LRE.L - Lancashire Holdings Ltd

[biaggio]

yes, they seem to be mirror images of each other.(they could help each other)

 

 

LRE.L still doing ~$200 million in business with very large profit margin, you would think that competitors would be after their customers.

 

 

so basically LRE stays small + will only write insurance if the price is right

 

in other words their competitive advantage or moat is their underwriting discipline

 

Thanks in advance

[Myth465]

One must remember that LREs model isnt scalable which is why we have those huge dividends and more recently share buybacks. They are quite happy staying small. Also the investments gains are not what I am looking for, but they are running 8% annualized for this year. Not too bad considering the short tail nature of the business and current rates.

[twacowfca]

Numbers are impressive.

 

Wait till you see Q4 and Q1.  These are normally low loss quarters without the rare earthquake.  Returning capital through the special dividend should goose their awesome ROE even more.

 

My question is what would prevent smart insurance guys like FFH, MKL, BRK from underwriting the same properties which would decrease profits/decrease underwriting results.  

 

Their reinsurance is written out of their Bermuda office through broker and client relationships.  Insurance is written mostly out of their London office through broker and client relationships.  The brokers hate BRK because they won't pay commissions.  LRE is the lead underwriter on a lot of the business that"s in their sweet spot. Other syndicates may participate, but most don't because they don't like possibly volatile returns.

 

Numbers look too good to be true

 

Yes, but they have been consistently as good over two decades of underwriting, including Brindle's record at Lloyds.   :)

 

Thanks for posting presentation

[twacowfca]

One must remember that LREs model isnt scalable which is why we have those huge dividends and more recently share buybacks. They are quite happy staying small. Also the investments gains are not what I am looking for, but they are running 8% annualized for this year. Not too bad considering the short tail nature of the business and current rates.

 

Actually, a lot of their business probably is scalable.  But that's the most volatile part of the business, and they will pass on a lot of good business when rates are high to avoid trouble if there is a big cat.  The next time there is a big storm, I think they will have substantially lower losses in relation to their capital than their close competitors.  95% of the rigs they are now insuring will probably survive in good shape.

[twacowfca]

Numbers are impressive.

 

My question is what would prevent smart insurance guys like FFH, MKL, BRK from underwriting the same properties which would decrease profits/decrease underwriting results.

 

Numbers look too good to be true

 

Thanks for posting presentation

 

FFH and LRE are totally different structures. FFH relies on investment income while LRE relies on Underwriting profit. FFH would not have grown as fast if it had used LRE model. LRE model is limited to a small underwriting size, their capital structure will shrink and grow with cycles. The best of both worlds woul be FFH to buy LRE and then take the profits and invest it for us.

 

BeerBaron

 

I mentioned that possibility to Prem after the last AGM, but he didn't seem very interested.  I think he, like WEB likes to buy insurers with a lot of long tail business to invest the float, and is happy to do so if he can break even or something close to even on the underwriting.

[twacowfca]

A new presentation

http://www.lancashiregroup.com/lre_group/investor_relations/results_presentations/presentations/

 

Notice the dog?  That's Brindle's dog.  He's huge, but friendly of course.  Wanders around their London office like he owns it.  Makes me think of what it must have been like for the King's dog to walk about the castle.  ;) 

[Myth465]

LOL on the dog. Thanks for the info regarding scalability. So you believe they could write a lot more but would end up overexposed to the sector with the prospects.

[twacowfca]

LOL on the dog. Thanks for the info regarding scalability. So you believe they could write a lot more but would end up overexposed to the sector with the prospects.

 

Yup.  But only when the pricing in their key areas is good.  Pricing in their sweet spots has been acceptable to excellent for the most part during the last five years.  However, in a year like 08 up till Ike hit, they would pass on a lot of business.

 

There is one class that has been generally strong since Katrina et al.  That's cat retro.  The retro they write is top of the food chain, the top tier of natural, elemental supercat risk.  However, too much retro can kill a company if the big one hits.  Sometimes there is an opportunity to write extra retro through a sidecar where hedge funds take most of the risk, but with substantial potential profit left for the reinsurer.  However, the growth of the cat bond market has reduced the interest in sidecars.

[calonego]

TWA,

 

I've owned this for a while, great organization...

 

I can't get a clean breakdown of totals for direct, Re and retro... Am I missing something??

