Monthly Archives: March 2013

Relative valuations of selected reinsurers and wholesale insurers

It’s been a great 12 months for wholesale insurers with most seeing their share price rise by 20%+, some over 40%. As would be expected, there has been some correlation between the rise in book values and the share price increase although market sentiment to the sector and the overall market rally have undoubtedly also played their parts. The graph below shows the movements over the past 12 months (click to enlarge).

12 month share price change selected reinsurers March 2013The price to tangible book is one of my preferred indicators of value although it has limitations when comparing companies reporting under differing accounting standards & currencies and trading in different exchanges. The P/TBV valuations as at last weekend are depicted in the graph below. The comments in this post are purely made on the basis of the P/TBV metric calculated from published data and readers are encouraged to dig deeper.

I tend to look at the companies relative to each other in 4 broad buckets – the London market firms, the continental European composite reinsurers, the US/Bermuda firms, and the alternative asset or “wannabe buffet” firms.  Comparisons across buckets can be made but adjustments need to be made for factors such as those outlined in the previous paragraph. Some firms such as Lancashire actually report in US$ as that is where the majority of their business is but trade in London with sterling shares. I also like to look at the relative historical movements over time & the other graph below from March 2011 helps in that regard.

Valuations as at March 2013 (click to enlarge):

Price to net tangible book & 5 year average ROE reinsurers March 2013

Valuations as at March 2011 (click to enlarge):

Price to net tangible book & 5 year average ROE reinsurers March 2011 The London market historically trades at the highest multiples – Hiscox, Amlin, & Lancashire are amongst the leaders, with Catlin been the poor cousin. Catlin’s 2012 operating results were not as strong as the others but the discount it currently trades at may be a tad unfair. In the interest of open disclosure, I must admit to having a soft spot for Lancashire. Their consistent shareholder friendly actions result in the high historical valuation. These actions and a clear communication of their straight forward business strategy shouldn’t distract investors from their high risk profile. The cheeky way they present their occurrence PMLs in public disclosures cannot hide their high CAT exposures when the occurrence PMLs are compared to their peers on a % of tangible asset basis. Their current position relative to Hiscox and Amlin may be reflective of this (although they tend to go down when ex dividend, usually a special dividend!).

Within the continental European composite reinsurer bucket, the Munich and Swiss, amongst others, classify chunky amounts of present value of future profits from their life business as an intangible. As this item will be treated as capital under Solvency II, further metrics need to be considered when looking at these composite reinsurers. The love of the continental Europeans of hybrid capital and the ability to compare the characteristics of the varying instruments is another factor that will become clearer in a Solvency II world. Compared to 2011 valuations Swiss Re has been a clear winner. It is arguable that the Munich deserves a premium given it’s position in the sector.

The striking thing about the current valuations of the US/Bermudian bucket is how concentrated they are, particularly when compared to 2011. The market seems to be making little distinction between the large reinsurers like Everest and the likes of Platinum & Montpelier. That is surely a failure of these companies to distinguish themselves and effectively communicate their differing business models & risk profiles.

The last bucket is the most eccentric. I would class firms such as Fairfax  in this bucket. Although each firm has its own twist, generally these companies are interested in the insurance business as the provider of cheap “float”, a la Mr Buffet, with the focus going into the asset side. Generally, their operating results are poorer than their peers and they have a liking for the longer tail business if the smell of the float is attractive enough (which is difficult with today’s interest rate). This bucket really needs to be viewed through different metrics which we’ll leave for another day.

Overall then, the current valuations reflect an improved sentiment on the sector. Notwithstanding the musings above, nothing earth shattering stands out based solely on a P/TBV analysis.  The ridiculously low valuations of the past 36 months aren’t there anymore. My enthusiasm for the sector is tempered by the macro-economic headwinds, the overall run-up in the market (a pull-back smells inevitable), and the unknown impact upon the sector of the current supply distortions from yield seeking capital market players entering the market.

Historical Price to Tangible Book Value for Reinsurers and Wholesale Insurers

Following on from the previous post, the graph below shows the historical P/TBV ratios for selected reinsurers and wholesale insurers with a portfolio including material books of reinsurance (company names as per previous post). The trend shows the recent uptick in valuations highlighted in the previous post. The graph is also consistent with the Guy Carpenter price to book value graph widely used in industry presentations.

Historical P to TBV Reinsurers & Wholesale Insurers 2001 to 2013Over the past 12 months the sector has broken out of the downward trend across the financial services sector following the financial crisis, most notably in the banking sector as the graph below from TT International illustrates.

TT International Bank Price to Book Ratio

Tangible book value growth across the wholesale insurance sector was approximately 10% from YE2011 to YE2012 and the weighted average operating ROE of 11% in 2012 has been rewarded with higher multiples.

The sector faces a number of significant issues and a return to valuations prior to the financial crisis remains unrealistic. An increase in capacity from non-traditional sources and the increased loss costs from catastrophes are cited in industry outlooks as headwinds although I tend to agree with EIOPA’s recently published risk dashboard in highlighting the impact of macro-economic risks on insurer’s balance sheets as the major headwind.

One issue that deserves further attention in this regard is the impact low interest rates have had on boasting unrealised gains and the resulting impact on the growth in book values. Swiss Re is one of the few companies to explicitly highlight the role of unrealised gains in its annual report, making up approximately 13% of its equity. In a presentation in September 2012, the company had an interesting slide on the impact of unrealised gains on the sector’s capital levels, reproduced below.

Reinsurer Capital & Unrealised Gains

P/TBV is one of my favoured metrics for looking at insurance valuations. But no one metric should be looked at in isolation. The impact of any sudden unwinding of unrealised gains if the macro environment turns nasty is just one of the issues facing the sector which deserves a deeper analysis.

Market valuations of wholesale insurers and reinsurers shift upwards

With many of the Bermudian, European and US wholesale insurers hitting 52 week highs last week, there is a definite shift in sentiment about the sector. It remains to be seen whether the shift is simply part of the overall market rally or a more structural shift in the markets view of the previously historic low tangible book multiples. A wide sample of firms in the reinsurance and wholesale insurance sectors are included in the graph below.

Wholesale Insurer & Reinsurer Valuations