LRE.L - Lancashire Holdings Ltd

[twacowfca]

Quite a study in contrasts in Bermuda this week at the S&P reinsurance conference. 

 

Mr. Mark Byrne was on a panel, and he expressed the opinion that reinsurance was a commodity business where no company could get an advantage over the competition.  We also heard his view that his reinsurance companies should hold on to extra capital so that they wouldn't have to take a 15% haircut from the banks when they otherwise might have to go back to them to raise capital  after experiencing large losses.

 

Then, I had the opportunity to sit down in the office of our favorite company and listen to a philosophy that was the polar opposite of Mr. Byrne's.  Their brilliant new chief underwriting officer explained the enormous amount of work that it takes to carve out products that provide them a competitive edge.  Then he told me how they carefully educate the brokers about the advantages to their clients of those products in what is normally a commodity business.

 

The results speak for themselves.  Check out the absence of large loss creep on LRE's earthquake exposure vs many other companies such as Flagstone, for example.  :)

[nwoodman]

Brilliant, thanks for sharing.  Any other insights come out of the conference in terms of policy pricing, capital losses from Euro exposure etc?  Thanks in advance

[twacowfca]

Brilliant, thanks for sharing.  Any other insights come out of the conference in terms of policy pricing, capital losses from Euro exposure etc?  Thanks in advance

 

Yup.  S&P's head watchdog said they did a thorough study of P&C primary insurers reserves.  The primary P&C insurers should run out of aggregate property reserve redundancies by the end of this year, but aggregate casualty reserve redundancies will last for another year or so at current rates of release.  Property premiums seem  to have bottomed and are rising, at least where there is some cat risk.  Workers comp is in the worst shape of all casualty classes in regard to continuing losses.

 

The retired CEO of a very large P&C reinsurer says that Dodd Frank is a fraud on the public.  It did nothing to stop MF Global from doubling it's leverage ratio as it was on a slippery slope to ruin.  In truth, it is actually a blank check for plaintiff trial lawyers to sue anyone for anything.  He says the trial lawyers are still filling in the amount on the blank check by actually writing the continuing to be developed regulations under the unspecified terms of the bill as they pull all sorts of things out of their wish bag.

 

One speaker opined that mainland Chinese CEOs rarely buy P&C insurance because they believe in fate.

 

The Florida State authority that reinsures windstorms is ridiculously undercapitalized for the next big one.  Losses could be as much as $500B if the next big one hits Miami.  Those losses that are reinsured by the state authority would then be dumped immediately onto every insurance company that does business in Florida as an assessment to bail out the state. 

 

Another speaker said that the losses from the Thai floods will cancel out every dime of profit that has ever been made out of the Singapore market.  He decried the stupidity of willy nilly international deworseification.  However, another speaker said developed markets for reinsurance will be mostly flat in the future while developing markets will grow six percent per year.

 

Another speaker indicated that model dependency sometimes makes international reinsurers patsies in the poker game with local primary insurers.  Local insurers for NZ earthquake risk evidently appreciated the full risks there and unloaded 90% of their earthquake risk to far away reinsurers who ignored something very important about the area.  The models of the international reinsurers failed utterly to predict the magnitude of the damage because their models were developed on experience in other areas.  New Zealand has very unstable soil in the urban areas of greatest risk.  The models did not capture this.  Now the reinsurers have become the patsy holding the bag with $15B in claims on policies with premiums that were inadequate to put it mildly.

 

All speakers on a panel agreed that Euro area financial companies are massively exposed to a run on the European banks at the worst or a mushdown at the least.    :-\

[nwoodman]

Q3 Investor presentation

 

http://www.lancashiregroup.com/lre_group/investor_relations/results_presentations/presentations/2011/q3-2011-investor-pres/q3-2011-investor-pres.pdf

[twacowfca]

Q3 Investor presentation

 

http://www.lancashiregroup.com/lre_group/investor_relations/results_presentations/presentations/2011/q3-2011-investor-pres/q3-2011-investor-pres.pdf

 

Thanks very much.  Please note on page 20 de minimus cat loss creep, the lowest among their peers.  :)

[rijk]

down nearly 9% today in London,........ do we finally get a chance to get in???

 

is this all related to the recent general market turmoil or is there a specific connection between lre and european sovereign debt or an insurance event that justifies a drop like this????