I'm guess there isn't like over 50% of the biz in Re or retro because the Re liabilities are 1/10th the Re receivable asset...

Any help is appreciated.

[twacowfca]

TWA,

 

I've owned this for a while, great organization...

 

I can't get a clean breakdown of totals for direct, Re and retro... Am I missing something??

I'm guess there isn't like over 50% of the biz in Re or retro because the Re liabilities are 1/10th the Re receivable asset...

Any help is appreciated.

 

Reinsurance for elemental risks (mostly hurricanes) was the majority of Lancashire's business right after their December, 2005 IPO because rates were the highest ever for that class, and reinsurance was relatively easy to write as they were building up their underwriting staff very selectively.  Reinsurance is the most commoditized of their lines of business.   Reinsurance may be lucrative when rates for cat coverage are high, but reinsurers that lack underwriting discipline are slaves to the market when it softens. Rates for the retrocessional policies they write are still very high after getting a boost in the wake of hurricane Ike.  But Lancashire have redirected most of their business in recent years to specialized insurance to reduce the potential volatility in future earnings associated with exposure to retrocessional policies.

 

Lancashire's main  niche in the reinsurance segment of their business is the kind of risk that most other companies would rather avoid: retrocessional policies assuming risk ceded by reinsurance companies that will pay off almost certainly at 100% of the policy limit only when there is a big loss like Katrina.  These policies will always have abnormal long term returns for those insurers that can survive the volatility and not withdraw from the market after a huge loss event when rates will subsequently be at the max.  Thus, in a sense, reinsurance companies that write top tier retrocessional policies at the highest attachment points have their own perpetual moat in the long run.  Aye, there's the rub: in the long run.  Many reinsurers exited that business after Katrina, just as rates were spiking to peaks that were three to six times higher than before Katrina.

 

Insurance companies lead a double life.  They are in the business of taking volatility away from their clients. But they are constantly seeking ways to reduce their own volatility.  Lloyds insurers do this not so much by assessing probabilities as by "making book" in the same way that a bookie makes his book at the racetrack. This is how Lloyds have done business for over one hundred years, going back to when Keynes described their methods in his Treatise on Probability.  

 

With high rates in the energy market, Lloyds syndicates prefer to insure very risky jack up rigs and then reinsure most of that risk.  This will guarantee a small profit most of the time and let them suffer only a small loss after a damaging hurricane.  With their bookmaking culture, they would rather have a small gain and a guarantee against a large loss than accept a lower premium rate for a deepwater rig that can't be easily reinsured, even though the deepwater rig is very likely to ride out the worst hurricane without significant damage.  

 

Lancashire, in contrast, prefer to insure deepwater rigs because of the high probability of suffering no loss at all from the worst windstorms. These huge floating rigs easily ride out the relatively low amplitude hurricane waves that occur in deep water, in contrast to the pounding hurricane waves that often occur in shallower water where most oil rigs are permanently situated.  The occassional small proportional loss from an accident to a deepwater rig like Deepwater Horizon is easily manageable.  They liked the part of their $50M coverage for that rig that was for elemental risk.  But, they did not particularily like the part of the coverage that was for accidental loss because of the mediocre accident records of the leasor and driller.  Therefore, Lancashire reinsured half the accident risk that they had covered, and that accident cost them only $25M instead of $50M, less than one month's profit.  The loss of a deepwater rig to a windstorm is something that has not yet happened.  The idea of many deepwater rigs going down in a big storm is most unlikely.  

 

Lancashire's preference for insuring against events that have never happened extends to other classes of insurance.  There are important exclusions and careful selections in the AV 52 insurance they write that make it highly improbable that they will ever have to pay a claim for that coverage.  They won't insure property against terrorism coverage if the property is in a high profile location.  But if a manufacturer in the american midwest wants terrorism coverage for their gated and guarded plants outside of urban areas,  Lancashire may be pleased to provide insurance as a much lower rate than the rate for covering a high profile possible target.   If you own older ships, Lancashire will not be at the head of the line offering insurance, even if you are willing to pay a high premium.  But, if you need coverage for the newest cruise ship that never sails into stormy seas and has state of the art safety precautions, Lancashire may be one of the underwriters for your coverage at an economical rate.  Lancashire's approach to choosing to insure specialized risks is like the approach Warren Buffett uses for risk arbitrage: carefully select risks that have a high probability of no loss.  This has worked very well for Brindle and Lancashire over the years.

