Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
16 April 2012
Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 237.
16 April 2012
CONTENTS
Part I: P&C Insurance Stocks Should Benefit As Cycle Firms............................................................ 4 Part II: Primary Commercial Lines: Full Cycle Turn In 2013?..........................................................32 Part III: Reinsurers: A Leveraged Play on the Property-Casualty Cycle .......................................54 Part IV: Insurance Brokers Are The Best Early P&C Cycle Play.......................................................76 Part V: Have Personal Lines Insurance Returns Peaked? ................................................................94 Part VI: P&C Stock Performance & Valuation.................................................................................. 112 ACE: Strong Global Franchise & Solid Book Value Growth......................................................... 123 ACGL: Balanced Presence in Insurance & Reinsurance ................................................................ 127 TRV: Strong Track Record and Attractively Valued....................................................................... 131 BRK.A/B Geared to Economic Recovery, Attractive Valuation ................................................ 135 CB: 2012 Guidance Could Be Conservative ..................................................................................... 139 PRE: Balanced Reinsurer with Potential For Improving Results.................................................. 143 XL: P&C Business Has Stabilized, Valuation Attractive ................................................................. 147 RNR: Superior Property Catastrophe Reinsurer.............................................................................. 151 Everest Re: Will Results Improve in 2012? ....................................................................................... 155 AWH: Reserve Releases Could Slow.................................................................................................. 159 AHL: Reinsurance Prices Could Improve, Limited Excess Capital .............................................. 163 MRH: Re-Focused On Core Property Catastrophe Reinsurance Business................................ 167 FSR: Increasingly Dependent on Retrocessional Support ........................................................... 171 OB: Facing Top-Line Pressure ............................................................................................................ 175 MMC: Improvement in Brokerage Organic Growth ...................................................................... 179 WSH: Earnings Could Recover in 2013............................................................................................. 184 AJG: Leverage to Improving P&C Prices & Recovering Economy ............................................... 188 BRO: Highest Leverage To Improving Pricing................................................................................. 193 AON: Leveraged To Improving Economy And Insurance Market .............................................. 197 PGR: Best-In-Class Operator.............................................................................................................. 202 ALL: ROE Goal of 13% by 2014 Appears Optimistic.................................................................... 206 THG: Chaucer Acquisition Expands THGs International Presence .......................................... 210
16 April 2012
We are constructive on the P&C insurance sector based on a positive inflection point in P&C pricing for the first time since 1999. We expect positive pricing momentum to persist, which could result in valuation multiple expansion for P&C stocks. This positive inflection point in P&C rates appears to be driven by deteriorating underwriting results, stabilizing industry capital positions, and rising property reinsurance costs. Although a full commercial P&C cycle turn may not occur until 2013, pricing trends are gaining positive momentum.
Top Picks
Pricing trends are positive, which is the most important factor for ACE, ACGL, CB, the P&C stocks. We prefer primary commercial insurers with strong TRV, XL balance sheets and high quality managements. Reinsurers are a more leveraged play than the primary insurers to a P&C cycle turn but typically generate volatile earnings. Reinsurers ROEs could recover assuming a return to normalized catastrophe activity. Insurance brokers benefit the most from rising P&C prices because most of the benefits of higher prices drop to the bottom line. Unlike the insurers, the insurance brokers do not assume underwriting risk or have large capital requirements. Personal auto margins and ROEs have likely peaked in the current cycle. We prefer low-cost operating model of direct writers (PGR and GEICO), which are gaining profitable market share from the exclusive agency insurers (ALL and State Farm). PRE, RNR
Insurance Brokers
PGR
Among the P&C insurance stocks, we prefer primary commercial insurers ACE, ACGL, CB, TRV and XL because of their high quality managements, potential for strong book value growth, and better-than-average underwriting performance. Among the reinsurers, we prefer PRE despite its recent challenges due to its discounted valuation and potential for meaningful ROE recovery in 2012. Berkshire Hathaway should generate attractive earnings power as well as book value per share growth. We anticipate BRKs GEICO unit as well as PGR should gain profitable auto insurance market share. Our outlook is favorable on the insurance brokers, especially MMC (our top pick among the brokers), WSH, AJG and BRO. These companies should benefit from a revenue tailwind as the economy recovers. Also, improved P&C prices should translate into rising organic revenue growth and operating margins. P&C pricing has bottomed, which means the insurance broker stocks could generate attractive upside potential because of positive operating leverage and improved investor sentiment. Our outlook for personal lines insurers, including ALL, PGR and THG, is mixed. Automobile insurance results have been strong, but margins have probably peaked. Meanwhile, loss frequency trends remain favorable, although this benefit will likely reverse as the economy improves. We view consumers growing preference for the direct sales channel in personal auto lines as a secular trend that should result in PGR and GEICO continuing to take market share from exclusive agency insurers including Allstate. Also, PGR and GEICO avoid natural catastrophe losses by not writing homeowners insurance business unlike ALL and THG.
16 April 2012
Year-to-date 2012, the Barclays P&C insurance index has underperformed both the S&P 500 Index (by 7 percentage points, as of April 11, 2012) and the S&P Financial index (by 15 percentage points) as a result of a shift to high-risk financial stocks that previously underperformed the P&C stocks in 2011. Since the March 2009 low, during the impact of the global financial crisis, the Barclays P&C insurance index rose 57% but has underperformed both the S&P 500 and S&P Financials. Figure 1: Barclays P&C Price-to-Book Index Historical Valuation
2.2 2.0 Absolute price-to-book 1.8
9/11 1Q04 P&C pricing peaks
60%
30%
1.6 1.4 1.2 1.0 0.8
ar -9 9 Fe b00 nJa 01 De c01 No v02 Oc t -0 3 pSe 04 Au 8 11 12 07 05 l-06 0 9 r-1 0 -0 rbngna ay Ju Ja Ju Fe Ap M M
Beginning of Financial Crisis
0%
Hurricane Katrina
-30%
-60%
Support Level
P&C insurer stock valuations are currently at the low end of the historical range
P&C insurer stock valuations are currently at the low end of the historical range, which provides an attractive entry point, in our view, although we acknowledge the overall valuation for the financials sector is depressed. As a point of reference, commercial P&C insurer valuations expanded in 2000 from approximately 1x book value to nearly 2x book value when price improvement became evident. Even if the P&C insurance sector recovers to an historical median valuation of 1.4x book value, it implies significant upside potential for the stocks. Figure 3: Stock Performance Since March 2009 Low
175% 150% 160%
As the commercial P&C cycle bottoms, earning power and ROE will likely deteriorate for several years due to worse accident year underwriting results, reserve strengthening, weak
16 April 2012 5
ar O - 99 c M t-99 ay D -00 ec -0 Ju 0 l F e -01 b Se -0 2 p Ap -02 r N - 03 ov Ju -03 nJa 04 n Au -05 g M -05 ar O - 06 c M t-06 ay D -07 ec -0 Ju 7 l F e -08 b Se -0 9 p Ap -09 r N - 10 ov Ju -10 nJa 11 n12
S&P Financial
S&P 500
investment income growth, and reduced share buyback activity. However, P&C industry balance sheet strain typically sets the stage for improved pricing, which should elevate P&C valuations as investors focus on the potential for rate improvement.
The P&C insurance sector faces long-term risks
The P&C insurance sector faces long-term risks from catastrophe losses (both natural and man-made), rising interest rates, increased inflation, and inadequate loss reserves. Current challenges also include:
Modest top-line growth as lower retention due to non-renewing unprofitable business offsets higher pricing, as well as low (although bottoming) exposure growth, and rockbottom interest rates. Expectations of declining EPS, returns on equity, and book value growth based on normalized catastrophe losses. Current earning power being overstated due to the meaningful benefit of loss reserve releases from prior years and the risk of reserve strengthening. Slowing share buybacks. Few consolidation opportunities (at current valuations) that could extract value from the property-casualty stocks.
Interest rates are expected to remain low through at least 2014, which curtails EPS growth for P&C insurers. Interestingly, the P&C stocks have historically shown a weak correlation to interest rate shifts.
In a low interest rate environment, insurers asset values would be expected to increase including the value of their large fixed income investments. However, net investment income could decline as invested assets are reinvested at lower interest rates. In a rising interest rate environment, the value of insurers fixed income investments would likely decline and result in an impact to book values. There is essentially no correlation between P&C insurance stocks and interest rates since 2001, which means the level of interest rates is not a meaningful driver of P&C insurance stock performance unlike other sectors within financials.
P&C insurance stocks would be expected to perform better in a deflationary economic environment than an inflationary one because it should lead to lower claims costs and
16 April 2012 6
higher earnings. Barclays economists estimate that inflation (as measured by core CPI) will persist at levels slightly above 2% y/y (not seasonally adjusted) throughout most of 2012, but rise more sharply by the end of the year and end 2013 around 2.8%.
In a deflationary environment, claims inflation would likely be constrained, potentially leading to loss reserve redundancies (insurers largest liabilities) and a benefit to earnings. In an inflationary environment, claims costs could rise leading to loss reserve deficiencies and reduced earnings.
Property-Casualty Insurance Sector: Commercial Insurers, Reinsurers, Brokers, and Personal Lines Insurers
The property-casualty insurance sector has several segments that have different dynamics:
Primary commercial insurers provide property and liability insurance to businesses and institutions. Major writers include AIG, Travelers, ACE, XL, and Chubb. Reinsurers provide contingent capital to primary commercial and personal lines insurers to spread the risk of claims. Put another way, reinsurance is insurance for insurance companies. This is a global market with major writers including Munich Re, Swiss Re, General Re (owned by Berkshire Hathaway), PartnerRe, and XL. Insurance brokers are distributors of insurers products and, unlike insurers, do not assume underwriting risk or have large capital requirements. The largest commercial insurance and reinsurance brokers are Marsh & McLennan, Aon and Willis. Personal lines insurers provide automobile and homeowners insurance to U.S. consumers. The largest auto and home insurers include policyholder-owned State Farm, Allstate, Geico (owned by Berkshire Hathaway), and Progressive.
Pricing trends are gaining positive momentum which could result in valuation expansion for P&C insurance stocks
Primary Commercial Insurers Benefit from an Improving Pricing EnvironmentPrimary commercial insurers benefit from a rising pricing environment for
the first time in a decade driven by deteriorating underwriting results, stabilizing industry capital positions, and rising property reinsurance costs, in our view. Although a full commercial P&C cycle turn may not occur until 2013, pricing trends have positive momentum. Premium volume growth could improve, reflecting higher P&C pricing and stabilizing exposure growth, although this could be partially offset by P&C insurers nonrenewing unprofitable business. That being said, as the commercial P&C cycle bottoms, earning power and ROE will likely deteriorate for several years due to worse accident year underwriting results, reserve strengthening, weak investment income growth, and reduced share buyback activity. However, P&C industry balance sheet strain typically sets the stage for improved pricing, which should elevate P&C valuations as investors focus on the potential for rate improvement.
Among the primary insurers, we view ACE and ACGL as having the best potential to generate profitable growth in an improving environment. CB, TRV, and XL should also benefit.
16 April 2012
20% $230 $172 $240 $247 $261 $261 $257 $239 $233 $236 $242 $251 15% 10% 5% 0% -5% -10% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E % Change in DWP
8
A more leveraged play than the primary insurers to a P&C cycle turn but typically generate volatile earnings.
As Do the Reinsurers. The reinsurers are also benefitting from higher P&C prices after over $100bn of insured global catastrophe losses in 2011. In addition, we anticipate the trend of primary insurers retaining increased exposure to boost their net premium volume has ended and demand for reinsurance is stabilizing. That being said, most of the Bermuda reinsurers are unlikely to increase their capacity in 2012, perhaps with the exception of RNR, after suffering meaningful catastrophe losses in 2011. Separately, the anticipated implementation of Solvency II in 2013 could result in some increased demand for reinsurance from European primary insurers. Among the reinsurance stocks, we prefer PRE despite its recent challenges due to its discounted valuation and potential for meaningful ROE recovery in 2012. We view RNR as the best-in-class property catastrophe reinsurer, and if its valuation were to compress we could become more constructive in our outlook.
Many reinsurers are based in Bermuda because of its proximity to the United States, the ability to write global exposures, Bermudas flexible regulatory system, and no taxes levied on profits generated out of Bermuda. However, pressure is increasing to charge taxes on Bermuda companies doing business with U.S. customers. As a result, several insurers have re-domesticated to Switzerland (ACE, AWH) or Ireland (XL) where there is less potential uncertainty regarding tax treaties. We expect more insurers to change their domicile outside of Bermuda, although there should be little if any impact to their business or earnings as a result. Lloyds of London remains an attractive venue to write specialty commercial P&C insurance lines due to this markets strong ratings, worldwide licenses, and opportunities to access global P&C businesses.
16 April 2012
Insurance brokers benefit the most from rising P&C prices because most of the benefits of higher prices drop to the bottom line
The Insurance Brokers Benefit the Most from Improved P&C Pricing. The insurance broker stocks should benefit from improved sentiment and valuation multiples as pricing improves. Higher P&C prices should improve the brokers organic revenue growth (the most important metric for these stocks), margins and earnings. Notably, margins could continue to expand, nearing peak levels seen in the last hard market in 2000-2004 driven by positive operating leverage.
The success of (as well as investor sentiment regarding) the insurance brokers including MMC, AON, and WSH is typically driven largely by commercial P&C insurance and reinsurance premiums (pricing and exposures). Improving pricing power in commercial lines insurance and reinsurance benefits the brokers commission-based business, while fee-based business could be mostly stable as customers look to contain costs. Moreover, exposure growth appears to be bottoming and could help insurers top-line growth once the economy recovers. For the insurance brokers, these trends should result in improving organic growth, operating margins, and annual EPS growth. Our top picks among the insurance brokers are MMC and WSH followed by BRO and AJG. MMC should have strong organic revenue growth and margin expansion opportunities in each of its businesses even in a slow-growth macro environment. WSH is a pure-play global insurance broker with the lowest valuation among its peers, although 2012 will likely be another transition year. BRO and AJG have the highest leverage to rising P&C prices because nearly all of their revenues are commission-based, although these stocks already trade at a premium valuation. AON (rated 2-Equal Weight/1-Pos) should also benefit from higher P&C prices, but we see a longer road to achieve improved organic growth and margin expansion compared to the other insurance brokers. Nearly all of BRO and AJG's brokerage revenues are commission-based, while the larger brokers (MMC, AON and WSH) contain a mix of both commissions and fees. This means the benefit of improved pricing should be more significant for BRO and AJG than MMC, AON, and WSH.
16 April 2012
3%
4%
Hard Market
Soft Market
00 001 002 003 004 005 006 007 008 009 010 011 12E 13E 2 2 2 2 2 2 2 2 2 2 2 20 20 20
Note: Based on the average insurance brokerage organic for MMC, AON, WSH, AJG, BRO. Source: Company data, Barclays Research estimates.
26% 24% 23% 22% 21% 18% 21% 20% 24% 23% 22% 23% 24% 22%
Personal auto margins and ROEs are benefiting from mostly benign claims inflation
Personal Auto Margins Have Likely Peaked; Homeowners Insurance Prices Up. Personal auto lines insurance underwriting margins are strong, and price increases are
positive, but slowing. However, competition is expected to intensify due to attractive margins in auto insurance and underwriting margins have probably peaked. Personal lines insurer growth is a function of growth in registered vehicles and the housing stock (for homeowners insurance), which should recover as the economic environment improves. A major factor for homeowners insurers is natural catastrophe losses which range in the U.S. from winter storms, tornadoes, and wind-related hurricane losses. Flood losses are typically not covered by private market homeowners insurers because the U.S. National Flood Insurance Program addresses this risk. Despite a slow-growth environment, auto insurers focused in the direct sales channel including GEICO and Progressive are gaining market share because consumers are increasingly comfortable with buying auto insurance over the telephone or internet directly. Allstates declining auto policies-in-force (PIF) also appears to be linked in part to its
16 April 2012
10
strategy of reducing catastrophe exposure in its homeowners insurance business because Allstate tends to offer competitive pricing when auto and homeowners insurance is bundled. Mutual insurer State Farm has the largest personal lines market share at 19%, although the company is losing money in its core underwriting business. Figure 9: U.S. Personal Lines Industry Premium Volume
in $ bil $250 $200 $150 $100 $50 $0 2001 2002 2003 2004 2005 2006 Auto
Source: A.M. Best, Barclays Research estimates.
2007
2008
2009
2010
2011E 2012E
Homeowner's
Figure 10: U.S. Private Passenger Auto Insurance Industry Combined Ratio vs State Farm
130%
Figure 11: U.S. Homeowners Insurance Industry Combined Ratio vs State Farm
145%
Catastrophes
120%
State Farm
135% 125%
110%
115% 105%
100%
95%
State Farm
90%
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 E 20 12 E
85%
16 April 2012
8 20 09 20 10 20 11 E 20 12 E
4 20 05
6 20 0
20 0
20 0
20 0
20 0
20 0
20 0
11
Company
Ticker
Rating
Price 4/11/2012
13E
Div. Yield
P/E 12E
13E
25%
21% 6% 41% 14% 9%
-8%
14% 10% 17% 12% 13% $2.14 2.86 1.88 1.29 3.61 $2.43 3.19 2.16 1.45 4.14
2.2%
2.8% 3.0% 3.8% 1.3% 1.3%
1.03
NM NM NM NM NM
0.90
2.89 2.44 3.07 2.07 1.92
0.84
2.74 2.20 3.03 1.94 1.76
0.79
2.56 1.98 2.93 1.77 1.64
10.0
14.8 12.1 19.3 18.3 13.3
10.5
13.0 11.0 16.6 16.4 11.8
9%
20% 19% 16% 11% 14%
7%
21% 19% 18% 11% 15%
14%
13%
2.8%
2.44
2.20
1.98
14.8
13.0
16%
18%
-3% NM 189%
7% NM NM
15% 8% 10%
14% 7% 9%
93%
14.7%
7%
-5.0%
2.6%
2.1%
0.94
NA
0.87
NA
0.80
NA
0.75
NA
9.9
12.3
10.6
13.0
10%
NA
9%
NA
Note: S&P 500 EPS estimates are a bottom-up calculation of consensus earnings forecasts.
Company
Ticker
Rating
Price 4/11/2012
Historical Price/Stated BV Share Price Performance Hi Lo Avg. Median 1 Mo. 12 Mos. 5 Yrs.
NM NM NM NM NM
NM NM NM NM NM
3% -2% 1% 1% 3%
6% -12% 2% 2% -7%
(a) Market cap for Berkshire Hathaway includes Class A and B shares outstanding.
16 April 2012
12
Allstates acquisition of Esurance and Answer Financial from White Mountains for $1.0 billion, and Nationwides $816 million acquisition of Harleysville. Figure 13: Recent Property-Casualty M&A Activity
Buyer Name QBE Insurance Group Ltd. Berkshire Hathaway CNA Financial Hanover Insurance Group, Inc. Allstate Corp. Doctors Company AmTrust Financial Services, Inc. ACE Ltd. Nationwide Mutual Insurance Co. Selective Insurance Company Alleghany Corp. CNA Financial Target Name Balboa Insurance Wesco Financial Corp. CNA Surety Chaucer Holdings Plc Esurance and Answer Financial FPIC Insurance Group, Inc. International Credit Mutual Reinsurance Penn Millers Holding Corp. Harleysville Group Inc. Montpelier U.S. Insurance Co. Transatlantic Holdings, Inc. Hardy Underwriting Bermuda Ltd. Deal Value ($MN) 700 548 477 503 1,000 361 315 105 816 56 3,535 227 Announce Price/ Book Price/ Tangible Date (%) Book (%) 02/03/2011 02/04/2011 04/20/2011 04/20/2011 05/17/2011 05/23/2011 06/30/2011 09/07/2011 09/28/2011 09/19/2011 11/20/2011 03/21/2012 NA 106 111 101 269 136 NA 101 208 NA 86 136 NA 119 128 112 NA 152 NA 101 215 NA 86 155
(a) CNA Financial already owned 61% of CNA Surety. Source: SNL data, Company data, Barclays Research
Catastrophe Losses Generate Volatile Earnings for Insurers. Catastrophe losses are unavoidable for the property-casualty insurance industry and result in volatile earnings that typically result in a discounted valuation for the P&C sector versus other financials. Insurers try to manage catastrophe risk by using risk modelling tools, limiting exposure to the most catastrophe-prone areas, and by purchasing reinsurance. U.S. catastrophe losses in 2011 were $34bn, the second highest level of annual catastrophe losses since 1990. Globally, insured catastrophe losses exceeded $100bn in 2011 driven by the Japan and New Zealand earthquakes as well as Thailand floods.
