Everest Re: double-digit compound trading at book value (NYSE: RE)
P&C insurance model
Insurers (and reinsurers) make money in two ways. The most obvious way is to underwrite risks, their core business. By selling policies, they agree to take risks that the policy buyer wishes to transfer to someone else. For the problem, the policyholder pays a premium to the insurer. Therefore, one way to make money is to set a price on your policies so that, over a large enough group of similar policies, you make money on average. In other words, your losses (payments to policyholders) and the costs of managing those losses are less than the premium collected.
The less obvious way for them to make money is through investing. Since the policies constitute a promise to pay if certain risks materialize later and the premiums are collected in advance, it is possible to accumulate cash in the bank. As premiums increase, as long as underwriting reaches at least break-even, then cash will continue to accumulate. In industry jargon, this is called “float” (money that will eventually be paid out to pay policyholders, but is still on the company’s balance sheet). This money can be invested, and the returns from these investments are the other way to profit from the business.
Both sides of the business have come under pressure in recent years. The capacity came to underwrite with new institutional entrants using new models (such as insurance securities, catastrophe bonds, etc.) which facilitated the placement of capital. Attracted by potential returns higher – and uncorrelated – than those available on traditional markets.
Low rates have also been a huge headwind for their investment portfolio. The value of the float (the privilege of being able to invest other people’s money) is closely linked to the level of possible returns on the financial markets. Yield compression became acute in 2020, when 10-year yields fell sharply below 0.7%.
As 2021 approaches, both headwinds turn into tailwinds, with rates rising rapidly in anticipation of better economic growth, improving investment prospects wallets. On the underwriting side, a few years of bad catastrophic losses (combined with losses related to COVID-19 last year) are already driving up premiums.
One of my favorite companies in the space, Everest Re (RE), is also a long-time holding of mine. For the following reasons, I think he is very well positioned as a long-term preparer:
Its premium growth Top AM management experience Top ratings Prudent capital allocation Current valuation at book value
Underwriting performance and outlook
Since 1995, when it went public, the company has increased book value per share by almost 12%. A long underwriting record means the business has the wherewithal to survive, which always comes first. In fact, the company is a spin-off of Prudential (then called Prudential Reinsurance), its then CEO (Mr. Joseph V. Taranto) still chairs the board. The good pace of growth in value per share means that no significant dilution has occurred on a net basis.
Underwriting performance has been good. Over the last five years, up to 2019, the combined ratio has averaged 96%, with 3/5 years below 100%. A combined ratio of 99% means that the underwriting profit as a percentage of bonuses was 1%. So, on average, the company earned 4% in bonuses over that five-year period. Importantly, premiums also grew nicely, from less than $6 billion to over $9 billion during this time, increasing the free float and therefore the size of his investment portfolio.
Last year, the combined ratio was 103% and written premiums increased again, reaching $10 billion.
Looking ahead, it is important to recognize that the P&C industry is cyclical in nature. In some ways, but not completely, policies are commodities and pricing is determined by the level of system capability at any given time. The barriers to entry are not that high; high premiums attract new capital, which then puts pressure on premiums. Eventually, premiums become too low and losses lead to direct capital reductions and exits, paving the way for the next price hike. It seems that we are currently in this “next recovery” period.
here is some predictions from Willis Tower Watson, the insurance brokerage firm (the term “aggravation” depends on the point of view):
- Rises in real estate rates are getting worse; for uncontested occupations, forecasts for 2021 are +15% to +25%, rising from 10% to +20% in the spring.
- The general liability forecast jumped from +7.5% to +15%, from +2.5% to +7.5%, more than doubling.
- The umbrella/excess predictions are even more striking than in the spring: the lowest expected increases are now 30% (for the low/moderate risk umbrella); and the highest remain at a staggering 150% (for high excess risk).
- Workers’ compensation, a long-standing possible respite from rate hikes, is even better, but no decline is expected.
- Planned car rate increases ranged from +8% to +15%, rising from +6% to +12%.
- All D&O categories are expected to grow by double digits, with some as high as 70%.
- Cyber insurance rate increases are expected to be +10% to +30%, up from +10% to +15% earlier this year.
These are very significant increases that are planned. Especially in the excess of loss portion which is the daily bread of reinsurance.
Investment performance and outlook
Driven by premium growth, the investment portfolio (including cash) grew from $17 billion in 2015 to $26 billion. as the portfolio is made up of fixed-income instruments, the company is hungry for yield like everyone else.
Fortunately, things are slowly changing on this front as well. Using the 10-year Treasury as a benchmark, yields have already fallen from 0.7% in the darkest days of 2020 to 1.4% today. How much is 70 basis points worth if you invested $26 billion in treasury bills, or almost $200 million.
Everest’s portfolio duration is less than 10 years and rate increases within ten years have been lower, however, the trend is favorable and it won’t take much “normalization” to really increase capacity. industry beneficiary. This trend may take longer to develop, the Fed Chairman does his best to point out that the board is in no rush to even consider rolling back QE let alone raising rates short term from scratch. But higher growth and some inflation will nonetheless contribute to eventual normalization. The timing is unknown, the direction seems fairly certain.
Capital structure/number of shares 2014-2020
Everest has less debt than most companies in the industry. As of December 2020, it had approximately $1.6 billion in debt maturing from 2044 to 2067. This is after the company raised $1.0 billion in October with a 3.5% coupon coming to maturing in 2050. I’ll put it a little differently, 30 years of fixed rate silver cost 3.5%.
Those debts represent just over 16% of its nearly $10 billion equity, a conservative ratio for the industry. All of this translates into an A+ (Superior) rating by AM Best, a key selling point, especially for large risks.
Source: Everest Re investor presentation
The number of shares has been reduced by approximately 25% over the last ten years or so. Recently stock purchases have been reduced during the big cat loss years in 2017 and 2018 and again in 2020 due to Uncertainty related to COVID-19.
At around $240, the shares are essentially trading at book value. There is little goodwill or intangible assets, so book value and tangible book value are the same. Bought at this price, the new investor essentially buys the business without any premium. Despite the track record of growth in earnings per share and book value, management expertise, etc. Valuation remains low given the headwinds cited above.
The chart below shows the book value multiple at 1 today, it is still around the low end of its historical range.
As for his peer group, a few observations:
- Low dispersion, valuations tightened in a range of 1 to 1.35.
- All suffered from the Fed’s rate cut in 2020.
- Everest Re, with a higher proportion of reinsurance business, commands a lower premium than book value, but a premium nonetheless, which has all but disappeared since last year.
Everest Re is expected to command a premium to book value while continuing to grow book value at least in line with the historic double-digit pace. The current valuation simply does not take into account the shift from headwind to tailwind on both sides of the business.