation, RGA is a very compelling investment at the current price. Much thanks to David Merkel for sharing his thoughts regarding insurance, the life reinsurance industry and RGA. Please conduct your own due diligence, as I am not an investment advisor. Long RGA.
Sources: RGA Investor Relations Website.