Figure 14: U.S. P&C Industry Insured Catastrophe Losses, 1990-Present
9/11
16 April 2012
19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 E 20 12 E 20 13 E
In the U.S., the largest catastrophe exposures include Florida and the Gulf Coast hurricane windstorm risk, and California earthquake risk. Tornadoes as well as winter and spring
13
storms can also cause substantial insured losses including an impact of $28bn in 2011. Hurricane Katrina in 2005 was the largest insured catastrophe in the United States with onshore losses of $46 billion (total insured losses were higher including damage to offshore oil rigs). The industry suffered significant international catastrophe losses in 2011 from the Japan earthquake ($30bn) and Thailand flooding ($10-$15bn). Among the largest manmade catastrophe losses are the terrorist attack on the World Trade Center ($32.5 billion of insured losses) in 2001 and the recent Deepwater Horizon oil rig loss ($4-$6 billion of industry losses). Insurers must address mega-catastrophe exposure to protect their solvency. Notably, catastrophe modeling firm AIR Worldwide estimates insurers could suffer approximately $100 billion of losses if there was a recurrence of the 1926 Miami Hurricane, the 1906 San Francisco earthquake, or the 1812 New Madrid, Missouri earthquake. Typically, we would not view an insured natural catastrophe loss of less than $10 billion to be a major event for the insurance industry because the claims expense would probably not exceed one years earnings for most individual insurers or reinsurers. As a point of reference, insured losses from major catastrophes are on average roughly half of economic damage. Homeowners insurers typically suffer the largest weather-related losses, but commercial insurers also have exposure. If an industry catastrophe loss in the U.S. is less than $5 billion, the reinsurers would normally be expected to have low exposure. Statesponsored facilities including the California Earthquake Authority, the Florida Hurricane Catastrophe Fund, and the Texas Windstorm Insurance Association can absorb some of the impact from catastrophic events. Figure 15 Distribution of U.S. Insured Catastrophe Losses by Geography, 1980-2010
Texas 11% Louisiana 10%
Figure 16: Distribution of U.S. Insured Catastrophe Losses by Catastrophe Type, 1990 1H2011
Wind/Hail/ Flood, 3.4% Geological events, 4.9% Terrorism, 6.6%
Rest of US 62%
Florida 17%
Source: ISO Property Claim Services, Insurance Information Institute, Barclays Research
Is the P&C Insurance Industry on the Cusp of a Hard Market? The last hard
market, in which insurance capacity declines and demand rises in a favorable environment for P&C insurance stocks, occurred from 2000-2005 and was exacerbated by large, unexpected losses from the September 11, 2001 World Trade Center terrorist attacks. The prior hard market was from 1984-1986 and was driven in part by a shortage of reinsurance capacity. Broad commercial P&C pricing improvement is now at a tipping point being led by workers compensation and property insurance, which together account for about half of U.S. commercial P&C insurance industry premium volume. Commercial P&C prices are
16 April 2012 14
rising driven by deteriorating underwriting results, stabilizing industry capital positions, and rising property reinsurance costs. Although a full commercial P&C cycle turn may not occur until 2013, pricing trends (the most important factor for the stocks) are clearly improving and should result in increasingly favorable investor sentiment. Figure 17: U.S. Commercial Net Written Premiums 2011
20%
15%
10%
5%
0%
-5%
-10% 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
2007-2009: First-ever three year period of annual declines 2007 2008 2009 2010 2011E 2012E 2013E
Note: Shaded years represent hard markets. Source: Insurance Services Office, Barclays Research
There are four factors we monitor to tell us when the commercial P&C insurance cycle is poised to reach a sustained tightening phase. Critically, all four factors (not just one or two) need to be achieved before a broad cycle turn should occur. As of now, most of these factors are in transition with momentum toward improvement and we anticipate a broad cycle turn could occur in 2013:
16 April 2012 15
Large underwriting losses Industry underwriting losses are increasing, driven by deterioration in property lines and workers compensation. Notably, the U.S. P&C industrys estimated combined ratio of 107.5% for 2011 reflects large catastrophe losses and is likely among the worst underwriting results on record. The industry underwriting loss for 2011 is expected to be substantial at $34bn and is on track to be the largest since 2001. A decline in industry surplus Likely to be achieved in 2011, which signals reduced capacity to absorb underwriting losses. We estimate the U.S. P&C industry is overcapitalized by roughly $120 billion (20% excess capital) assuming normalized industry operating leverage, although this outlook could be overly optimistic if reserve deficiencies emerge. A tight reinsurance market Property reinsurance rates are up 5%-10% at mid-year 2012 after a series of large international catastrophe models although casualty reinsurance pricing is weak. Reinsurance is a global market, with Munich Re, Swiss Re, and General Re (part of Berkshire Hathaway), and the Bermuda market being major participants. Renewed management underwriting discipline Increased discipline appears to be emerging with primary insurers increasingly pushing for rate increases at renewal although competition for new business remains strong.
Note: Hard market years are shaded. Source: Source: Insurance Services Office, Barclays Research
16 April 2012
19 8 19 4 8 19 5 8 19 6 8 19 7 8 19 8 8 19 9 9 19 0 9 19 1 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 0 20 1 0 20 2 0 20 3 0 20 4 0 20 5 0 20 6 0 20 7 0 20 8 0 20 9 1 20 0 11 20 E 1 20 2 E 13 E
Statutory surplus
Premiums/Surplus
P&C Industrys Excess Capital Position Has Likely Peaked. The U.S. P&C
insurance industry appears to be in a significant excess capital position with historically low operating leverage. Based on our analysis, we believe U.S. (not counting Bermuda or Europe) industry excess capital could be roughly $120 billion (20% of U.S. industry capital)
16
Premiums-to-surplus
$600
at year-end 2011, although industry excess capital has likely peaked. We note that pricing was improving in 1999 despite a significant technical level of excess capital, which means the same situation could occur now. Our sense is excess capital could be eroded if premium growth accelerates, capital positions decline, or both. Figure 20: U.S. P&C Industry Excess Capital
$50
$0
-$50
-$100 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 1994
-40%
Surplus Redundancy
The rating agencies, especially A.M. Best domestically and Standard & Poors outside the U.S., have a strong influence on insurers capital requirements. This situation is partly due to property-casualty insurance in the U.S. being regulated almost entirely at the individual state level rather than at the federal level. The commercial P&C insurers and reinsurers are particularly sensitive to ratings because many customers as well as insurance agents and brokers would likely switch insurers if ratings fell below the A- level. Also, an insurer would not want to be in a position where it was forced to raise dilutive equity capital after suffering significant underwriting losses or an erosion of its capital base due to investment losses. After significant industry loss events, such as the World Trade Center attack in 2001 or Hurricane Katrina in 2005, many insurers needed to recapitalize with equity or equity-linked units to preserve adequate ratings from the rating agencies. Insurers were able to stabilize their franchises once they recapitalized and expanded, but it reduced the pace of price improvement since the industrys balance sheet faced reduced strain.
16 April 2012
17
in $ bil $4
$3
15%
$2
10% 5% 0%
$1
AL L M RH TR V PR E PG R AW H
R AC E GL AC E
AH L TH G
O B RN R XL
2009 2010 2011E
O B AW H PR E PG R RN R AC G L RE AL L TR V
AH M L RH TH G
XL AC E CB
Reduced Underwriting Profits. The U.S. P&C industry is generating large underwriting
losses (claims and underwriting expenses more than offset premiums collected) resulting from catastrophe losses and several years of weak commercial P&C pricing. Notably, topquartile insurers meaningfully outperform the industry average. We expect the U.S. P&C industrys combined ratio to deteriorate to 109% by 2013, which would be the highest level since 2001 and above the 15-year average of 104%. Figure 23: U.S. P&C Industry Reported Combined Ratio
120% 115% 110% 105% 100% 95% 90% 85% 80% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 9/11
Acc Yr CR
Acc Yr CR ex cat's
Pre-cat CR
Cat CR impact
Note: Hard market years are shaded. Source: Insurance Services Office, Barclays Research.
Note: Accident year combined ratio excludes effect of loss reserve development from prior years. Source: Insurance Services Office, Barclays Research
U.S. P&C industry underwriting results have benefitted from reserve releases over the past six years that boost current period earnings. We expect the pace of reserve releases to slow through 2012 with deficiencies recognized in subsequent years.
16 April 2012
CB
$0
18
Figure 25: U.S. P&C Industry Prior Year Loss Reserve Development, 1992-2013E
$30 $25 $20 $15 $10 $5 $0 ($5) ($10) ($15) ($20) 8% 6% 4% 2% 0% -2% -4% -6% Combined Ratio Points
2012E 2013E
in $ billion
Note: Hard market years are shaded. Source: Insurance Services Office, Barclays Research
in $ billions
19 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 00 20 0 20 1 0 20 2 0 20 3 04 20 0 20 5 0 20 6 0 20 7 20 08 0 20 9 E 1 20 0 E 1 20 1 E 1 20 2 E 13 E
PY Reserve Development ex A&E Combined Ratio Points Asbestos & Environmental Development
effective distribution and superior service capabilities, strong risk management, and careful monitoring of claims trends. Companies that best meet these hurdles in our view include TRV, ACE, ACGL, CB, PGR, and Berkshire Hathaway.
There is a strong relationship between P&C insurers long-term stock price performance and book value per share growth
There is a strong relationship between P&C insurers long-term stock price performance and book value per share growth (Figure 27), which confirms our view that this metric is important to track for P&C insurers. Figure 27: Book Value Growth vs. Share Price Performance, 2002-Present
25%
ACGL 15% AWH PGR Share price CAGR YE02-Present 5% RE TRV PRE AHL -5% OB XL FSR MRH ALL CB ACE
RNR THG
-15%
-25%
-35% -5%
0%
5%
10%
15%
20%
25%
Investors also appear to reward P&C insurers that generate a strong, sustainable net return on equity (includes realized investment gains/losses excluded from operating results). Figure 28 shows the companies generating the highest returns with the lowest volatility are CB, ACE, TRV, ACGL, and PGR. On the other hand, the companies producing the lowest long-term returns with the highest volatility include MRH, FSR, and XL.
16 April 2012
20
Figure 28: Net Return on Equity vs. Standard Deviation (2002 2011)
25%
Hi ROE/Low Vol
PGR
Hi ROE/HiVol
20%
ACGL
RNR
10%
RE THG ALL AHL MRH
5%
FSR XL
0%
Low ROE/Low Vol Low ROE/Hi Vol
-5% 2002 Operating Income and Net Income are for Travelers as a standalone entity.
OB Common shareholder's equity is net of the remaining adjustment of subsidiary preferred stock to face value. 0% 5% 10% 15% 20% OB Operating and Net Income are adjusted for economically defeasing the Company's mandatorily redeemable preferred stock.
Net ROE and Operating ROE are calculated off of average shareholder equity.
25%
The U.S. P&C insurance industry generates $440 billion of annual premium volume which is roughly evenly split between commercial lines and personal lines. Other major commercial lines and reinsurance markets are in Bermuda, the U.K., continental Europe, and the Far East.
In recent years, industry premium volume has stagnated due to competitive pricing and low exposure growth, but this trend is reversing
In recent years, industry premium volume has stagnated due to competitive pricing and low exposure growth, but this trend is reversing. Commercial lines insurance is economically sensitive because exposure growth is driven by factors including payroll trends, corporate sales volumes, new business formations, and real estate development activity. In personal lines, exposure growth drivers include growth in registered passenger vehicles, and to a lesser extent the pace of home sales. In a challenging economic environment, consumers hold onto vehicles longer, and used vehicles cost less to insure than new cars and trucks.
16 April 2012
21
Other 2%
$439bn
Other 4% Homeowner's 28%
16 April 2012
er ic an
at e
22
Figure 31: U.S. Private Passenger Auto Insurance Market Share, 2011
20% 19% 16% 12% 8% 4% 0%
rm t ls Fa e Al t a e at O IC s GE gre o Pr e siv l h de e rs ily AA tua ric m wi ve l u US a n Zu a F M tio n Tr rty N a i ca e r b e Li Am
9% 6% 5% 5% 5% 4%
2%
2%
1%
G AI
St
Commercial Lines & Reinsurance Pricing Has More Momentum Than Personal Lines. Commercial lines P&C pricing is now in positive territory for the first time
since late 2003. Rates are also increasing at an accelerating pace. Currently, commercial P&C pricing is only about 8% above 1999 levels (end of the last soft market) on average, and prices are about 50% below peak pricing achieved at year end 2003. In 4Q11, commercial P&C pricing increased 3% y/y on average, up from 1% y/y in 3Q11, and flat prices in 2Q11, according to the latest survey by the Council of Insurance Agents and Brokers. P&C price increases accelerated across all lines in 4Q with the largest increases in workers compensation (up 8%) and commercial property (up 6%), which together account for about half of U.S. commercial P&C insurance premium volume. P&C prices also increased across all account sizes. Insurance carriers are asking for rate increases on renewal business, walking away from underpriced business, and terms and conditions are tightening. Competition for new business still exists, although the gap between pricing for new and renewal business is narrowing. Figure 33: Average and Cumulative Commercial Rate Changes by Account Size
40%
9/11
175
2005 Hurricanes
165 155
30%
20%
2005 Hurricanes
Financial Crisis
145
9/11
10%
135 125
Japan earthquake
0% 115 -10% 105 95 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 Small Accounts Midsized Accounts Large Accounts
-20%
Small Accounts
Midsized Accounts
Large Accounts
Source: Company data, Barclays Research, Council of Insurance Agents and Brokers
16 April 2012
23
U.S. property catastrophe reinsurance pricing has increased following over $100bn of global insured catastrophe losses in 2011. This shift represents the first time reinsurance pricing increased since 2006 after the devastating impact of Hurricane Katrina. Reinsurers capital shrank in 2008 during the financial crisis as a result of mark-to-market losses on investments and rebounded in 2009 and 2010 and remained largely unchanged in 2011 despite large catastrophe losses. Reinsurance broker Guy Carpenter estimates the reinsurers included in its global composite are overcapitalized by roughly 12% as of yearend 2011, which implies roughly $20 billion of excess capital. Figure 34: Global Reinsurance Composite Shareholders Funds
in $ bil $200 $159 $160 $120 $90 $80 $40 $0 2003 2004 2005 2006 2007 2008 2009 2010 2011 $104 $110 $140 $129 $166 $171 $174
Personal lines insurance pricing is highly regulated by each U.S. state and tends to be a politically sensitive issue for consumers. As a result, volatility in personal lines pricing is typically much lower than in commercial lines and reinsurance. Currently, personal automobile insurance pricing is up 3% y/y, and homeowners insurance rates are up 2% according to CPI data, although this level of increase appears understated following significant U.S. catastrophe losses in 2011. Figure 35: Personal Auto Insurance Y/Y Price Change Figure 36: Tenants and Household Insurance Y/Y Price Change
10% 8% 6% 4% 2% 0% -2%
1/1/2009
1/1/2011
16 April 2012
There are two ways: underwriting profits and investment income. Insurers strive to generate underwriting profits by charging enough premiums to more than offset expenses for claims and operating expenses. Insurers typically focus on consistently generating an underwriting profit regardless of market conditions, although this result is not easy to achieve. If there are few opportunities to write profitable business, the most disciplined insurers will reduce premium volume to protect underwriting profits, although this result appears to be difficult to achieve. We view Arch Capital and Berkshire Hathaway as being among the few companies disciplined enough to walk away from underpriced insurance and reinsurance business. Investment income is a function of invested assets and portfolio yields. On average, about 75% of P&C insurers investment portfolios are in fixed income investments. Notable exceptions are Berkshire Hathaway and State Farm, which both have significant allocations to equities. As a result, investment income growth is difficult to generate as a result of modest growth in investment portfolios along with the low interest rate environment. For example, new money yields are 100bps-150bps below the portfolio yield for many P&C insurers, which is a headwind for future investment income as well as earnings.
Figure 37: U.S. P&C Industry Underwriting Profits and Net Investment Income
Net Investment Income
Net Investment Income, in $Bil $60 $50 $40 $30 $20 $10 $0 9% 8% 7% 6% 5% 4% 3% Avg. Portfolio Yield
Underwriting gains/losses
Underwriting Profits (In $Bil) $40 $20 $$(20) $(40) $(60)
Hurricane Andrew Hurricane losses
Sept. 11 attacks
Hurricane losses
19 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 2099 2000 2001 2002 2003 2004 2005 2006 2007 2008 2 09 20010 2011E 2012E 13 E
Note: Hard P&C market years are shaded. Source: Insurance Services Office, Barclays Research
Are Loss Reserves Adequate? P&C insurers core loss reserve redundancies appear to
be largely exhausted. This situation could result in future reserve deficiencies that cause a drag on earnings, returns on equity, and share prices of property-casualty companies. Insurers set aside loss reserves to pay future claims costs because they do not know the ultimate cost of these claims when the insurance policy is written. The establishment of initial loss reserves is an estimate of future claims expense that is adjusted over time. If claims costs are determined to be less than initially expected, the insurer releases reserves and earnings benefit this has been the situation since 2006. On the other hand, if not enough loss reserves are established to cover claims costs, the company suffers from adverse reserve development and earnings suffer which occurred from 2001-2005. It is important to note that establishing accurate loss reserves for long-tail casualty lines such as workers compensation and commercial liability is a more challenging task than setting reserves for short tail lines such as commercial property insurance. This is because long-tail claims often involve complex litigation and may take years to settle (product liability, for instance) while short-tail claims are typically less complex to quantify (a fire loss, for example) and settle quickly. However, there was substantial reserve strengthening
16 April 2012
19 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 2099 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20 1 0 2011 2012E 13E E
Net Investment Income Average Portfolio Yield
25
particularly by reinsurers on large international cat losses including the Japan and New Zealand earthquakes, as well as the Thailand floods As an example, the figure below shows a reconciliation of Chubbs beginning and ending net loss reserves, which is the largest liability on its balance sheet.
Incurred losses (inclusive of prior year loss reserve development, which show reserve releases for the past three years) are reflected in the income statement. Meanwhile, claim payments only affect cash flow and not the income statement. The difference between incurred losses and paid losses (with an adjustment for FX) are equal to the change in loss reserves.
Figure 38: Chubb Reconciliation of Beginning and Ending Net Loss Reserves
Year Ended December 31 In $ mil Net loss reserves, beginning of year Net incurred losses and loss expenses related to Current year Prior years Net payments for losses and losses and loss expenses related to Current year Prior years 2,746 4,300 7,046 Foreign currency translation effect Net loss reserves, end of year
Source: Company data.
2011 $20,901
2010 $20,786
2009 $20,155
67 $21,329
The P&C industry is most likely now in an increasingly deficient loss reserve position
The P&C industry is most likely now in an increasingly deficient loss reserve position since most commercial lines insurers and reinsurers released substantial reserves on unseasoned business. If loss cost inflation rises, reserve releases could reverse course to adverse development at a fast pace. One reason for robust reserve releases over the past several years are lower than anticipated claims (loss cost) inflation. The sustainability of this trend is questionable in our view, especially if tort costs or general economic inflation rise. Notably, the rating agencies have warned that loss reserve redundancies are largely exhausted, and we tend to agree with this assessment. We expect the pace of reserve releases to slow through 2012 with deficiencies probably being recognized in subsequent years. A.M. Best estimates U.S. P&C industry core loss reserves (excluding asbestos and environmental reserves, and statutory discounts mostly in the workers compensation line) are deficient by $9 billion (less than 2% of carried loss reserves). Reserves strengthened over the period of 2002-2007, but appear to be weakening since then, and A.M. Best expects insurers will need to increase reserves in accident years 2008-2010. Workers compensation reserves appear the most deficient.
16 April 2012
26
Figure 39: U.S. P&C Estimated Reserve Deficiencies 2011 (in $ bil)
Product Line Workers' Compensation Reinsurance - Nonproportional Assumed Other/Products Liability Commercial Multiple Peril Commercial Auto Liability Homeowners Personal Auto Liability Medical Professional Liability All Other Lines Total Core Reserves Asbestos & Environmental Total Reserves
Total Deficiency 8.2 3.4 4 1.5 0 -0.2 -1.8 -4 -2.2 8.9 7.4 16.3
Note: Excludes mortgage guaranty and financial guaranty segments. Also excludes statutory discounting. Source: A.M. Best Co., Barclays Research
We closely monitor tort costs trends. A strong correlation exists between tort costs and the property-casualty underwriting cycle based on our analysis. The peak of the 1980s hard P&C market occurred in 1986-1987 when tort costs were at historically high levels as a percent of GDP. Also, the last hard market began in late 1999 when tort costs were at their lowest point in 20 years. Rising tort cost inflation could lead to worse underwriting profits for P&C insurers. Tort costs as a percent of GDP could bottom in 2011, which could signal a P&C cycle turn. Figure 40: U.S. Tort Costs As A Percentage of GDP, 1980-2013E
Peak of last hard commercial Trough of last soft prop/cas market (Profits commercial deteriorate) 2.4% prop/cas market 2.2% (profits improve)
2.6%
Peak of last hard prop/cas mkt (profits deteriorate) Deepwater Horizon Oil Rig Explosion
2.0% 1.8% 1.6% 1.4% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E
Source: Towers Perrin, Barclays Research.
