Even though investment returns are low, and likely to remain so for the near future, many insurance company stocks have come to life over the last six months. One of the strongest has been Allied World Assurance (NYSE:AWH), a relatively small global insurance company that splits its activities among American and international insurance and reinsurance. While there are a lot of fine attributes that make Allied World a solid hold, the momentum in the stock has taken the cheapness out of the name.
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Strong Premiums, but Iffy Pricing
Like other insurance companies including W.R. Berkley (NYSE:WRB) and XL Group (NYSE:XL), Allied World has been reporting some solid premium growth recently. In the first quarter of 2012, for instance, net written premiums grew more than 20%.
While many insurers have talked about hardening markets (that is, prices moving up), Allied World's experience suggests that the improvement has not be universal or even. Overall, rates moved up more than 3%, but there was a huge spread between lines like professional liability insurance (where D&O was flat to up 2%) and U.S. property where prices rose by double-digits.
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One of the bear stories on Allied World has been that the company is too exposed to lines with little (or even negative) pricing leverage. One quarter does not dispel this concern (and, frankly, worries about sagging rates is an evergreen bear story), but it's clear that some markets are strengthening significantly.
Good Trends and an Attractive Balance Sheet
Allied World also seems to be making good progress on its profitability, as the expense ratio in the last quarter looked pretty good. It was also noteworthy that while the loss ratio was a bit higher than many analysts expected for the first quarter, it was only a small miss and a lot of the difference was from relatively uncommon man-made accidents like the Costa Concordia.
Overall, Allied World looks to be in very solid shape. Estimating redundant capital levels relies on a huge amount of guesswork, but relative to companies like Arch Capital (Nasdaq:ACGL) and XL, Allied World seems to be in very good shape (with perhaps 10% redundant capital). That points to the possibility of further positive reserve developments.
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The company's investment portfolio remains weighted towards short duration assets, with notable concentrations in corporate debt and sovereign debt of countries like Canada and Germany. All in all, it seems fair to say that Allied World's portfolio is such that if this portfolio goes south, there are going to be some widespread problems in the market.
Allied World is also in solid shape from a deployable cash perspective. There's a half-billion dollar buyback in place, and I would suspect that the company is on the prowl for deals. With valuations moving up, though, it may be hard to find attractive targets. Likewise, the company may choose to use some of that capital to write even more business.
The Bottom Line
I like how Allied World has evolved over the years, moving from a heavier weight on long-tail policies to a more diversified mix, as well as broadening its overall mix of business while carving out special excellence in areas like professional liability and healthcare. It's also very much worth noting that this company has delivered the goods in terms of performance over the years--posting good book value growth and market returns.
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Like Arch Capital and W. R. Berkley, I think Allied World is a good candidate as a long-term holding, though investors have to realize that the insurance industry is vulnerable to a lot of external factors that are well outside of their control (including disasters and interest rates).
But also like Arch Capital and Berkley, I don't see Allied as especially cheap today. I suspect that my long-range ROE estimate (10%) may be too low, and that depresses the apparent fair value, but I would rather play it safe. Accordingly, Allied World looks as though it may be 0-10% undervalued, which isn't really enough to entice me to buy the shares of even a well-run insurance company.
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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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