Merger Fever: Results Analysis

Merger Fever: Results Analysis

The reinsurance world will be a different place when 2015 numbers are released; already we know that Renaissance Re has combined with Platinum, Axis is merging with PartnerRe, and XL with Catlin. That is unlikely to be the end of the matter.

Reading the 2014 full-year results is a bit like entering Doctor Who’s Tardis and travelling back in time. First we get the announcements about the January 2015 renewals, and then we get the figures that are a result of events in 2014, including the prices charged at the renewals 12 months previously.

Although in most cases there is a direct comparison between the reported numbers, in no case is there a direct like-for-like comparison. Taking rough measures such as net income divided by GWP could give misleading results.

That said, the low combined ratios of Montpelier Re and RenaissanceRe indicate more the area in which they underwrite than any dazzling genius on the part of the underwriters. Those two companies have benefited most from the benign natural catastrophe environment in recent years, but they are also the companies most threatened by the influx of new capital from other capital providers and new business structures.

The share price to earnings ratio of the various companies are all within a narrow range. By this parameter, Everest Re looks cheap and White Mountains looks expensive. There is even an argument for not including White Mountains within this group at all, consisting as it does of two subsidiary operators, Sirius Group and One Beacon. Axis too is divided into insurance and reinsurance brands (Lancashire, meanwhile, tends to term itself an insurer rather than a reinsurer – it is also listed on the London Stock Exchange rather than in the US).

Bermuda’s Arch Capital recorded net income of $812.4m, up from $687.8m in the prior year. Arch splits about 67/33 in favour of insurance versus reinsurance. In the final quarter of 2014, growth in the insurance segment was running at twice the rate of growth in reinsurance.

White Mountains Insurance Group is best considered as two separate operations – Sirius and One Beacon. Sirius Group had what was termed by White Mountains chief executive Ray Barrette “another excellent year”. Adjusted book value per share was up by 8% year on year. One interesting point here is the impact that the appreciation of the US dollar had on the Bermuda-domiciled sector. Insurers and reinsurers have automatically self-balancing portfolios (i.e., they pay out claims in the same currency as they take in premiums), meaning that there is no fundamental exchange exposure to individual risks. However, if the currency in which the company reports appreciates compared with the currencies in which a company write policies and pays claims, then the bottom line for domestic investors is impacted by the relative decline in the value of foreign policies.

For White Mountains, foreign exchange currency losses were about $15 per share, or two percentage points of growth in average book value per share. The group reported only a 4% ABVPS (average book value per share) growth for 2014, so effectively it saw a third of ABVPS growth wiped out by currency changes. For Sirius the FX appreciation reduced the ABVPS gain by 5pp, from 13% to 8%.

Sirius, led by Allan Waters, booked a 76% combined ratio (CR). Q4 saw $18m in losses from flooding in Jammu and Kashmir regions of India, plus $8m from Cyclone Hudhud. For 2014 as a whole the CR included 7pp ($59m) of cat losses, less than the 10pp incurred in 2013. Sirius kept up with favourable reserve development, worth 29pp ($63m) for the year. That was higher than the 6pp ($48m) achieved in 2013.

Gross written premiums at Sirius were up 7% year on year to $185m, with the growth primarily reflecting expansion in accident and health lines. There were also increases in property and aviation lines, but the property catastrophe excess and trade credit business was cut back.

The recent history of OneBeacon has been less happy. The insurer’s GAAP combined ratio for the year was 102%, up from 92% in 2013. Unfavourable loss reserve development contributed 8pp to the 100%+ CR level. OneBeacon closed the sale of its run-off business in Q4 2014 and has now become a pure primary specialty company. As chief executive Mike Miller put it: “The transformation of OneBeacon to a pure specialty company is complete. After reviewing the company’s clean balance sheet, free of legacy liabilities, its strong capital position and the profitability of its underwriting operations, we intend to maintain the dividend at its current level. Welcome to the ‘new’ OneBeacon.”

Nagging questions remain, however. The main one is surely: is this the right time to become a 100% specialty company? Five years ago, it would have been a brilliant move. Today, the concern will be that too many other players are making the same move into an ostensibly attractive space.

Should Lancashire Holdings be included in this group? It is UK tax resident; it is listed in the UK, and it is mainly an insurer rather than a reinsurer. As such, the logical answer might be, “no”. And yet its formation, original location and history all have a Bermudian feel to it.

