Archive for the 'Insurance' Category

Reinsurance Valuations at Long-Term Lows

Posted on March 14, 2012, 9:59 am. Closed

Via Guy Carpenter, valuations of reinsurance companies are at long-term lows:

The challenging macroeconomic environment of subdued growth and low interest rates meant the reinsurance sector ended 2011 trading near 20-year lows. As Figure 1 illustrates, the average price to book ratio for the sector of 0.893 is just greater than one and a half standard deviations down from the 20-year average of 1.32.

4_Historical Global P&C Reinsurer Valuation

It’s my experience that extremes do not last forever, so if you’re an enterprising investor, looking at reinsurance companies seems like a great use of time.

Hard-Hit Insurers: SeaBright (SBX) Rode Through Storm, Can Flagstone (FSR) Do the Same?

Posted on March 23, 2011, 11:02 am. Closed

Back in August when shares of SeaBright Holdings tanked due to the need for reserve strengthening, I reflected that shareholders were most likely overreacting and that the company was likely a bargain at $7 per share. Well, since then shares have climbed back up to $10 per share. That’s an annualized return of 64%. It also turned out that other intelligent investors saw the same opportunity—the very capable investors at Alleghany (Y) added to the shares of SBX they had purchased in the first quarter of 2010.

Another company that is currently being hit hard is Flagstone Reinsurance (FSR). The company has published several press releases that have contributed to a very large sell-off in the stock:

  • February 28, 2011. $60-$80 million in loss events due to flooding and storms in Australia. Plus, there was the 6.3 magnitude earthquake in Christchurch, New Zealand, for which the company has not yet provided loss estimates.
  • March 15, 2011. The company reports preliminary loss estimates related to the New Zealand earthquake to be between $60-$90 million.
  • March 21, 2011. FSR reports that Moody’s has placed the ratings of the company under review.

So prior to the Japan earthquake, FSR was set for losses of $120-$170 million. Now, the market appears to be worried whether Flagstone will need to strengthen reserves after the Japan earthquake. In FSR’s 10-k, the company said it does “a significant amount of catastrophe business in Japan.”

I have no idea whether FSR is a good reinsurer or not. They’ve only been public for four years. Management of any insurance company can set reserves to really anything they want, whether its prudent or not, so when investing in the insurance arena, you have assure yourself that management is trustworthy and as conservative about underwriting and reserving as they claim to be.

But with FSR trading at half its book value, it seems that the market is overreacting (once again). Even if it turns out FSR management was not so good, the stock price will likely rebound after all this bad news fades away and the company starts to book new business at more favorable rates.

Is There Anything Assuring About Assured Guaranty?

Posted on February 1, 2011, 5:57 am. 2 Comments

In the past three weeks, Assured Guaranty (AGO) has gone from $19.50 to $14.50. The newest and biggest and fear is that S&P might downgrade AGO due to changes in its rating system, meaning that AGO could be forced to raise additional capital.

Some background on AGO…

Although AGO had to raise capital and accept a $1 billion investment from Wilbur Ross, AGO still did a much better job of underwriting and managing the credit crisis than their rivals like MBIA and Ambac. AGO even managed to acquire FSA, a large muni bond insurer, expanding their market dominance. AGO is basically a monopoly right now—it was the only company writing new insurance on municipal bonds during 2010.

AGO also had a AAA until S&P downgraded them to AA+ in October 2010. AGO claims the October downgrade was unwarranted and was due to changes in criteria as opposed to changes in AGO’s capital position and risk portfolio. Furthermore, S&P did not provide clarity on their capital evaluation and the stress loss scenario S&P imposed seemed to be unduly harsh—1,600 bank failures and 25% unemployment.

Another thing I like about AGO is that value investor Bruce Berkowitz is high on MBIA. If he could purchase more of the stock he would, but New York State law prevents an investor from going above the 9.9% threshold. If Berkowitz is high on MBIA, a less well-run company compared to AGO, this gives me greater confidence in AGO.