16 April 2012
27
Figure 42 shows the U.S. P&C insurance industrys investment portfolio is heavily weighted toward high-grade fixed income investments, with a 14% overall allocation to equities, and 5% to other total return investments. Notably, Berkshire Hathaway and State Farm own about approximately 63% of the industrys equity exposure. Excluding these companies, the industry investment allocation to equities would be about 6%. Figure 41: U.S. P&C Industry Investment Allocation - 2011
Contract Loans 0% Cash & Short Term Other Investments 6% 5%
Real Estate 1%
Mortgage Loans 0%
Bonds 73%
Industrial 36%
< 1 Year
1 - 5 Years 5 - 10 Years
10 - 20 Years
> 20 Years
Note: Excludes affiliated company investments. Source: SNL data, Barclays Research.
P&C insurers invested asset leverage at 266% is low compared to other financials
P&C insurers invested asset leverage at 266% is low compared to other financials including banks, securities brokers, and life insurers. This means that declining investment valuations would not be expected to have a substantial impact on shareholders equity. We estimate each 100bp parallel upward shift in the yield curve could reduce book value per share on average by 5%. XL appears to have the most risk to rising interest rates, with each 100 bps increase in yields potentially impacting its book value by 13%.
16 April 2012
28
Figure 45: Impact of a 100 Bps Increase in Interest Rates as a Percent of Book Value (as of YE 2011)
Impact of 100 bps Increase in Interest Rates As a Percent of Book Value A/T 0%
500%
400%
Median=266%
300%
200%
100%
0% RNR AHL ACE AWH RE THG TRV PRE CB PGR ACGL XL ALL
(a) As of YE11, ALL estimates a 100 bp immediate, parallel increase in interest rates would decrease the net fair value of assets and liabilities by $127 million pre-tax. In addition, in the event of a 100 bp increase in interest rates, the assets supporting Allstates life insurance products of $8.1 billion would decrease in value by $660 million pre-tax. Source: Company data, Barclays Research.
The insurers with the lowest-risk investment portfolios in our view include Travelers and Chubb. Although both have significant exposure to municipal bonds, our sense is the risk of loss is low based on the strong diversity and high credit quality of their portfolios. Allstate, Arch Capital, and PGR appear to have the highest risk tolerance in their investment portfolios among the P&C insurers we cover.
16 April 2012
R AC E GL M RH TR V AW H O B RN R FS R PG R AL L
XL PR E CB AC E TH G AH L
29
Figure 46: P&C Exposure to Topical Invested Assets, as a % of Book Value, December 31, 2011
60%
40%
30%
20%
10%
0% ALL ACGL PGR XL AWH THG RNR PRE CB RE ACE AHL TRV
Subprime/Alt-A RMBS
CMBS
ABS/CDO
Whole Loans
Figure 47: P&C Exposure to Topical Invested Assets, December 31, 2011
$14 $13 $12 $11 $10 $9 in $ billion $8 $7 $6 $5 $4 $3 $2 $1 $0 ALL XL PGR CB ACGL ACE AWH PRE TRV RE THG RNR AHL
Subprime/Alt-A RMBS
CMBS
ABS/CDO
Whole Loans
16 April 2012
30
Figure 48: Exposure to Equities and Alternative Assets, as a % of Book Value, December 31, 2011
50% 40% 30% 20% 10% 0% ALL ACGL RE RNR AWH XL PGR Equities PRE CB TRV THG ACE AHL
Alternative Investments
Source: Company data, Barclays Research
Figure 49: Exposure to Equities and Alternative Assets, December 31, 2011
$6,000 $4,000 $2,000 $0 ALL TRV CB ACE XL RE PGR ACGL Equities PRE AWH RNR THG AHL
Alternative Investments
Source: Company data, Barclays Research
16 April 2012
31
We are constructive on the P&C insurance sector based on a positive inflection point in P&C pricing for the first time since 1999. We expect positive pricing momentum to persist, which could result in valuation multiple expansion for P&C stocks. This positive inflection point on rates appears to be driven by deteriorating underwriting results, stabilizing industry capital positions, and rising property reinsurance costs. Although a full commercial P&C cycle turn may not occur until 2013, pricing trends are gaining positive momentum. We view commercial P&C insurance pricing trends as the most important factor for the stocks because it is a leading indicator of revenue growth, margins, earnings, and ROE. In addition, rate trends have a significant influence on investor sentiment in the P&C sector. That said, as the commercial P&C cycle bottoms, earning power and ROE will likely deteriorate for several years due to worse accident year underwriting results, reserve strengthening, weak investment income growth, and reduced share buyback activity. However, P&C industry balance sheet strain typically sets the stage for improved pricing, which should elevate P&C valuations as investors focus on the potential for rate improvement. Among the P&C insurance stocks, we prefer primary commercial insurers ACE, ACGL, CB, TRV and XL because of their high quality managements, potential for strong book value growth, and better-than-average core underwriting performance. The following figure shows positive momentum in pricing and exposure growth in TRVs core commercial P&C insurance business. Figure 50: Travelers Commercial Insurance Pricing Business Insurance excluding National Accounts
Note: Statistics are subject to change based on a number of factors, including changes in actuarial estimates. Source: Travelers Cos.
In a confirming trend, commercial P&C pricing increased 3% y/y on average in 4Q11, up from 1% y/y in 3Q11, and flat prices in 2Q11, according to the latest survey by the Council of Insurance Agents and Brokers. This reinforces our view that P&C pricing is at a positive inflection point. Prices are clearly improving after pricing increased on average in 3Q11 for
16 April 2012 32
the first time since late 2003, which is clearly a favorable result for the sector. TRV and CB see similar trends as well as an accelerating rate of improvement over the past several months. Interestingly, P&C prices are on average only about 8% above 1999 levels (end of the last soft market), and prices are about 50% lower than peak prices in 2003. Figure 51: Average Year-over-Year Commercial P&C Rate Changes by Account Size
40% 9/11 30%
Figure 52: Cumulative Index Of Commercial P&C Rate Changes by Account Size
175 165 155 145 9/11 135 125 2005 Hurricanes Financial Crisis Japan earthquake
20%
2005 Hurricanes
10%
0%
115 105
-10%
95 1Q00 3Q00 1Q01 3Q01 1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11
-20% 4Q99 2Q00 4Q00 2Q01 4Q01 2Q02 4Q02 2Q03 4Q03 2Q04 4Q04 2Q05 4Q05 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10 4Q10 2Q11 4Q11
Small Accounts
Midsized Accounts
Large Accounts
Small Accounts
Midsized Accounts
Large Accounts
Source: The Council of Insurance Agents and Brokers. Chart prepared by Barclays Research.
Source: The Council of Insurance Agents and Brokers. Chart prepared by Barclays Research.
Commercial rate increases accelerate. P&C price increases accelerated across all lines in 4Q11 with the largest increases in workers compensation (up 8%) and commercial property (up 6%), which together account for about half of U.S. commercial P&C insurance premium volume. P&C prices also increased across all account sizes. Insurance carriers are asking for rate increases on renewal business, walking away from underpriced business, and terms and conditions are tightening. Competition for new business still exists, although the gap between pricing for new and renewal business is narrowing. Figure 53: Average Commercial Rate Changes by Lines
60%
50%
2005 Hurricanes
200
40%
9/11
180
Financial Crisis
Japan earthquake
30%
20%
2005 Hurricanes
Financial Crisis
Japan earthquake
160
9/11
140
10%
0%
120
-10%
-20% 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
100 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 Commerical Auto Workers' Compensation Commercial Property General Liability Umbrella
Commercial auto
Workers' compensation
Commercial property
General liability
Umbrella
Source: The Council of Insurance Agents and Brokers. Chart prepared by Barclays Research.
Source: The Council of Insurance Agents and Brokers. Chart prepared by Barclays Research.
16 April 2012
3Q11
33
The commercial P&C insurers appear optimistic about the P&C pricing environment
The commercial P&C insurers appear optimistic about the P&C pricing environment. For example, TRV said it achieved rate increases in 4Q11 in all products for the fourth consecutive quarter, while CBs renewal rate increases in its commercial insurance business continued to accelerate and rate increases were secured on almost three-quarters of business renewed in the fourth quarter. ACE CEO Evan Greenberg said U.S. commercial P&C business began to achieve flat to modestly positive rate increases in most products in 2011. Notably, improved pricing continued in 2012, led by property and workers compensation insurance. Outside the United States, P&C pricing remains soft with the exception of catastrophe-exposed areas. Insurance brokers AJG and AON both see pricing continuing to rise. Figure 55: Commercial P&C Pricing Commentary Increasingly Positive
Commercial Lines TRV Pricing remained positive across all segments for the fourth consecutive quarter and accelerated in 4Q11. Renewal rate gains in Business Insurance exceeded 6%, up from 3% in 3Q11, led by workers compensation and commercial auto. Commercial accounts increased 8% (up from 4% in 3Q11), the highest level since the end of 2003. For the month of December 2011, renewal rate gain was 8% and preliminary review of January 2012 suggests similar progress. TRV believes that these written rate levels exceed current views of loss trends. U.S. commercial renewal rates rose 6% in 4Q11 compared to 4% in 3Q11 and 2% in 2Q11. CB saw renewal rates increase across every line of business, with property increasing the most, followed by general liability, workers comp, excess umbrella, package, commercial auto, boiler, and marine. CB secured rate increases on about 70% of standard commercial insurance business renewed in 4Q11 vs. 30% a year ago. Outside the US, rate increases were obtained in cat-exposed regions, while Europe renewal rates were flat. Separately, professional liability renewal rates turned positive in the fourth quarter to +1% compared to -1% in 3Q11, the first positive rate increase in the US for professional liability since 2009. ACE saw P&C rates steadily firming in North America with overall rates increasing 1.6% in 4Q11. Notably, December price increases were the highest with rates increasing over 4%. International P&C rates are softer than U.S. rates. ACGL continued to see improvement in rates across the board. Rates in most lines of business moved into positive territory with the exception of the executive assurance (down 6%) and medical malpractice (down 1%-7%).
CB
ACE
ACGL
Insurance Brokers MMC MMC views the overall P&C rate environment as improving, with property catastrophe, particularly in the U.S. and Pacific, showing the most firming. Rate increases for property cat ranged from +5-15%. U.S. property, workers comp, excess casualty, and general liability rates all increased in 4Q. Rates were also flat to down internationally. Commercial P&C insurance placed by Aon renewed flat on average in 4Q11, an improvement to -1.9% in 3Q11, from -2.5% in 2Q11, and -5.3% in 1Q11. WSH saw mid-single digit rate increases for property catastrophe renewals in its North America segment, however rates overall were flat in the fourth quarter for the segment. Separately, renewal rates increases were segmented by individual loss history for January 1 renewals, with positive trends continuing for catastrophe-affected property renewals in the U.S. The new RMS 11 wind model did not affect January 1 renewals in Europe. AJG is seeing P&C rates increasing at the same rates as the CIAB 4Q11 Survey (small accounts +3.1%, medium accounts +3.5%, large accounts +1.8%). Property rates are generally increasing more than 3% and in particular the middle market is showing firming. AJG has seen up to 100% rate increases in catastrophe-exposed property accounts and views this line as being in a hard market. BRO is seeing an intensifying push by insurers to increase rates. However, it views noncatastrophe exposed areas and certain product lines are still very competitive.
AON WSH
AJG
BRO
16 April 2012
34
Stabilizing demand. Commercial P&C insurance exposure growth is low driven by a slow economic recovery, but appears to be stabilizing. Insured exposures, including payrolls and commercial real estate development, declined significantly during the economic recession, but appear to have troughed. We view commercial P&C insurance as a late-cycle economic recovery opportunity because overall economic conditions need to improve before demand for insurance coverage rises. Recent commentary from insurers signals demand has likely stabilized, although the recovery is expected to be slow. Broad economic indicators including payrolls and construction show that demand for insurance coverage is poised to recover. Private nonfarm payrolls are recovering (Figure 56) but are still 5% below peak levels. In addition, U.S. private non-residential construction is improving however current levels are nearly 38% below the peak in January 2008 (Figure 58). The most recent data reported shows U.S. private non-residential construction continues to recover. Figure 56: Private Nonfarm Payrolls
Improving payrolls lead to increases in Workers' Comp premiums
$400
$350 in $ billion
$300
$250
$200
Jan 9 -0 Jan 0 -1 Jan 1 -1 Jan 2 -1
2 1 0 9 8 7 6 5 4 3 -0 n -0 n -1 n -1 n -1 -0 n -0 n -0 n -0 n -0 Ja Ja Ja Ja Jan Ja Ja Ja Ja Jan
Source: U.S. Census Bureau.
Figure 58: P&C Exposures Are Stabilizing a Tailwind for Expanding Premiums Volume
Exposure commentary ACE TRV MMC WSH Exposure growth increased 3.5% in 4Q11 as a result of gradually improving economic growth. Exposures are up in 4Q and audit premiums increased y/y. Exposures in the Business Insurance segment remain positive and show continued improvement. MMC sees a macroeconomic environment similar in 2012 similar to 2010 and 2011. Audit premiums were flat overall in 4Q11. WSH sees signs that the economy is improving in the U.S., although International was negatively impacted by tough economic conditions in the U.K. The company sees exposures growth normalizing in 2012. Economic conditions improved for AJGs clients with some audit premium increases in the most recent quarter. Exposures are stabilizing overall.
AJG BRO
Insurers book value growth is expected to slow as accident year margins deteriorate and reserve releases slow late in the P&C cycle. A composite of commercial P&C insurers reported book values grew nearly 7% in 2011 despite larger catastrophe losses and reduced investment income (5% growth excluding unrealized investment gains). Reported book value growth in 2012 could be around 9% (+9% excluding AOCI from investment gains)
16 April 2012 35
and 6% in 2013. Unlike the life insurers, book value excluding AOCI for the P&C insurers is unlikely to be the most relevant base line for valuation near-term because unrealized investment gains could fluctuate due to changes in interest rates. Figure 59: Commercial Insurers As-Reported Book Value Growth for Top Quartile Performers
Reflects recovery from financial crisis
Figure 60: Commercial Insurers Book Value Growth Ex AOCI for Top Quartile Performers
30%
35% 30%
29.3%
25% 20% 17.0% 15% 13.9% 14.2% 10.8% 8.5% 3.7% 4.8%
17.4% 9.0%
6.6%
6.1%
10% 5% 0%
7.2%
16 April 2012
36
property lines, the renewal pricing range was wide; however the majority of risk managers we surveyed saw prices increases.
Notably, price increases are no longer limited to loss-impacted programs
Notably, price increases are no longer limited to loss-impacted programs. The overall median year-over-year price change for all commercial property/casualty lines is 3% as of early 2012, with a range of down 7% to up 38%. In our most recent survey, only 12% of respondents anticipate rate decreases in commercial P&C insurance programs, with 21% noting flat renewals, and 67% anticipating price increases. Six months ago, 30% of respondents experienced rate decreases in their P&C programs, 38% noted flat renewals, and 32% anticipated price increases.
Early 2011
8% 32% 28%
Mid 2011
Early 2012
12% 30%
21%
64%
67%
38%
Rate increases
Source: Barclays Research
Rate decreases
Flat renewals
A Small But Increasing Percentage of Buyers Characterize the P&C Market as Hard
More risk managers characterized the overall commercial P&C market as hard
In our most recent survey, 7% of risk managers called the P&C market hard (up from 0% six months ago) and 81% characterized the overall commercial P&C market as stable (up from 70% six months ago). Meanwhile, 13% of respondents called the market soft, compared to 30% six months ago. Notably, roughly half of risk managers we interviewed viewed the catastrophe-exposed property insurance market as hard (vs. none six months ago). None of the respondents said the catastrophe-exposed property insurance market is soft, versus roughly 10% six months ago.
16 April 2012
37
Soft
Source: Barclays Research
Stable
Hard
NA
16 April 2012
38
Tighter
Source: Barclays Research
No change
Less restrictive
16 April 2012
39
Figure 64: How Difficult Was the Renewal Process This Year?
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
Ja n04 Ja n05 Ja n06 Ja n07 Ja n08 Ja n09 Ja n10 Ja n11 Ja n03 Ja n12 Ju l-0 3 Ju l-0 4 Ju l-0 5 Ju l-0 6 Ju l-0 7 Ju l-0 8 Ju l-0 9 Ju l-1 0 Ju l-1 1
Renewal process was more difficult.
More difficult
No change
Less difficult
16 April 2012
40
Property 46%
Liability 50%
Commercial liability insurance protects the assets of a business when it is sued for something the business did (or failed to do) that caused monetary damage, bodily injury or property damage to someone else. A businesss liability exposure includes not only paying damages and perhaps a penalty as the result of a successful lawsuit against it, but it also includes attorneys fees and other costs involved in defending a company against a liability claim. The top three liability lines as a percentage of total liability premiums are: Other Liability (Claims-made, which includes Directors & Officers Liability as well as Errors & Omissions insurance, and Occurrence, which includes general liability), Workers Compensation, and Commercial Auto Liability. Property insurance provides protection against most risk to property, such as fire, theft, and some weather damage. The top three property lines as a percentage of total property premiums are: Commercial Multiple Peril, Inland Marine, and Fire.
16 April 2012
41
Marine 7%
Workers Compensation
18%
Provides coverage for medical care and rehabilitation for workers injured in the course of employment, as well as lost wages. It also provides death benefits for dependants, in the case where an employee is killed in work-related situations. A package policy that includes coverage for property (insurance on buildings and their contents), boiler and machinery (i.e., equipment breakdown), crime, and general liability. Protects a business when it is sued for something the business did (or failed to do) that caused monetary damage, bodily injury or property damage to someone else. Protects against physical damage (collision, comprehensive, and specified perils) and legal liability related to the operation of vehicles in the course of conducting business. Fire insurance provides coverage against losses caused by fire and lightening. Allied lines include coverage for wind, water damage, and vandalism. A commercial coverage that protects the policyholder from legal liability arising from negligence, carelessness or a failure to act that causes property damage or personal injury to others. Includes Directors & Officers and Errors & Omissions liability.
15%
12%
Commercial Auto
11%
11%
8%
Commercial insurers are diverse in terms of size, specialty, and role in the industry. The four largest U.S. writers by market share are AIG (Chartis) (8% market share), Travelers (6% share), Liberty Mutual (6%), and Zurich (4%). Figure 68 shows the top 25 commercial P&C insurers by market share which accounts for nearly two-thirds of the total commercial P&C market. Notably, AIG still has the largest market share despite its past turmoil. The dozen largest predominately U.S. commercial lines insurers also account for approximately one-
16 April 2012
42
quarter of industry capital. We view these companies as price leaders with significant influence on P&C market conditions. Figure 68: U.S. Commercial Lines Market Share, 2011
9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
AI G Tr av el Li er be s rty M ut ua l CN A at io nw id e Fi na nc ia W l .R .B er kl ey As su ra nt FM G lo ba O l ld Re pu bl ic Be F ar rk m sh er i re s H at ha w ay To ki o M ar in e
CN A h FM W. R. Be rk l ey AC E x Fai rfa G lo ba l Al l i an z Zu ric
Ch ub b
AC E
fo rd
Q BE St
Ch ub b
an z
Zu ric
ar t
Al li
Figure 69: Largest U.S. Commercial P&C Insurers by Statutory Surplus, 4Q11
$30 $25 $20 in $bn $15 $10 $5 $0
AIG rs Tra ve le utu a Ha rtfo rd l
16 April 2012
L ib e rt yM
Am
er ic an
at e
Fa rm
43
20% $230 $172 $240 $247 $261 $261 $257 $239 $233 $236 $242 $251 15% 10% 5% 0% -5% -10% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E
% Change in DWP
44
Hurricane Andrew
9/11
insurers could be negatively impacted as a result of the need to increase reserves in the most recent accident years (specifically 2008 through 2010). The pace of reserve releases moderated in 2011 compared with recent years and the difference year-over-year would have been greater if not for AIGs substantial reserve strengthening in 4Q10. A.M. Best believes the overall P&C industrys reserve cushion is largely exhausted because of sizeable reserve releases over the past six calendar years. The declining impact of reserve releases are likely to weigh on the industrys bottom line in 2012. Figure 72 shows loss reserves and paid-to-incurred loss ratio for the U.S. P&C industry (including personal lines and balance insurers). The P&C industry experienced annual loss reserve growth in 2010 following a lack of growth since 2008. We expect continued loss reserve growth through 2013, which could imply upward pressure on calendar year combined ratios. Figure 72: U.S. P&C Industry Loss Reserves & Paid-to-Incurred Ratios, 1979-2013E
$700 $600 $500 in $ bil $400 $300 $200 $100 $0 1979 1981 1983 1985 1987 1989 1991 1993 1995
1997
1999
2001
2003
2005
2007
2009
2011E
Loss Reserves
Paid-to-Incurred Ratio
Note: Historical data and estimates include commercial lines, personal lines, and balanced insurers. Hard commercial P&C insurance market periods are shaded. Source: A.M. Best, Insurance Services Office, Barclays Research estimates.
