Partner Re Reinsurance Presentation

[Viking]

Partner Re gave a presentation on reinsurance industry at UBS conference on May 12. For those wanting a good review of PRE and the industry here is the link to the web cast and powerpoint presentation: phx.corporate-ir.net/phoenix.zhtml?p=irol-eventDetails&c=63283&eventID=2220143

Key takaways (made at end of presentation during Q&A):

1.) maintaining a triple 'A' investment portfolio and achieving a 10% ROE is not possible (with risk free rate = 2%)

2.) re-insurance business is pretty stable

3.) most critical decision today (that will drive future ROE) will be regarding investment portfolio

4.) Partner Re will be looking to increase risk in investment portfolio moving forward (have not yet done so) to increase investment income

 

My guess is many of their peers are in the same boat (still sitting on very conservative investment portfolios). ORH looks to, again, be sitting in a very enviable spot having already shifted bonds from Tresuries to Municipals and Corporates and also having increased stock portfolio (assuming changes at FFH reflect what has happened at ORH).

 

Both Partner Re and ORH are trading at about 0.90 x book. ORH is likely sitting on about $5.00 (after tax) in unrealized gains & Q2 earnings (taking them close to 0.80 x book). An interesting story is  developing at ORH that Mr. Market once again appears to be missing (just like CDS position).

 

Being in Canada, the recent 10% runup of the CAN$ vs the US$ has not helped my current ORH position. Perhaps it is time to get more aggressive and taker advantage of:

1.) high CAN$

2.) decent ORH price to current BV ($39.56/$43.5 = 0.91)

3.) $5.00 of 'hidden value' (that will continue to be very volatile)

[Mungerville]

Unlike others, ORH does have a AAA portfolio guaranteeing 10% Returns when buying at 90% of book.  So those guys at Partner RE are wrong because it is possible and ORH is doing it.  They should have said that its almost impossible and that would be true... but Hamblin Watsa seems to do the almost impossible every 18 months.

 

That's 10% in the bag unless the whole industry experiences a disaster on the underwriting or investment side.

[Mungerville]

If the stock market rallies further and ORH does not, I'll have to start selling other stuff and really get aggressive.

[Viking]

Mungerville, it looks to me that investors do not like the outlook for re-insurance stocks:

1.) underwriting results are OK (not great)

2.) interest/dividend income is falling

3.) investment gains/losses has been killed

 

Sum this up and you have near term pcture that is ugly and ROE that will be sub par. The near term outlook is similarly poor:

1.) given the recession, insurers are not accepting price increases

2.) low Treasury yields will ensure interest income stays very low

3.) investment gains/losses will remain low as portfolio managers are stuck like a deer in the headlights (making small changes to portfolios)

 

Interesting thing is the above does not describe ORH at all, but the market does not see it or they do not believe it. Worst case scenario (driven by another ugly equity selloff with the S&P falling to lower lows), I see ORH finishing the year with positive book value growth (perhaps from $45 to $46). Best case scenario (and not wildly optomisitc), the market for reinsurance hardens by year end, interest income will be solid and equity markets rally another 20% from here and FFH books some nice gains which results in book value increasing by $10 from $45 to $55. They are very well positioned and FFH has demonstrated that they will be very oportunistic with the investment portfolio. At some point Mr Market will figure it out and the stock will run up... patience is the key.

[Viking]

WR Berkley aslo presented at the UBS conference. They expect the market to harden into Q4 and 2010 due to two basic reasons:

1.) pricing is too low today

2.) balance sheets need to be repaired

 

The Q&A session at the end of the call was very interesting: ir.wrberkley.com/events.cfm

They also are struggling with the current investment climate and were asked if they will begin to hold more equity securities:

1.) "We make money in insurance business"

2.) "Have to make sure the capital account is not jeopardized from a statutory point of view"

3.) "Equity securities will jeopardize capital account"

4.) "High quality fixed income securities will not"

5.) "Capital account lets you write insurance business... thing that generates return"

 

VERY different business model than FFH...

