Category: Insurance

Insurance Earnings So Far 1Q07 ? VI

Insurance Earnings So Far 1Q07 ? VI

Looks like Seeking Alpha missed yesterday’s post.? Oh, well.? Onto the tidal wave of earnings:

Life

Assurant beat handily, on higher revenues.? Only the health division lagged. Prudential Insurance beat as well, with its international division leading the way.? UnumProvident beat, showing that its turnaround has legs.? American Equity missed stating that their interest spread margins had shrunk.? That’s a difficult condition to turn around in the short run, particularly given the long duration of the liabilities.? I would stay away.

Personal lines

Twenty-first Century, Erie Indemnity, Infinity Property Casualty, Horace Mann, and Cincinnati Financial all beat, while Kingsway and ALFA both miss.? Infinity reported before Wednesday’s open, and raised guidance; it was up 11% on the day.? Kingsway had to raise reserves, and ALFA had damage from tornadoes down South.

Primary Casualty

Procentury, FPIC, First Mercury, White Mountains, and EMC Insurance beat.? CRM Holdings met estimates.? OneBeacon missed estimates.? In general, it has been a great quarter for long tail insurance writers.? Investment income up, claims low, what more can you ask for?? Premium trends are mixed.? Only FPIC and EMC Insurance wrote less business.

The Bermudans

Both Endurance Specialty and Aspen Holdings beat, and both wrote less business than this time last year.? Endurance had significant claims from European windstorm Kyrill.? Ren Re beat earnings handily Tuesday evening, but the stock went nowhere on Wednesday, given the shrinkage of written premium.? The same may prove true of Endurance and Aspen.

We’re past the halfway point of the earnings season for insurance.? In general, Bermuda and primary casualty are strong.? Life and personal lines are pretty good.? Only mortgage is having any significant difficulties.

Full disclosure: long AIZ ENH

A Modest Proposal to Raise Taxes on Mr. Buffett (and me)

A Modest Proposal to Raise Taxes on Mr. Buffett (and me)

I doubt that it will go anywhere, but there is a proposal on Capitol Hill to tax private equity funds more.? As usual with Congress, we can criticize this from two angles.? The first is that they are creating a discriminatory rule that will create more clever structuring, but not result in significantly more taxes.? Private equity funds might float stubs of their holdings on the public equity markets in order to avoid taxation.? There are other ways they could deal with it as well.

The other criticism is that the proposal is not broad enough.? We need to tax everyone on the appreciation of their assets every year, whether they have sold them or not. Granted, this modest proposal would require a substantially larger IRS, but as for real estate, the Feds could piggyback off of what is done at the state level, with suitable massaging to create comparability.

This would whack the life insurance industry, certain tax-efficient mutual funds, etc.? It would lead to many abandoning their holdings on which they wanted to avoid taking the tax hit.

With the money raised here, the AMT could be easily eliminated.? What’s more, we could lower the top marginal tax rates, still bring in excess revenue.? We could have a flat tax, and the rich would pay a lot more than today.? No more shelters; everyone pays on the increase of their beneficial income, whether they have received it in cash or not.? This would create greater liquidity and volatility in the markets as stock that was locked away comes out for sale to create liquidity for tax payments.

Do I want this system?? If it is part of radical simplification and flattening of the tax code, yes.? Those who benefit from the system would pay their fair share, rich and poor alike.? I might end up paying more, but it would be more equitable.

PS — private businesses would still be difficult to apply this to, but I would tax them on their EBITDA.

Insurance Earnings So Far 1Q07 ? V

Insurance Earnings So Far 1Q07 ? V

When I started writing this series, I did not think that I was starting to write a series, but it seems that I have done so.? Since this is percolating out to a number of media outlets, let me simply ask that if you find this valuable, email me, or post a comment on my blog.? I will continue this series through the end of first quarter earnings, but with demand, I would do this next quarter, assuming that I am not swamped.? On to the earnings:

Life

At last the big dogs of this sub-industry begin to report.? I mentioned about the disappointments from Genworth and Principal yesterday, well, they got whacked in Tuesday’s trading, as did Sun Life, which met estimates, but they decided to eliminate their Clarica brand, which presumably will reduce some future revenues.? On the other hand, the buy side may simply have gotten ahead of the sell side.