 

Lancashire's business has changed dramatically since their first year of operation.  Reinsurance now accounts for only a little more than one fourth of their premiums.  Their projected maximum loss (PML) from a very bad "hundred year storm" that would cause losses two and one half times as bad as the losses from Katrina is now equal to only about 8 months of earnings in a low loss year.  Today's PML is down from a PML that was about 50% higher in their first two years of operation.

 

They have achieved this transformation by concentrating on insurance, rather than reinsurance, and specializing in insuring against events that have never happened and probably never will happen within a lifetime to the extent of a bad loss.  This business is written out of their London office into the Lloyds market right accross the street.  The Lloyds market is full of all sorts of little moats, based on broker and client relationships and a company's reputation that is built up as a lead underwriter for specialized coverage.  

Lancashire is the lead underwriter for some of their favorite niches.

 

The downside of Lloyds is that it's so tight and clubby that the members sometimes engage in groupthink and follow a leader off a cliff.  Lancashire avoids this by being nearby, but not part of the club. Brindle and his team know the key brokers and leading underwriters in the syndicates. They are able to participate in the Lloyds market without being caught up in the institutional imperative.

 

There is a nice pie chart in the Q3 presentation that breaks their business down into component parts by percentage.  :)

 

[calonego]

TWA,

 

Thanks for the reply.

I missed the direct vs Re pie in the Q3 slideshow, thanks!

That's about where I was expecting it to be, but I seem to forget where they hide this stuff every 6-8 mths!

[tombgrt]

Embarrassed to ask but I like to be sure... How would I get to an accurate estimate of the current BV?

Simply subtract 1,40 from 8,43 (reported in Q3) and add a certain percentage for BV growth in the last 3 months afterwards?  :-X

 

And how are special dividends taxed? The same as normal dividends? Or does it variate depending where you are from (Belgium, Europe in my case). We have a double fiscal system here, taxing twice for foreign stocks. That would leave me with 67,5% of each special dividend.

[twacowfca]

Embarrassed to ask but I like to be sure... How would I get to an accurate estimate of the current BV?

Simply subtract 1,40 from 8,43 (reported in Q3) and add a certain percentage for BV growth in the last 3 months afterwards?  :-X

 

And how are special dividends taxed? The same as normal dividends? Or does it variate depending where you are from (Belgium, Europe in my case). We have a double fiscal system here, taxing twice for foreign stocks. That would leave me with 67,5% of each special dividend.

 

The estimation of forward BV is not quite straightforward.  Q4 fully diluted book value per share will be better than you might think because of the many warrants outstanding.  The warrant strike price is lower than the stock price.  Therefore, the automatic lowering of the stock price after the big special dividend gets the stock price closer to the warrants'  strike price of $5.00/SH for most of the warrants.  This has a favorable impact on the calculation of fully diluted BV/SH.

 

As a rule of thumb, I assume that the fully diluted book value per share of LRE will increase 5% to 8% in a quarter that does not have a big cat loss in the areas where they write business.  This is consistent with their past results.  Q4's increase may be in the upper end of that range for the current low loss quarter.  We'll see.

 

The special dividends are not tax efficient in many jurisdictions because Bermuda, as an income tax free jurisdiction, does not have tax treaties with other countries.  The tax free earnings of Bermuda companies are somewhat less desirable when paid out as dividends.  Thus, it's more efficient to hold LRE in a tax free account if possible.  On the other hand, returning capital to shareholders through large special dividends does have a beneficial effect on FDBV/SH.  

 

Hypothetically, if enough money were paid in special dividends to reduce BV/SH to the strike price of the warrants (about $5.00 per warrant for the great majority), there would be no dilution at all from exercise of the warrants at that same price!

[tombgrt]

Embarrassed to ask but I like to be sure... How would I get to an accurate estimate of the current BV?

Simply subtract 1,40 from 8,43 (reported in Q3) and add a certain percentage for BV growth in the last 3 months afterwards?  :-X

 

And how are special dividends taxed? The same as normal dividends? Or does it variate depending where you are from (Belgium, Europe in my case). We have a double fiscal system here, taxing twice for foreign stocks. That would leave me with 67,5% of each special dividend.