Although it was created as recently as 2005, Lancashire Holdings is now a different beast from those days. It has gone through the Accordion Re sidecar experiment (or perhaps it should be termed ‘episode’), and now has Cathedral Underwriting, Kinesis, and Lancashire as its three main platforms. But that is only the part of it. Kinesis Capital Management (Bermuda) is the parent of KCM Marketing Services (London). There is LICL Bermuda, and Lancashire Insurance Services (UK). Only Cathedral retains solely a UK identity.

Lancashire also reports in dollars, not pounds. Lancashire redomiciled in 2012, following the publication of the latest proposals for the reform of the UK’s Controlled Foreign Companies rules. But, while Hiscox feels like a UK company that is domiciled in Bermuda, Lancashire feels like a Bermuda company that is domiciled in London.

Breaking down precisely how much at Lancashire is primary cover and how much is reinsurance is not easy. But in broad terms, of the $907.6m in premiums, $104m are defined as property reinsurance and $18.1m are called property retrocession. On the energy side, it’s mainly primary stuff. If one pays close attention to Lancashire’s numbers, it’s clear that its exposures are to the geographically diverse offshore energy, property reinsurance and property catastrophe excess of loss.

For 2014 the company booked an increase in net profit and significant growth in GWP. However, this can be attributed to 2014 being the first full year that Cathedral was included in Lancashire’s figures.

Lancashire’s history has been distinctive. It has consistently paid out the vast majority of its profits (much to the joy of those who were wise enough to invest in the company when it launched), and sometimes has almost looked like a sidecar without the need of a main motorcycle. With Richard Brindle now departed, the talk in the market is that Lancashire is one of the main targets for takeover/consolidation which, if it turns out to be true, would make the company a short-lived but extremely successful example of how a listed company can be run properly and to the benefit of all concerned.

Everest Re, with premiums of $5.2bn in 2014, sits in an ambiguous position when it comes to M&A fever. Hunter or hunted? If you take the word of chief executive Dominic Addesso, the answer is “neither”. The company feels that it is performing well and has no need to deviate from that strategy.

The problem is, if you are going to become one of the hunted, you often don’t have much choice in the matter. Ask Aspen. There seems little doubt that some of the recent consolidation announcements have at least in part been defensive. If the music is playing and the number of chairs is falling, it’s probably best to choose your partner now, rather than wait for the music to stop.

Although Everest Re is growing, in 2014 its profits were not. Net income for the year declined to $1.2bn, from $1.3bn. The impact of this on shareholders was mitigated by a high level of share repurchasing through 2014. For the year, Everest repurchased 3.2m shares at a cost of $500.0m. That left the net income per common share at $25.91, up from $25.44 the previous year. It has continued to repurchase in 2015, buying $36m-worth of stock in January.

But this in a way is also an acceptance that in the current soft market it is hard to find a place to put your money that will generate a return on equity better than can be achieved by buying back stock. Addesso stated that “Everest continues to find and create opportunities for profitable growth due to our broadly diversified platform”. But the evidence seems to indicate that finding these opportunities in the current market environment is proving a bit of a struggle.

Everest Re is operating with the lowest price-to-earnings ratio, at 6.84. The market looks to be making it relatively cheap.

At Montpelier Re, the first instinct of the dispassionate analyst is to say “my, isn’t it small?”. It seems hard to believe that, even at the beginning of the 2000s, a monoline reinsurer booking premiums of nearly three-quarters of a billion dollars a year would not have appeared small at all. That it should seem so today is an indication of the grade inflation that has affected the size needed for any reinsurer to be a significant player in the world reinsurance sector.

Back in the early 1990s you could probably have got away with forming a reinsurer with $50m of capital. Today, if anyone were going to form a new listed reinsurer, you would be hard-pressed to imagine less than a billion dollars being acceptable. When Lancashire launched Accordion Re in 2011 it was with $250m of capital (about $200m of it external), and that was just a sidecar.

As a monoliner that is moving heavily into third-party capital management with Blue Capital Re, Montpelier Re is still making money. Its combined ratio last year was 65.6%, a double-digit increase on 2013, but still a payout ratio that most insurers would die for. But is its business model still viable in the new reinsurance world order? Net earned premiums were up in 2014 ($645.2m versus $599.6m) and net income rose too. The capital under management at Blue Capital is also experiencing steady growth, now at $790m. Book value per share was up 15% year on year. And yet one constantly returns to the lack of size. The recent announcement that Fairfax was buying Brit for $1.88bn, and that Platinum went for $1.89bn, will surely not have gone unnoticed at Montpelier, where a similar amount of cash would be required to persuade shareholders that consolidation might be a good idea.

