Analysts Look at Challenges Facing Reinsurance Stocks
06/23/2011 — PHILADELPHIA -- With reinsurance stocks trading below book value, three equity analysts at the CAS Seminar on Reinsurance faced down the key questions about the industry sector: Why are reinsurance stocks depressed? What will have to happen to lift their prices?
On hand with the answers were property-casualty insurance analysts Meyer Shields, analyst at Stifel, Nicolaus & Co.; Gregory Locraft, an executive director at Morgan Stanley; and Dean Evans, equity analyst at Keefe Bruette & Woods. Raju Bohra, executive vice president at Willis Re moderated the panel session held on June 7.
The analysts’ outlooks on the market differed. Evans called himself “cautious,” Locraft termed himself “more bullish,” and Shields was “more optimistic than most,” particularly regarding property-casualty brokerages. But their assessments centered on the same two topics:
- Low rates. Insurers and reinsurers have been reducing their rates for several years, a standard phase in the well-established underwriting cycle. The belief that rates are at their ebb, or close to it, has buyers waiting for an upturn. “Wall Street wants things to get really bad before it starts buying,” Locraft said.
- Reinsurers’ earnings have been driven by reserve reductions. Companies regularly re-estimate what they will pay on outstanding claim liabilities, and in recent years those estimates have been falling. The takedowns help earnings, but leave investors wary, since those estimates tend to be cyclical, just like rates. And investors don’t want to invest in companies on the cusp of reserve increases, especially if rates remain low. “It has never paid to get in front of that trend,” Locraft said.
Evans, the Keefe Bruette & Woods analyst, noted that reinsurers have a lot of positives to help their valuations. They are valued at 85 percent to 90 percent of book value, well below the long-term average of 120 percent to 130 percent. Catastrophe rates appear to be rising, on the heels of 15 months of large catastrophe losses, starting with last year’s Chilean earthquake, through the 2011 March earthquake and tsunami in Japan.
In addition, reinsurers have a strong capital position, with a clean balance sheet - having avoided the absolute worst of the 2008 stock market meltdown, he noted. And merger activity seems poised to rise, which would make all reinsurers more valuable.
But Evans also expressed concerns. Investment yields are low, which lowers the return that reinsurers generate when they invest premium while waiting for claims to settle. Also, outside of catastrophe business, pricing remains weak, he said. Evans also worries about loss trends; if claims were to become more frequent or settlements grow significantly, reinsurers would suffer. And he believes reinsurers are overexposed to major catastrophes, especially in Florida.
Locraft, the Morgan Stanley director, recognized the same issues, but believes they are already reflected in reinsurers’ stock prices. To that he added the impact of a major upgrade in the hurricane model from modeling firm RMS. The new model significantly increases reinsurers’ estimates of hurricane loss exposure to certain storms, putting upward pressure on reinsurance prices, he said.
Overall, Locraft believes that the “best of breed” companies will reward their owners over time.
Shields, the Stifel Nicolaus analyst, observed that favorable reserve development is drying up, with reserve releases for commercial insurers down 50 percent thus far in 2011 from a year earlier. He emphasized his positive view for insurance brokers, noting the top three - Aon/Benfield, Guy Carpenter and Willis - command a significant share of the market, so any good news for reinsurers will help them, too.
Shields also pointed to Solvency II, Europe’s regulatory overhaul, as a positive for brokerages. The regulation will, in essence, require many companies to purchase more reinsurance. No matter whom they purchase from, he said, brokerages stand to benefit from the brokerage fees they would receive.
“The reinsurance industry has perfected the art of getting capital quickly,” Shields said. Their moves are so smooth, he said, that it has helped flatten the pricing cycle for catastrophe reinsurance.
Locraft noted that companies have been returning capital through stock buybacks. Companies that buy back more than 4 percent of their shares typically perform better.
“It kind of becomes a no-brainer as long as you can withstand a Japan-type event,” he said. For now, though, he expects few buybacks, as companies will hold their capital through hurricane season, which lasts through the summer.
But Evans questioned whether reinsurers will be able to attract capital as quickly in the future. After major catastrophes like Hurricane Katrina or the World Trade Center, new companies were formed. “Are capital markets going to step in and recapitalize like they did in the past?” he said.
And he added a caution regarding stock buybacks. “We do tend to penalize companies that make herky-jerky capital actions,” he said. Companies are rewarded for a more consistent approach, he said.
Worse still are companies that continually raise their reserve estimates. Even one across-the-board increase raises suspicions on Wall Street, said Locraft, because one increase is invariably followed by more.
He said “These things come in bunches and trigger a cockroach effect. When Wall Street sees one, everybody scatters.”
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