Other Fears

Some other fears affecting investors is the impending muni crisis. Thanks to doomsayers like Meredith Whitney, investors now have a totally irrational fear that there will be hundreds of muni bankruptcies and even states going bankrupt. I see a host of reasons why things will not be as bad as they seem right now. Tax revenues for 2010 are going to be higher than they were in 2007. In the past several weeks, we’ve seen elected officials making tough decisions about their budget problems or getting prepared to make those tough decisions. Then there are simple facts like the costs of bankruptcy can easily outweigh any benefit. It’s also damn hard for a municipality to successfully file for Chapter 9, as it must: (1) be specifically authorized by state law to be a debtor (and there are only 27 states that authorize this); (2) demonstrate insolvency; (3) must be voluntary; and (4) must show proof of an attempt to avoid filing.

There’s also the fact that Chapter 9 has been pretty rare since the creation of the law in 1934. And the majority of debt defaults have occurred with unrated issues. AGO has only underwritten “BBB” or better rated bonds—78% of AGO’s net par outstanding is “A” or better.

Pundits also make bankruptcy sound like an easy choice. It’s not. Warren Buffett has also declared his fears and also stopped underwriting new business after 18 months. And as for Buffett, I would watch very closely to see if his words match up with his actions. I wouldn’t put it past him to play up the possibility of bad things happening in the muni debt markets so that he has a better opportunity to come swoop in on all of the deals when they arrive due to irrational selling.

I also like the fact that the buy-side dominated the questioning in the most recent quarterly conference call I listened to. I think there were a total of 5 different hedge funds represented versus 3 sell-side firms. And guess which group was asking the better questions? I have literally never experienced this before with a conference call. The fact that the buy-side is so well represented on a conference call is a positive sign for me.

Then there is the large discount to book value and huge discount to adjusted book value. And then there is the ongoing success of bond insurers and Fannie and Freddie of achieving rescissions and put-backs. Bond insurers could recover more than $4 billion from banks for breaches of representations and warranties on RMBS they guaranteed…

You get the point. I think there’s a whole lot of good news on the horizon and not much else can go wrong that hasn’t already gone wrong in the past three years.

Today AGO is holding a conference call to speak about S&P’s changes. I’ll be listening. Whatever AGO decides it needs to do, it will be positive for the stock price at current levels. If AGO needs more capital, then great—it gets more capital which it probably won’t need and the stock responds positively from these levels. If AGO doesn’t need more capital, then great—the stock responds positively from these levels.

The Power of Float

Posted on November 23, 2010, 11:53 am. 3 Comments

In the insurance industry, float is a very important concept to understand. Float is money that does not belong to the insurance company, but it is money the company gets to hold temporarily. Float arises because (1) premiums are paid upfront for insurance protection and because (2) loss events that occur today do not always result in immediate payment of claims as it may take many years for losses to be reported (asbestos losses would be an example), negotiated and settled.

An insurance company that can generate float at a low cost, or if it can generate float at negative costs where the company is being paid to hold onto other people’s money, is a wonderful thing. And if the insurance company can invest the float at attractive rates of return, this is even better. Warren Buffett’s Berkshire Hathaway is a prime example.

Two other examples are Markel (MKL) and Fairfax (FFH.TO; FRFHF). Both are companies that have long histories of generating low-cost float and sometimes at negative costs. Low cost float coupled with investing prowess is a powerful combination.

Below is a chart I made that shows Fairfax’s historical cost of float compared to the average long-term yield in Canada.

And below is chart of Markel’s historical cost of float compared to the average U.S. ten-year yield.

As you can see from the charts, Markel does a better job than Fairfax at generating low-cost or negative-cost float. However, in my opinion both companies are far above the industry average in this regard, and both have great investors in the form of Tom Gayner and Prem Watsa.

When looking at any insurance company as a potential investment, I always consider the ability of the company to generate low-cost float and to invest the float at above-average returns.

Insurance Humour From 1996

Posted on November 8, 2010, 5:51 pm. Closed

The above article is from Emerson, Reid’s Insurance Oberserver, December 1996.

