Blue Capital Reinsurance Holdings: The Surprisingly Catastrophe-Proof Reinsurer

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About: Blue Capital Reinsurance Holdings Ltd. (BCRH)
by: The CrickAnt
Summary

Hurricane Dorian, which battered the Bahamas early on last Monday, could cause insurance industry losses of up to $25 billion, according to analysts at UBS.

Florida, the Carolinas and Georgia are the states which would suffer from economic consequences of this devastatingly powerful storm, generating tremendous amounts of rainfall.

In my opinion, this hurricane might bring to light some Florida-exposed insurers and reinsurers, like Blue Capital, which has decided to cease active operations and redistribute excess capital to shareholders.

Hurricane Dorian, which devastated Bahamas one week ago, affected the East Coast of the U.S. generating tremendous amounts of rainfall and causing damages in Florida, the Carolinas and Georgia.

Hurricane Dorian's project path as of 1pm EDT, 9/3/2019

Source: Weather.com

According to analysts at UBS, Hurricane Dorian could cause insurance industry losses in the range of $5 billion to $40 billion with a base-case at $25 billion. Although Florida-exposed insurers and reinsurers might be adversely affected, this event which could change the lives of thousands of people, may also create some opportunities in the investment field. Historically, one of the best times to invest in insurance can be following a major event provided that event causes rates to rise significantly. One of these opportunities might be Blue Capital Reinsurance Holdings (BCRH), a Bermuda-based reinsurance company.

Blue Capital Reinsurance Holding is a reinsurer which was exposed to the Florida insurance market over the last years. The company suffered significantly from the adverse impacts of hurricanes Maria and Irma. Their book value shrank, their dividend was cut, and the stock price plunged accordingly.

However, earlier in 2019, after several years of losses, Blue Capital decided to cease active operations, pursue an orderly run-off of its liabilities and portfolio, and redistribute the excess capital to its shareholders over the next three years.

Unfortunately, Hurricane Dorian summoned up old fears related to the reserve deficiency. Indeed, there is a risk that Blue Capital might be affected by Dorian. In fact, all reinsurers exposed to the Florida market might be adversely impacted.

However, in Blue Capital’s case, the situation is slightly different from its competitors. Before deciding to cease operations, Blue Capital decided to lower its exposure to the riskiest markets. One of them was Florida, where the Atlantic hurricane season might be very costly for property and casualty insurers and reinsurers.

For the first six months of 2019, the premiums written by Blue Capital for the Florida market amounted to $0.1 million or a 98% drop compared to last year in the same period.

https://static.seekingalpha.com/uploads/2019/9/2/28329263-15674435096890633.png

Source: Q2 2019 Report

Essentially, Blue Capital decided to exit the Florida reinsurance market as much as possible.

But let’s assume I’m wrong.

In the latest 10-Q, Blue Capital estimated that a 1 in 100-year event as a Florida hurricane should cost $13 million net of reinsurance, or an adverse impact on shareholders’ equity of 14%.

https://static.seekingalpha.com/uploads/2019/9/2/28329263-15674435097039742.png

Source: Q2 2019 Report

Under the worst-case scenario, hurricane Dorian might cost around $13 million to Blue Capital, impacting the book value per share adversely by around $1.48, a 14% drop. Excess capital available would decline to $8.88 per share or a deteriorated return of 10% at the current price in a worst reasonable case scenario.

But let's try another method to extrapolate the more likely cost of hurricane Dorian.

In 2017, there were three hurricanes Harvey, Irma and Maria, for which Blue Capital incurred $46.3 million of losses. In 2018, the reinsurer incurred $17 million of losses for hurricanes Florence and Michael.

https://static.seekingalpha.com/uploads/2019/9/2/28329263-15674435097675672.png

Source: 2018 Annual Report

Premiums written specifically for Florida amounted respectively to $1.9 and $4.9 million in 2017 and 2018.

https://static.seekingalpha.com/uploads/2019/9/2/28329263-15674435097652934.png

Source: 2018 Annual Report

In other words, the losses represented around 900% of the gross premiums written for the Florida exclusive market. In that case, we might be able to reproduce the same exercise based on the 2019 figures.

For the first six months of 2019, the gross premiums for Florida were $0.1 million. Hence, the costs associated with Dorian with a loss ratio in the range of 895%-945% might be a much more reasonable $0.89 to $0.94 million.

https://static.seekingalpha.com/uploads/2019/9/2/28329263-15674435097691412.png

Source: Author’s calculations

The problem is some people say that it might be the worst hurricane they have ever seen, even though the current outlook is more optimistic than it was one week ago. In that case, Dorian might be more expensive than Harvey, Irma, and Maria together. Let’s assume Dorian might cost five times what the Unholy Trinity's (Harvey, Irma, and Maria) cost.

In this case, Dorian will impact the book value of the company adversely by $5 million in total which is only 60¢ per share. In this case, the potential upside is “only” $1.70 per share or 21% after Hurricane Dorian struck Florida.

Last week, BCRH's stock price oscillated near to $8.07. Based on that stock price, BCRH had 10%-27% potential upside.

https://static.seekingalpha.com/uploads/2019/9/2/28329263-15674435097785025.png

Source: Author’s calculations

As the hurricane weakened over the last days, the stock price increased and the potential upside dropped accordingly. Nevertheless, a safety margin is still there.

Chart Data by YCharts

At the current price ($8.78) as of this writing, the potential upside is 1.3% to 17% after the adverse impact of Hurricane Dorian on the book value. In addition, Blue Capital's shareholders might enjoy excess capital distribution, as the reinsurer declared recently a $1.51/share special dividend. Although I'm not willing to increase my position in Blue Capital, I remain long on the stock and might add more shares, following Hurricane Dorian's incurred loss estimation provided by Blue Capital.

Disclosure: I am/we are long BCRH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.