 

regards

rijk

[tombgrt]

You wish. Special dividend...  :D

[rijk]

ok, thanks...

 

regards

rijk

[link01]

They seem to have gotten better over the years.  It's possible that hitting their long term average return may be easier now than when they first started.  Their 100 and 250 year projected maximum losses have come down nicely in recent years.  It's possible to speculate that their average return going forward will be higher than in the past, especially in view of Solvency II and the prospect of a hard market in the not too distant future.  An average coupon of 20% on about $7.90 BV/SH is still better than anything else I see now, even with LRE's total return price up 50%+ in the last 12 months.

 

alas, it looks as if the new solvenyII rules will be watered down due to pressure from- who else- industry players. which is disappointing from the viewpoint of stronger, better managed insurers like lre who were counting on the weaker capital positions of insureres in the aggregate to help harden rates to the benefit of those less capital constrained.

 

makes lre a just little harder hold at 1.5x book value?

 

http://online.wsj.com/article/SB10001424052970204059804577229502818976934.html

 

Crisis? What crisis? Ultralow interest rates and the prospect of sovereign defaults ought to be toxic for insurers' balance sheets. Yet most European insurers report robust capital positions. France's AXA and Spain's Mapfre even improved their solvency ratios in 2011. New rules designed to better judge the risks that insurers take had threatened to leave the industry with a €37 billion ($48.6 billion) capital shortfall. Now, they have been so watered down that this gap has disappeared. Investors should question why.

 

Current European solvency rules are inadequate. Capital requirements are set as a proportion of reserves or premiums written. Different national rules make comparing insurers' solvency hard. Outside the Netherlands and the U.K., assets aren't always marked to market. In France, insurers can include unrealized gains on bonds but omit unrealized losses. In most countries, the value of insurers' liabilities—the amount they must pay out for future claims—can be fixed when they were written. In Germany, Munich Re's capital is inflated by rules that mark its assets, but not its liabilities, to market.

 

Regulators' answer to this is "Solvency II," which will apply from 2014. The rules will require insurers to mark both assets and liabilities to market and introduce risk-based capital weightings. But their effect depends largely on the discount rate used to value liabilities. Initially, regulators proposed using the most conservative "risk-free" rate available, the interbank swap rate. But they have since rowed back from this in two key ways.

 

First, they bowed to pressure from U.K. and German life insurers, which argued that using such a low-discount rate would disproportionately harm their large annuity-style business. These businesses may now be allowed to use a higher discount rate for policies that can't be cashed in by customers and where the insurer is less vulnerable to market risks.

 

The second fudge is designed to protect insurers in countries like Italy and Spain, where bond spreads have widened from the swap curve, meaning their assets are worth less but the value of their liabilities is rising. Insurers may now be allowed to include a "countercyclical premium," or higher discount rate at times of market stress. Without this, up to 30% of Europe's insurers would need to start rebuilding capital, notes J.P. Morgan.

 

Some compromise was inevitable. The new rules risked causing wild swings in solvency based on market moves, making it hard to price products and potentially triggering unnecessary capital increases. Unlike banks, insurers can rebuild capital by stopping writing new business and collecting premiums. But the rules have moved a long way from the market-based view of risks originally intended. And a solvency regime that ignores all European sovereign credit risk looks increasingly unrealistic. Investors could end up none the wiser

 

[twacowfca]

LRE Q4 results out: 13.4 growth in fully converted BV/SH for full year.  Not too shabby in a year that's a tie for worst cat year ever.  This is well ahead of all their competitors who have cat exposure. Most of their peers either lost their shirts last year or barely broke even.  All but 1.8% of LRE's return was from underwriting.  IMO, they may have over reserved $40M in Q4.  Time will tell.

[accutronman]

Latest from Citi on LRE:

 

Conclusions: Lancashire has delivered another strong set of results in 2011.

Generating a 13% ROE and paying another large special dividend is an achievement

against the background of the worst year for catastrophe losses ever. We expect

underwriting margins to remain better than peers and note that its capital position is

marginally better at the start of 2012 than it was at the start of 2011. The shares trade

at a premium on 1.44x 2012E NTA, but we believe this is justified by strong

underwriting and capital management. We retain our Buy recommendation.

