Seeking Alpha
Long only, deep value, value, special situations
Profile| Send Message| ()  

The Financial Times reports that Lloyd’s of London insurers and reinsurers are nervously watching the progress of Hurricane Earl as it moves along the East Coast. The hurricane is the most threatening to the East Coast since Hurricane Bob brushed North Carolina’s Outer Banks and struck New England as a Category 2 hurricane in 1991. Initial reports suggest that Hurricane Earl caused less damage to the Outer Banks than initially feared but its exact course toward New England is still uncertain. The hurricane is still a dangerous Category 2 storm with winds of 105 miles per hour.

Earl is the third named Atlantic hurricane of the year and experts are predicting more activity before the hurricane season winds down in November. Tropical Storm Fiona is currently in the Atlantic with winds of 50 miles per hour and is not projected to make landfall. Two additional systems have the potential to develop into tropical storms. Earl’s current storm stack is pictured below (see the NOAA website for updated detail and storm tracks.)

(Click on Image for Larger View)

Soft Market Persists amid M&A Speculation

Despite increased hurricane activity, large losses from the Chilean earthquake in February, and costly winter storms in Europe, premium rates are still soft in most business lines except for Latin American quake risks and offshore Gulf of Mexico energy policies. The Financial Times reports that the trend is likely to persist barring large storm related losses.

The combination of a soft market and low investment returns have created an environment where Lloyds insurers are trading at low valuations and at many cases below tangible book value. This has created speculation regarding the potential for industry consolidation as smaller players remain under pressure:

Michiel Bakker, head of the European Capital Markets and Advisory unit at Willis, the insurance broker, says that while many of the ingredients for consolidation in the Lloyd’s market are there, he is cautious about the level of M&A activity to come.

“First-half losses hit some of the smaller companies hardest, which highlights the advantages of size and diversification,” Mr Bakker says. “Also there is a general expectation that capital requirements for insurers will go up, which could drive consolidation.

However, there are some reasons to doubt a surge in M&A activity:

According to Stephen Catlin, chief executive of Catlin, it is not just the level of capital requirements that could encourage consolidation, but also the cost of complying with beefed up regulations.

He said: “I think it’s going to be very, very difficult for the small players to survive not because of lack of quality but simply because the cost of business is increasing”.

But there are plenty of obstacles to M&A. Low valuations may attract interest from financial buyers such as Apollo, but bankers say it is extremely difficult for a board to consider recommending a bid that is below book value.

There is also a cultural issue, according to Mr Dorner. “The strong personalities involved in the sector have made mergers difficult in the past.”

Berkshire Hathaway’s (BRK.A) General Re and Berkshire Hathaway Reinsurance Group subsidiaries have economic interests in certain Lloyd’s syndicates based on the disclosures in Berkshire’s 2009 annual report.

Disclosure: The author owns shares of Berkshire Hathaway.

Source: Hurricane Earl, And Other Threats to Insurers