Notes From the 2010 Markel Shareholders’ Meeting

Posted on May 11, 2010, 3:31 pm. 2 Comments

Yesterday I flew up to Richmond, Virginia for the Markel (MKL) annual shareholders’ meeting and post-meeting dinner. Coming off the heels of the  Berkshire meeting, Markel’s smaller meeting was a welcome change. The event was much more dignified and refined compared to Berkshire.

There wasn’t a whole lot to talk about at the Markel meeting, which is fine by me. Markel is one of the best specialty P&C insurers in the country. It’s a superb business run by passionate managers and employees. One of the more popular topics had to do with the progress and results of the One Markel initiative. This initiative began over a year ago and involved the company has transitioning away from a business model with four separate units (each with separate and/or overlapping insurance products) to a model with five regional offices that offer the full array of Markel’s insurance products.

Many of the Markel employees and managers had very positive things to say about One Markel. The producers for the company have more and easier access to Markel’s products. People also said that One Markel has resulted in a steady increase in submissions, which means more opportunities to underwrite for a profit. One Markel has also been helpful in ensuring the consistency of underwriting and pricing of the products. The initiative has also increased the ability to add new products and enhance existing one.

Finally, one Markel employee said one of the surprise benefits of One Markel is that company has been able to attract new talent. With the old system, a potential new employee who wanted to underwrite a certain product but could only do so if they moved to a different part of the country where that product was based. With the new system, that potential new employee does not have to move because all of Markel’s products in each of the regional offices.

With all the positives, one employee explained that the only negative thing about One Markel is that employees now have to deal with four different technology platforms in the underwriting process. However, this is a learning process and its just a matter of time before people become accustomed to the new system. Markel will continue to improve service, will continue to be creative problem solvers, will continue to enhance products, will continue to identify true partners, and will continue to attract new talent.

Bill Stovin, the leader of Markel International in London, was also at the meeting and gave a very informative update on the international operations, which include London Wholesale, Retail, and Overseas. It sounded to me like the international operations are doing quite well. Wholesale has introduced several new products: Equine, Credit Risk, and Personal Accident. These are small now but premiums should grow pretty well over the years. Markel has even sponsored two jockeys, Bill showed a picture of a jockey on a horse with “Markel” embroidered on the white pants. Equine is just one example of the specialty markets to which Markel caters. Markel wants to be the specialist insurer of choice for people.

Tom Gayner fielded questions about Markel’s investments and Markel Ventures, Markel’s newest division for their private investments and purchases. Gayner said Markel Ventures represents permanent capital and a long-term home for private companies. He also expects about $40 million in revenues this quarter for the venture segment, which would mean roughly $160 in revenue for the year.

Gayner said he is very optimistic about the future of Markel and went on to explain that the company’s secret weapon is love. I’m not joking here. It sounds silly but I think Gayner is right. I believe everyone at Markel loves what they do and there are many employees who have been with the company for several decades. There is a breadth of experience and continuity at Markel that is just not present at any other company. Markel’s success comes from their people and their people are some of the best out there.

I was very impressed by the Markel event and I’m now an even bigger believer in the company. Markel is a Berkshire-like company and has the culture to continue to do great things for shareholders for a long time to come.

UFCS Beats Expectations

Posted on April 28, 2010, 11:53 pm. 1 Comment

United Fire & Casualty (UFCS) recently beat quarterly earnings expectations and shares have skyrocketed from $19 to $24.

I wrote about UFCS on two separate occasions back in November last year and mentioned it briefly in January:

I saw UFCS as a company with negative sentiment (mostly continuing claims and expenses from Hurricane Katrina; yes, a hurricane from 5 years ago) that grossly outweighed the fact it was just a decent life and P&C insurance company that was bound to rebound (so to speak). UFCS was selling at a P/B of 0.73 and is now at a P/B of 0.93. If you had been reading my blog and agreed with my view that UFCS was very undervalued and bought at $17.00 per share, you would now have gain of about 38% (roughly 93% annualized) and you’d be beating the S&P 500 by about 30 percentage points.

It’s best to remember that better investment opportunities often come from overlooked and unpopular stocks. I think UFCS is a good reminder of both of these points.