Overall, loss frequency and severity remain favorable due to a slowly recovering economy and low inflation, although if this situation reverses, we believe loss reserves could become deficient. Net loss reserves for commercial insurers we cover increased in 2011 following declines in the last several years, perhaps signaling efforts to improve the adequacy of reserves. Among the largest insurers, TRVs and XLs loss reserves declined the most since year-end 2005, although reserves increased for both companies in 2011. XLs premium volume also declined in part due to its financial difficulties during the financial crisis. Meanwhile, CB, ACE, and ACGLs loss reserves have increased over the same time period. For CB, we suspect part of this increase is due to directors and officers (D&O) liability claims arising from the global financial crisis.
16 April 2012
2013E
45
YE 20 05
YE 20 06
YE 20 07
YE 20 08
YE 20 10
YE 20 09
YE 20 11
YE 20 09
YE 20 06
YE 20 07
YE 20 08
YE 20 10
YE 2
YE 20 05
YE 20 06
YE 20 07
YE 20 08
YE 20 09
YE 20 10
Commercial P&C results have benefitted from the ongoing favorable development of loss reserves from business written in the hard market accident years of 2001-2005. We expect the pace of reserve releases to moderate in 2012, and subsequent years could show adverse development.
16 April 2012
YE 20 11
YE 20 06 YE 20 07 YE 20 08 YE 20 09 YE 20 10 YE 20 11
YE 20 05
01 1
YE 2
00 5
YE 20 05 YE 20 06 YE 20 07 YE 20 08 YE 20 09 YE 20 10 YE 20 11
46
Figure 74: U.S. P&C Industry Prior Year Loss Reserve Development, 1992-2013E
$30 $25 $20 $15 $10 $5 $0 ($5) ($10) ($15) ($20)
19 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 0 20 1 0 20 2 0 20 3 0 20 4 0 20 5 0 20 6 0 20 7 20 08 0 20 9 E 1 20 0 E 1 20 1 E 1 20 2 E 13 E
in $ billion
Note: 2005 reserve development excludes a $6 billion loss portfolio transfer between American Re and Munich Re. Including this transaction, total prior year adverse development in 2005 was $7 billion. The data from 2000 and subsequent years excludes development from financial guaranty and mortgage insurance. Historical data and estimates includes commercial lines, personal lines, and balanced insurers. Source: A.M. Best, Insurance Services Office, Barclays Research estimates.
16 April 2012
an z
Al ls
Al li
Ev er e
Gross Reserves
(a) Figures include both asbestos and environmental reserves. (b) Year-end 2010 is shown for gross reserves because data is not available for 2011. Source: Company data, Barclays Research
We estimate the entire U.S. P&C insurance market has about $120 billion of excess capital at year end 2011, which translates into about 21% of U.S. industry capital, although P&C industry excess capital has likely peaked. The industry's excess capital position reflects historically low operating leverage and growth in capital from retained earnings and investment gains. We anticipate that industry excess capital could ease reflecting both faster premium growth and stable capital. Notably, P&C prices rose in 1999 despite the industry being (on paper) almost 20% overcapitalized.
Excess Capital
$135
$50
$0
-$50
-$100 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 1994
Surplus Redundancy
Note: Historical data and estimates includes personal lines and balanced insurers Source: ISO, Barclays Research estimates
16 April 2012
XL
Ca
pi ta
l( a)
48
Commercial lines P&C insurers with the most estimated excess capital excluding AOCI at year end 2011 could be CB ($4bn), ACE ($3bn), and XL ($1.5bn). Excess capital for the P&C commercial insurers we cover could be redundant by 12% of common equity based on our analysis 1. Share repurchase activity is likely to slow as a result improved top-line growth opportunities as well as concerns about continued large catastrophe losses and slowing loss reserve releases. As a result, we anticipate several companies are likely to retain excess capital even though it would depress ROE. Figure 77: Estimated Excess Capital at YE 2011 (in $bn) Figure 78: Estimated Excess Capital By YE 2011 as a % of 4Q11 As-Reported Book Value
25% 20% Median=12% 15%
$4.0
$3.0
$2.0
10%
$1.0
5% 0%
AHL
TRV
AWH
ACGL
ACE
XL
CB
The commercial insurers excess capital position has likely peaked. In 2011, excess capital declined driven by over $100bn of global catastrophe losses and increased operating leverage. As a result, insurers returned less excess capital to shareholders in the form of share repurchases as shown in the following figure. Figure 79: U.S. Commercial Industry Share Repurchase Activity
$25 $20
in $ bil
$19.1
$15 $10.5 $10 $6.9 $5 $0 2006 2007 2008 Industry ex AIG & HIG 2009 AIG HIG 2010 2011 $4.0 $10.3
Note: Excludes Allstate and Progressive. AIG repurchased $3bn in stock in 1Q12, which is not reflected in this chart. Source: Company data, Barclays Research
The following figures show share repurchases since 2005 for the commercial insurers we cover. The pace of share repurchases is likely to slow in 2012 and 2013 for commercial
1
We estimated P&C insurers excess capital by taking the average of estimated long-run operating leverage as well as financial leverage.
16 April 2012
49
insurers driven by deteriorating underwriting results and declining reserve releases. Notably, we do not anticipate ACE will repurchase stock except to offset dilution from shares issued for executive compensation because of its preference for acquisitions. Meanwhile, ACGL is unlikely to repurchase stock before 4Q12 due to increased potential for large transactions as well as perhaps committing more risk capacity to Japan earthquake and Florida wind. Figure 80: Cumulative Share Repurchases Since 2005 Net of Shares Issued
$20 $17 $16
Figure 81: Cumulative Share Repurchases Since 2005 as a Percent of Shares Outstanding, Net of Shares Issued
60% 50% 40% 30% 30% 41% 43% 48% 49%
in $ bil
$12 $10 $8
$3
-30% -40% -50% -41% XL (b) AHL AWH (a) CB ACGL TRV
ACGL
CB
TRV
Note: (a) Allied World's initial public offering was completed in July 2006. (b) XLs share repurchases are net the companys $2.2bn (143.8mn shares) issuance in August 2008. Source: Company data, Barclays Research
Note: (a) 2005 year-end share count is used for all companies with the exception of AWH, for which we used 2006 year-end share count. (b) XLs share repurchases are net the companys $2.2bn (143.8mn shares) issuance in August 2008. Source: Company data, Barclays Research
16 April 2012
50
Figure 83: Top-Tier Commercial P&C Operating ROE Excluding Prior Year Loss Reserve Development
20% 17%
16% 12%
10%
10%
9%
8%
8%
ACE, Chubb, Arch Capital, and Travelers are used as a proxy top-tier performers in the commercial P&C industry. Source: Company data, Barclays Research estimates
ty
Fu nd
of
Li be r
Fu nd
at e
(a) YE2010 market share data used for State Fund of NY and State Comp Fund of CA which is the latest data available. Source: SNL, Barclays Research
Liberty Mutual is the largest writer of workers compensation insurance in the U.S. with 10% market share, and top ten largest writers in total account for 54% of the overall market. The market share of the next largest workers' comp writers are AIG (9% market share), TRV (8%), HIG (8%), and Zurich (6%).
16 April 2012
St
at e
Co m
St
ld
2013 E
51
2004
2005
2006
2007
2008
2009
2010
2011
2004
2005
2006
2007
2008
2009
2010
2011
HIG writes the most workers compensation insurance as a percentage of its overall U.S. P&C business
Of the stocks we cover, HIG writes the most workers compensation insurance as a percentage of its overall U.S. P&C business at 30% compared to 15% for TRV and 14% for ACGL. This data only captures U.S. workers compensation premiums as a percentage of U.S. P&C business, which means work comp business as a percentage of overall global P&C premiums would be much lower for AIG, ACE, and ACGL. From 2008-2010, AIGs profitability in workers compensation was worse than the industry average while TRV, HIG, ACE, and CB's workers comp underwriting results were better than the industry's, although HIGs results deteriorated in 2011. Figure 85: Workers Compensation Writers, % Total U.S. Company Premiums2011
35% 30% 25% 20% 15% 10% 5% 0% HIG TRV ACGL AIG ACE CB THG XL BRK
The last economic downturn caused the workers comp market to lose more than a quarter of its total premiums and profitability declined significantly. Moreover, the most recent recession caused the largest percent decline in payrolls since the 1948-1949 recession. Reduced payrolls translate into lower workers' comp premium volume. Indeed, net written premiums fell for the fifth consecutive year in 2010 to $34 billion (-3% y/y), the lowest level since 2001. For 2011, while the line is expected to continue to face headwinds from growing medical costs and increased claims frequency, employment appears to have stabilized and workers comp could be among the first lines to see exposure gains as the macroeconomic environment improves. Notably, the Barclays economic research team expects the unemployment rate to continue to trend lower to 8.0% and 7.2% for 2012 and 2013, respectively. Workers comp loss costs could rise with increasing healthcare costs. In 2011, hospital services costs rose 5.2% vs. a 3.1% increase in the overall CPI and a 1.6% increase in the core CPI. Figure 87 shows workers comp combined ratios have increased dramatically since 2006. Notably, insurers results show significant variability with state funds reporting particularly challenged results since many of them are writers of last resort. In 2011, the workers comp industry combined ratio likely deteriorated another 2 points to 119%, representing the worst result since 2001. California workers compensation represents approximately 18% of the overall workers comp market and has faced significant profitability pressure. California workers comp rates are increasing rapidly. For example, Everest Re raised rates 15% in 2011 on top of 9% rate increases in 2010.
16 April 2012
52
Private Carriers
State Funds
Note: State Funds available for 1996 and subsequent. Source: National Council On Compensation Insurance (NCCI), Barclays Research
Reserves for the workers comp line also appear to be increasingly deficient according to A.M. Best, which estimates a $4.4bn deficiency in reserves (excluding discount) in 2010, up from $1.8bn in 2009. On a positive note, workers compensation rates increased in 2011 for the first time since 3Q04. Pricing appears to be improving as workers compensation rates were up 7.5% in 4Q11 based on CIAB data, however it remains to be seen whether price increases will outpace loss cost inflation. Figure 88: Workers Comp Average Rate Change y/y
30%
25%
180
20%
170
15%
160
10%
150
5%
140
0%
130
-5%
120
-10%
110
4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
16 April 2012
4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
-15%
100
53
Reinsurers are a levered play on the P&C cycle and typically generate more volatile earnings and ROEs than primary insurers. When claims costs are low, the reinsurers earnings and returns on equity tend to benefit more than the primary insurers, with the reverse being true in a period of elevated claims activity. In 2011, the second largest year of insured global catastrophe losses along with depressed investment income resulted in negative ROEs for many Bermuda reinsurers. However, P&C reinsurers should now benefit from higher property catastrophe pricing. The reinsurers ROEs are likely to recover through 2013 assuming more normalized catastrophe activity, although reinsurers will continue to face headwinds from lower investment income growth, weaker accident year underwriting results, slowing reserve releases, and reduced share buyback activity.
How to Distinguish Among Reinsurers. Reinsurers differentiate their businesses based on product line and geography. Some reinsurers focus on short-tail property lines including: RNR, MRH, VR, and FSR. Other reinsurers are global and diversified by product lines including: Munich Re, Swiss Re, General Re (part of Berkshire Hathaway), PartnerRe,
16 April 2012 54
Everest Re, and Transatlantic. Still other companies write commercial insurance with a less significant presence in reinsurance including XL, ACE, and ACGL. The worlds largest reinsurers based on P&C premium volume are Munich Re, Swiss Re, Lloyds of London, Berkshire Hathaway, and Hannover Re. Reinsurers compete mostly on the basis of pricing, size of capital positions (bigger is usually better), and ratings from S&P and A.M. Best. Importantly, primary insurers avoid reinsurers with questionable solvency because the primary insurers always want to be certain they can collect on claims they present to their reinsurers. Primary insurers are expert buyers of reinsurance coverage, which means it is important to discuss with primary insurers their purchasing trends when analyzing the reinsurers. Currently, demand from primary insurers for reinsurance protection is growing reflecting large catastrophe losses in 2011. In addition, demand for reinsurance is benefiting from the adoption of changes to catastrophe models. Specifically, RMS (a major catastrophe model vendor) changed its assumptions to reflect hurricanes impacting further inland resulting in larger loss expectations and therefore the need for increased reinsurance coverage. Figure 90: Top 25 Global P&C Reinsurers based on Gross Written Premiums, 2010
in $ bn $25 $20 $15 $10 $5 $0 RenaissanceRe PartnerRe Toa Re Transatlantic Tokio Marine Munich Re Swiss Re Hannover Re Odyssey Re Korean Re EverestRe Berkshire Hathaway China Re Caisse Centrale Catlin Lloyd's Allianz SE MAPFRE RE MS&AD Gen'l Ins. Corp. of India SCOR S.E. Aspen
55
Reinsurers can either offer coverage directly (such as Munich Re, Swiss Re, or General Re), or through reinsurance brokers such as Aon Benfield, Guy Carpenter (part of Marsh & McLennan), or Willis Re. Reinsurers that distribute products through brokers include Transatlantic, Everest Re, and PartnerRe as well as most other Bermuda reinsurers. Competitive threats to traditional reinsurance coverage include reinsurance sidecars (collateralized facilities managed by a reinsurer with the risk assumed by investors), industry loss warranties (reinsurance protection based on total industry insured losses or other factors such as maximum wind speed rather than company-specific losses), and catastrophe bonds (transfers cat risk to the capital markets). Figure 92 shows the largest reinsurers based on shareholders equity, although the capital base for many of these companies supports primary insurance as well as reinsurance exposure.
16 April 2012
Axis
QBE
XL
ACE
Note: Values reflect total shareholders equity, which supports all business written including reinsurance. Source: A.M. Best, Barclays Research
Reinsurers experienced modest balance sheet strain in 2011 as a result of major reinsurance loss activity; however, this has set the stage for improved pricing. The Japan earthquake is estimated to have caused over $30bn in insured losses and ultimate losses from the Thailand floods could range from $10bn-$15bn. Among the P&C reinsurers we cover, the companies with the largest catastrophe losses in 2011 as a percentage of book value include FSR, PRE, MRH, and RE. Notably, while industry insured losses from the U.S. tornadoes ($13bn) and Hurricane Irene ($6bn) in 2011 were meaningful, these events largely affected the primary insurers.
16 April 2012
Arch
Axis
QBE
XL
ALL
AHL
XL
THG
RNR
PGR
AIG
$30
$8 $5 $2 $1
$10
$13 $6
$15
Source: Insurance Council of Australia, Munich Re, AIR Worldwide, Insurance Information Institute
Other major historical catastrophe losses included Hurricane Andrew in 1992, the September 11, 2001 terrorist attacks, and Hurricane Katrina in 2005. These events resulted in many reinsurers recapitalizing to protect their ratings from the rating agencies, as well as revising their risk management framework. Start-up reinsurers formed as a result of supply-demand imbalances after these three events with mixed results. Notably, no startups emerged following significant catastrophe losses in 2011 because capacity was still adequate, although several reinsurers including RNR, Alterra, and Validus formed sidecars to take advantage of supply/demand imbalances in niche markets, such as retrocessional reinsurance (reinsurance for reinsurers).
16 April 2012
FSR
57
Figure 94: Guy Carpenter U.S. Property Catastrophe Rate on Line Index
Year Over Year Change in Rate On Line (Base 1989)
250 200
152
154 145
195
40%
100
115
150 100
8%
20% 0%
0% 15% 23% 68% -3% -13% -20%
10%
-3%
50 0
-20%
Reinsurers Have Adequate Capital. Reinsurers should benefit from rising property
catastrophe reinsurance rates, although most of the reinsurers do not have substantial excess capital to increase their risk appetite or buy back stock. Also, we anticipate little appetite for M&A activity given current depressed valuations for P&C reinsurers and the potentially high cost of using stock as currency for acquisitions. This differs from the trend of consolidation of P&C reinsurers in prior cycles as companies sought to acquire growth and achieve economies of scale in the face of declining reinsurance prices and returns on equity. Also, several reinsurers have exited their non-core primary insurance operations due to insufficient scale and a lack of underwriting profits. Among those companies, MRH sold its U.S. primary insurance business to Selective, and RNR sold its U.S. primary insurance business to Australian insurer QBE. Most reinsurers slowed share buybacks in 2011 after suffering large catastrophe losses. We do not anticipate meaningful share repurchase activity in 2012 because most reinsurers excess capital positions are modest. Of the reinsurers we cover, PRE, MRH, and RE could repurchase stock, but we expect the pace to be modest. RNR, AHL, and ACGL are unlikely to repurchase stock until after the 2012 hurricane season.
16 April 2012
19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 1/ 11 1/ 12
YOY Change
Hurricane Andrew
Hurricane Katrina
300
58
Financial crisis
$4.0 $3.0 $2.0 $1.0 $0.0 2006 2007 2008 2009 2010 $0.2 $2.2 $1.6
2011
Note: Data include PRE, RE, AWH, MRH, FSR, RNR, TRH, AXS, PTP, ALTE and VR. Source: SNL data, Barclays Research
16 April 2012
59
R TR V
CB
PR E
RE
XL
Volatility is measured as the standard deviation of operating ROE. Source: Company data, Barclays Research estimates
Note: To show comparable volatility of operating EPS, we divided each companys standard deviation of operating EPS by its average EPS. Source: Company data, Barclays Research
Hurricanes have caused the largest U.S. insured losses in the past 10 and 20 years. As a result, investors often focus their attention on the reinsurers when it comes to hurricane (windstorm) risk, which runs from June to November and peaks in September. In 2011, there were 19 named storms during the Atlantic hurricane season, tying it with 1887, 1995, and 2010 as one of the busiest years for tropical storms, however insured losses were modest with only five tropical storms and one hurricane making landfall. Hurricane Irene was the first U.S hurricane to make landfall since 2008, resulting in approximately $6bn of insured losses. Notably, insured losses from the 2011 hurricane season did not reach levels to meaningfully impact the reinsurers.
16 April 2012
AW
FS R M RH
PG
$50 Insured Damage (in $ bil, inflation adjusted) $45 $40 $35 $30 $25 $20 $15 $10 $5 $0
$45.5
$22.4 $12.7
Katrina (2005)
Andrew (1992)
Ike (2008)
Wilma (2005)
Charley (2004)
Ivan (2004)
Hugo (1989)
Rita (2005)
Irene (2011)
Frances (2004)
We find it interesting that the reinsurance market seems to largely ignore the level of hurricane activity and instead focuses on whether there were insured windstorm losses. Notably, most of the largest insured industry catastrophe losses in the past 20 years were from U.S. hurricanes. Our analysis, which we describe on page 64, shows the reinsurer stocks have a history of outperforming the S&P 500 in September for eight of the past ten years regardless of insured hurricane damage as investors concerns ease regarding potential hurricane losses. Figure 99: Top Ten U.S. Hurricanes by Modeled Inflation-Adjusted Insured Losses
$120 2009 Modeled Insured Loss (in $ bil, inflation adjusted) $101.0 $100 $80 $60 $40 $20 $0
26 ) 65 ) i( 19 (1 9 (1 9 (1 9 (1 (1 95 0) Ea sy 5) 0) 19 47 ) 20 0 19 0 (1 9 96 0) 92 ) 28 ) 38 )
$57.0
$55.0
da le (
st on (
a(
Be tsy
ke ec ho be e
Ka tr i n
nd r
Ga lve
lan d
iam
Fo rt La ud er
re at O
Gr ea tN
ew
En g
Do
nn a
ew
$5 $4 $3 $2 $1 $0
16 April 2012
in $ bil Lloyd's Munich Re Berkshire Hathaway XL Capital Swiss Re Montpelier Re Everest Re Axis Capital IPC Re Renaissance Re Zurich Re PXRe Partner Re Endurance Aspen Platinum Allied World White Mountains Arch Capital Transatlantic Odyssey Re Hannover Re Employer Re Max Re
Ja pa n Hu rr ica ne Ka tri na (
PXRe
Montpelier Re
IPC Re
Aspen
Axis Capital
$62
Everest Re
Allied World
$30
Partner Re
$19
Insured Losses
XL Capital
Lloyd's
$17
Odyssey Re
Max Re
$15
Arch Capital
$15
Transatlantic
Hannover Re
$14
White Mountains
Munich Re
$13
Swiss Re
Figure 100: Top Ten Costliest Natural Catastrophes by Insured Losses (in $ bil)
$13
Zurich Re
Employer Re
Note: The $62 billion of insured losses from Hurricane Katrina in this exhibit includes losses from non-U.S. insurers and reinsurers as well as offshore oil rig losses that are not included in Figure 99. Source: Munich-Re, Insurance Information Institute, Barclays Research
20 ea 05 rth ) qu ak e (2 Hu 01 rr 1) ica ne Hu Ike rr (2 ica 00 ne 8) No A rth nd re r id w ge (1 ea 99 rth 2) qu ak es Th (1 ai 99 la 4) nd flo od s( Ih 20 ur 11 ric ) an e va Hu n rr (2 ica 00 ne 4) W ilm a U. (2 S. 00 To 5) rn ad oe s( Hu 20 rr 11 ica ) ne Ri ta (2 00 5)
$12
Berkshire Hathaway
62
Capital Raised
in $ bil $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 $0.5 $0.0 XL Capital Axis Capital Endurance Partner Re Everest Re Montpelier Re Odyssey Re Max Re Platinum Arch Capital Arch Capital Axis Capital IPC Re Aspen PXRe Allied World
16 April 2012
63
U.S. Hurricane Mid-Atlantic hurricane Northeast hurricane Gulf hurricane Florida hurricane Hawaii hurricane U.S. Earthquake New Madrid earthquake California earthquake Northwest earthquake European Windstorm Western European windstorm UK & Ireland windstorm Scandinavia windstorm Other Countries Japan earthquake Canada earthquake Australia earthquake Australia cyclone Turkey earthquake New Zealand earthquake Japan windstorm Chile earthquake
Source: Company data
21% 20% 7%
The annual Atlantic hurricane season lasts from June 1 to November 30. Although it may appear counter-intuitive, reinsurer stocks typically offer a short-term buying opportunity in the month of September as the typical peak of hurricane season approaches. Over the past ten years, on average, our index of P&C reinsurers increased 3% in September versus a 1% decline in the S&P 500. This average historical 400 basis points of outperformance versus the S&P 500 in September alone reflects relief as the risks subside from the historically most active part of hurricane season. Notably, RNR, RE, and PRE appear to have the greatest sensitivity to hurricane season.
