I post quarterly updates comparing results among selected reinsurance companies. For an overview on how I analyze the reinsurance industry, please see this previous summary. Part of the investing thesis for the reinsurance sector is that it provides a form of relatively non-correlated exposure to the rest of the equity market. I also have some research demonstrating that outside of periodic large catastrophes, the reinsurance companies are actually relatively non-correlated to each other, as well as the rest of the market (correlation co-efficient below 0.5 for each).
Briefly, I track quarterly-updated price to book value, and look at recent historical trend in combined ratio. This shows market valuation, as displayed by P/B, and underwriting skill which is reflected in sequential combined ratio.
The third quarter earnings releases just wrapped up. The North Atlantic hurricane season has been remarkably mild this year. The reports were unusually consistent with each other.
|company||current price||Q3 BV||Q3 P/B||Q3 Combined Ratio||Q2 Combined Ratio||Q1 Combined Ratio||Q4 Combined Ratio||Q3 Combined Ratio||market cap (B)||% of 52wk hi|
|Aspen Insurance Holdings (AHL)||$39.51||40.43||98%||92%||97%||90%||108%||87%||2.65||99%|
|Axis Capital Holdings (AXS)||$48.50||44.6||109%||86%||88%||83%||112%||85%||5.54||100%|
|Endurance Specialty (ENH)||$56.60||54.33||104%||88%||90%||85%||119%||100%||2.51||99%|
|Montpelier Re Holdings (MRH)||$28.05||28.06||100%||54%||69%||62%||116%||73%||1.40||98%|
|Partner Re (PRE)||$100.37||94.86||106%||75%||98%||82%||95%||81%||5.34||99%|
|Platinum Underwriter (PTP)||$62.88||60.87||103%||66%||74%||45%||25%||61%||1.75||99%|
|Everest Re (RE)||$156.42||140.2||112%||88%||88%||81%||108%||87%||7.49||100%|
|Validus Holdings (VR)||$40.19||35.67||113%||69%||79%||61%||123%||70%||4.01||100%|
|XL Group plc (XL)||$31.25||32.96||95%||95%||94%||88%||104%||92%||8.94||94%|
Table 1. Comparison of selected reinsurance companies.
Summary of management discussion
A few key trends were readily noted in this quarter's earnings releases and conference calls.
- Book value increased trended at 1-3% increase quarter over quarter.
- At least half of companies continue share buy-back programs.
- Gross premiums written tended to be flat to slightly increased.
- Investment income continues to gradually diminish as bond portfolios roll-over and re-invest.
- Given the lack of large catastrophes, the pure-play reinsurance companies outperformed the diversified insurance/reinsurance companies. Take more risk, and get more reward in the mild quarters.
- Industry valuations are approaching pre-2008 levels with price to book 113%. Only a few laggards are still available below 100%.
Using my favorite measure of price-to-book, the current best valuations appear to be AHL, MRH, XL. Among these, AHL has the most diversified insurance business, with substantial mix of primary insurance and reinsurance, while MRH is a more pure play on property/casual reinsurance. This makes MRH combined ratios much more volatile depending on catastrophe events. XL was nearly wiped out in the 2008 collapse and I have avoided that one, apparently as have other investors given their sector-wide low price to book.
I think valuations are reaching a peak. Capacity has not been reduced and I think the industry is vulnerable to a catastrophe at this point. In the absence of a capacity-reducing event which would bring in stock prices, I still focus on the companies trading below book value. Even if the valuation is justified due to below-average underwriting, I still like the 10% safety cushion that those valuations provide. This safety cushion has diminished compared to the past few years, and valuations look compressed within a tight range. I don't think this is the time to pay up for quality.
Share prices have done well, but much of this is due to improvements in price to book - and that is a one-off type of gain since they are clustering in the upper end of the P/B range around 110%. I wouldn't expect much further valuation expansion from here. Thus, I am not making any new investments in this sector at this time. Many of my covered calls have also gotten exercised, which has systematically reduced my exposure in accordance with my investment plan. I am now writing out of the money puts to reacquire shares below current market prices, which would get me back in after a sell-off and generates premium income in the meantime.