After the close today, both MetLife and Lincoln National beat estimates.? I reviewed them in detail, and I couldn’t find much to quibble with.? MetLife’s International division did especially well.


Primary Commercial

Markel beat handily after the close, with a rising top line as well.? Two of the companies? beating the estimates yesterday soared — Hanover Group and Ohio Casualty.? National Interstate missed estimates after the close due to a higher than expected expense ratio.

Personal Lines

Safeco beat estimates by a tiny bit, but it looks like the buyside was looking for more.? Given the incredible performance of the stock over the past twelve months, it was just a matter of time before a pullback would happen.? I still think Safeco is overvalued versus peers, even after the fall in price.

The Bermudans

Ren Re beats the estimate by a wide margin, but on a lower earned premium year-over-year.? I suspect the stock moves up, but the questioning on the conference call should be interesting as they flesh out the strategy of management.

Here’s my quick summary of the sectors then: in general, primary commercial, and P&C reinsurance (the Bermudans) have done well.? (Amazing what you can do when there are few catastrophes, or negative legal trends.)? Personal lines, title, and life are mixed bags, but generally positive.? Mortgage has had problems, and I expect that the problems will persist for at least a few quarters.

Full disclosure: long MET and LNC

Insurance Earnings So Far 1Q07 ? IV

Insurance Earnings So Far 1Q07 ? IV

I estimate that we are almost halfway through insurance earnings season now, so here are the broad trends from the various insurance subindustries:

Primary Commercial

What a hot subindustry.? Beating the estimates were CNA, James River, Ohio Casualty, American Financial Group, American Safety, Navigators Group, and Hanover Group.
All but Ohio Casualty and CNA increased their net written premiums.? Ohio casualty was particularly impressive, with the loss ratio improving in the commercial and specialty lines.

Now, I am not a fan of the commercial lines in this part of the cycle, good as earnings look for now.? Here are things to look at for analysts because of the long-tailed nature of this business:

  1. Are the current year loss picks (loss estimates from new business as a percentage? of earned premium) deteriorating?
  2. How much income is arising from release of prior accident year reserves?
  3. How much is pricing deteriorating?
  4. Are terms and conditions deteriorating?
  5. Are they daring to grow in areas where pricing and terms and conditions are deteriorating?

Too many red flags and you should discount current earnings heavily.

Mortgage Insurance?

No good news here. ? PMI and Genworth both miss.? Genworth misses due to mortgage claims (LTC takes a day off from capital destruction), and PMI misses due to higher mortgage claims in the US and Australia.

Life

Principal Financial misses due to higher death claims.? Odd reason for a big company; the law of large numbers should be doing more for them.? High valuation, so it might take some abuse tomorrow.? That said, I would view it as transitory, so if PFG get smashed, I want to pick up the pieces.

The Bermudans

Axis Capital beats handily.? What else would you expect in a low cat quarter?? If it doesn’t rise much tomorrow, it means that the P&C reinsurers have reached equilibrium with the good quarter.

Conglomerates

Unitrin misses on lower net written premiums, and poor performance in their personal lines, and their Unitrin Direct line.

That’s all for now; let’s see what tomorrow brings.

Why Financial Stocks Are Harder to Analyze

Why Financial Stocks Are Harder to Analyze

One of my readers, Steve Milos, asked me the following question:

Free cash flow is a metric that I like to use when judging investments in most types of companies. However, I?m not sure how to apply it to insurance companies, or even how to calculate it, given the uncertainty of claims. Do you use it? How do you calculate it? Currently, I?ve used P/E, P/Book, dividend yield, combined ratio as metrics for insurance companies instead.