16 April 2012
64
Figure 104: Average September Stock Performance for P&C Reinsurers (2002-2011)
4% 3% Average Price Performance (2002-2011) 2% 1% 0% -1% -2% -3% September P&C Reinsurance Index S&P 500 S&P Financials S&P P&C -0.8% -1.9% 0.7% 3.3%
Note: P&C Reinsurance Index includes XL, RE, PRE, RNR, AWH, AHL, and MRH as of respective IPO dates. Index is equal weighted. Source: SNL, Barclays Research
Reinsurers typically rally in the month of September with the index of P&C reinsurer stocks gaining 3% on average in the past ten years versus a 1% average decline in the S&P 500. The index rose in September in eight of the last ten years, and also outperformed the S&P 500 in eight of the past ten years. There are two instances in the past ten years when the index underperformed the S&P 500 in September:
1) In September 2005 the index underperformed the S&P 500 by 2% due to the stock performance of two property catastrophe reinsurers after suffering losses from Hurricanes Katrina & Rita. 2) In September 2009 the index underperformed the S&P 500 by 1%, which we attribute to profit taking after the reinsurance stocks generated significant outperformance vs the S&P 500 of 10% in July and August 2009.
16 April 2012
65
3%
5%
-3% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
-5%
-2%
-1%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Note: P&C Index includes XL, RE, PRE, RNR, AWH, AHL, and MRH as of respective IPO dates. Index is equal weighted. Source: FactSet, Barclays Research
Note: P&C Index includes XL, RE, PRE, RNR, AWH, AHL, and MRH as of respective IPO dates. Index is equal weighted. Source: FactSet, Barclays Research
16 April 2012
66
25% 20% 15% 12% 10% 5% 0% -5% -10% -15% 2000 2001 2002 9/11 1% 15%
20% 13%
23%
$6 $5 $4 $3 $2 $1 $0 -$1 -$2 -$3 2000 2001 2002 2003 2004 2005 Hurricane Katrina Hurricane $100+ billion Ike cat losses 2006 2007 2008 2009 2010 2011
67
9/11
Hurricane -3% Ike $100+ billion -9% cat losses 2005 2006 2007 2008 2009 2010 2011
Based on results for Axis, Endurance, Everest Re, Flagstone, Montpelier, PartnerRe, Platinum, RenaissanceRe, Transatlantic, Validus, and Alterra. Source: Company data, Barclays Research
Based on results for Axis, Endurance, Everest Re, Flagstone, Montpelier, PartnerRe, Platinum, RenaissanceRe, Transatlantic, Validus, and Alterra. Source: Company data, Barclays Research.
P&C reinsurance pricing has steadily improved following several years of declines driven by large global catastrophe losses in addition to increased demand for reinsurance protection. U.S. property catastrophe reinsurance prices could increase 5%-10% at the mid-year 2012 renewals, following price increases of 10%-15% at the January 2012 renewals. Japan 4/1 property reinsurance rates are being quoted up 25%-30% on top of the 50%-60% rate increases in 2011. Most insurers expect pricing increases to continue in 2012 as reinsurers face deteriorating underwriting results and pressured investment yields.
16 April 2012
RNR
XL
PRE
RNR saw U.S. property catastrophe rate increases of approximately 10% y/y, including increases of 25% for loss-impacted accounts and 15% for accounts with hurricane exposure. Pricing on renewals for international primary placement continued to be significantly softer than the U.S., which RNR largely expected. Consistent with what the company has seen in 2011, rate increases were greater on accounts with losses, with Australia and Japan renewals seeing increases of as much as 50% versus loss-free European renewals up 5%. XL saw increases of 7.5-12.5% y/y for loss-free U.S. property cat renewals versus 1540% increases on loss-impacted placements. International property cat increased 3070% for renewals with losses, while UK and Continental Europe renewals saw singledigit increases. PRE was pleased overall with the outcome of the January 1 renewal and saw positive indications of rate stability in most lines of business. U.S. property catastrophe pricing year-over-year increases varied from 5-20% and international rate increase were up 5% or less; however, cat-exposed zones like Australia saw increases of 50% or more. MRH said it achieved year-over-year rate increases of 10% overall in its property catastrophe book. Rates increased 14.7% in the U.S., with national and regional placements varied depending on exposure and loss history, while International property catastrophe business increased 5.1%. Pricing was relatively in line with MRHs expectation, although rate increases in European wind were not as high as the company anticipated. Everest Re saw rate increases on the order of 15% for property retrocessional (reinsurance for reinsurers) renewals, 5-10% for property catastrophe placements with no losses, and greater increases in loss-affected areas. This was consistent with the companys outlook for 1/1. RE expects rate increase of this magnitude to continue in 2012. U.S. property catastrophe rates rose 10-15% y/y while Europe remained flat to up 5%, which is in line with the companys guidance for improved pricing as a result of the high level of catastrophes going into the January 1 renewal reason. The company still expects further increases in cat-exposed property in the first two quarters of 2012, particularly for the Japan reinsurance renewals in April. Property catastrophe renewal rates were mixed, although there were some signs of improvement, particularly in North America. Rates were up single-digits year-over-year for U.S. property cat renewals with no international exposure versus 40-50% increases for accounts with catastrophe exposures worldwide. Rates were up as much as 300400% in loss-affected regions like Japan, New Zealand, and Australia.
MRH
RE
AHL
AWH
On the demand side, we expect demand for reinsurance protection to increase modestly in 2012 as primary insurers look to retain decreasing levels of exposure in loss-prone regions following large weather-related losses. Demand should also increase as primary insurers slowly adopt catastrophe model changes.
16 April 2012
68
$170
$169
$29 $28 $27 $26 $25 $24 $23 2005 2006 2007 2008 2009 2010 2011 $25 $26 $26
AIG, Chubb, CNA, The Hartford, Travelers, ACE, Allstate, W.R. Berkley, XL, and Arch Capital are used as a proxy for the P&C primary commercial insurance industry. Source: Company data, Barclays Research
AIG, Chubb, CNA, The Hartford, Travelers, ACE, Allstate, W.R. Berkley, XL, and Arch Capital are used as a proxy for the P&C primary commercial insurance industry. Source: Company data, Barclays Research
Overall, reinsurers anticipate improved demand for coverage driven by exposure growth as a result of the slow economic recovery. In addition, primary insurers appear to be purchasing more coverage in regions which experienced high catastrophe activity in 2011 as well as to support their own premium growth. Figure 113: Reinsurers Commentary on Demand Trends
Company Comment
MRH
MRH sees potential for increased demand in 2012 as a result of catastrophe model changes continuing to be implemented, buyers reducing their retention for risk, and exposure growth if global economic conditions improve. RNR could benefit from increased demand for reinsurance in Florida. Citizens, the state-run insurer of last resort, could purchase up to $1bn of reinsurance vs $575mn last year, and RNR is a large reinsurer on this program. Also, the Florida Hurricane catastrophe fund (FHCF) could provide less capacity resulting in increased demand for private market reinsurance. Finally, Demotech (a FL rating agency) may not give Florida insurers credit for purchasing reinsurance from the FHCF. RE expects opportunities to grow property catastrophe reinsurance premiums in 2012 as the adoption of catastrophe model RMS 11 continues globally. PTP said it has a comfortable capital cushion should the company see attractive opportunities to expand. The market has yet to digest the effects of catastrophe model RMS 11 and the company expects demand for capacity in peak catastrophe zones, particularly in Japan. FSR saw a balanced demand and supply for capacity at January 2012 renewal season versus over-subscription in the past. Early indications point to increased demand for capacity at the mid-year Florida renewals reflecting the full implementation of RMS 11.
RNR
RE PTP
FSR
Major Reinsurance Renewals Occur in January and Mid-Year. Investors focus on the major reinsurance renewal seasons for indications of pricing trends. The first key reinsurance renewal period is in January for global reinsurance programs. The mid-year renewals in June and July are for reinsurance programs in the Southeast U.S. including Florida property catastrophe coverage. Japanese property reinsurance programs renew on April 1.
16 April 2012
69
Leading up to the January renewals, reinsurers meet at several conferences to discuss market conditions and negotiate contracts. The Monte Carlo Reinsurance Rendezvous is the first of these conferences, which occurs in September and is attended by both global and European-focused reinsurers. The Baden-Baden, Germany meeting takes place in late October and targets European programs. The annual meeting of the Property Casualty Insurers Association of America (PCI) also takes place in late October and caters to the U.S. primary insurance programs. Figure 114: Global P&C Reinsurance Renewal Calendar
U.S. Florida/ Southeast U.S. Europe including UK Asia-ex Japan Japan Notes
January February March April May June July August September October November December
Major
Major
Minor
Minor
1/1 key renewal date for property and casualty reinsurance coverage - U.S. nationwide, Europe.
Minor
Minor
Major
6/1 Florida homeowner's U.S. property catastrophe reinsurance renewals. 7/1 Southeast U.S. property catastrophe reinsurance renewals.
Early Sept. Monte Carlo Reinsurance Rendezvous (meetings for 1/1 reinsurance renewals). Late Oct. Baden-Baden, Germany (for 1/1 European renewals) & PCI of America (for 1/1 U.S. renewals). January renewal indications are provided.
Reinsurance Market Share Is Increasingly Concentrated. Gross written premiums for the top 50 global property-casualty reinsurers in 2010 were $135 billion. Market share is highly consolidated with the large European reinsurers (Munich Re, Swiss Re, Lloyds, and Hannover Re) controlling nearly half of the entire global market share. The U.S. and Bermuda-based reinsurers control about one-third of the total market share.
16 April 2012
70
Other 31%
RGA 4%
SCOR S.E. 5%
Lloyd's 7%
% Chg in GWP
Reinsurers combined ratios rose in 2011 to the worst result since 2005 as a result of large global catastrophe losses. We anticipate combined ratios could improve in 2012 assuming normal catastrophe activity as reinsurance pricing increases. However, slowing reserve releases could impact the bottom line.
16 April 2012
71
Reinsurers Have Adequate Capital. Reinsurers capital positions were stable in 2011 as the impact from significant catastrophe losses were mostly offset by growth in capital from retained earnings and investment gains as well as reduced share buyback activity. Notably, Guy Carpenter estimates the reinsurance sector held excess capital of approximately 12% (approximately $20 billion) as of year-end 2011.
Figure 119: Guy Carpenter Reinsurance Composite Shareholders Funds
in $ bil $200 $159 $160 $120 $90 $80 $40 $0 2003 2004 2005 2006 2007 2008 2009 2010 2011 $104 $110 $140 $129 $166 $171 $174
Excess capital for the reinsurers we cover could be redundant by 4% of common equity on average as of the end of 2011 (less than P&C insurers). We estimate the reinsurers with the most estimated excess capital as of year-end 2011 as a percentage of book value are likely to be RNR (15%), RE (9%) and PRE (6%). We suspect FSRs capital position could be deficient; however, this pressure should ease as FSR reduces its overall risk by reducing gross written premium by 30% in 2012. Reinsurers are expected to use excess capital toward organic growth opportunities instead of returning capital to shareholders in the form of share buybacks and/or M&A. Our outlook reflects improving property catastrophe reinsurance pricing and increased demand for reinsurance protection.
16 April 2012 72
PRE
RE
RNR
Figure 122: Reinsurers Cumulative Share Repurchases Since 2005 Net of Capital Issuance (in $ bil)
Figure 123: Reinsurers Cumulative Share Repurchases Since 2005 as a Percent of Shares Outstanding, Net of Capital Issuance
50% 40% 40% 33% 30%
20% 20%
20%
$0.5 10% $0.0 -$0.5 PRE FSR MRH RE RNR -8% 0% -10% PRE RE FSR RNR MRH
Note: Data is adjusted for forward share issuance agreements. MRH, RE, and PRE all raised equity capital post-Hurricane Katrina. PREs share repurchases are net the companys $1.9bn (25.7mn shares) issuance in 2009. Source: Company data, Barclays Research
(a) Flagstones YE06 shares outstanding are used because FSR completed its IPO in March 2007. (b) PREs share repurchases are net the companys $1.9bn (25.7mn shares) issuance in 2009. Source: Company data, Barclays Research
16 April 2012
73
The Florida reinsurance market represents approximately 15% of the worlds property catastrophe reinsurance premiums according to reinsurance broker Guy Carpenter. Reinsurers with higher than average exposure to Florida market include RNR and RE, while PartnerRe is underweight the Florida market. The Florida market could see pricing increase as demand improves and capacity likely remains stable. A unique aspect of the Florida reinsurance market is The Florida Hurricane Catastrophe Fund (FHCF), a state-sponsored facility. In the wake of Hurricane Andrew in 1992 the FHCF was created one year later to provide capacity as national insurers threatened to exit the Florida residential property insurance market. The FHCF was hard-hit in 2004 as a result of several large hurricane losses. Since then, the FHCF reduced its capacity due to underfunding. As a result, some of the FHCF business could move to the private market and benefit property catastrophe reinsurers including RNR, RE, MRH, and FSR. In 2012, the FHCF could provide less capacity and Citizens (Florida state-sponsored primary insurer of last resort) could purchase up to $1bn of reinsurance protection vs $575mn in 2011. The Texas Windstorm Insurance Association (TWIA) is the insurer of last resort in Texas for wind and hail coverage. TWIA was formed after Hurricane Celia hit in 1970 and many insurers ceased writing coverage in the states coastal areas. TWIA suffered $2.5 billion of losses as a result of Hurricane Ike in 2008, of which $1.5 billion was covered by external private market reinsurance. TWIA stopped buying private reinsurance in 2009 due to substantial rate increases, although it has the ability to assess insurers operating in Texas to help fund shortfalls. The TWIAs total exposure is more than $60bn with the ability to cover only several billion of losses, meaning that TWIA would likely face substantial funding shortfalls if a major hurricane hits Texas. The most costly earthquake in the U.S. occurred in 1994 in Northridge, California and resulted in insured losses of $15 billion ($23 billion in inflation-adjusted dollars). After this event, insurers feared potential insolvency from another large earthquake and significantly reduced writings of new California homeowners insurance policies that are required to cover earthquake losses. The California Earthquake Authority (CEA) was established in 1996 to provide capacity to the residential property insurance market. As of year-end 2011, the CEA had $296 billion in total policy exposure with nearly $10 billion in claims-paying capacity, although only about 12% of homeowners in California purchase earthquake coverage. The CEA wrote over $600 million of premiums in 2011, while ceding approximately $200 million to external reinsurers.
16 April 2012
74
Catastrophe bonds present substitution risk for traditional reinsurance, especially in times of tight capacity. These bonds are primarily used to transfer (re)insurers peak zone property catastrophe exposure to the capital markets when traditional reinsurance coverage is either unavailable or too expensive. Catastrophe bonds can be attractive to investors because natural catastrophe trends are expected to be mostly uncorrelated with equity and fixed income markets. Catastrophe bonds are typically fully collateralized and pay interest to investors unless a catastrophe loss exceeds a predetermined trigger (based on the insurers actual losses, industry losses, or objective measures such as a hurricanes maximum wind speed). If a claim under the cat bond is triggered, the principal would be used to pay claims and bondholders risk losing future interest payments and principal. The catastrophe bond market currently addresses roughly $12 billion of exposure, which is equal to about 6% of the $200 billion global catastrophe reinsurance capacity. In terms of transaction count, 2011 was the second most active year in the history of the market according to Guy Carpenter. Further penetration by cat bonds could occur if their acceptance as a substitute for traditional reinsurance increases. Figure 124: Catastrophe Bond Issuance
$8 $7 $6
in $ bil
$7.0
$4.6 $3.9
16 April 2012
19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11
75
Part IV: Insurance Brokers Benefit the Most from Improving P&C Pricing
In our view, the insurance brokers are attractive because most of the benefits of higher prices should improve earnings and margins. Insurance brokers are the distributors of insurers products and, unlike the insurers, do not assume underwriting risk or have large capital requirements. The fortunes of brokers (especially for commission-based revenues) are driven by commercial P&C insurance and reinsurance premium volume, which could increase. P&C prices are now in positive territory for the first time since 2003, and exposure growth, which is tied to the economy, is improving. As a result, the brokers should generate higher organic revenue growth, positive operating leverage, and higher valuations. The average insurance broker P/E is 15x our 2012 EPS estimates versus the historical range of 9x-32x (historical median=16x) and a P/E of 12x for the S&P 500.
Our top pick among the insurance brokers is MMC
Our top pick among the insurance brokers is MMC, followed by WSH, BRO, and AJG. MMC should have strong organic revenue growth and margin expansion opportunities in each of its businesses even in a slow-growth macro environment. WSH is a pure-play global insurance broker with the lowest valuation among its peers although it faces headwinds in 1H12. BRO and AJG have the highest leverage to rising P&C prices because nearly all of their revenues are commission-based, although these stocks trade at a premium valuation. AON (rated 2-Equal Weight/1-Pos) should also benefit from higher P&C prices, but we see a longer road to achieve improved organic growth and margin expansion compared to the other insurance brokers. Nearly all of BROs and AJG's brokerage revenues are commission-based, while the larger brokers (MMC, AON and WSH) contain a mix of both commissions and fees. This means the benefit of improved pricing should be more significant for BRO and AJG than MMC, AON, and WSH. MMC and AON are distinct because they each have sizable consulting operations. Consulting earnings will likely benefit from a rebound in demand as the economy improves. We see several opportunities for the P&C insurance brokers:
Brokers Organic Revenue Growth Could Accelerate. Organic revenue growth, a key metric for the insurance brokers, could benefit from rising P&C prices and exposures. Commercial P&C (re)insurance prices are rising, driven by deteriorating underwriting results, stabilizing industry capital positions, and rising property reinsurance costs, in our view. Also, economic conditions are improving, which could result in customers purchasing more insurance coverage especially as payrolls rebound.
16 April 2012
76
4% 3% 2% 1% 2%
4%
0%
-1% -2%
09 20
0%
10 20
11 20
E 12 20
E 13 20
Brokers Margins Could Expand. The insurance brokers successfully expanded margins due to aggressive cost cutting. Cost reduction efforts are mostly finished, although we expect margins to continue to expand driven by positive operating leverage. Interestingly, the average pre-tax brokerage margin could expand to 24% by 2013, approaching margins at the peak of the last hard market in 2003 before the loss of contingent commissions. The overall average recovery will likely be led by MMC.
26% 24% 23% 22% 21% 18% 21% 20% 24% 24% 22% 23% 22% 23%
Insurance Brokers Could Show the Fastest Earnings Growth. We expect the insurance brokers to generate 13-14% average EPS growth each year in 2012 and 2013 driven by higher organic revenue growth as well as margin expansion, with MMC, AJG and BRO generating the strongest growth. Meanwhile, WSH and AON could generate the slowest EPS growth.
16 April 2012
77
Note: Based on the average earnings per share growth excluding unusual items for MMC, AON, WSH, AJG, BRO. Source: Company data, Barclays Research estimates.