 

The estimation of forward BV is not quite straightforward.  Q4 fully diluted book value per share will be better than you might think because of the many warrants outstanding.  The warrant strike price is lower than the stock price.  Therefore, the automatic lowering of the stock price after the big special dividend gets the stock price closer to the warrants'  strike price of $5.00/SH for most of the warrants.  This has a favorable impact on the calculation of fully diluted BV/SH.

 

As a rule of thumb, I assume that the fully diluted book value per share of LRE will increase 5% to 8% in a quarter that does not have a big cat loss in the areas where they write business.  This is consistent with their past results.  Q4's increase may be in the upper end of that range for the current low loss quarter.  We'll see.

 

The special dividends are not tax efficient in many jurisdictions because Bermuda, as an income tax free jurisdiction, does not have tax treaties with other countries.  The tax free earnings of Bermuda companies are somewhat less desirable when paid out as dividends.  Thus, it's more efficient to hold LRE in a tax free account if possible.  On the other hand, returning capital to shareholders through large special dividends does have a beneficial effect on FDBV/SH.  

 

Hypothetically, if enough money were paid in special dividends to reduce BV/SH to the strike price of the warrants (about $5.00 per warrant for the great majority), there would be no dilution at all from exercise of the warrants at that same price!

 

Thanks for your explanation twacowcfa. I am not really sure if I fully understand how the warrants have a positive effect on the FDBV/SH tho. :x

 

Isn't 5% to 8% a rather high estimate? An average of 6,5% BV per quarter would give an annual growth rate of 28%+. Of course, that would be assuming they don't suffer a big cat loss.

 

How do you think a hardering market would eventually effect LRE? Would they actually benefit much from it? Considering they are speciality insurers with already amazing combined ratio's, I would think there is little room for improvement? Because they are so specialised and small, they are able to move swiftly to the best area's within their expertise anyway.

[twacowfca]

Embarrassed to ask but I like to be sure... How would I get to an accurate estimate of the current BV?

Simply subtract 1,40 from 8,43 (reported in Q3) and add a certain percentage for BV growth in the last 3 months afterwards?  :-X

 

And how are special dividends taxed? The same as normal dividends? Or does it variate depending where you are from (Belgium, Europe in my case). We have a double fiscal system here, taxing twice for foreign stocks. That would leave me with 67,5% of each special dividend.

 

The estimation of forward BV is not quite straightforward.  Q4 fully diluted book value per share will be better than you might think because of the many warrants outstanding.  The warrant strike price is lower than the stock price.  Therefore, the automatic lowering of the stock price after the big special dividend gets the stock price closer to the warrants'  strike price of $5.00/SH for most of the warrants.  This has a favorable impact on the calculation of fully diluted BV/SH.

 

As a rule of thumb, I assume that the fully diluted book value per share of LRE will increase 5% to 8% in a quarter that does not have a big cat loss in the areas where they write business.  This is consistent with their past results.  Q4's increase may be in the upper end of that range for the current low loss quarter.  We'll see.

 

The special dividends are not tax efficient in many jurisdictions because Bermuda, as an income tax free jurisdiction, does not have tax treaties with other countries.  The tax free earnings of Bermuda companies are somewhat less desirable when paid out as dividends.  Thus, it's more efficient to hold LRE in a tax free account if possible.  On the other hand, returning capital to shareholders through large special dividends does have a beneficial effect on FDBV/SH.  

 

Hypothetically, if enough money were paid in special dividends to reduce BV/SH to the strike price of the warrants (about $5.00 per warrant for the great majority), there would be no dilution at all from exercise of the warrants at that same price!

 

Thanks for your explanation twacowcfa. I am not really sure if I fully understand how the warrants have a positive effect on the FDBV/SH tho. :x

 

Isn't 5% to 8% a rather high estimate? An average of 6,5% BV per quarter would give an annual growth rate of 28%+. Of course, that would be assuming they don't suffer a big cat loss.

 

How do you think a hardering market would eventually effect LRE? Would they actually benefit much from it? Considering they are speciality insurers with already amazing combined ratio's, I would think there is little room for improvement? Because they are so specialised and small, they are able to move swiftly to the best area's within their expertise anyway.

