Everest Re Trying To Balance Risk And Opportunity

By Stephen D. Simpson, CFA | June 12, 2012 AAA

Plenty has been written over the last few months about the hardening market in many insurance markets. With companies forced to pay out for major disasters across the globe, including major earthquakes and floods, companies are now pushing through policy price increases for the first time in quite a while.

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When it comes to Everest Re (NYSE:RE), though, there appears to be some limit to how much this hardening market will help. Everest Re is a quality insurance company, and one with substantial property reinsurance exposure, but the company's decision to prudently manage its risk exposure could limit some of the growth potential from these market developments.

Looking Back on Q1 - OK Growth, but Improving Underwriting
Investors can see some of that in the results that the company reported for the first quarter. Premium growth was actually non-existent; the company reported around a 1% decline in net written premiums as a 5% increase in reinsurance was overwhelmed by a 21% decline in the insurance business. That's weaker even than ACE Limited (NYSE:ACE), and well behind the likes of XL Group (NYSE:XL), Arch Capital (Nasdaq:ACGL) or RenaissanceRe (NYSE:RNR).

Pricing isn't the problem. Pricing in Florida is on track to grow roughly 5-10% this year (and Everest is a leading underwriter in Florida) and Japan is up as much as 60% in some cases. The problem, though, is that the company is already where it wants to be in terms of probable maximum loss (PML) in markets like Florida and Japan, and is instead looking to regions like the Northeast and Midwest for underwriting growth. Like Allied World (NYSE:AWH), the company is also looking to expand its sizable crop insurance business in North America.

SEE: The History Of Insurance In America

Losses Getting Better, Will It Help Reserves?
Everest Re's reported loss ratio for the first quarter was quite solid and the catastrophe loss looked good. Then again, based on the reports of other companies in the sector, it should have been expected to be good.

One of the ongoing questions for Everest concerns its balance sheet and reserve position. Historically, Everest's balance sheet has been a little weaker than those of rivals like Arch Capital or RenRe. Likewise, Everest doesn't have a great history of releasing reserves. Analyzing reserves is an inexact science, but Everest Re's reserve position seems to be improving and while the company does not appear to be dramatically over-reserved, there should be enough flexibility there to expand the business (by underwriting more business) and/or continue respectable dividends and buybacks.

Risks Remain and Always Will
There are always risks and uncertainties with insurance, and that's particularly true with companies like Everest Re that underwrite policies with infrequent but potentially massive payouts. For instance, Everest Re is every bit as vulnerable to the weak interest rate environment today as any other insurance company, and the low rates have forced the company to choose between earning less and taking on greater risk.

There are also meaningful risks inherent to the business. Of the reinsurance stocks I follow relatively closely, only PartnerRe (NYSE:PRE) and RenRe have more exposure to property reinsurance than Everest Re, and the company has far more at risk here than ACE, XL or Arch Capital. If there's a major hurricane or another major earthquake in a populated area, there are going to be losses. On the flip side, property reinsurance is one of the strongest markets from a price perspective and Everest Re could lock up some profitable business.

The Bottom Line
Everest Re falls between stocks like Arch Capital and Allied World, which look fairly priced today and those like ACE and XL, that look reasonably interesting. If Everest Re can achieve the same sort of long-term return on equity as Arch Capital or Allied World (around 10%), fair value approaches $120. Everest Re also looks a little undervalued on a price/book or price/tangible book perspective and though investors shouldn't ignore the past issues with the balance sheet and reserves, this could be a reasonable investment idea on even a modest pullback.

SEE: Financial Ratio Tutorial

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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