During the last P&C cycle turn, the pure-play broker stocks reacted to rate increases starting in 1Q99, about four quarters before the insurers. 2 In 1999, when commercial P&C price increases first emerged the insurance broker stocks increased about 30% on average (vs +20% for the S&P 500). In 2000, when P&C price increases accelerated to the low double digits, the insurance brokers rose 75% on average (vs a10% decline for the S&P 500).
2 We used stock performance data for HRH, BRO, and AJG during 1998-2000 because they are largely pure-play insurance agents. MMCs stock performance was boosted by its Putnam Investments unit during this time period, while Aons stock performance suffered from missteps after digesting several large acquisitions. WSH completed its IPO in June 2001.
16 April 2012
78
As a point of historical reference, the pure-play insurance broker stocks rose as P&C pricing declines slowed in 1998, but underperformed the S&P 500 by about 10% during this period. The insurance brokers stock prices then rose, in general, in 1999 as pricing turned positive, and increased considerably in 2000. Figure 128: P&C Insurance Broker Absolute Stock Performance, 1998-2000
120% Absolute Annual Stock Price Change 100% 83% 80% 60% 42% 40% 20% 0% 1998 BRO 1999 HRH AJG 2000 17% 10% 3%
-40% 1998 BRO 1999 HRH AJG 2000
Figure 129: P&C Insurance Broker Relative Stock Performance to the S&P 500, 1998-2000
120% Absolute Annual Stock Price Change 100% 80% 60% 40% 23% 20% 1% 0% -20% -9% -24% -10% 27% 51% 93% 107%
97%
47%
41%
28%
Figure 130: P&C Price Change Versus BRO Stock Price and S&P 500, 1998-2004
P&C Prices Year-OverYear Change 30% 25% 20% 450% 15% 10% 5% 250% 0% 150% -5% 350% Cumulative Stock Price Performance 650%
Figure 131: P&C Price Change Versus BRO Trailing P/E, 1998-2004
P&C Prices Year-OverYear Change 30% 25% BRO Trailing P/E 60 55 50 45 40 35 5% 30 0% -5% -10%
1Q 98 2Q 98 3Q 98 4Q 98 1Q 99 2Q 99 3Q 99 4Q 99 1Q 00 2Q 00 3Q 00 4Q 00 1Q 01 2Q 01 3Q 01 4Q 01 1Q 02 2Q 02 3Q 02 4Q 02 1Q 03 2Q 03 3Q 03 4Q 03 1Q 04 2Q 04 3Q 04 4Q 04
BRO
550%
25 20 15
S&P 500
-10%
1Q 98 2Q 98 3Q 98 4Q 98 1Q 99 2Q 99 3Q 99 4Q 99 1Q 00 2Q 00 3Q 00 4Q 00 1Q 01 2Q 01 3Q 01 4Q 01 1Q 02 2Q 02 3Q 02 4Q 02 1Q 03 2Q 03 3Q 03 4Q 03 1Q 04 2Q 04 3Q 04 4Q 04
50%
P&C Prices
P&C Prices
S&P 500
BRO
16 April 2012
79
Figure 132: P&C Price Change Versus AJG Stock Price and S&P 500, 1998-2004
P&C Prices Year-OverYear Change 30% Cumulative Stock Price Performance 450%
Figure 133: P&C Price Change Versus AJG Trailing P/E, 19982004
P&C Prices Year-OverYear Change 30% 25% 35 P&C Year-Over-Year Price Chg 20% 30 15% 10% 5% 20 0% 15 -5% AJG P/E 25 AJG Trailing P/E 40
AJG
25% 20% 15% 10% 5% 0% -5% 400% 350% 300% 250% 200% 150% 100%
S&P 500
-10%
1Q 98 2Q 9 3Q 8 98 4Q 9 1Q 8 99 2Q 9 3Q 9 99 4Q 99 1Q 0 2Q 0 00 3Q 0 4Q 0 00 1Q 0 2Q 1 01 3Q 0 4Q 1 01 1Q 0 2Q 2 02 3Q 0 4Q 2 02 1Q 03 2Q 0 3Q 3 03 4Q 0 1Q 3 04 2Q 0 3Q 4 04 4Q 04
-10%
9 2Q 8 9 3Q 8 9 4Q 8 9 1Q 8 9 2Q 9 9 3Q 9 9 4Q 9 9 1Q 9 00 2Q 0 3Q 0 0 4Q 0 0 1Q 0 0 2Q 1 01 3Q 0 4Q 1 0 1Q 1 0 2Q 2 0 3Q 2 02 4Q 0 1Q 2 0 2Q 3 03 3Q 0 4Q 3 0 1Q 3 0 2Q 4 0 3Q 4 0 4Q 4 04
10
50%
1Q
P&C Prices
P&C Prices
S&P 500
AJG
16 April 2012
80
60% Fees
80%
100%
Commissions and fees represent over 95% of insurance broker unit revenues. Insurance brokers also collect fiduciary income, which is income earned on unremitted premiums and claim proceeds (this practice dates back many years and has remained in place). Fiduciary income, which is pure profit for the insurance brokers, has declined meaningfully due to low short-term interest rates in recent years, and we expect it to remain compressed until interest rates increase. Figure 135 shows the trend in MMCs fiduciary assets as well as declines in the investment yield and investment income that is also a factor for peers. Figure 135: MMC Fiduciary Assets & Fiduciary Income
Fiduciary Income
6% Investment Yield 5% 4% 3% 2% 1% 0% $200 $160 in $ mil $120 $80 $40 $0
05 06 07 08 09 10 11 E 12 20 20 20 20 20 20 20 20 20
81
$54
$45
$47
$48
$50
Fiduciary Assets
Source: Company data, Barclays Research estimates.
Investment Yield
13
We examined market share trends for the worlds 10 largest insurance brokers. MMC has gained market share since 2009, although the company has not yet recaptured market share lost following the 2004 NY Attorney General-led investigations. Aon, the worlds largest insurance broker, lost market share in 2010 and 2011 for the first time since 2008. WSH gained market share with its acquisition of HRH in 2008. AJGs and BROs market share appear mostly stable over time. Figure 136: Insurance Brokerage Market Share among Worlds 10 Largest Insurance Brokers
NYAG investigations 40% 35% 30% 25% 20% 15% 10% 5% 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 BRO WSH HRH acquisition MMC AJG
Benfield acquisition
AON
MMC
AON
WSH
AJG
BRO
Note: MMC & AON revenues are Insurance Brokerage only and exclude the Consulting operations. Source: Company data, Business Insurance, Barclays Research.
Rising P&C Prices and Improving Exposures. The impact of changes in exposures is probably as meaningful as the impact from changes P&C rates. During the latest economic recession, clients purchased less insurance coverage due to declining rating factors such as sales volumes, payrolls, and commercial real estate occupancy. This headwind appears to have abated and exposure growth could begin to rise as the economy recovers. Insurance broker organic growth improved in 2011 and we expect this trend to continue in 2012 and 2013. Clients Resist Paying Increased Fees. We expect fees to be mostly stable, while insurance broker commissions could rise as P&C premiums increase. Based on the results of our 2012 Commercial Insurance Buyers Survey in which we interviewed 75 risk managers, we found risk managers resist paying increased insurance broker fees. Risk managers expect broker fees to be up 1% on average at the early 2012 renewals, versus flat renewals six months ago. Roughly 75% of respondents expect to pay their
82
16 April 2012
insurance brokers unchanged fees in 2012 compared to 2011, 19% could pay a higher fee, and 7% could negotiate a lower fee.
Insurance Brokers Turnover Slows. Competition among the insurance brokers increased in late 2010 driven by weak economic conditions and reduced new business growth, but slowed in 2011 and early 2012 as some risk managers already locked in multiyear agreements with customers. Based on the results of our latest Insurance Buyers Survey, fewer customers appear to be switching insurance brokers. The percentage of respondents that switched brokers decreased slightly to 3% compared to 4% six months ago in part due to risk managers signing multiyear fee agreements over the past year. Several risk managers signed multi-year deals with their brokers to lock in flat broker fees or modest (likely inflation-linked) increases.
More respondents switch brokers after the 2005 NY Attorney General investigations
Turnover increases as broker competition increases. Risk managers unlikely to switch brokers.
15% 10% 5% 0%
Average=11%
06
05
07
08
11
10
l-0
l- 0
l- 0
l-0
n-
n-
n-
l-0
l-1
n-
n-
l-1 Ju
l-0
Ju
Ju
Ju
Ju
Ju
n-
Ja
Ja
Ja
Ja
Ju
Ju
Ja
Increased Insurance Broker Compensation Transparency. The large insurance brokers (MMC, AON, WSH, AJG) settled various conflict of interest allegations in 2004 with state regulators. The brokers paid significant fines, but more importantly agreed to stop collecting highly profitable commissions. Contingent commissions were viewed as posing a conflict of interest because these commissions are paid by insurers to brokers while the broker is obligated to represent its clients interests. As part of the settlement, disclosure requirements for insurance broker compensation increased. Interestingly, insurance agents such as BRO never had to stop taking contingent commissions. Recently, the ban on contingents for brokers has been relaxed by state regulators although it is not expected to result in meaningful benefits for the brokers because of customer pushback. For example, Marsh is not accepting contingent commissions from insurers in the U.S., Canada, or other large insurance markets. However, WSH is now
16 April 2012
Ja
Ja
Ja
n-
n-
12
09
83
accepting contingent commissions on employee benefits business due to a structural shift in compensation for this line of coverage. Organic revenue growth, a key metric for the insurance brokers, could improve in 2012 and 2013, reflecting rising P&C prices and a rebound in exposure growth. MMC could report the highest organic growth of +5% in 2012 and +6% in 2013 driven by international growth. Notably, revenues for BRO and AJG are tied to commissions and have greater sensitivity to P&C prices and exposures, whereas revenues for MMC, AON, and WSH are more fee-based and therefore have less sensitivity to P&C premiums than insurance agents. Figure 138: Insurance Brokerage Organic Revenue Growth
MMC
Loss of contingent commissions & NYAG investigations 0% -2% Hard Market -10% 2%
AON
Loss of contingent commissions & NYAG investigations
WSH
Loss of contingent commissions & NYAG investigations
20%
20% 15%
2% 3%
4%
8% 5% 4% 3% 4% 2% 4% 2% 1% 2%
-10%
Soft Market
Hard Market
Soft Market
16 April 2012
E 13 20 2E 1 20 1 1 20 10 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
E 13 20 2E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
E 13 20 2E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 06 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
AJG
Loss of contingent commissions & NYAG investigations
BRO
5% 2% 2% 2%
3%
5% 5%
10% 5% 0%
6%
0% 1%
-5% -10%
Hard Market
Willis deconstructs its organic revenue growth between net new business growth and changes in P&C rates as well as other market factors such as exposure, which can be viewed as a proxy for the industry. For Willis, changes in rates and exposures continue to be a headwind on organic growth although this appears to be stabilizing. The benefit on organic growth from net new underlying business declined in 2011 due in part to defections from its 2008 acquisition of HRH. Notably, the company expects this impact to stabilize in 2012.
E 13 20 2E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 04 20 3 0 20 2 0 20 1 0 20 0 0 20
84
16 April 2012
85
MMC
9.0 8.5 8.0 7.5 7.0 6.5
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11
AON
9.0 8.5 8.0 7.5 7.0 6.5
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12
WSH
9.0 8.5 8.0 7.5 7.0 6.5
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12
AJG
9.0 8.5 8.0 7.5 7.0 6.5
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12
Following are some comments from customers on relationships with their insurance brokers: I will propose to pay my insurance broker a flat fee even though I expect our P&C insurance prices to increase (Manufacturing risk manager) We received a 50% reduction in our broker fee in 2011 after marketing the program to other brokers, and I expect our fee to be unchanged in 2012 (Large financial company) Our broker fee will be flat for the next three years due to a multi-year deal, which we entered into in 2011 (Utility) Insurance brokers are asking for additional commissions but this could be difficult to achieve. (Technology) We will pay our insurance broker a slightly higher fee because our company is growing, although the increase is less than our broker requested. (Consumer)
international organic growth was modestly lower than MMC, while Aon grew low-single digits internationally. Many large European insurers and reinsurers, which have a significant presence in the international P&C market, sell coverage directly and do not use an insurance broker. This factor could limit the insurance brokers growth opportunities abroad. Figure 141: Insurance Brokerage Revenues by Geography FY2011
MMC
AON
WSH
International 53%
U.S./Canada 47%
International 51%
U.S./Canada 45%
International 1%
BRO
U.S. 81%
U.S. 99%
Note: MMC & AON revenues exclude reinsurance brokerage. (a) Mostly Australia, Bermuda, Canada & the U.K. Source: Company data, Barclays Research.
2010
MMC
2011
WSH (a) AON (b) MMC
(a) WSH includes the international business, which represents roughly 53% of WSH's non-U.S. exposure. (b) Aons international revenues has been restated for years 2009-2011 to reflect the transfer of the Health and Benefits business from Consulting to Brokerage as of January 1 2012. Source: Company data, Barclays Research
(a) WSH includes the international business, which represents roughly 53% of WSH's non-U.S. exposure. (b) AON international organic growth is a weighted average of U.K., Europe & Asia Pacific organic growth for 2008. Aons organic revenue growth has been restated for years 2009-2011 to reflect the transfer of the Health and Benefits business from Consulting to Brokerage as of January 1 2012. Source: Company data, Barclays Research.
16 April 2012
87
AON
40% 35% 30% 22% 25% 20% 15% 10% 5%
E 13 20 2E 1 20 1 1 20 0 1 20 09 20 8 0 20 7 0 20 6 0 20 5 0 20 04 20 3 0 20 2 0 20 1 0 20 0 0 20
WSH
40% 35% 30% 21% 25% 20% 15% 10% 5%
E 13 20 E 12 20 1 1 20 0 1 20 09 20 8 0 20 7 0 20 06 20 5 0 20 04 20 3 0 20 02 20 1 0 20
23%
AJG
40% 35% 30% 25% 20% 15% 10% 5%
E 13 20 2E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 07 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 01 20 0 0 20
BRO
40% 35% 30% 25% 18% 20% 15% 10% 5%
E 13 20 2E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
36%
16 April 2012
88
Roughly 45% of MMCs overall revenues are from Consulting versus Insurance Brokerage, although one-third of its earnings are from Consulting and two-thirds are from Insurance Brokerage. Aon meaningfully increased its presence in Consulting with the acquisition of Hewitt in October 2010 for $5 billion. Roughly one-third of Aons overall revenues are now from consulting after the acquisition, up from 17% previously. WSH and BRO are pure-play insurance brokers. A.J. Gallaghers revenues are roughly three-quarters Insurance Brokerage and one-quarter Risk Management (Gallagher Bassett), a third-party claims administrator that derives most of its revenue from settling claims for corporate propertycasualty programs on a fee-for-service basis. Figure 145: Insurance Brokers Revenue Mix - 2011
MMC
Consulting, 33% Consulting, 46% Insurance Brokerage, 55% Insurance Brokerage, 100%
AON
WSH
AJG
BRO
Note: AONs revenues have been restated for 2011 to reflect the transfer of the Health and Benefits business from Consulting to Brokerage as of January 1 2012. Source: Company data, Barclays Research estimates
MMCs Consulting business (Mercer & Oliver Wyman), is one of the largest in the U.S. with $5.3 billion in revenues and is larger than the combined Aon/Hewitt consulting business, which has about $3.8 billion in revenues. MMCs consulting operation focuses on retirement, health & benefits, outsourcing and management consulting. Aon/Hewitts consulting business focuses on benefits outsourcing as well as retirement and & financial management, talent and organization consulting, health management, and communications. Aons consulting revenue mix has a higher allocation to outsourcing business than MMCs.
16 April 2012
89
Retirement 20%
Outsourcing 60%
Consulting 40%
Outsourcing 14%
MMCs Consulting business should benefit from improved demand. MMC believes it can improve margins by several points (from 12% currently) with new leadership at the Mercer unit. We expect high-single digit to low-double digit earnings growth in MMCs Consulting unit in 2012 and 2013. Our outlook for this MMCs Consulting unit assumes 5-6% revenue growth in both 2012 and 2013, and adjusted margins of 12-13% in 2012 and 2013 versus 13% margins both in 2003 and 2004 (perhaps a comparable phase of economic recovery), although this could be conservative. As a point of reference, each one-point change in MMCs Consulting margin is $0.07/share after-tax annually. Figure 148: MMC and AON Consulting Pre-Tax Earnings & Margins Excluding Unusual Items
MMC Consulting Pre-tax Earnings Ex Unusual Items
(in $ mil) $750 $600 $450 $300 $150 $0
97 998 999 000 001 002 003 04R 05R 06R 007 008 009 010 011 12E 13E 2 2 2 2 2 2 20 2 2 2 1 1 19 20 20 20 20
15% 12% 9% 6% 3%
14%
13%
13%
13% 12%
12%
12%
13%
Pretax earnings
% change
5.0%
20 11 20 12 E
20 06
20 07
20 08
20 09
20 02
20 03
20 04
20 05
20 10
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013
16 April 2012
20 01
20 13
$0
90
Aon acquired Hewitt Associates in October 2010 for $5 billion (a robust valuation of 15x 2011E EPS and 7.5x 2010E EBITDA based on consensus estimates). The transaction significantly expanded Aons economic exposure with 33% of overall revenues from the consulting business versus 17% previously. Aon anticipated this transaction will provide it with a leading global consulting brand, $3 billion in additional revenues, and $335mn in annualized cost savings by 2013 (10% of Hewitts expense base). Aons Consulting business operating margin is 12% at YE 2011 and 18% excluding non-cash amortization. Aon targets a long-term operating margin in its Consulting business of 22% excluding non-cash amortization although it is unclear how quickly this can be achieved.
MMC
Yes
MMC said its customer response to accepting contingent commissions is mixed and income from contingent commissions is insignificant but could grow over time. The company does not intend to accept contingent commissions in the U.S. or Canada. Aon said its customer response to potentially accepting contingent commissions has been muted. WSH does not accept contingent commissions in its core P&C business because it believes these agreements present a conflict of interest. However, WSH will be accepting contingent commissions in its Employee Benefits business starting in April 2012. WSH expects contingent commissions in Employee Benefits could be $4-$5mn in 2012. AJG is accepting contingent commissions. The company accepted $38mn ($0.23/shr A/T assuming a 100% pre-tax margin) in contingent commissions in 2011 and expects contingent commissions to be roughly flat in 2012. BROs contingent commissions were never banned due in part to BRO being an agent and representing the insurer. The companys contingent commissions were $43mn ($0.19/shr A/T) for the FY 2011.
AON WSH
Yes Yes
AJG BRO
Yes Yes
16 April 2012
91
($1,000)
2008
MMC
2009
WSH
2010
2011
MMC
WSH
16 April 2012
92
AON
Pension contribution & restructuring charges Hewitt acquisition In $ mn $700 $600 $500 $400 $300 $200 $100 $0
WSH
Loss of contingents, pension contributions, 2005 accounting change
02
03
20 12 20 E 13 E
04
05
06
08
07
09
10
11
2012E
AJG
$350 $300 $250 In $ mn $200 $150 $100 $50 $0 2012E 2013E 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 In $ mn Headwaters synfuel settlement $400 $350 $300 $250 $200 $150 $100 $50 $0
BRO
2012E
AON
20%
WSH
Hewitt acquisition
11% 12%
2013E
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
HRH acquisition
25% 24% 17% 17% 17% 12% 11% 10% 10% 10% 11%
15%
10%
New mgmt
9% 7% 5% 5% 6% 9% 11%
13%
14%
15%
11%
10% 5% 0%
10% 5% 0%
10% 8% 7%
9%
8%
8%
9%
9%
9%
9%
10%
16% 12% 8% 4% 0%
11%
20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
AJG
32% 28% 24% 20% 16% 12% 8% 4% 0%
30% 21% 23% 19% 19% 15% 15% 9% 10% 11% 8% 10% 12%
20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
37% 34% 28% 25% 21% 20% 19% 18% 15% 13% 12% 12% 12% 13%
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
Note: Calculations based on net income excluding unusual items as a percentage of average total capital. Source: Company data, Barclays Research estimates.
