Edward Noonan of Validus is always good copy and the Q1 conference call for Validus provided some insight into the market ahead of the important July 1 renewals. When asked by an analyst whether the catastrophe market was reaching a floor, Noonan answered that “I’m starting to think we might be heading for the basement”.
He also said “I think the truly disruptive factor in the market right now is ILS money. I made a comment that we’ve always viewed the ILS manager business behaving rationally. I can’t honestly say that (anymore with) what we’re seeing in Florida right now. I mean we have large ILS managers who are simply saying – whatever they quote we will put out a multi-hundred million dollar line at 10% less.”
I have posted many times on the impact of new capital in the ILS market, more recently on the assertion that ILS funds havw a lower cost of capital. Noonan now questions whether investors in the ILS space really understand the expected loss cost as well as experienced traditional players. Getting a yield of 5% or lower now compared to 9% a few short years ago for BBB – risks is highlighted as an indication that investors lack a basic understanding of what they are buying. The growing trend of including terrorism risks in catastrophe programmes is also highlighted as a sign that the new market players are mispricing risk and lack basic understanding on issues such as a potential clash in loss definitions and wordings.
Validus highlight how they are disciplined in not renewing underpriced risk and arbitraging the market by purchasing large amounts of collaterised reinsurance and retrocession. They point to the reduction in their net risk profile by way of their declining PMLs, as the graph below of their net US wind PMLs as a percentage of net tangible assets illustrates.
This is positive provided the margins on their core portfolio don’t decrease faster than the arbitrage. For example, Validus made underwriting income in 2012 and 2013 of 6% and 17% of their respective year-end net tangible assets. The graph below also shows what the US Wind PML would be reduced by if an operating profit of 12% (my approximation of a significant loss free 2014 for Validus) could be used to offset the US Wind net losses. Continuing pricing reductions in the market could easily make a 12% operating profit look fanciful.
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I think that firms such as Validus are playing this market rationally and in the only way you can without withdrawing from core (albeit increasingly under-priced) markets. If risk is continually under-priced over the next 12 to 24 months, questions arise about the sustainability of many existing business models. You can outrun a train moving out of a station but eventually you run out of platform!
Posted in Insurance Firms, Insurance Market
Tagged CaT pricing heading for basement, catastrophe programmes, collaterised reinsurance, disciplined ILS pricing, disruptive factor, Edward Noonan, ILS, ILS funds, ILS managers, ILS pricing, insurance pricing, July 1 renewals, lack risk understanding, loss definition wordings, market discipline, mispricing risk, net PMLs, potential clashes, pricing reductions, property catastrophe rates, reinsurance pricing, risk arbitrage, risk profile, terrorism risks, underpriced risk, US Wind PML, Validus
The market is currently full of overdue anguish, with the air coming out of some of the frothier areas of the market notably in the biotech and internet sectors. To get an idea of the movements, I had a quick look at the S&P500 against a number of other indices such as the Powershares S&P high beta, S&P low volatility, & Nasdaq Internet ETFs plus the Nasdaq Biotech Index (SPHB, SPLV, PNQI & NBI respectively) as per the graph below.
click to enlarge
One of the more amusing bubbles in the recent run-up has been that surrounding the creeping legalization of cannabis in the US. Penny stocks in the sector, as if straight out of “The Wolf of Wall Street”, have been rocketing. Some of the more dubious firms have jumped on the bandwagon by coming up with fanciful plans on exploiting cannabis markets after having tried their luck as software, oil exploration or even tanning companies! Firms such as CannaVest (CANV) and Vape Holdings (VAPE) have shown classic pump & dump penny stock rises and falls in recent months.
One stock that has rode both the biotech and the cannabis buddle is a UK firm called GW Pharmaceuticals (GWP.L) founded in 1998 to develop cannabinoid prescription medicines to meet patient needs under medical supervision. Their main product, Sativex, a treatment for moderate to severe spasticity is approved or near approval in a number of countries such as Norway, Israel, and Austria. Bulls point to approval in the US of Sativex and the potential for other cannabinoid products in areas such as cancer and diabetes to justify the current valuation of multiples of revenue for this loss making firm. GWP has risen from 50p last year to a high (forgive the pun!) of 400p in March with a fall back to 250p recently. Cannabis stocks offer the ultimate high for aging stoners, add in some biotech hype for GWP and the sky is the limit to a happy ever after fantasy……….will people ever learn!
To me, the deflating of sector bubbles is a very healthy sign of a rational market. Whether an outbreak of rationality will last is another matter.
Posted in Equity Market
Tagged biotech, cannabinoid prescription medicines, cannabinoid products, CannaVest, CANV, classic pump & dump penny stock, Deflating Bubbles, ETFs, GW Pharmaceuticals, internet sectors, legalization of cannabis, moderate to severe spasticity, Nasdaq Biotech Index, Nasdaq Internet, NBI, penny stocks, PNQI, S&P high beta, S&P low volatility, Sativex, SPHB, SPLV, The Wolf of Wall Street, VAPE, Vape Holdings