Investors are fairly spoiled for choice when it comes to the insurance sector, so not only can they afford to be picky, but they pretty much have to be. With the sector having been relatively strong of late, despite weak investment returns, a lot of the great bargains in the space have disappeared. RenaissanceRe (NYSE:RNR) is a difficult case in point; while this company remains a top-flight reinsurance company and is not exactly overpriced, it's not that much of a bargain either.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Conditions Improving, but...
On first blush, last year was about as bad as it gets for insurance underwriters. There were multiple serious earthquakes, severe storms like tornadoes and hurricanes, and major flooding in Australia and Thailand. Not surprisingly, reinsurance companies like RenRe and PartnerRe (NYSE:PRE) reported losses for the year, while Arch Capital (Nasdaq:ACGL) reported a significant drop in profits.

As it turns out, though, 2011 wasn't as much of a disaster as you might imagine. Most of the major insurance companies were in good shape with respect to their reserves, and investors have since looked back on the disasters as a potential catalyst for a harder market (that is, higher premiums). And they have been right - prices have increased in markets like Japan and Australia, as well as Florida.

SEE: How An Insurance Company Determines Your Premiums

Competition Is Whittling Down the Prices
Unfortunately, while rates have improved, they haven't been improving as much as Wall Street's sell-side community had been hoping. Based on the reports coming from companies like Arch Capital, PartnerRe, Everest Re (NYSE:RE), XL Group (NYSE:XL) and RenRe, pricing in Florida has been increasing more on the order of mid-single-digits instead of the high-single-digits that analysts had projected. Likewise, while the pricing jumps in Japan look gaudy, they have been easing off.

Why is pricing coming in weaker than expected? The disasters and catastrophes in 2011 didn't destroy capital or investor interest in the sector like 9/11 or Hurricane Katrina did. Consequently, there has been pretty active issuance of cat bonds and formation of side-cars and hedge fund-sponsored start-ups. All that means is that there's a lot of capital looking for underwriting business.

Now, RenRe has been pretty aggressive in expanding its side-car business, as well as putting excess capital to work in writing reinsurance business. Nevertheless, lower-than-expected pricing may start to lead analysts to rein in earnings and book value growth assumptions.

SEE: Can Earnings Guidance Accurately Predict The Future?

Can RenRe Maintain Its Advantage and Double-Digit ROEs?
RenRe has long been a leader in property reinsurance, using sophisticated risk analytics and modeling to generate superior returns. It's worth asking if those superior returns are sustainable. Post-9/11 and Katrina, most of the surviving or newly-created insurance companies have intensified their risk-modeling efforts and the industry may have closed some of the gap with RenRe. Likewise, as RenRe grows larger, it's going to be harder and harder to maintain those returns (absent large returns of capital to shareholders).

It's also worth noting that RenRe is highly dependent on brokers. Nearly 90% of the company's business goes through Aon (NYSE:AON), Willis (NYSE:WSH), or Marsh & McLennan (NYSE:MMC). It's hard to get worked up about this as a risk factor, as it has been the case for so many years now, but it's worth noting all the same.

SEE: How Companies Use Derivatives To Hedge Risk

The Bottom Line
Berkshire Hathaway is a very good example of the sort of capital and returns that a well-run reinsurance business can produce. RenRe isn't "another/the next Berkshire," but it is a very well-run property reinsurance company. I do believe investors can depend upon this company to produce returns on equity and book value growth that put it in the top tier of reinsurance companies over the long run.

That said, today's price is not immensely compelling. Assuming that RenRe can maintain low teen ROEs for the long term, the stock is about 10-15% underpriced today. That's not a bad "hold" and may even be enough for long-term investors, but it doesn't make for the greatest buy on the market.

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

Related Articles
  1. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  2. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  3. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  4. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  5. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  6. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  7. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  8. Investing

    Don't Freak Out Over Black Swans; Be Prepared

    Could 2016 be a big year for black swans? Who knows? Here's what black swans are, how they can devastate the unprepared, and how the prepared can emerge unscathed.
  9. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  10. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
Trading Center