16 April 2012
20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
BRO
2013E
2002
2003
2004
2005
2006
2007
2008
2009
2010
20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
2011
20
20
20
20
20
20
20
20
20
20
93
Our outlook for personal lines insurance, which is coverage for consumers vehicles and homes, is mixed. Personal auto insurance pricing power is slowing, although personal auto margins and returns on equity are benefiting from mostly benign claims inflation. We expect attractive underwriting margins in auto insurance to result in increased competition and perhaps lower returns. Homeowners insurance prices, on the other hand, are rising after several years of large underwriting losses, although rates remain inadequate. As a result, increased homeowners rates are needed across the board in nearly all states and deductibles need to increase. The preferred personal lines operating model is to be a pure play auto insurer with little to no exposure to volatile homeowners insurance, in our view. Successful examples of the focused personal auto strategy include GEICO (owned by Berkshire Hathaway) and PGR based in part on their direct sales efforts. CB has a profitable niche in the high-end personal lines market that is largely driven by homeowner insurance, but the company largely avoids hurricane-prone regions. ACE and AIG (Chartis) seek to raise their presence in high-end personal lines coverage as well. In the Unites States, automobile insurance is compulsory and accounts for one-third of property-casualty insurance industry premiums. For the top-tier performers, auto insurance generates strong returns on equity in part because of the ability to generate underwriting profits while employing high operating leverage. Auto insurance rates can generally be changed every six months, which means insurers can quickly adjust pricing to shifts in claims trends (either frequency or severity) that impact underwriting margins. Currently, personal auto insurers profitability is benefitting from price increases outpacing loss cost inflation. Policyholder-owned State Farm, the largest personal lines insurer, is losing money in auto insurance, which provides opportunities for the industry to raise rates. Also, it remains to be seen whether automobile insurance loss frequency trends, which have been favorable for years, could remain benign due to less miles driven in a weak economy. Notably, auto insurers are seeing worse-than-expected physical damage loss severity trends as a result of increased costs for used vehicles. Homeowners insurance is mostly a volatile, catastrophe-prone business with high capital requirements generating adequate returns in years with low natural catastrophe claims activity but suffering large underwriting losses in years with adverse weather. Rate changes are subject to review by each state, and there is little ability for homeowners insurers to raise rates to adequate levels in the highest catastrophe-prone states including Florida. We view automobile insurer Progressive (PGR) as one of the best-managed companies in the industry. Its valuation is robust with P/E multiple of 16x our 2012 operating EPS estimate and a price-to-book multiple of 2.2x, although we believe this is justified due to its consistent and superior high-teens ROE and ability to gain market share. Allstate trades at a significant discount to PGR with a P/E of 8x and a price-to-book multiple of 0.9x, although this situation appears warranted due to Allstates declining auto insurance policies-in-force (PIF), earnings volatility due to weather-related catastrophe losses, a lower return on equity, and challenges in its life insurance business. We see several important trends emerging in the personal lines insurance industry:
Personal Lines Industry Growth Could Be Modest Despite Rate Increases. Automobile insurance (70% of the personal lines market) benefits from low-single digit rate increases, although rate increases are slowing. State Farm, the largest personal auto
94
16 April 2012
insurer, is expected to remain disciplined on pricing to offset the impact of poor underwriting results. However, low growth in registered vehicles places downward pressure on premium volumes. In homeowners insurance (30% of personal lines premiums), rates are rising after several years of higher than average claims activity, although unit growth could remain depressed due to weak home sales activity. Figure 154: U.S. Personal Lines Industry Premium Volume
in $ bil $250 $200 $150 $100 $50 $0 2001 2002 2003 2004 2005 2006 Auto
Source: A.M. Best, Barclays Research estimates.
2007
2008
2009
2010
2011E 2012E
Homeowner's
Auto Insurance Margins Have Likely Peaked. The private passenger auto insurers currently benefit from rate increases modestly outpacing loss cost inflation, resulting in stable margins for top-tier insurers. It remains to be seen whether rate increases will continue to outpace loss cost improvement as the economy recovers. This is because loss frequency trends could worsen as unemployment declines because more people would be driving in increasingly congested traffic conditions.
Year-Over-Year % Chg
2Q 99
3Q 00
4Q 01
1Q 08
1Q 98
3Q 05
3Q 10
4Q 06
1Q 03
2Q 09
2Q 04
Note: Results are adjusted for the 2005 hurricanes by excluding comprehensive costs in affected states in 3Q05, 4Q05, 3Q06 and 4Q06 and excluding comprehensive losses in 2Q11 and 3Q11 due to large catastrophe losses including Midwest storms and Hurricane Irene. Source: ISO, Bureau of Labor Statistics, Barclays Research
Direct Insurers Gain Market Share. We view market share gains by direct personal lines writers of the market, as a secular shift. Direct auto insurance writers such as PGR and GEICO are gaining market share mostly from the exclusive agency channel (such as ALL
95
16 April 2012
4Q 11
and State Farm). The exclusive agency sales channel, including State Farm and Allstate, still the controls more of the market than direct, but consumers show increasing comfort with buying auto insurance without an agent, and direct insurers often offer coverage for lower prices than competitors.
Growth Rate
Growth Rate
Reduced Underlying Underwriting Profits. In personal auto, the combined ratio could be roughly unchanged in 2011 and 2012 versus 101% in 2010. In homeowners, the combined ratio likely deteriorated from 107% in 2010 to 124% in 2011 due to large catastrophe losses, but we expect it to improve in 2012 to 105% reflecting our outlook for normalized catastrophes. Notably, results at State Farm, the largest personal auto and homeowners insurer, are worse than the industrys results, and the top-tier insurers meaningfully outperform the industrys average combined ratio.
16 April 2012
Growth Rate
96
Growth Rate
12%
Figure 158: U.S. Private Passenger Auto Insurance Industry Combined Ratio
130%
Catastrophes
120%
State Farm
135% 125%
110%
100%
State Farm
90%
85%
10 20 11 E 20 12 E
07
05
01
06
02
03
04
08
09
Returns on Equity Could Decline. Return on equity for the personal lines insurance industry could compress reflecting increased competition and modest investment returns. Return on equity in personal auto should be higher than ROEs for insurers that write both homeowners insurance and personal auto, because auto insurance requires less capital and generates higher underwriting margins. Progressive, a pure-play auto insurer, could see its ROE fall to about 14% by 2013. Allstate, which writes personal auto, homeowners, and life insurance, saw its ROE fall from 13% in 2001 to 4% in 2011 (impacted substantially by catastrophe losses), but could rebound to 9-10% in 2012 and 2013 assuming normalized cat losses. Figure 160: PGRs Return On Equity, 2005-2013E
30% 25% 26% 25% 20% 15% 10% 5% 0%
20 11 20 12 E 20 13 E 20 08 20 09 20 06 20 05 20 07 20 10
19% 19%
21% 17%
20% 18% 13% 10% 10% 5% 0% 2005 2006 2007 2008 2009 8% 9%
16%
15% 14%
15%
20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 E 20 12 E
20
20
20
20
20
20
20
20
20
20
10% 4%
9%
2010
insurance losses tend to be severity driven (a high average cost of claims) due to the impact of catastrophes and exposure to increased commodity prices. Returns in auto insurance have historically exceeded homeowners insurance with less volatility, which explains why auto insurers such as PGR are awarded higher valuation multiples than diversified personal lines insurers. As far as we can tell, most insurers appear to prefer to write auto insurance rather than homeowners insurance because homeowners suffers from elevated catastrophe exposure.
Automobile insurance: Provides consumers protection against losses resulting from owning or operating a vehicle, including physical damages to the automobile or bodily injuries resulting from an accident. In the United States it is compulsory to have auto insurance before using or owning a vehicle, although roughly 14% of U.S. drivers are estimated to be uninsured, according to the Insurance Research Council. Insurers pay for physical damage to repair or replace vehicles, as well as medical costs for people injured in auto accidents. Homeowner s insurance: Provides protection against losses to a home and its contents, and pays for living expenses if the home is unable to be occupied, as well as liability insurance for accidents that may occur at the home. Typical claims are for fire, water damage, theft, and wind/weather damage. Homeowners with mortgages are typically required to purchase replacement cost coverage on the home.
Figure 162: Personal Lines Insurance Market Dominated By Automobile Coverage - 2011
Homeowner's 28%
16 April 2012
98
Preferred auto insurance Standard auto insurance Non-standard auto insurance No fault auto insurance
Insurance for drivers who have never had an accident. Insurance for drivers with few accidents. Insurance for drivers with poor driving records, lapse of insurance coverage, or no prior insurance coverage. Each driver recovers losses arising from an auto accident from their own insurer, regardless of fault, eliminating the need for expensive litigation. Drivers in no-fault states sometimes file fraudulent claims to pierce the threshold required to sue. States with no fault auto insurance include: Florida, Michigan, New Jersey, New York and Pennsylvania.
U.S. personal lines insurance market share is highly concentrated with the top ten insurers accounting for 65% of the market. State Farm and Allstate have the first and second largest market share, respectively, with Progressive and GEICO being the fastest growing companies. Direct auto insurance writers PGR and GEICO are gaining market share, while market share among the independent agency channel (TRV, HIG) has remained stable and the exclusive agency channel has lost share (ALL and State Farm). For example, GEICOs market share increased to 9.1% in 2011 from 8.5% in 2010, and PGRs market share (includes direct and agency) increased to 8.0% in 2011 from 7.7% in 2010, while Allstates market share fell slightly and State Farms was relatively unchanged. In homeowners insurance, market share among the largest insurers is mostly stable. Policyholder-owned State Farm is the largest homeowners insurer with 21% market share, more than double the presence of Allstate. Many homeowners insurers avoid coastal exposure in the Gulf states and along the East Coast as far north as New England to mitigate wind-related exposure. As a point of reference, each one point gain in U.S. personal auto insurance market share is equivalent to approximately $1.7 billion of annual premiums, and each one point gain in U.S. homeowners insurance market share is equivalent to approximately $800 million of premiums.
16 April 2012
99
Figure 164: U.S. Private Passenger Auto Insurance Market Share, 2011
20% 19% 16% 12% 8% 4% 0%
rm t ls Fa e Al t a e at O IC s GE gre o Pr e siv l h de e rs ily AA tua ric m wi ve l u US a n Zu a F M tio n Tr rty N a i ca e r b e Li Am
9% 6% 5% 5% 5% 4%
2%
2%
1%
G AI
St
16 April 2012
100
12 Average Vehicle Age (years) 11 10 9 8 7 6 2012E 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Passenger Cars
Source: Polk, Barclays Research
Light Trucks
New Vehicles
Source: Polk, Barclays Research
Used Vehicles
16 April 2012
20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 1 M 1 ar -1 2
The number of registered passenger vehicles (a proxy for unit growth for the auto insurers) could increase 0%-1% annually through 2015. Notably, the historical average annual growth in registered vehicles over the past 20 years is 2%. Also, the number of uninsured motorists, which is somewhat correlated with unemployment, is 14% and could curtail auto insurance industry growth.
101
2001
2003
2005
2007
2009
2011 2013E
Increases in auto insurance rates are slightly outpacing increases in loss cost inflation, resulting in favorable auto insurance underwriting margins. Auto insurers began raising rates in early 2008, with increases now averaging 3% year over year, but we expect competition to increase as a result of attractive margins. Importantly, the spread between rate increases and loss cost inflation decreased in 4Q11. Figure 172: Personal Auto Insurance Prices Change
12% Year-over-year change 10% 8% 6% 4% 2% 0% -2% 1/1/1999 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012
Price increases are slowing
Auto insurance loss costs consist of loss frequency (the number of claims) and severity (the average cost of claims). Industry loss frequency trends have been favorable for years but this benefit could ease as the economy recovers. For instance, as the number of unemployed persons declines, there could be an increase in loss frequency because more people would be driving on congested roads. Industry loss severity costs are a function of motor vehicle maintenance and repair costs, vehicle parts and equipment costs, medical costs, and used vehicle prices. Severity inflation trends have been benign in recent years but have increased recently as a result of rising costs for used cars which could pressure margins.
16 April 2012
102
The Barclays "Pure Premium Spread" is the difference between auto insurance price increases and loss cost inflation adjusted for loss frequency trends. It is a key factor in monitoring the personal auto insurance market. The spread has been positive since early 2008 as price increases outpaced loss cost inflation, although increased loss cost inflation could emerge as the economy recovers. Figure 173: Barclays Auto Insurance Pure Premium Spread
15% 10% 5% 0% -5% -10% -15% 1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Note: Results are adjusted for the 2005 hurricanes by excluding comprehensive costs in affected states in 3Q05, 4Q05, 3Q06 and 4Q06 and excluding comprehensive losses in 2Q11 and 3Q11 due to large catastrophe losses including Midwest storms and Hurricane Irene. Source: ISO, Barclays Research.
Will Loss Frequency Remain Favorable? The improving trend in loss frequency over the past two decades can be largely attributed to improved safety of cars, roads, and drivers. For example, anti-lock brakes, daytime running lights, and graduated driver licensing all result in safer cars and driving habits.
Loss frequency is partly a function of miles driven, with accident rates typically rising as miles driven increase. Miles driven increased so far in 2012 reflecting modest economic improvement after declining in 2011. Also, demand for gasoline, which is an indicator for miles driven, fell 2.7% ytd 2012 (down from the original estimate of a 4.2% decrease). Near term, miles driven could increase if unemployment levels fall. Notably, Allstates loss frequency trends remained favorable in 4Q11, likely due to a decrease in miles driven in a weak economy. However, severity trends deteriorated modestly. We expect miles driven to rise as the economy recovers, which could translate into increased motor vehicle accidents.
16 April 2012
103
2.4
1.6
# Crashes
Motor vehicle severity loss cost trends are a function of motor vehicle maintenance & repair costs, parts & equipment costs, and medical costs. Inflation for these factors has remained in the mid-single digits range for the industry in recent years, but could rise.
16 April 2012
19 7 19 9 8 19 1 8 19 3 8 19 5 8 19 7 8 19 9 91 19 9 19 3 9 19 5 9 19 7 9 20 9 0 20 1 0 20 3 0 20 5 0 20 7 09 20 11
104
Used Vehicle Costs Are Rising. Another factor affecting loss severity is the cost of
used vehicles, which are a factor in determining settlement values for insured vehicles. The cost of used vehicles is up 2.9% y/y in February 2012. Despite being down from doubledigit increases in 2010 (albeit from low levels), auto insurers are seeing loss severity increase above their expectations. For example, ALL said property damage severity increased 5.8% y/y in 4Q11 for Allstate brand standard auto with much of the increase reflecting rising prices for used auto parts. PGR also experienced increased property damage severity trends as a result of the increasing costs of used cars and parts, and TRV experienced a higher-than-expected level of physical damage severity in personal auto in 2011. Barclays U.S. Auto & Auto Parts analyst, Brian Johnson, expects used vehicle pricing to stabilize at strong levels as two years of weak new vehicle sales (and in particular curtailed leasing) is likely to limit supply of late-model vehicles. Figure 178 shows Manheim Consultings index of wholesale used car prices which is up 1.8% y/y and is currently at historically high levels. Figure 177: Manheim Used Vehicle Value Index
130 125 120 115 110 105 100 95 Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Separately, national healthcare reform could also impact auto insurance loss cost trends. Under national healthcare reform, health insurance coverage could be expanded to more people, but with programs that traditionally under-reimburse. As a result, doctors and hospitals could have an incentive to shift medical costs to personal lines as well as workers compensation insurers, where reimbursement levels and coverage tend to be more robust. Also, no managed care system exists for people involved in automobile accidents, potentially leading to higher medical costs for auto insurers.
16 April 2012
105
Figure 178: Components of Auto Insurance Loss Severity Inflation Year-over-Year Price Change
Motor Vehicle Maintenance and Repair Motor Vehicle Parts and Equipment
9%
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012
7% 5% 3% 1% -1% -3% -5% 1/1/2000 7/1/2000 1/1/2001 7/1/2001 1/1/2002 7/1/2002 1/1/2003 7/1/2003 1/1/2004 7/1/2004 1/1/2005 7/1/2005 1/1/2006 7/1/2006 1/1/2007 7/1/2007 1/1/2008 7/1/2008 1/1/2009 7/1/2009 1/1/2010 7/1/2010 1/1/2011 7/1/2011 1/1/2012
Medical Care
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011
16% 12% 8% 4% 0% -4% -8% -12% -16% 1/1/2000 7/1/2000 1/1/2001 7/1/2001 1/1/2002 7/1/2002 1/1/2003 7/1/2003
1/1/2004
7/1/2004
1/1/2005
7/1/2005
1/1/2006
7/1/2006
1/1/2007
7/1/2007
1/1/2008
7/1/2008
1/1/2009
7/1/2009
1/1/2010
7/1/2010
1/1/2011
7/1/2011
16 April 2012
1/1/2012
106
GEICO, 3.4%
1998
Others, 92.6%
Others, 87.4%
Others, 82.7%
2004
2011
Direct auto insurers, such as PGR and GEICO, are gaining market share
Direct auto insurers, such as PGR and GEICO, are gaining market share from insurers in the exclusive agency channel, such as Allstate, based on our analysis of policies-in-force (PIF) trends.
Direct: Auto PIF for PGR (direct channel) and GEICO increased 6% and 7% year-overyear, respectively, in 4Q11. Exclusive agency: ALLs standard auto PIF fell 1.5% year-over-year in 2011, after declining 1.5% in 2010. Allstate enhanced its presence in the direct channel in 2011 with its acquisition of Esurance, although Esurances underwriting results are weak and its premiums are small relative to Allstates. It remains to be seen whether the acquisition will result in sales channel conflict with Allstates own exclusive agents.
The trend of direct writers gaining market share has been exacerbated by a slow economic recovery as consumers seek reduced auto insurance costs. PGRs and GEICOs direct sales strategies and large advertising expenditures result in market share gains by stressing low prices. PGR has a strong track record of developing differentiated auto insurance products and we expect similar programs to be offered by competitors. Examples include Snapshot (usage-based insurance) and name-your-price auto insurance (consumers decide what they would like to pay, and coverage is adjusted accordingly). PGR continues to see increased adoption of its Snapshot product and expects higher retention rates from customers who elect to use the product. Other auto insurers are increasingly adopting the use of technology to voluntarily track individual driving habits including GPS. The Hartford is introducing its device and believes the data is compelling. Meanwhile, Liberty Mutual notes that privacy concerns are offset by consumers ability to benefit from safer-drive discounts. Notably, an online survey conducted by Deloitte Research of over 1,000 auto policyholders showed one-third of respondents said they would willing to install a device to monitor their driving behavior to be eligible for a discount on their auto insurance premium.
16 April 2012
107
Figure 180: GEICO and PGR Are Gaining Market Share in Auto Insurance
GEICO Policies-In-Force Growth Y-o-Y
25% 20% 15% 10% 5% 0% -5% 1999 2000 -1% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 9% 9% 11% 12% 12% 30% 20% 11% 10% 6% 7% 0% 0% -10% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 YTD 2012 2%
22%
24% 18% 9% 4% 1% 8% 2% 2% 8%
9%
8%
8%
5%
5%
6%
-4% 2002
Note: ALL PIF is standard auto only. GEICO PIF is voluntary auto only. Direct auto insurance accounts for 43% of PGRs personal auto insurance premium volume. Source: Company data, Barclays Research.
Direct insurers GEICO and Progressive have aggressively increased advertising expenditures in an effort to grow policies-in-force. GEICO, using its ubiquitous Gecko and Caveman ads, has the largest annual advertising expenditures among the personal auto insurers at $1.0 billion in 2011, nearly double the amount PGR spends. Notably, we expect PGR, ALL, State Farm and GEICO to all grow their advertising budgets further. Figure 181: Personal Lines Advertising Expenditures, 2005-2011
GEICO
16 April 2012
108
The direct insurers low cost competitive advantage is particularly evident when comparing their expense ratios to peers. GEICO has the lowest expense ratio of 18% versus 22% at PGR, 24% at State Farm, and 28% at Allstate. Figure 182: GEICO Is the Low Cost Producer
30% 28% Expense Ratio 26% 24% 22% 20% 18% 16% 14% 2004 2005 2006 ALL 2007 2008 2009 PGR 2010 2011 2012E 2013E GEICO State Farm GEICO State Farm PGR ALL
Note: State Farm is auto only and ALL is Allstate Brand standard auto only. Source: A.M. Best, Company data, Barclays Research estimates.
16 April 2012
109
Percentage Of Drivers
Source: National Safety Council, Barclays Research.
Percentage of Accidents
Demand for homeowners insurance could be negatively impacted by depressed home sales and housing starts (number of new homes on which construction has begun). This is because homeowners are more likely to shop their homeowners insurance coverage when purchasing a new home. As a result, we expect low exposure growth in homeowners
16 April 2012 110
insurance over the next few years. Notably, homeowners insurance premiums are based on the replacement cost of a home, rather than the market value. If the market value of the home falls, this does not mean the replacement cost or the homeowners insurance premium will fall in lockstep. Figure 186: U.S. Housing Starts & Existing Home Sales
Housing Starts
2500 In Thousands, SAAR 2000 1500 1000 500 0
S e 05 pM 05 ar S e 06 pM 06 ar S e 07 pM 07 ar S e 08 pM 08 ar S e 09 pM 09 ar S e 10 p1 Ja 0 nM 11 ar M - 11 ay -1 Ju 1 lSe 11 pN o 11 v1 Ja 1 n12 ar
Homeowners insurance losses tend to be severity-driven and have high volatility due to the impact of catastrophes. U.S. regions with the highest catastrophe exposure include the southeast U.S. due to hurricane and tornado losses, California due to earthquakes, and to a lesser extent the mid-west U.S. and northeast U.S. due to storms. The largest catastrophe losses have historically mostly resulted from hurricanes, followed by tornados and winter storms. Figure 187: Insured Catastrophe Losses by Cause, 1990-1H11
Wind/Hail/ Flood, 3.4% Geological events, 4.9% Terrorism, 6.6% Winter Storm, 8.0% Tornado, 31.8%
Note: Catastrophe losses are for all U.S. P&C insurance coverage. Source: ISO Property Claim Services, Insurance Information Institute, Barclays Research. Source: Barclays Research.