Before I start, for those that have access to RealMoney, I would refer you to the following two articles:

Parsing the Financials of the Financials, and

Time to Get Personal with Insurers (free at TSCM).

Quoting from a recent article at RealMoney:

The free cash flow of a business is not the same as its earnings. Free cash flow is the amount of money that can be removed from a company at the end of an accounting period and still leave it as capable of generating profits as it was at the beginning of the accounting period. Sometimes this is approximated by cash flow from operations less maintenance capital expenditures, but maintenance capex is not a disclosed item, and changes in working capital can reflect a need to invest in inventories in order to grow the business, not merely maintain it.

And quoting from the first article that I cited above: The cash-flow statement is of great use in gauging the health of industrials and utilities, but it tells us next to nothing about financials. One of the best values of cash-flow statements is that they enable one to attempt to derive estimates of free cash flow (the amount of cash that a business generates in a year that is left over after it has paid all of its expenses, including capital expenditures to maintain its existing business). Deducting maintenance capital expenditure from EBITDA often approximates free cash flow.

However, cash-flow statements for financials can’t in general be used to derive estimates of free cash flow, because when new business is written, it requires capital to be set aside against risks. Capital is released as business matures. In order to derive a free cash-flow number for a financial company, operating earnings would have to be adjusted by the change in required capital.Sadly, the change in required capital isn’t disclosed anywhere in a typical 10K. Even the concept of required capital can change depending on what market the financial institution is in and what entity most closely controls the amount of operating and financial leverage it is allowed to take on.

Federal or state regulators sometimes impose the biggest constraints on leverage — this is particularly true for institutions that interact closely with the public, i.e., depository institutions and life and personal-lines insurers. For companies that raise capital in the debt markets or do business that requires a strong claims-paying-ability rating, the ratings agencies may lay on the tightest constraints.

Finally, in rare instances of loose regulatory structures, the tightest constraint can be the company’s calculation of how far it can push its leverage before it blows up. Again, this is rare; many companies estimate the capital required for business, but regulatory or rating agency standards are usually tighter.

Actuaries have their own name for free cash flow. They call it distributable earnings. It is equal to earnings less the change in capital necessary to support the business. When sales are growing, typically distributable earnings are less than earnings. When sales are shrinking, typically distributable earnings are more than earnings.

As pointed out in the second quotation above, the hard part is knowing what entity requires the most capital to be held against the business. Is it the regulators, the rating agencies, or the company itself? The tightest constraint determines the capital that is required.

The second part of what makes it hard is that the capital standards for the rating agencies are dimly known to outsiders. Internal company capital standards are not known to outsiders either. Finally, the regulatory standards for capital are known but complex. The formula is known, but not all of the data that goes into the calculation is public. A further difficulty is that different companies run at different percentages above the minimum capital standards, and typically, that is not disclosed.

Aside from that, there is the problem of whether the reserves are fairly stated, but the nuances of that are beyond this discussion. What can an insurance analyst do to get something near free cash flow?

Ask questions on leverage policy. Ask the company how they decide what the maximium amount of business they could write next year is. Premiums-to-surplus? Statutory net income/loss limits? How much more could you borrow at the holding company at your current rating? Questions like this cut through the clutter of what you don’t know, and allow you to estimate how much capital they will have available to increase dividends, buy back stock, or buy other strategic assets. You can also read reports from the ratings agencies, since they focus on this.

In practice, I have a “back of the envelope” feel for how loose or tight capital is at firms that I analyze. I spend more time on pricing power, since it correlates better with stock price performance in normal situations. I look for the sustainability of underwriting margins. I also graph Price-to-Book versus Return on Equity, looking for companies that earn a lot on their net worth, and have a reasonable chance of sustaining those earnings.

I hope that helps explain how to analyze insurance companies, approximating some aspects of free cash flow. If you have a question, pose it below so others can benefit from your question and my answer.

