Merkel: P/C Lessons from Bermuda

By David Merkel | May 17, 2007

Bermuda? Business only. Going to hit about a dozen companies in two days with one of my favorite P&C analysts, Harry Fong of Calyon. I hope there are a decent number of insurance only buy-side analysts along for the ride. They make grilling the management teams so much fun.

As an aside, the last time I was in Bermuda was after Wilma. I was traveling with Bill Wilt of Morgan Stanley (another good analyst). Because of a glitch, only seven buy-side analysts were on the trip, but four were “insurance only.” Between us and Bill, we got a lot done. The meetings were free-form, with a lot of good give and take.

But the night before the meetings started, I had just gotten to my hotel, and I was hungry. The hotel bar was the only thing open, so I went down with my computer to get a burger or something. While sitting there, waiting for my food to come, I worked on a RealMoney article. A fellow that I have never met walked up to me and said, “You’re David Merkel; what are you doing here?” I was floored; I asked him how he knew me, and he said that I wrote for RealMoney. Amazing what that little picture will do.

He explained to me that he was there for the Bermuda tour. I told him that I am glad he was there for the Morgan Stanley tour. He looked at me puzzled and said he was there for the Lehman tour. The Lehman tour was well planned… too well planned. 24 analysts in all. Whereas we got the give and take, they got the canned presentations. Oh well.
Wait, this was supposed to be about earnings. We have only two companies. American International Group (AIG) beat by a healthy amount on both the top and bottom lines. Whether out of hedge fund mischief, MR Greenberg selling out of spite, or that the buy-side had gotten ahead of the sell side because of prior good earnings this quarter, AIG stock traded down in the after hours. Hallmark Financial Services (HALL), primarily a personal lines insurer, met estimates. Nothing amazing one way or another.

My Bermuda trip went well. Here’s what I learned:

1. On net, pricing is actually improving at present. Property rates have been improving, with 6/1 and 7/1 renewals at the same level as last year. Casualty rates continue to deteriorate across almost all lines with aviation and D&O possibly having the most overcapacity. Florida rates have been improving, because insurers are buying coverage above the Florida Hurricane Catastrophe Fund, and second event coverage as well. Demand is high. (And Florida is not charging anywhere near enough for reinsurance in their fund… a disaster waiting to happen.)

2. Everyone wants to expand their specialty businesses, whether through tuck-in acquisitions, or lift-outs of underwriting teams. At the same time, more of the business is being written standard by admitted writers.

3. Because capacity with the highly rated carriers is adequate, the class of 2005 is having a hard time gaining enough business. This is exacerbated by the insureds generally taking higher deductibles, and insurers retaining more and ceding less. Also, sidecars are less needed in such an environment; many are maturing, and disappearing.

4. “Revenge of the Nerds” could have been the theme of the meetings. Only two of the ten companies are growing their business. Most are doing buybacks, and rest, minus Axis, are considering it. All of them are following roughly the same investment models (excluding Max Capital), and all of them are following roughly the same risk control strategy, though a few are limiting their writings at absolute limits, rather than probability based limits, which have been known to overexpose companies when rare bad events hit.

5. Conservatism is generally a good, but over-conservatism is a bad. Platinum Underwriters is too conservative, and is losing vitality by not writing business unless they are almost certain they will make a 10% ROE. They are shrinking now.

6. Finally, reserves are the biggest area of disagreement. Everyone says their own reserves are conservative, but few are willing to prove it, like PartnerRe (NYSE: PRE – News) and ACE (NYSE: ACE – News). XL Capital (NYSE: XL – News) may be going that way as well, disclosing reserve triangles. In general it seems that if there are problems, it should be located in the portfolios of the heavier Casualty writers, like Arch Capital Group Ltd. (NasdaqGS: ACGL).

I came away relatively happy with our positions. I like Allied World (NYSE: AWH – News), Endurance (NYSE: ENH – News), and PartnerRe roughly equally well. I was impressed with Flagstone (NYSE: FSR – News), and think that it could be a good buy during a wind crisis. Arch and Max Capital (NasdaqGS: MXGL) presented well; there are reserving questions with Arch though. XL did well, but I still wonder if they have control over their lines the way PartnerRe does. Platinum (NYSE: PTP – News) is too conservative, and Axis (AXIS) smacked of braggadocio, somewhat touchy and defensive. Answers were among the least clear given.

Final note, on people: The Arch meeting was a hoot. They spoke their minds and dished on everyone, though not by name (clever analysts know, though). XL’s CEO expressed contempt for MR Greenberg (“glad he’s gone”), and AWH’s CEO talked about his friendship with Greenberg, and how it is bringing AWH business. Going with Harry Fong was a plus — his 30 years of experience is unmatched, and he has a quirky way of teasing the answers out.

Copyright David Merkel (c) 2007
Reprinted with permission from The Aleph Blog

David J. Merkel, CFA, FSA, is a leading commentator at the investment website, where he writes on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better. Merkel is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm. Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

Full disclosure: long AWH, ENH

Topics Florida Property Casualty AIG Bermuda

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