Insurance Stock Drops

Posted on January 8, 2010, 11:28 am. Closed

This week I’ve noticed a bunch of the insurance stocks that I follow have dropped a good bit. Here is the list:

  • ACE
  • AGII
  • ENH
  • EMCI
  • ESGR
  • RE
  • IPCC
  • MXGL
  • MIG
  • NATL
  • PRE
  • PTP
  • RLI
  • NAVG
  • TWGP
  • UFCS
  • VR

I haven’t delved too deeply into the reason for the drop in stock prices, but I’m guessing its mostly related to recent talk about interest rate hikes. Hiking up the interest rates I believe has a negative effect upon the prices of most bonds, which are a huge part of insurance company investment portfolios.

With some research I think one could find some insurance companies that might have sold off too much as result of interest rate fears. Alternatively, one could also devote some time to research insurance companies that devote an above average percentage of their investment portfolio to equities as I think equities would tend to outperform bonds in an environment where interest rates slowly creep up (as they eventually will).

Fairfax Financial to delist shares from NYSE

Posted on November 20, 2009, 12:07 am. Closed

Via the Globe and Mail:

Fairfax Financial Holdings Ltd. is delisting from the New York Stock Exchange, having decided that the expense and inconvenience of being listed in the United States outweigh the benefits.

The Toronto-based company has been listed on the NYSE for about seven years. In 2006, it filed a lawsuit in New Jersey alleging that a group of powerful U.S. hedge funds short sold its shares and then schemed to drive down its stock price using a series of tactics, including intimidating executives and influencing analysts.

For a time, the company felt that a U.S. listing was necessary to enable its U.S. employees to own its shares, and to attract U.S. investors.

But these days it’s relatively simple for U.S. investors to use the Toronto Stock Exchange, and Fairfax’s ability to easily raise $1-billion through a share offering in September has demonstrated its ability to attract investors. Fairfax sold most of the shares on a so-called agency basis, meaning it took on the risk that they might not sell, rather than offloading the issue to banks. The insurer was raising the money to buy the part of its subsidiary Odyssey Re Holdings Corp. that it didn’t already own.

“After our recent privatization of Odyssey Re, Fairfax now wholly owns all of its primary businesses and is the largest property and casualty insurance company based in Canada, with worldwide operations in over 50 countries,” chief executive officer Prem Watsa said in a news release Thursday. “While our decentralized operations have global reach, after reviewing the factors relevant to our continued listing on the NYSE, we determined that our company and its shareholders will be better served by the simplified focus and lower cost resulting from the maintenance of only our original TSX listing.”

The voluntary delisting will have no impact on the company’s substantial operations in the U.S., he added.

“In recent years, as markets have become significantly more global and liquid, our constituents, including shareholders and employees, no longer require multiple listings,” Mr. Watsa said.

The delisting is expected to take effect around Dec. 10.

Sounds to me like Watsa is proving once again he is one of the world’s best value investors. Everything he does is about increasing value for the shareholders of Fairfax.

United Fire & Casualty Has Been Down This Road Before

Posted on November 17, 2009, 1:53 am. Closed

For several months, United Fire & Casualty (UFCS) has been in the dumps. I’m fairly certain it’s still paying for the catastrophes of last year. UFCS is by no means the best underwriter of risk or the best investor of its premiums, but I think it has staying power. UFCS was founded in 1946 and has done well since then. (click for larger size)

2009-11-16-ufcs

Just by looking at the chart, you can see that UFCS has undergone about three price corrections of similar magnitude to its most recent price correction. After each of the three previous times, the stock has rebounded nicely over time.

Here is some 10-year data for UFCS:

ufcs-10-year-data

I’m not a big fan of those high combined ratios (i.e., unprofitable underwriting), but UFCS currently has a P/B ratio of 0.7 and its 10-year average is 1.2. On a simple P/B ratio-based valuation, UFCS is trading at a 30% discount. If we assume UFCS were to trade at a more normal 1.1 P/B ratio, that means UFCS is now at a 40% discount.

I have no idea how long it will take UFCS to reach its intrinsic value, but I feel pretty confident that the true worth of the company will eventually be reflected in the stock price.