[bookie71]

The official results:

http://otp.investis.com/clients/uk/lancashiregroup/rns/regulatory-story.aspx?cid=326&newsid=237870

[sdev]

Actually the most worrisome thing to me is that Neil McConachie abruptly announced he is leaving after 2012. He has only been in that position for a short amount of time on a relative basis. I would like to know more about why that happened, but happy that he will stay on the board. He was always a good person to listen to on the conference calls. In addition, as long as Brindle is tied to the operation, I'll feel somewhat at peace.

 

1.6x book these days? I liked it better when it was still around book and had the option to buy more.

[Myth465]

LRE is getting pricey. I have nothing to really replace it with though. 1.6 is pretty high and cuts down on the superior return they offer. On the other hand, we are entering a slightly hard market due to all the cats..... Not sure what to do so I will probably just hold. 1.5 - 2 was my sell range though.

[twacowfca]

Actually the most worrisome thing to me is that Neil McConachie abruptly announced he is leaving after 2012. He has only been in that position for a short amount of time on a relative basis. I would like to know more about why that happened, but happy that he will stay on the board. He was always a good person to listen to on the conference calls. In addition, as long as Brindle is tied to the operation, I'll feel somewhat at peace.

 

1.6x book these days? I liked it better when it was still around book and had the option to buy more.

 

Neil was key in getting financial credentials for LRE at their startup and during the early years.  He's a good financial man, but it doesn't take enormous skill to keep their portfolio high quality and short duration.  Richard runs the underwriting from London through their daily underwriting call.  Neil has wanted to return to the UK for sometime. His children are still young and can take advantage of the education system on the big island. 

 

 

[biaggio]

LRE is getting pricey. I have nothing to really replace it with though. 1.6 is pretty high and cuts down on the superior return they offer. On the other hand, we are entering a slightly hard market due to all the cats..... Not sure what to do so I will probably just hold. 1.5 - 2 was my sell range though.

 

why not replace it with cash until you find something?

[Myth465]

biaggio I am thinking of doing so. Was going to buy AIG, but may have missed the boat on that one. I am thinking of selling this with 3-4 other holdings to raise a big cash pile.

 

twacowfca at what BV point would you be a seller. I am up 50% and have 1-2 years worth of dividends. Holding insurers too high above book proved disastrous with AIG and FFH.

[twacowfca]

biaggio I am thinking of doing so. Was going to buy AIG, but may have missed the boat on that one. I am thinking of selling this with 3-4 other holdings to raise a big cash pile.

 

twacowfca at what BV point would you be a seller. I am up 50% and have 1-2 years worth of dividends. Holding insurers too high above book proved disastrous with AIG and FFH.

 

That's a good question. If you think their returns are too good to last, you might want to sell.  But, if you are correct in thinking that Brindle and team can equal or exceed Brindle's long term average return, you'll have a great compounding machine if you stay with a winner who has the best short tail underwriting record in recent decades.  :)

 

Their normalized dividend paying ability is still about 13%/annum at the current price of the stock, based on LRE's six year history and Brindle's much longer record at Lloyds in the 80's and 90's.  If Brindle has, in fact, gotten better in recent years, their renormalized returns are probably higher than the historical average, especially with cat rates now at record highs.

 

They don't hoard extra capital or use it to chase mediocre business; they pay earnings out in dividends or share repurchases unless rates are very attractive.  This lets them focus on the most profitable underwriting opportunities as they pop up with very high premiums after major cats.  Their underwriters are switch hitters, able to drop an entire class of coverage if rates are inadequate and move to a more profitable class.  They don't build corporate castles; they run a lean, mean underwriting machine.

 

Their dividends are now qualified for the 15% tax rate in the US beginning January 1, 2012 when their move to UK tax domicile became effective.  They pay zero corporate income tax on profits.

 

The market is now hardening like concrete in the diversified cat exposed areas where their underwriting strength lies. They picked up coverage that other insurers had dropped in NZ last year at rates that were 600% higher than the year before the NZ earthquakes.  Some rates for Asian coverage are reported to be 2 1/2 times higher now than before the disasters there last year.

 

Their reputation is so good that they are able to offload much of the risk of exploiting peak rates in certain cat exposed lines by using investors' money in sidecars,  getting an override plus a potential profit commission with the outside investors bearing most of the risk of the joint ventures.