 

There was a question regarding AIG and why they were not shrinking faster. The answer was the shrinkage is gaining momentum and they are being asked to write less business and pretty much all of their good people are actively looking to leave.

 

WR Berkley feels they have not seen so much opportunity before them as they currently do! 

[Mungerville]

"Mungerville, it looks to me that investors do not like the outlook for re-insurance stocks:

1.) underwriting results are OK (not great)

2.) interest/dividend income is falling

3.) investment gains/losses has been killed"

 

Yeah, that's why I'll outperform.  Its pretty obvious to me that a well run reinsurer with an 8-10% annualized risk-free head start (i.e. BRK guaranteed munis) will outperform an index fund very significantly over the next years.

 

 

 

 

[Crip1]

WR Berkley aslo presented at the UBS conference. They expect the market to harden into Q4 and 2010 due to two basic reasons:

1.) pricing is too low today

2.) balance sheets need to be repaired

 

The Q&A session at the end of the call was very interesting: ir.wrberkley.com/events.cfm

They also are struggling with the current investment climate and were asked if they will begin to hold more equity securities:

1.) "We make money in insurance business"

2.) "Have to make sure the capital account is not jeopardized from a statutory point of view"

3.) "Equity securities will jeopardize capital account"

4.) "High quality fixed income securities will not"

5.) "Capital account lets you write insurance business... thing that generates return"

 

VERY different business model than FFH...

 

There was a question regarding AIG and why they were not shrinking faster. The answer was the shrinkage is gaining momentum and they are being asked to write less business and pretty much all of their good people are actively looking to leave.

 

WR Berkley feels they have not seen so much opportunity before them as they currently do! 

 

Which suggests to me that ORH is being greedy when others are fearful.

 

-Crip

[Viking]

Crip, I have done a bit of a deep dive with the medium sized reinsurers over the past 6 weeks and it has helped me better understand their differences.

 

One thing that stands out is how conservative almost all investment portfolios are. Part of this is due to the type of business written. Those companies writing short tail business (one to two years out) really should stay away from equities. Bottom line is yields at most insurers is going to be very low for the forseeable future. And because Treasury bond yields are now pretty much as low as they can go (actually moving the other way), there will be no further realized investment gains due to falling interest rates for Treasuries. With historically low interest and dividend income and limited opportunity for realized investment gains, to hit ROE return targets insurers are going to have to have stellar underwriting. The fellow at WR Berkley said that given the level of pricing the past 12 months (not great) he was surprised with the CR numbers being reported. I think he was suggesting that insurers over the past few quarters were pulling large numbers from prior year reserves and reporting underwriting numbers that were a little (or a lot) inflated. Bottom line, the cushion (prior year reserves) has likely shrunk quite a bit the past 6 quarters and companies will have even less wiggle room on a go forward basis.  

 

One of the insurance executives (Veritus?) was asked why he was not buying back stock in the current environment (with company stock trading at around 0.8 of BV) and he said that when the hard market hits and you grow premiums they tend to be sticky - meaning the new business normally stays with you for three years on average - and profitability of this business (quite high) then drives serious book value growth over a two or three year period.

 

I set up a portfolio of the mid sized re-insurers in Google to compare stuff and what amazed me was how many of these companies are trading at a price to book that is lower than ORH = 0.9 (most). Looks to me that ORH is starting to get some respect and the level it is trading at is more a reflection of how poor the investment community views the reinsurance industry right now.

 

The catalyst for reinsurance stocks will be confirmation that the market is hardening. Year to date, the signs are positive. Next on the watch are June 1 renewals in Florida and then July 1 renewals in general. As Mungerville mentioned perhaps the best thing we could hope for is a terrible year regarding hurricanes. I have little doubt that if that happened most insurers do not have the capital and with the capital markets largely closed the hard market would be here in full force.

