Reinsurance Group of America

I read an article by Zacks on RGA.  I thought it was poorly reasoned.  Here’s what I wrote as a comment:

“However, the primary factors to our Neutral recommendation are Reinsurance Group’s reliance on availability for affordable retrocession. The company had increased the maximum amount of coverage that it retains per life in the U.S. from $6.0 million to $8.0 million. This reduces the amount of premiums it pays to retrocessionaires, but increases the maximum effect a single death claim can have on its results, and therefore may result in additional volatility to its results.

Also interest rates are likely to remain low in 2011 and spreads narrow further. We expect to see additional pressure on the Reinsurance Group’s investment income. Moreover, management’s conservative positioning of the investment portfolio is expected to exert pressure on yield.”

I hate to say this, but you don’t know life reinsurance that well if this is your reasoning. Interest spreads are not a major factor in RGA’s profitability. Also, the retrocession cartel charges an arm and a leg for coverage. The earnings will be more volatile, but they have always been volatile with RGA. The time to buy is after a bad quarter, because mortality is random, but RGA underwrites well.

Let me get this straight. This company has a big moat; it’s part of the life reinsurance oligopoly. It’s trading at a forward P/E of 6, a trailing P/E of 5.5, and 65% of unadjusted book. This company is a leader in its industry globally, and you rate it a hold?

Let me tell you a secret. You almost never lose on companies with little debt, trading at single digit P/Es, and trading below book, conservatively stated.

I own this stock, and so do my clients.

RGA is trading cheap enough that I am considering making it a double-weight in my portfolio.  It is a single-weight at present.  It is genuinely rare that one finds such a quality company with protected boundaries trading at such levels.  There are five companies that dominate life reinsurance globally, and in my opinion, RGA is the best, though they are a close number 2 by most measures of market share.

I don’t like writing about individual companies, because when you are right, one person praises you.  When you are wrong 10 people criticize you.  But for all that I simply say that I am long RGA for myself and my clients.

6 Comments

  • RichL says:

    The stock prices of insurers seem awfully cheap. I buy them, and they get cheaper!

    One potential issue is ASU 2010-26, the new accounting rule that requires the writedown of DAC emanating from life companies unsuccessful efforts to sell policies. A Citigroup report mentioned that ~ 30% of DAC is of this variety, and the rule roughly will cut life firms book values by 10%, though with broad variation depending on individual firms circumstances.

    When the market’s mode is to sell first and ask questions later, perhaps this is impacting the prices?

  • FrankM says:

    David – what is your assessment of the risk reinsurers face to their investment portfolios when Greece (and being optimistic) the rest of the PIIGS default? I am thinking of RGA and PRE in particular.

  • cold.as.ice says:

    Who are the five companies that dominate life reinsurance globally?

  • Rich — accounting rules affect GAAP earnings but don’t affect distributable earnings. Investment results stem from the ability of managements to generate, use and grow free cash flow. So, I don’t worry about accounting rules.

    Frank — I looked at RGA’s 10K, they don’t seem to have much exposure directly, but who can measure the exposure to core Eurozone banks? PRE’s 10K said: Included in the non-U.S. sovereign government, supranational and government related category are obligations of non-U.S. sovereign governments,
    agencies, political subdivisions and supranational debt. Non-U.S. government related obligations rated investment grade (BBB- or higher) by Standard &
    Poor’s (or estimated equivalent) comprised 60% of this category, with investment grade non-U.S government agency obligations, non-U.S. sovereign
    government obligations, and supranational debt accounting for the remaining 18%, 18% and 4%, respectively. The decrease in this category from $548
    million at December 31, 2009 to $385 million at December 31, 2010, is primarily related to fixed income securities underlying the funds held – directly
    managed account that have matured during the year, as the Company has matched the duration of its fixed income securities with the expected loss payments
    related to the run-off of the Paris Re reserves that are guaranteed by Coliseé Re under the Reserve Agreement. The decrease is also due to the sale of
    substantially all of the non-U.S. governments and agency obligations related to Italy, Spain, Greece, Portugal and Ireland in January 2010.

    So, they have no direct exposure, but remember the banks.

    CAI — The big five are: Munich Re, Swiss Re, RGA, Hannover Re, and Berkshire Hathaway (new to this list).

  • Doug says:

    With short-term rates at or near zero, do you think p/c and health insurance firms’ earnings will take it on the chin? Don’t they depend on float?

    • In the short run, it will hurt their earnings. But earnings on float have been coming down for a long time, and pricing power has made up the difference. Combined ratios have declined industry-wide because insurers can’t earn as much on their assets, so they make it up on the underwriting.

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