 

 

As the price of the stock rises, there is a drag on the increase in BV/SH because the company would have to give up more value in a potential conversion of the warrants than the company would receive from payment of the $5.00/SH strike price.  When the share price declines, there is a reverse effect.

 

Lancashire has been overcapitalized for the amount of insurance they write.

As book value is right sized they have a potential to increase their historical growth rate in book value as a percentage of their equity.  Historically, they have averaged a little less than 5% growth in FDBV/SH per quarter.  With adjustment for their start up year when earned premiums lagged, their growth in FDBV/SH  would have been higher.  Their history includes losses from hurricane Ike, the Chile earthquake and other lesser catastrophes.  Most of their losses have been cats.  In a quarter with no exposed cat losses, their loss ratio has been in the very low double digits.  One quarter their loss ratio was actually negative, although their accident year loss ratio was positive.  :)

 

They are highly profitable.  Therefore a generally hardening market would help struggling insurers more than Lancashire.  However, a hardening market would provide greater opportunity to be nimble and shift to other lines should some of their lines soften.  They stay nimble and don't hesitate to pass on business if they don't  like the rates and shift to other lines that may become more attractive

[tombgrt]

 

As the price of the stock rises, there is a drag on the increase in BV/SH because the company would have to give up more value in a potential conversion of the warrants than the company would receive from payment of the $5.00/SH strike price.  When the share price declines, there is a reverse effect.

 

Lancashire has been overcapitalized for the amount of insurance they write.

As book value is right sized they have a potential to increase their historical growth rate in book value as a percentage of their equity.  Historically, they have averaged a little less than 5% growth in FDBV/SH per quarter.  With adjustment for their start up year when earned premiums lagged, their growth in FDBV/SH  would have been higher.  Their history includes losses from hurricane Ike, the Chile earthquake and other lesser catastrophes.  Most of their losses have been cats.  In a quarter with no exposed cat losses, their loss ratio has been in the very low single digits.  One quarter their loss ratio was actually negative, although their accident year loss ratio was positive.  :)

 

They are highly profitable.  Therefore a generally hardening market would help struggling insurers more than Lancashire.  However, a hardening market would provide greater opportunity to be nimble and shift to other lines should some of their lines soften.  They stay nimble and don't hesitate to pass on business if they don't  like the rates and shift to other lines that may become more attractive

 

I get in now, that part on the warrants.  ;D Thanks.

What would you estimate the current FDBV/SH would be for Q4? Or would that be to hard to tell?

 

I appreciate the depth of your answers, they are really useful and mke a lot of sense.

[Myth465]

I think you can take Q3 BV, subtract the dividend, and add Q3 earnings for Q4. That will give you a conservative number inmo. I think earnings will be higher due to reserve releases and lack of cats.

 

Just to give you an idea Q4 featured a combined ratio of less than 26%

[sdev]

Not sure that using q3 earnings is conservative. Definitely possible and maybe considered probable but not conservative.

[Myth465]

Not sure that using q3 earnings is conservative. Definitely possible and maybe considered probable but not conservative.

 

LOL to each there own. But you are correct, I guess anything could happen with 2 more days left in the year or they could have a huge increase in reserves for some unannounced reason. For me it appears conservative.

[biaggio]

Is the fact that they write short tail insurance decrease the risk that they are not booking enough reserves for future losses? (sorry if this is  a stupid question). With a combined ratio of less than 26% I can t help but think that something is not right.

[twacowfca]

Is the fact that they write short tail insurance decrease the risk that they are not booking enough reserves for future losses? (sorry if this is  a stupid question). With a combined ratio of less than 26% I can t help but think that something is not right.

 

It does look too good to be true, but there is no place to hide reserve deficiencies for long in short tail property insurance if a company doesn't play games with finite reinsurance.  Neither LRE nor the other better Bermuda and Lloyds companies that specialize in property insurance or reinsurance do this.  In fact, LRE and their friendly competitors have a history of consistent and substantial over reserving.  

 

The main exception to this virtuous pattern would be the aftermath of a megacatastrophe like KRW in 2005.  Then, it took a few months longer than normal to sort things out and properly establish reserves for reinsurers especially.  If a megacatastrophe were to happen, LRE would be one of the first companies to establish reserves with a high degree of certainty because the retro policies they underwrite have top tier attachment points that would not be impacted much by all the nitty gritty details that apply to other policies.  LRE anticipate they will pay off their retrocessional claims quickly after a megacatastrophe and maintain their sterling reputation in the industry.

