With PartnerRe (PRE) trading around $98.60, non-insurance investors probably look at the book value on the stock of $109.26 and think the firm is a steal and an obvious arbitrage situation. It is not. In fact, up until recently I thought the global reinsurer was closer to a 'hold' than a 'buy'. The stellar loss environment of 2013 (i.e. there were very few major disasters in 2013), the Fed's move to raise rates which should drain excess capacity from the reinsurance market, and the generally limited impact of higher interest rates on the firm's investment book have changed my mind.
Today, PRE trades around 0.90X book-value. I think the stock is a moderate buy based on an improvement in that book-value over the next year (I expect CYE 2014 BV/share around $118), and multiple expansion to perhaps 0.95X book-value if the reinsurance market does indeed begin to improve as I expect. With the company set to earn ~$9.90 a share on an operating basis by my estimates this year, and the stock yielding just shy of 3% in dividends, the stock is a reasonable value. Further, PartnerRe has consistently raised their payout year after year since the early 1990's, so I think long-term investors are safe starting a position around these levels. Even if I am wrong about the reinsurance business firming up in the next 12 months, at some point it will turn and PRE will benefit. Until then, if the company continues to perform as it has done over the last two years, investors should have no complaints.
Reinsurance companies are really just in the business of reducing the risks of insurance sold to consumers by others. In the case of PartnerRe, the firm provides reinsurance coverage on catastrophe, property, casualty, motor, agriculture, aviation, surety, and marine insurance. The company has a subsidiary (PartnerRe Health) that does Life and Health as well. Broadly though, PartnerRe's business is not very consumer centric - there isn't a whole lot of brand equity risk, nor does the company need to worry about new initiatives to try and attract consumer business, etc. Instead, PRE's business comes down to three things for the most part; how much does the company have to pay out in any given year for losses (most impacted by major natural catastrophes, but also by events like drought), how strong is pricing in the reinsurance market, and what happens to the firm's book value in any given year.
The first factor - the relative incidence of losses - is largely out of the company's control. That's not to make the business sound easy - after all, if PartnerRe doesn't make wise choices on what books to reinsure and doesn't diversify its book well, then there won't be a company the first time a bit of bad luck occurs. But once a firm reaches this level of operational competence (which PRE and virtually all public insurers certainly have), there is simply not much they can do to mitigate additional loss likelihood. As such, I don't have a lot else to say on that point.
The second factor, reinsurance pricing, is partially out of the company's control. Reinsurance markets are essentially cyclical. When a major disaster like Katrina or 9/11 hits, reinsurance capital rushes for the exits and reinsurance premiums sky rocket. Then after a few years of strong pricing and limited disasters, the market decides risks have subsided, capital moves back in, competition in the reinsurance market increases, and pricing falls. Right now we are at the end of that cycle. A lack of serious loss events recently, combined with very low yields in other areas of the capital markets, has led hedge funds and other institutional investors to put money into the reinsurance space including through dedicated capital vehicles in some cases. This has led to tremendous competition across the space and low reinsurance rates. There is nothing that PRE can do about any of this.
What the company can do though is choose to deploy its capital judiciously. For example, writing less reinsurance in the property space and more in the crop space makes sense if crop insurance pricing is stronger now than it has been historically in comparison with property pricing. There are indications that PRE is doing exactly this type of thing. In particular, the company has reduced it CAT business which frees up capital to be deployed elsewhere including to share buybacks (something the company has been doing pretty actively for a while now anyway). In its earnings call last week, the company said that market conditions are competitive across most of the reinsurance lines as more and more reinsurers have picked up on where they should put capital to take advantage of pricing. For example, global specialty insurance has been an opportunity for the last year, but that area is now becoming more competitive. CAT pricing is probably the most competitive in my view with tremendous amounts of excess capital in the space right now. To offset this, PRE is expanding its other business lines somewhat and it added a multi-year mortgage insurance deal (adding about $40M in profitable business for 2014). On the positive side, a decent chunk of PRE's growth last quarter and going forward is in the firms Life and Health lines due to strength in demand around Obamacare. So while, PRE cannot do anything about the cyclical nature of its industry or the point we are at in the cycle right now, the firm can choose how it wants to participate in the markets given the external conditions. Fortunately for the firm and investors though, I think some of the excess capital in the reinsurance business will start to drain out over the next twelve months. As the Fed continues to taper and long-term interest rates rise, I think the reinsurance market will look like a less appealing area for third-party capital, and we will start to see a slow exit. Any major increase in natural disaster losses would speed this exodus. (It's possible the recent cascading snowstorms could qualify although they don't appear to be all that costly from an insurance standpoint thus far.)
That brings me to my third point regarding PartnerRe and its value - the firm's investment book. PRE can't do anything about the loss ratio it faces once insurance is written, and it can't do much about the competition it faces, but it can choose how to position its portfolio. As most investors are probably aware, credit spreads have tightened over the last six months, equity markets have rallied dramatically, and the risk-free-rate has increased, albeit marginally and intermittently. In this environment, it is hardly surprising that PRE is doing well. Yet at the same time, in evaluating PRE's book two things stand out.
First, I am impressed that the rise in yields hasn't dinged PRE's portfolio more. The reason for this is that the company's portfolio duration is currently sitting around 3.0 years. Thus a 1% increase in rates will only lower the portfolio value around 3%. (Yes, yes, I know this is not accounting for concavity of course, but it's approximately correct.) That's very good - even if rates spike (which I don't think they will to be clear), the damage to PRE will be limited.
The second factor regarding PRE's book is the magnitude of their share repurchases. For full year 2013, PRE bought back 7.7 million shares or 13% of shares outstanding. Doing this now not only returned capital to shareholders, but the buybacks also added $1.50 to book value per share on the remaining shares since shares are trading below book. These buybacks of course are in addition to the dividend the company is continuing to pay which was increased for the 21st consecutive year to $0.67 a quarter from $0.64 a quarter. In addition, PartnerRe has the capacity to buyback an additional 4.3 million shares under their current authorization. I fully expect the company will take advantage of this over the next year. All things considered, it is always impressive when a company has the governance in place to return capital to shareholders in a value-additive way while still preparing the company for long-term success in the future. PartnerRe appears to be doing just that, and as a result, I think the company continues to be a good buy up to at least $105 a share.