 

AIG is one company that may really screw things up. It was mentioned that they were historically the price leaders. Right now they are a mess and the fear is they could hold pricing too low for too long (who cares if they cheat a little bit on the underwriting when the losses will not show up for a few years). One scenario regarding AIG is parts of their business could simply implode as companies view them as too risky to do business with (insurance, just like banking is built on faith and trust). So perhaps a wounded AIG slows the arrival of a hard market... all this likely does is ensure they (AIG reinsurance) will dramatically shrink a little later as reserving issues do them in (all these re-insurers are sharks and will not hesitate to kill off one of their own). I loved the question posed to one company CEO that asked in the Bermuda reinsurers were openly telling customers that they were not willing to write business with AIG as a partner. The insurance exec said that they have an obligation to their shareholders to only partner with companies that are financially sound, have an ability to pay AND an ability to process claims properly (meaning Uncle Sam's backing is not enough... their underlying business model cannot be impaired as they lose people etc). It sounds to me that there are large cracks appearing in the AIG reinsurance business model and many customers are rethinking how they utilize reinsurance and the role that AIG will play in the future. Bottom line is AIG is in deep trouble.

 

Regarding ORH:

- they write longer tail business (on average) and therefore can put equities into their portfolio as a 5 year time horizon is fine. When I look at the equities, the current BV = $43.80 pretty much locks in most of the downside risk. They likely are sitting on $5 or $6.00 in pretax gains (including bonds). My guess is we will see FFH take profits on part of the equity positions (i.e. be opportunistic) as they were in Q1 when it looked like they had about 15% turnover. Why not sell some Wells Fargo at $25 and reinvest in some stallwart with a high dividend yield. When the markets sell off again, sell the stallwart and buy Wells Fargo again. We will see.

- their current before tax portfolio yield (interest & dividends) of 4.55 to 5% (not sure which) is at the very high end of their peer group.

- the fact they hold no US Treasuries may prove to be brilliant (should Treasuries continue to sell off in the coming months). Yes, at some point all bonds will be impacted... my guess is corporates and municipals will not move up as fast (spreads will continue to narrow).

- they currently have $550 million they could use to buy back stock. The fact they are not right now with the stock trading at 0.9 x BV (closer to 0.8 x May 23 BV - my estimate) is very telling. They must be expecting a hard market to get started very soon.

- I think ORH is licking their chops right now. They have an industry leading yield on their portfolio. In Q2 they backed up the truck and purchased corporate bonds and more equities and are now sitting on some pretty large gains. The reinsurance market is LOOKING like it will harden at any time and they have the surplus capital to grow a great deal.

- the key to me will be their underwriting results on a go forward basis. As I have posted before, there is a decent chance that the legacy issues (pre-2001) are done. As well, they earned so much the past two years from investments their prior year reserves SHOULD be in great shape as they did not need reserve releases to help (yes, I know insurance companies do not manage their business this way... and I don't buy it!). We should see average CR's and decent prior year reserve releases. In other words their underwriting should start to move to the front of the pack (instead of being at the back). Before people get their back up, if you look at ORH overperformance since 2002 it has come via investment gains. Period. What I am saying is with better than average yield, continued better than average investment gains AND NOW better than average underwriting as we enter a hard market this will be a $100 stock in the next couple of years. I think that is the bull case (that has been gestating in my mind the past few weeks). Will all factors come together? Perhaps not... however, I do like the risk reward. Please feel free to rain on my parade (I have thick skin) and sorry for the long post.

 

PS: and for other Canadians (like me) should the CAN $ continue to rise and ORH stay below $39US then the opportunity gets even better.

 

PS 2: if anyone has come across any good articles or write ups where AIG or the re/insurance industry is going please point me in the right direction. Thanks!

[Viking]

Here is a great summary article on reinsurance from Aon Benfield (players, size, 2008 results compared)... ORH performance sure stands out.

 

www.aon.com/attachments/ABAFY2008.pdf