Indeed, the comparisons with Platinum (premiums of $582m and earnings of $164m) are significant. Montpelier Re has long said that it sees a future as a standalone company, and in any rational sense this could be true. But this is a time of merger & acquisition fever. These are not rational times.

Axis Capital, the putative partner of PartnerRe in an $11bn deal, is of a similar size at the moment to that of Everest Re. Its gross premiums for the year were roughly flat at $4.7bn, with the combined ratio deteriorating a fraction of a percentage point to 91.6%. Axis writes a small proportion more insurance than it does reinsurance ($2.53bn compared to $2.17bn in 2014), with the reinsurance sector, predictably, having the superior combined ratio in another benign year. Natural catastrophe losses in 2014 contributed 2.4 points to the combined ratio, down from 5.4 points in 2013. Axis also put in a good year on reserve releases for 2014 at $259m (6.7pp of the combined ratio) compared with $219m (5.9pp) the previous year.

Operating income per common share was $5.32, down from $5.49 in 2013. This decline was entirely attributable to foreign exchange impact. Earnings per share before the impact of investment gains and foreign exchange were $7.29 a share, compared with $5.93 a share the previous year.

Chief executive Albert Benchimol uttered most of the familiar phrases, noting that that market environment had become “increasingly competitive, particularly in the reinsurance market”.

But, of course, Benchimol was one of the six players at this particular party (with Catlin, XL, PartnerRe, RenaissanceRe and Platinum Holdings) that had another tale to tell, a tale of merger/acquisition. Benchimol said: “The union of our two strong companies will allow us to do even more for our clients and partners…”.

Argo, something of a minion in the grand scheme of things, booked GWP of $1.90bn, up from $1.89bn. Net income rose to $183.2m, from $143.2m in 2013. Net income per share was $6.90, up from $5.14. In terms of price to earnings, this puts Argo a fraction on the low side of average (most are in the 8s or 9s; Argo is 7.55) The combined ratio for the year improved 1.3pp over 2013, reaching 96.2%. Argo has five main segments: Excess & Surplus Lines, Commercial Specialty, International Specialty, Syndicate 1200 and a run-off segment. International specialty is the smallest of the four active sectors, with E&S Lines and the Lloyd’s syndicate having the lion’s share of the premiums. But no division really stands out, and none appears to be “non-core”. Indeed, if M&A fever were not sweeping the reinsurance globe, the view would be that Argo was a neat and well-run ship.

Net favourable prior reserve development was up slightly, to $37.7m (worth 2.8pp to the combined ratio), from $33.6m (2.6pp of the combined ratio).

Pre-tax catastrophe losses were $17.7m (1.4pp of the combined ratio) down from $22.7m (1.9pp of the combined ratio).

For a mainly monoline operation, RenaissanceRe has quite a few complications to it. These are likely to increase at the conclusion of its purchase of Platinum Holdings. This is not the place to head into the complexities of RenRe joint ventures DaVinci Re, Top Layer Re, and its Lloyd’s operation, syndicate 1458.

One notable factor about RenRe was that it cut its GWP level in 2014. This was voluntary. Capital was returned to shareholders; GWP fell to $1.55bn, from $1.61bn in 2013. That reduced the net income per share to $12.60, from $14.87 the previous year. The number of shares outstanding dipped significantly. As chief executive Kevin O’Donnell termed it, RenRe achieved an increase in tangible book value per share “while demonstrating discipline and objectivity about the risk we assumed and the pricing required”.

For which, read, pricing in monoline property-casualty finally went beyond the pail in a few cases. For all the normal talk of “profitable growth”, in this particular sector, you really had to walk away from some of the stuff the brokers were dropping at your doorstep.

But, as was the case with Benchimol at Axis, O’Donnell had a hook. “Over the past few years, we have steadily developed the spectrum of products, platforms and scale we offer, in anticipation of the evolving needs of our customers. The acquisition of Platinum Underwriters Holdings will accelerate our efforts, broadening our client and broker base and our capital flexibility”.

Next issue: Endurance, XL Group, Aspen, PartnerRe, Validus and Catlin.

By Peter Birks –

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