Insurance Earnings So Far 1Q07 ? III

Insurance Earnings So Far 1Q07 ? III

Here we go again:

Financial Guaranty

MBIA pulls out a positive surprise and ends the day up. I suspect that in the current environment where there is a lot of skepticism over structured finance, that it doesn’t take much of a positive surprise to give MBIA a lift. Too many shorts.

Title

Stewart misses badly, and doesn’t fall much. Part of it is due to a charge for title claims that is likely to be nonrecurring. STC has a good track record, little debt, and is trading below book already. How much can it get hurt?

Primary Casualty

Travelers beats and raises guidance and the price falls. Huh? They showed decent top line growth as well. Could that be a worry in a softer pricing environment? It could, but so far that’s not the way other stocks have responded. Philadelphia Consolidated misses and the stock falls, though the company maintains their earnings guidance. When you have a high multiple, investors expect more I guess.

Mortgage

After lackluster results from RDN and MTG, Triad Guaranty beats earnings and the stock jumps 5%. Amazing what good earnings will do when peers have missed. That said, I would be skeptical of future quarters in 2007.

The Bermudans

Transatlantic beat by a decent amount and the stock went nowhere. Perhaps the recent market moves after the reports of the earnings of peers have silently moved the bar above where the sell side left it. Arch Capital beats as well; we’ll have to see how it does tomorrow. I wouldn’t expect much of a move. The valuation on a book basis is significantly higher than that of peers. It takes more of a beat to significantly move the needle. Anybody done a good reserve analysis on ACGL?


Diversified

Old Republic (that venerable and stodgy firm; I like stodgy.) missed estimates. General insurance did well, while mortgage and title both lagged. Hartford beats and raises guidance. Good quarter all around, particularly in variable annuities. Makes me think that when the life companies start reporting next week, that asset- and mortality-sensitive ones should do well. We’ll see how HIG does tomorrow. I’ll be listening to the call. Who knows, maybe I’ll lob in a question.

Full disclosure: long HIG

Insurance Earnings So Far 1Q07 — II

Insurance Earnings So Far 1Q07 — II

Updating yesterday, here we go again:

Brokers

Willis beats, with stronger revenues as well.? Probably goes up tomorrow.? Brooke Corporation beats, but who can really tell, their press release reveals few details.? Personally, I believe every company that reports earnings should provide an income statement, balance sheet and statement of cash flows at minimum.? I shouldn’t have to wait for the 10Q, or go to their website for a supplementary packet.

Title

Landamerica and Fidelity National both stronger than expected.? LFG went higher yesterday; FNF goes higher tomorrow.? If housing continues to sag, I would expect earnings to flatline, despite business from foreclosure sales and default processing.

Personal Lines

Commerce Group misses, blames weather and some technical items.? Would expect it to fall tomorrow, despite the enhanced buyback.? Personally, I distrust companies that announce expanded buybacks when earnings are poor.

Life

Still no core life companies have reported. National Financial Partners preannounces a miss.? Stancorp misses; looks like the Street just got ahead of the trend.? SFG still reaffirms annual guidance, so the damage should be limited.? I like SFG management a lot so if the price falls dramatically, it should be bought.

The Bermudans

Montpelier beats.? I suspect that the sell side got too pessimistic about MRH’s business prospects given the changes in Florida law.? As Pat Thiele of PartnerRe put it on his conference call, there is more business to be done by private reinsurers in Florida than one might expect.? It will be interesting to hear what Tony Taylor says on his conference call tomorrow.? Perhaps he will grace us with another quote from the Bible? 😉

That’s all for now.? Earnings season is in full swing, and we are 25% through.

Insurance Earnings So Far 1Q07

Insurance Earnings So Far 1Q07

As of this evening, maybe 15% of the insurance industry has reported earnings. Insurance is different from other industries because of the accounting complexity involved. That complexity is necessary, because insurance is one of the few industries where one does not know the cost of goods sold at the time of sale. That’s why insurance is one of the slowest industries to report earnings. As one might expect, the insurance companies generally report in order of increasing accounting complexity. I’ll go through the insurance sub-industries to give you a feel for what is working, and what is not.

