With the 2004 and 2005 storm seasons clearly etched in their minds, some investors are overreacting every time the wind blows and missing an opportunity, explains Lindsey Rogerson.

Reinsurers have been "making hay while the sun shone" this summer, according to market observers. Indeed it is now becoming clear that predictions of a "vintage year" by Hannover Re earlier this year may be right on the money. Converium recently said its 40% increase in premium income had exceeded expectations, and Guy Carpenter said average increases on catastrophe rates in Mexico and the US were up by 76% and 129% respectively.

But as yet few reinsurers are willing to go on record, as Hannover Re has done, and declare this a bumper year. Many continue to hedge their bets with cautious talk of waiting to see how the rest of the hurricane season unfolds, a situation which has seen fund managers selling-off rather than flocking to their stocks.

While it is understandable that reinsurers are exercising some restraint given the substantial increases in two rounds of renewals, is it any wonder that fund managers spent August selling down their reinsurance holdings while companies remained silent on the prospect for healthy profits in 2006?

At the time of writing there had been eight named storms in the Gulf of Mexico, compared to 18 at the same point in 2005. Indeed, weather forecasting groups, while still predicting an above average hurricane season for the Gulf of Mexico, have scaled back their forecasts for both the number and severity of storms for the rest of the year. If these reduced predictions turn out to be correct then many reinsurers in Bermuda, Europe and the US should be sitting on some healthy profits ... in theory.

But European reinsurance groups in particular are not just exposed to weather-related risks in the Gulf of Mexico. In 2002, European insurers and reinsurers were hit by a $4.1bn loss when much of Northern Europe was subject to extensive flooding. So how hard and how much rain falls in Europe this autumn remains a real concern.

But this concern must be put in context. Yes, the industry took a truly spectacular hit in 2005 but for the most part the industry has picked itself up and dusted itself off. Most have used Katrina to review the size and exact nature of business lines, freeing up capacity or raising fresh capital to take advantage of underwriting opportunities as and when they appear.

Hiscox's Syndicate 33 is the latest. Not content with starting up a new Bermudian reinsurer in 2005 - Hiscox Bermuda - the whole operation now intends to relocate to the island permanently. In September, the Hisox board announced it was upping sticks and re-domiciling. This was followed by a similar announcement by Omega Underwriting just days later.

Indeed there is mounting evidence that Katrina could ultimately prove a defining moment for reinsurance companies, but in a positive way. David Spiller, president and chief executive of Guy Carpenter, aptly summed up reinsurer behaviour post-Katrina. He said: "Rather than rush to the exits from the catastrophe reinsurance picture show, reinsurers in most parts of the globe stood their ground. They distinguished between areas where there was clear evidence of increased risk and areas where perceived risks remained relatively stable. In brief, the market generally reacted in a highly intelligent and discerning manner. Such a measured approach on the part of the industry is unique in itself and a hopeful sign for the future."

A bright future

All of the above taken together should, on paper at least, mean that from an investment manager's point of view there is much in the reinsurance world to excite at the moment. Standard news of acquisitions, consolidations, bond raising and sidecars is usually enough to prick a hedge fund manager's interest. However recent buying and selling trends suggest that fund mangers are shying away from such opportunities.

Joshua Shanker, a reinsurance analyst at Citigroup, believes the recent round of selling surrounding Tropical Storm Ernesto, which saw the PartnerRe shareprice fall 1.9% and Everest Re's fall 4% are an overreaction. "Short-term investors appear prone to sell reinsurance stocks as tropical depressions form into threatening hurricanes. However, considering the seven major storms of the last two years (Charley, Frances, Ivan, Jeanne, Katrina, Rita and Wilma) it would appear that, more often than not, reinsurance stocks have outperformed the market over the course of a hurricane's formation and landfall. Moreover, the flurry of buying associated with the relief rally has often caused the stocks to appreciate during a hurricane's migration to land."

Based on this research, Shanker said he was not only continuing to recommend the shares of both PartnerRe and Everest Re, but also believed there was a buying opportunity there: "While we advocated a basket of property-exposed reinsurance stocks as the best way to engage this opportunity while defraying the risk of loss from any one reinsurer, we believe that recent weakness in shares of PartnerRe and Everest Re make them opportunities to take advantage of."

He is far from alone in noting opportunities for investors in a post-Katrina world. Guy Carpenter singled out the increased use of sidecar investment vehicles and catastrophe bonds in its annual report published this month. In "The world catastrophe reinsurance market" it says that not only did sidecars and catastrophe bonds constitute an efficient way for investors to participate in a rising market, but they also helped dilute risk for established reinsurers - a factor which played well with rating agencies. Guy Carpenter also said it believed that considering the structural changes the industry had undergone, a stable season might be just what the industry needs. It is obviously also what fund mangers are waiting to see.

- Lindsey Rogerson is a freelance journalist.


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