 

 

Interestingly, the Solvency II regime will impact the European and Bermuda markets increasingly as companies prepare for its implementation in the next few years.  This will eliminate most of the games insurers play with reserves.  The better reinsurers that are well capitalized and conservative in reserving will benefit enormously as the poorer primary insurers will have to raise capital or, more likely, cede more premiums to the better reinsurers.  This will promote the hardening of markets in Europe and, indirectly, worldwide.

[Myth465]

Not Bad. Not Bad at all.

 

I cant wait for a sell off. I need more of this gem. Looks like I was a bit conservative.

 

 

GROWTH IN FULLY CONVERTED BOOK VALUE PER SHARE, ADJUSTED FOR DIVIDENDS, OF 6.4% IN Q4, 23.3% IN 2010; COMBINED RATIO OF 20.8% FOR Q4, 54.4% FOR 2010 FINAL DIVIDEND OF 10.0 CENTS PER COMMON SHARE FULLY CONVERTED BOOK VALUE PER SHARE OF $7.57 AT 31 DECEMBER 2010

 

http://www.lancashiregroup.com/lre_group/investor_relations/

[twacowfca]

Plus, accident year Q4 loss ratio 7.2% and total investment return (0.4)%, reflecting the short duration of their portfolio that was resistant to the greater volatility that some other P&C companies with longer durations have experienced recently.  :)

[twacowfca]

Reactions recently posted an article about Lancashire indicating that analysts are finally beginning to consider the possibility that something more than mere luck is behind their results.

 

 

Bermuda-domiciled specialist underwriter Lancashire has reported what one leading analyst called a “stunning underwriting result” for 2010. While the firm has posted pre-tax profits of $339.2m, down 12% against 2009, it has produced a combined ratio of just 54%. The combined ratio for the fourth quarter of 2010 was 20.8%.

 

Eammon Flanagan, an analyst at UK-based Shore Capital, said: “This performance enhances Lancashire’s burgeoning reputation as a quality underwriter and makes a mockery of its previous reputation as a ‘white-knuckle’ ride. Whilst accepting that its risk appetite is likely to be greater than its peers, it still delivered, what we expect to be, a sector beating combined ratio.”

 

Due to a strong focus on capital and cycle management, the firm’s return on equity for 2010 was 23.3%.

 

There were no shares repurchased during the fourth quarter of 2010 compared to $16.9m of shares repurchased in the same period of 2009. In total $136.4m of shares were repurchased in the year ended December 31, 2010 and $16.9m in the year ended December 31, 2009.

 

A spokesperson for Lancashire, Jonny Creagh-Coen, told Reactions that his firm had successfully managed to navigate its way through most of the catastrophes in 2010 thanks to strict underwriting discipline. This process includes regular underwriting conference calls between all key members of staff, including the CEO and chief underwriting officer.

 

“We very carefully select the business we write,” he said. “The conference call is like a very strong ERM [enterprise risk management] tool. It allows us to make quick decisions. There is a need to have a nimble approach.”

 

“We view this performance as quite stunning given the level of ‘cat’ losses during 2010. The Chile earthquake loss estimate was reduced by c$7m to $85m, whilst Deepwater losses are expected to amount to $25m [unchanged]. Lancashire anticipates losses from the New Zealand earthquake and from the Q4 2010 Queensland floods to amount to less than $5m… again a terrific outcome, in our view,” added Flanagan.

 

Creagh-Coen added: “The days of underwriting to generate investment income are over. We put underwriting first.”

 

He also said that while energy remains a core focus for the firm, the political unrest and violence in the Middle East was once again making political violence cover a more high-profile business line. “It reminds people to cover certain risks. It concentrates the mind.”

 

[JoJo1]

“The days of underwriting to generate investment income are over. We put underwriting first.”

 

Does Fairfax has a Chief Underwriting Officer? What are their underwriting strategies?

Why is it running like crazy with LRE and doesn't work with Fairfax?

Are they "incompetent"? A result of their patchwork culture? I cannot believe in such simple answers, there somewhere is some more science :-)

 

<jr>