Brokers

Rough quarter. AJ Gallagher and Hilb Rogal Hobbs both missed earnings, and will probably be punished tomorrow, if Brown & Brown is any measure. Brown & Brown beat earnings by a little, but their organic growth (same store sales) was negative for the first time in who knows how long. Stock down 7%. Well, what could you expect? Premium rates are falling, and insureds are not increasing their coverages by as much, so premiums go down, and commissions move in lockstep.

The Bermudans

Diversified writers have done well. Aside from windstorm Cyrill and some snowstorms in the Midwest, catastrophes have been light, and there have been few trends in the casualty marketplace that would indicate deteriorating on old business. New business is another matter — pricing is weakening rapidly, and in select markets, terms & conditions are getting compromised. Supposedly pricing is still above levels adequate to earn a profit adequate to justify the capital employed, though in some cases, I am beginning to wonder.

That said PartnerRe, Everest Re, ACE, Platinum, and XL all beat earnings handily. The latter three should do well tomorrow. IPC Re beat as well; they only do property, so they may be indicative of Ren Re, and Montpelier.
Personal Lines

Pricing is deteriorating here, and volume growth is light to non-existent. Allstate and Progressive reported good quarters with weak premium growth, and they have moved higher. Cincinnati Financial guided higher, and has run from there. State Auto Financial missed earnings badly, and got whacked. Selective missed due to the Midwest storms, but raised 2007 guidance… we’ll see how the market treats them tomorrow… should be okay. Midland beat and raised guidance; they have special niches, so good for them, but not indicative of broader trends.
Life

None of the bread-and-butter life companies have reported yet. Those that have reported are one-of-a-kind companies that live in their own space. Reinsurance Group of America beat earnings with strong revenues and was up significantly; they reinsure most of the life space. Maybe that means that mortality margins will be good. Aflac, Ameriprise, Delphi Financial, and Torchmark had good quarters as well. In aggregate, this could be a great quarter for the life companies.

Mortgage

MGIC and Radian both had poor quarters due to bad performance at C-BASS, which each of them owns 46% of. C-BASS services and securitizes mortgage loans, including subprime loans. Away from that, their core businesses seemed to be performing adequately for now. I would be cautious here; residential real estate pricing trends are weak at best.
Primary Casualty

WR Berkley and Chubb; both beat estimates. Chubb is up; Berkley is down. Chubb raises guidance, while Berkley sounds conservative. Neither has rising written premiums. This is clearly the part of the cycle where conservative players pull in their horns. Be on the lookout for companies in this space that show rising premiums written amid the falling premium rates. They will be shorting candidates later this year.
Stay tuned for more on this busy season.

