On Tower Group

Lo, how the mighty have fallen.

Let’s take a step back and see the full stock chart.

My, but Tower Group [TWGP] was a juggernaut in its time, but I never bought it or sold it.  Let me explain:

In 2005 my boss at the hedge fund came to me and said, “Why don’t we own Tower Group?  One of my friends owns it and says it is the greatest company in insurance.”

Me: “They are a new company underwriting in tough lines, with a weird reinsurance agreement from a small Bermuda company.  They are growing too fast, and I doubt they are as profitable as they claim.”

Boss: “Well, should we short them then?”

Me: “I don’t think shorting into strength is smart, so no.  We should do nothing here.” (After a little more, boss leaves, probably annoyed at me because I recommended no action.  He was a man of action!  I am a prudent risk-taker, and very selective about when I short.)

As an analyst of insurance stocks, I was always skeptical of Tower Group for three reasons:

  1. The acquisitive nature of Tower Group.
  2. The rapid growth in premiums, 52% per year over the last 10 years — no insurance company can successfully grow that rapidly in a mature market.
  3. Odd reinsurance agreements that made me wonder.

But by the time I ceased being a buy side analyst for a hedge fund in 2007, there was nothing to make me short Tower Group, much as I did not like it.  And so, I stopped following the company, because it is much easier to look only for companies to be long.  (TWGP remained on my “consider shorting” list till the end of 2007.)

I stopped following it.  Had I been following it, I would have noted the unusual strengthening of reserves for losses from prior year business (Page F-32, worth $69 Million) from the 10-K filed on 3/4/2013.  Someone selling on that day or soon after would have received something in the $18s/share vs. $4s/share now.  Large reserve strengthenings are often a harbinger of greater reserve strengthenings to come.

After their writedown, Tower Group was downgraded by the rating agencies to the degree that few will buy new insurance or reinsurance from them.  Further, they are seeking a buyer, and the buyers are skittish.

Thus, the company is probably in runoff. Runoff means there are no more new premiums, and the company aims to pay all legitimate claims until it closes its doors, hopefully leaving the equity investors a little.  Unless you are an expert, I would avoid taking any action here.  It is quite possible that reserves were set fraudulently, and that we have been given as much as the market can absorb in losses.  It’s also possible that the third-party actuaries have given a conservative view of reserves, and things get better from here.

I feature this company tonight to indicate how fraught with uncertainty it is to invest in insurance stocks, particularly those that grow premiums fast — that is usually a negative sign.

I have no idea where Tower Group goes from here, but they are a poster child for past fast growth and weak reserving.

2 Comments

  • Mr T. says:

    So many little gems contained in one blog post.

    “One of my friends owns it and says it is the greatest company in insurance” One of the worst ways to make investment decisions is to rely on advice from someone who benefits from you investing.

    “Well, should we short them then?”
    The chart shows that even though you were right in your analysis, you would probably have lost on the short trade. Your assessment was that they were behaving in such a way that would EVENTUALLY lead to the business blowing up. The critical word here is eventually.

    The third thing I got from the post is that Income of a company is only part of the story. If a company has taken on massive risk in order to get these returns, and the risk profile is likely to continue, it will likely eventually blow up.

  • avico says:

    Interesting. I took a little gamble on TWGP, as i am betting most of the news is already in the price (its the 3rd wave of selling already) but I really have no idea about reserve quality.

    Interesting thoughts about the premium growth. I wonder why it took so long for the auditors to make reserves higher but I guess thats just insurance. Black box

    I am betting that the CEO, M Lee with 4% of shares outstanding will work for S/H and that there is a buyer out there given most P&C companies are doing OK nowadays.

    But at the end of the day its a gamble, for sure. So keep positions small.

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