Despite myriad problems facing the reinsurance sector, investors remain upbeat, explains Lindsey Rogerson
Given falling premium income, the ongoing investigation in the US and recent catastrophe payouts it may come as a surprise that analysts and fund managers are so upbeat about the reinsurance sector. But not only are they up beat, some have been dishing out upgrades, while fund managers are eyeing up investment opportunities.
At present, Hiscox Insurance Fund, is comprised of 17% reinsurance stocks, a weighting virtually unchanged over the last 12 months, and according to Nick Martin, investment analyst on the Hiscox Insurance Portfolio Fund, the fund is now looking to increase this weighting. "We are just waiting for a bit more of an opportunity," he explained, "but we think there is a case for putting a bit more money into the reinsurance sector at the appropriate time."
This could be good news for US small- to medium sized reinsurance groups as the fund tends to favour them over their larger European-based rivals for the simply reason that the Securities and Exchange Commission reporting rules generate greater transparency, according to Martin, which enables better analysis of companies.
"The US companies are better in terms of transparency. A lot of the older, larger (European) insurers, because they have been around for a long time, have much more legacy issues that are difficult for us to get to grips with," said Martin.
However Credit Suisse First Boston (CSFB) believes that Munich Re's efforts in the last two years are now starting to show through in the company's results, demonstrating that it is on top of its legacy issues. But as yet this has not led to upgrading of the company by most of the credit rating groups. To gage the importance of good credit ratings, one needs to look no further than Hannover Re, the only European reinsurer to grow premium income in Q1 05, up 12% at a time when it had the highest credit rating in its sector.
Pre-tax profits in the first quarter of 2005 were up 29% at Munich Re and CSFB feels the insurer has dealt with the issues at its subsidiary, American Re which had been pulling it down. CSFB's Robin Mitra, Farooq Hanif and Merryleas Hyde said in a recent research note that, "Management has been highly convincing in its reserves analyses for American Re. In this regard, we do believe that the group should not have to increase reserves in the US for the next three to four years, and in this respect the results of American Re should not only improve, but should be much more dependable."
Not only that, but CSFB is predicting for Munich Re the double whammy so loved by all fund managers, at present, that of a rising dividend and a return of money to shareholders via share buy-backs. "We are forecasting a dividend increase of 25% to EUR2.5 per share but we believe it could easily rise by 45% to EUR2.9 per share. At the same time, management appears committed to repurchasing shares in the future. We regard the shares as among the best value in the sector."
Benfield points out that three of the four big European insurers (those that report quarterly) have been negatively impacted in their results by movements in the US$, Euro exchange rate, which fell 4.7% in the three months to the end of June 2005, relative to the first quarter of 2005.
The reinsurance broker also noted that Converium, Hannover Re, Munich Re and SCOR had all seen their underwriting effected by the Erwin storm, which hit much of Northern Europe in January this year (see table).
However, Benfield believes that while the US reinsurers managed to "emerge relatively unscathed" from the Erwin storm, they will be hit by the seemingly inevitable overactive hurricane season, when it strikes later this year.
It also expressed confidence in the US reinsurance market's commitment to disciplined underwriting, which it attributes to an overall fall of 9% in premium income in Q1 2005.
Hiscox's Martin said, "We are still pretty upbeat on the US reinsurers.
A lot of them (company share prices) have held up well, but you would expect valuations to be higher than what they are, if you look at the return on equity in the second quarter."
One possible reason for this is put forward by Morgan Stanley, which believes the price-firming in the primary US insurance market will inevitably have to pass in part to the US reinsurance sector. Analysts Michael Broom and Jon Hocking said in a recent note, "We do not believe that the reinsurance segment can remain insulated from these primary pressures indefinitely - this could be a more important change to market sentiment over the medium-term."
Of course any such sentiment would eventually impact on European reinsurers, as well, to varying degrees: Converium and Hannover Re have exposure of 23% and 28% to the US market, while Munich Re and Swiss Re have considerably less, 14% and 15% respectively. In fact SCOR is the only reinsurer examined by Morgan Stanley free of significant US exposure.
However, Nick Martin feels that share prices are not reflecting performance for an alternative reason, attributing them rather to a quirk of investment markets. "Investors always want disciplined underwriters but at the same time they don't like to see premium income fall, so reinsurers can't win.
At the moment, we are seeing premium income coming down which is what you want to see as a sign of sensible underwriting, but at the same time people are thinking well if that is as good as it is going to get, perhaps it is time to move on to something else."
Martin also believes that the fact that primary insurers are holding on to a lot more business, without the need for reinsurance is an incredibly good sign for the cycle as a whole. "One of the main ways a cycle can start collapsing is if cheap reinsurance is available, because that tempts irresponsible players in the primary market, so it is good for the reinsurance market as a whole that this is not happening."
- Lindsey Rogerson is a freelance journalist.