Full disclosure: long ALL RGA short MTG RDN

Around the Web, and then Some

Around the Web, and then Some

  1. There were two articles on reinsurers this morning suggesting that there should be a lot of consolidation via M&A. I’m not so sure. First, most players there want to acquire, not be acquired. Second, most of them don’t trust the underwriting and reserving of their competitors to the degree that they trust their own. To the extent that current players want to diversify, it is cheaper to do it organically than by acquisition. With the high degree of ease of entry into the market, the franchise value of a reinsurer is low. Now, maybe the property-centric reinsurers want to diversify (a smart idea, but they are stubborn), or the new reinsurers want to buy in a reverse merger one of the class of 2001 to eliminate the capital haircut from the ratings agencies (but they don’t have the cash for it). Those ideas make sense, but scale isn’t that much of a virtue here, and with P&C reinsurers the reserving is opaque as mud. I can see a deal or two getting done, but not a lot of them.
  2. With all the hand-wringing in the Wall Street Journal this morning on free trade, just watch, we impose some series of tariffs or restrictions that reduce the current account deficit, only to see the capital account surplus shrink also, leading to higher interest rates and a lower dollar, breaking the current cycle giving the US cheap imported goods in exchange for dollar denominated bonds.
  3. Throw a rock, hit a commentator who says that the Bank of China (or other major central bank with large dollar holdings) would never sell their positions because it would work against their interests, driving the value of the dollar down. That’s a half truth at best. Here’s why: the central bank will eventually focus on the future, realizing that sunk costs are sunk. Just because you have a big dollar position, does that mean you have to add to it to preserve its current value. Ignore the past, and let the dollar denominated securities mature. Use fresh cash and maturity proceeds to buy assets in the currencies that you like. It won’t cause a panic, but the dollar will still adjust down. Recognize from the start that the dollar assets are worth less than current exchange rates, and maximize value from there. (Large holders of any asset under pressure have to think this way to maximize value.)
  4. Buyer Beware. Or maybe, it should be borrower beware. People are generally less competent at making rational choices when they are borrowing rather than paying cash. So it is no surprise that when Beazer finances homes that they sold, buyers might have gotten less than an optimal deal. This is true with many financial transactions. In general, the more moving parts in a transaction, the worse off the average person is in evaluating a deal. Better to line up your financing separate from the decision to purchase an asset, or you could end up up with a bop on your beezer, figuratively speaking.
  5. So FASB might have a tighter leash on its neck from the SEC? Not sure whether that is good or bad. Neither organization gets high marks in my book. FASB desperately needs a more coherent overarching approach to accounting, rather than the piecemeal addjustments that they are doing. The SEC, if anything, is more beholden to political pressure, and the idiocy that that brings into accounting.
  6. Then there’s Texas, basically invalidating the GASB on reporting the liability for long term government employee benefits. You might remember my piece at RealMoney, Pensions: Things Can Always Be Worse. Well, this is an example of that, and it is not limited to Texas. Though the Texas argument may have merits, governments all over the country are finding that they have to finally recognize the present value of the pension promises that they have made, and disclose it to the citizenry. It will be a mess, because a large amount of these promises are totally unfunded, much like Social Security, Medicare, and most other programs of our Federal Government.
  7. It takes a week, but finally the market comes around to my view of the FOMC, though it takes Bernanke before Congress to correct the view of the markets. Inflation is not on hold, but the FOMC is, for now.
SFAS 159

SFAS 159

I’m not an accountant.? I have never taken an accounting course in my life.? Yet as an actuary and a financial analyst, I have had to use accounting rules to understand financial statements, both in the production of them, and the interpretation of them.? (I even remember writing a paper explaining the effect of the then-current FAS 52 on foreign exchange when I was a grad student.)

 

There are a number of Statements of Financial Accounting Standards that I think have been mistakes.? We are between paradigms.? The central question is this: how often do we want to re-estimate the value of balance sheet items, and if they change, how should they be reflected in the income statement?

 

There are two consistent ways to do this.? Other methods are a kludge in my opinion.? Method one is amortized cost on both sides of the balance sheet.? Method two is the estimation of fair market value on both sides of the balance sheet.

 

But SFAS 159 allows companies to elect which assets and liabilities (with some restrictions, and subject to SFAS 115) they can value at amortized cost or at fair market value, together with disclosure on how the assets/liabilities are valued.

 

Now, I know that the FASB is trying to create standards that will be more consistent with international accounting standards, but what they are doing here will make accounting less comparable across US companies, particularly given that adherence to SFAS 159 is optional.

 

For companies with no long term agreements, SFAS 159 will not have any major impacts, but as for me, given that I follow the insurance industry, this will make my life more complex, without any equivalent increase in understanding.

 

As I said once to a panel of the IASB and FASB, create two consistent financial statements, one amortized cost, and one fair market value.? This would mean two income? statements and two balance sheets, and one cash flow statement.? They though that was too much work, but I disagree; companies are doing that work now, but they are not reporting it.? Better they should disclose what they know.

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