 

In the middle of the last decade, before Katrina, the financial crisis, and the worst cat loss year ever in 2011, most Bermuda Re's traded for about 1.5 times BV, and the better Lloyds insurers traded for about 2 times BV.  I don't think 1.6 times BV is high for the best of class company.  Objectively, their peers are trading at a big discount to the normalized P/B for cat exposed Bermuda and Lloyds property insurers. 

 

I would expect that whole group of insurers to see gains in share prices if 2012 is a normal or low loss year.  However, if 2012 is a bad year for losses and LRE performs as well as it did in 2011, a 13.4% increase in fully converted BV/SH is something most companies would be delighted to have in a good year.  :)

 

 

[link01]

Their dividends are now qualified for the 15% tax rate in the US beginning January 1, 2012 when their move to UK tax domicile became effective.  They pay zero corporate income tax on profits.

 

The market is now hardening like concrete in the diversified cat exposed areas where their underwriting strength lies. They picked up coverage that other insurers had dropped in NZ last year at rates that were 600% higher than the year before the earthquakes there.  Some rates for other Asian coverage now are reported to be 2 1/2 times higher now than before the disasters there last year.

 

 

very good points, twa. but not so sure about the dividend treatment in 2013 & beyond:

 

C:\Users\lance\Desktop\Qualified dividend - Wikipedia, the free encyclopedia.htm

 

then, qualified dividends will be taxed at your income tax rate. income taxes are likely to rise for the forseeable deficit-ridden future. and that will make their policy- going forward- of paying out their estimated excess capital at the end of each year a very inefficient long term compounding vehicle...at least less than it could be if they were to beef up their investment team with top notch portfolio mangers & instead retain most of their earnings.

 

 

[twacowfca]

Their dividends are now qualified for the 15% tax rate in the US beginning January 1, 2012 when their move to UK tax domicile became effective.  They pay zero corporate income tax on profits.

 

The market is now hardening like concrete in the diversified cat exposed areas where their underwriting strength lies. They picked up coverage that other insurers had dropped in NZ last year at rates that were 600% higher than the year before the earthquakes there.  Some rates for other Asian coverage now are reported to be 2 1/2 times higher now than before the disasters there last year.

 

 

very good points, twa. but not so sure about the dividend treatment in 2013 & beyond:

 

C:\Users\lance\Desktop\Qualified dividend - Wikipedia, the free encyclopedia.htm

 

then, qualified dividends will be taxed at your income tax rate. income taxes are likely to rise for the forseeable deficit-ridden future. and that will make their policy- going forward- of paying out their estimated excess capital at the end of each year a very inefficient long term compounding vehicle...at least less than it could be if they were to beef up their investment team with top notch portfolio mangers & instead retain most of their earnings.

 

Good point.  But this will hit all qualifying US and foreign dividends unless Congress again extends, or makes permanent, the current low tax rate for dividends as they have done in the recent past.  Regardless, the US tax rate on LRE's dividends will no longer be disadvantaged, compared to their US or UK peers.  :)

[sdev]

I just wish the stock was around book so I could reinvest the dividends (or just have them buy back stock!).

[twacowfca]

I just wish the stock was around book so I could reinvest the dividends (or just have them buy back stock!).

 

Yup, as much as I like LRE, I'm still anchored to to their early years when they sold for book or less.  I almost had to kick myself last year to increase my holdings by another 15 %.  My anchoring made it hard to appreciate that they are still a normalized DCF bargain, based on the past record.

 

I reminded myself that I once had the remarkable privilege to see the original bill of sale and the  short, handwritten financial statement whereby Asa Candler paid 1.5 times NAV to purchase all rights to the Coca Cola Company from John Pemberton for about $2,900.00.  :)

[Myth465]

Thanks for your comments TWA. I read a Geoff Gannon article which agreed with your point. LRE might be an easy 20%-30% a year for years on out. Why cut your winners. I will give it until 2x BV and then will reevaluate. Will also add significantly at 1X BV. Thanks again.

[bookie71]

The best thing that happened to me a couple of years ago is that somehow my order got entered twice. (Probably doe to my hitting the enter button twice)

[twacowfca]

The best thing that happened to me a couple of years ago is that somehow my order got entered twice. (Probably doe to my hitting the enter button twice)

 

That's great!