16 April 2012
ar
111
16 April 2012
112
12% 9% 8%
4%
2%
P&C Insurer & Reinsurer Valuation Is Based on Price-to-Book. For the property-casualty insurers and reinsurers, our baseline valuation metric is book value per share, which is a somewhat conservative starting point because it gives no credit to future earning power. We also monitor tangible book value per share (excludes goodwill) as a more constructive metric, although we believe most if not all of the intangibles of the insurers and reinsurers we cover are unlikely to become impaired. The P&C companies with the largest amount of intangibles related to past acquisitions include BRK.A/B, ACE, TRV, and CB. In establishing our price targets, we typically use a price-to-book multiple approaching current level multiplied by the end of the next years (currently 2012) estimated book value per share. Figure 191-Figure 193 show price-to-book valuation for 4Q11 for the commercial insurers, reinsurers, and personal lines insurers we cover. On average, the P&C commercial insurers, personal lines insurers, and reinsurers are trading at 0.87x 4Q11 book value, 0.96x tangible book value, and 0.94x book value per share excluding unrealized net investment gains. Valuations for the P&C insurers are near historical lows, but seemingly cheap multiples should be viewed in the context of the S&P Financials index trading at a depressed 1.02x book value. P&C insurers as-reported book value per share include accumulated other comprehensive income (AOCI) that is mostly unrealized net investment gains. A significant portion of these unrealized gains arises from P&C insurers meaningful investments in fixed income securities that have increased in value as interest rates declined. Interest rates have increased year-to-date in 2012 which could reduce unrealized gains, although Barclays Interest Rate Strategy team expects 10-year U.S. Treasury yields to be capped at about 2.5%, which likely limits the downside risk. A rising rate environment is typically unfavorable for P&C stock performance because it results in book value erosion, although we do not expect significant book value deterioration near-term due to rising rates. We will also closely monitor book value per share excluding shifts in unrealized investment gains and losses to track underlying trends. There is a wide range in price-to-book multiples for the P&C insurers, and return on equity is not always the best indication of valuation multiples for this sector. Figure 190 shows weak explanatory power for P&C insurers price-to-book value versus next years ROE (Rsquared=66%). Currently, the median price to stated book value multiple for the P&C insurers and reinsurers we cover is 0.90x, which signals that returns on equity will likely be
16 April 2012 113
mostly consistent with the cost of capital in coming years especially if the benefit of loss reserve releases were to slow. In terms of stock selection, we favor P&C stocks with the most potential to generate profitable growth in an improving environment, namely ACE, ACGL, BRK, TRV, XL, and PRE. Figure 190: P&C Insurance, Reinsurance & Personal Lines Price-to-Book Vs ROE
3.00 2.50 Price-To-Book 2.00 1.50 1.00 0.50 0.00 4% y = 14.027x-0.0247 R2 = 0.66
6%
8%
10%
12%
14%
16%
18%
2012E ROE
Note: Includes TRV, ACE, ACGL, PRE, RE, BRK.B, CB, OB, AWH, AHL, XL, MRH, FSR, RNR, THG, PGR, ALL. Source: FactSet, Barclays Research estimates
PGR is awarded the highest valuation in the P&C sector of 2.21x book value based on its strong track record of delivering high returns on equity with low volatility. Berkshire Hathaway is awarded a modest valuation of 1.19x book value (1.75x tangible book value) based on the benefit of CEO Warren Buffetts management and investing acumen, as well as impressive operating results and book value per share growth. CB is valued above peers at 1.22x book value because of its prized franchise in high-end personal lines as well as commercial insurance. RNRs valuation is above other Bermuda reinsurers at 1.26x book value because its a best-in-class property catastrophe reinsurer with a strong track record of generating superior book value per share growth and returns on equity. Several commercial lines insurers and reinsurers writing high-severity exposures that could result in increased earnings volatility (including PRE, FSR, MRH, and XL) are currently awarded low valuations. Price-to-book valuations for these companies are below 1x stated book value; however, these companies trade mostly in line with the sector average based on forward P/E multiples.
We use forward year P/E multiples mostly as a way to triangulate our valuation work for the P&C insurers and reinsurers. These companies are in the business of protecting customers against catastrophe losses that can cause significant volatility in insurers results. P/Es based on 2012 operating EPS (excluding net realized investment gains and losses) average about 10x currently for the commercial lines and reinsurers.
16 April 2012
114
Price-to-Book Value
1.5
1.0
0.5
0.0
XL TH G RE M RH PR E AL L AW H TR AC V G L AC E
M edia n= 10x 2012E EPS
FS R AH L
We do not expect interest rates to increase meaningfully further in the near term which means P&C insurers could maintain sizeable cumulative net unrealized gain positions. As a result, as-reported book value per share growth will be our baseline for insurers valuation going forward. Figure 195 shows our expectations for year-end 2012 and 2013 book value per share, book value per share excluding AOCI (or before unrealized fixed income gains if available) and tangible book value per share including AOCI.
16 April 2012
CB O B RN R BR K PG R
115
Figure 195: As-Reported Book Value Per Share, Book Value Excluding AOCI, and Tangible Book Value
Book Value, as reported 4Q11 YE12E YE13E Book Value, ex AOCI 4Q11 YE12E YE13E Tangible Book Value 4Q11 YE12E YE13E
Commercial Lines & Reinsurance TRV ACE ACGL PRE BRK.B CB XL RE OB AWH AHL MRH FSR RNR Personal Lines PGR THG ALL $9.47 56.24 36.92 $10.49 58.76 40.09 $11.20 61.36 43.20 $8.36 52.16 34.40 $8.99 54.43 36.75 $9.67 57.03 39.66 $9.47 51.46 34.31 $10.49 54.66 37.49 $11.20 57.60 40.45 $62.32 72.76 32.03 84.82 66.57 57.15 29.64 112.99 11.56 80.11 38.43 22.71 10.90 59.27 $66.70 79.91 35.43 96.23 76.02 59.50 32.29 126.70 10.59 88.84 41.26 24.13 11.47 66.84 $70.60 84.81 38.06 104.71 83.72 63.10 34.59 135.96 10.34 94.20 44.36 25.35 11.86 72.66 $55.01 67.09 30.88 77.94 59.44 50.78 27.80 106.16 11.68 79.74 32.58 22.77 11.08 59.05 $58.59 73.00 33.74 86.15 64.80 52.72 32.29 115.94 10.71 86.52 35.11 24.20 11.65 65.94 $61.93 78.24 36.37 93.62 70.61 55.94 34.59 124.99 10.45 91.79 37.86 25.42 12.04 71.71 $52.65 58.43 32.03 75.85 45.08 55.44 28.36 112.99 11.56 71.91 38.16 22.71 10.90 58.45 $56.15 65.46 35.43 86.17 54.53 57.68 30.93 126.70 10.59 80.11 40.98 24.13 11.47 66.00 $59.33 70.26 38.06 93.65 62.23 61.17 33.14 135.96 10.34 85.12 44.23 25.35 11.86 71.78
16 April 2012
116
The companies with the largest AOCI (a proxy for net unrealized investment gains as a percentage of book value) are: AHL (15% of reported book value), PGR (12%), and TRV (12%). Figure 196: AOCI as a % of 4Q11 Reported Book Value
18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4%
FS R M RH O
Median=6% of 4Q11 BV
B RN R AW H AC G L AL L
PR E BR K. B
TH G
The Barclays P&C Index vs. the S&P P&C Insurance Index. We created a Barclays marketweighted property-casualty index composed of: ACE, AXS, CB, RE, PRE, RNR, TRH, TRV, WRB, XL, ACGL. We believe this index is more relevant to property-casualty insurance investors compared to the S&P P&C Insurance index because the S&P P&C index has the majority (57%) of its value tied to Berkshire Hathaway. Looking at the Barclays index of large reinsurers and insurers, the property-casualty (re)insurance stocks currently trade at historical lows on an absolute basis at 0.99x book value (ten-year historical range=0.85x2.13x, median=1.37). However, low valuations should be viewed in light of depressed valuations for the overall financial sector since the beginning of the global financial crisis in 2008.
16 April 2012
R AH L
117
CB
TR V
RE
XL
AC E
PG
ACE 23%
AXS 4%
CB 18% PRE 4% RE 5%
The P&C insurance stocks current valuation relative to the S&P Financials index appears elevated based on historical metrics, although we believe this trend should continue, driven by improved commercial pricing trends. The P&C index currently trades at a 3% discount to the S&P Financials versus a historical support level of roughly a 32% discount. If the price/book valuation of the S&P Financials index continues to rise, we anticipate the P&C insurance sector's valuation could increase as well. In addition, improving investor sentiment on P&C insurers as a result of price increases could very well push valuations higher.
16 April 2012
S&P Financials Current Valuation: S&P Financials Index 1.02x BV Barclays P&C Index 0.99x BV
pSe
nJa
1 vNo
Although the P&C insurers currently trade at cyclical low valuations, we acknowledge the valuation of P&C insurers are expensive compared to the rest of Financials.
From late 1999 through year-end 2007, prior to the recent financial crisis, the Barclays P&C index traded at an average 32% discount to the S&P Financials index. Since the beginning of 2008 (approximately the start of the financial crisis), the Barclays P&C index has traded at an average 10% discount to the S&P Financials index.
It is important to note that current valuations for P&C insurers cannot be viewed in isolation and, instead, should be viewed relative to the valuation of overall financials. On an absolute basis, the historical trough valuation of P&C insurers is 1x book value. However, the last time this low valuation level occurred was in early 2000 around a broad-based P&C cycle turn during which time overall financials traded at approximately 3x book value. Currently, P&C trades at an attractive valuation of approximately 1x book value, but this valuation must be viewed in light of overall financials now trading at roughly the same valuation. Figure 201: Barclays P&C Index Price-to-Book Valuation Relative to S&P Financials
Relative Valuation Pre Financial Crisis (Pre 1/1/08) Minimum=60% discount Maximum=18% discount Median=32% discount Std. Deviation=12% Relative Valuation Post Financial Crisis (Post 1/1/08) Minimum=26% discount Maximum=82% premium Median=10% discount Current=3% discount Std. Deviation=22%
Source: SNL, FactSet, Barclays Research
Beginning of Financial Crisis
16 April 2012
ay
Fe
-9
Insurance Brokers Trade Mostly on P/Es. Our outlook is favorable for the insurance brokers, especially MMC, WSH, AJG, and BRO because these companies should benefit from a revenue tailwind as the economy recovers. Also, improved P&C prices should translate into rising organic revenue growth and operating margins. P&C pricing has bottomed, which means the insurance broker stocks could generate attractive upside potential because of positive operating leverage and improved investor sentiment. The insurance brokers trade mostly on P/E multiples rather than price-to-book valuations because, unlike the insurers, the brokers have low earnings volatility and do not have significant capital requirements. The Street consensus estimates for brokers are based on adjusted GAAP EPS excluding restructuring costs but including non-cash amortization expenses from acquisitions (although Aon is moving to a focus on cash earnings). We also monitor the brokers valuations based on price-to-cash EPS (gives full credit for cash generation), and enterprise value-to-EBITDA (adjusts for different capital structures). Based on our market-weighted index, the insurance brokers currently trade at 14.9x 2012 adjusted GAAP EPS estimates, which is below the historical median of 15.6x, and trade at an 13% premium to the S&P 500 P/E of 13.2x compared to a historical average discount of 5%. We view this premium valuation to the S&P 500 as warranted because the brokers are the best early-cycle P&C stocks, in our view, and should benefit from positive pricing momentum. Interestingly, the brokers currently trade on average at 9.2x EV/EBITDA, which is below the historical average of 10.3x. Figure 202: Current Valuation Metrics for Insurance Brokers
EV/EBITDA
12.0 10.0 8.0 6.0 4.0 2.0 0.0 AON BRO MMC 2012E WSH AJG 0.0 AON WSH BRO 2012E MMC AJG 4.0 2.0 7.6 8.0 8.3 8.5 10.0 10.3 8.0 6.1 6.0 6.5 7.9 7.9
Price/EBITDA
8.9
P/E
20.0 18.3 14.8 15.0 12.1 10.0 13.3
19.3
Price/Cash EPS
16.0 14.0 12.0 10.0 10.0 8.0 6.0 10.7 13.6 12.4 14.1
16 April 2012
120
Median=-5%
EV/EBITDA 16.0 14.0 12.0 10.0 8.0 6.0 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Median=10.3x
Note: Index is market cap weighted and includes MMC, AON, WSH, AJG, & BRO. Source: FactSet, Barclays Research
We also value the insurance brokers based on a sum-of-the-parts analysis because Consulting represents a meaningful portion of MMCs and Aons earnings. Our price target valuation multiples for the insurance broker segments range from 14x for AON to 22x 2012 estimated earnings for BRO, based on BROs best-in-class margins. We value the consulting businesses at MMC and AON at 12x-15x 2012 estimated earnings, roughly in line with Towers Watson (13x FY12), which is likely the best comp, but below Accenture (16x FY12). Figure 204: Insurance Broker Sum of the Parts Valuation
Marsh & McLennan 1 -Overweight Pct 2012E P/E Segment Earnings Multiple Marsh 80% 18.0 Mercer 39% 15.0 Corporate -19% 15.0 Total 100% Willis Group 1 -Overweight Pct 2012E P/E Segment Earnings Multiple Brokerage 100% 15.3 Arthur J. Gallagher 1 -Overweight Pct 2012E P/E Segment Earnings Multiple Brokerage 81% 20.5 Risk Mgt. 23% 22.0 Financial Svcs. -4% 10.0 Total 100% Brown & Brown, Inc 1 -Overweight Pct 2012E P/E Segment Earnings Multiple Brokerage 100% 21.5 Aon 2 -Equal Weight Pct 2012E P/E Segment Earnings Multiple Brokerage 89% 13.5 Consulting 33% 12.0 Corporate -21% 10.0 Total 100%
16 April 2012
121
The following pages provide for each company under our coverage: Investment thesis, potential catalysts, and risks; Major metrics that we believe investors should focus on; Long-term valuation trends; and a Summary financial model.
16 April 2012
122
Price Target
$90
13E
$7.00
Div. Yield
2.6%
P/E 12E
9.5
13E
10.3
Investment Thesis ACE has the advantages of global scale, a strong management team, and has a solid balance sheet, in our view. The company has a superior franchise in global commercial P&C insurance, and a growing presence in accident and health, as well as international P&C. ACE has a strong balance sheet in our view, with $3bn of excess capital that could be deployed in acquisitions. Unlike most other P&C insurers, ACE does not typically repurchase its shares. We view ACE as having one of the strongest loss reserve positions, which should serve the company well as the P&C insurance cycle bottoms. Risks Similar to other property/casualty insurers, ACE faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, and rising interest rates. Lower than anticipated accretion from acquisitions could result in lower earnings than projected. A slowdown in reserve releases could be a headwind to earnings, although we believe ACE has one of the strongest reserve positions in the industry.
Potential Catalysts ACE could deploy excess capital for M&A, which could result in higher than projected earnings. Top-line growth could be better than anticipated as P&C insurance rates improve and exposures grow as the economy improves. ACEs growth opportunities appear to be in Latin America, A&H, and global specialty P&C. Attractive valuation.
Valuation Since 2000, ACE has traded at a median trailing price to stated book value of 1.3x, with a range of 0.81x2.03x. Since 2008, the median is 0.96x. Our $90 price target is based on 1.1x our YE12 estimated book value per share of $80, and a P/E of 12x our 2012 EPS estimate of $7.60. ACE currently trades at 0.99x 2011 book value, which is a slight premium to the overall sector, and 9.5x 2012E EPS of $7.60, mostly in line with the sector average.
ACE Limited, headquartered in Zurich, Switzerland, is one of the world's largest providers of property-casualty insurance and, to a lesser extent, reinsurance. The company provides products and services globally mostly to commercial clients.
16 April 2012
123
Total Net Written Premiums FY 2011: $15.4 billion Life, 12% Global Reinsurance, 6%
$7.72
$7.79 $6.97
$7.60 $7.00
$3.00 $2.00 2006 2007 2008 2009 2010 2011 2012E 2013E
100%
$90
Book Value
98%
Book Value Per Share
95% 93% 90% 88% 85% 83% 80% 2006 2007 2008 2009 2010 2011 2012E 2013E Combined Ratio CR Ex Cats and PY Development
8% $30 $15 $0 2006 2007 2008 2009 2010 2011 2012E 2013E 4% 0%
16 April 2012
124
ay -0 3
ay -0 5
ay -0 7
ay -9 9
ay -0 1
16 April 2012
0%
ay -1 1
ay -0 9
N 1 -0 ov
9 -0 ov
1 -1 ov
3 -0 ov
5 -0 ov
7 -0 ov
09 bFe
1 t-0 Oc 99 cDe
7 r- 0 Ap 05 nJu 03 gAu
10 cDe
125
16 April 2012
126
Price Target
$46
Price Range
39 - 30 4Q11 Price/BV ex Gdwill
1.18
Cap (Bil)
$5.1
13E
$2.50
Div. Yield
0.0%
P/E 12E
13.7
13E
15.1
Investment Thesis
Potential Catalysts
In our view, Arch Capital has one of the best-managed P&C franchises along with superior long-term track records in both P&C underwriting and book value per share growth. The company shrunk its reinsurance business in soft market conditions, and shifted its business mix in primary insurance toward short-tail lines with increased expected returns. Arch Capital consistently generates strong returns on equity driven in part by consistent underwriting profits, aggressive share repurchase activity, and a high quality investment portfolio. The company establishes conservative loss reserves as evidenced by its elevated accident year combined ratio and growth in net loss reserves.
Risks
ACGL could experience faster than anticipated top-line growth as it benefits from increased potential for large transactions. ACGL has a strong franchise in both primary insurance and reinsurance and can deploy capital where it sees fastest P&C prices increases and highest returns. Reserve releases could persist due in part to ACGLs conservative stance to reserving. Share repurchase activity could slow in 2012 due to increased potential for large transactions as well as perhaps committing more risk capacity to Japan earthquake and Florida wind.
Valuation
Similar to other property/casualty insurers, Arch faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, and rising interest rates. Arch is a large writer of casualty insurance and reinsurance, which means it could face risk if loss cost trends rise, perhaps in future years. A slowdown in reserve releases could be a headwind to earnings, although we believe ACGLs reserve position is strong. The pace of share repurchase activity could slow in 2012.
Since 2002, ACGL has traded at a median trailing price to stated book value of 1.27x, with a range of 0.61x1.76x. Since 2008, the median is 1.06x. Our $46 price target is based on 1.3x YE12 estimated book value per share of $35, and a P/E of 17x our 2012 EPS estimate of $2.75. ACGL currently trades at 1.18x 2011 book value and 13.7x 2012E EPS of $2.75, which is at a premium to the sector average, although we believe this is warranted due in part to ACGLs superior track record of growing book value and generating strong returns.
Arch Capital, based in Bermuda, writes commercial insurance as well as reinsurance on a worldwide basis through operations in Bermuda, the U.S., Europe, and Canada with a focus on specialty lines.
16 April 2012
127
$4.50 $4.00 $3.50 $3.00 $3.21 $2.76 $2.20 $3.82 $3.51 $3.12 $2.75 $2.50
Reinsurance, 36%
$2.50 $2.00
Insurance, 64%
$1.50 $1.00 $0.50 $0.00 2006 2007 2008 2009 2010 2011 2012E 2013E
100% 96%
Book Value Per Share
92% 88% 84% 80% 2004 2005 2006 2007 2008 2009 2010
$30
20% 15%
$15
10% 5%
0%
Combined Ratio
16 April 2012
128
Operating ROE
2 -1 ar M 11 ar M 10 ar M 09 ar M 08 ar M 07 ar M 06 ar M 05 ar M 04 ar M 03 ar M 02
-0 2
-0 3
-0 4
-0 5
-0 6
-0 7
-0 8
-0 9
Au g
Au g
Au g
Au g
Au g
16 April 2012
Au g
Au g
Au g
Au g
Au g
-1 0
-1 1
2 -1 ar M 1 -1 ar M 10 ar M 9 -0 ar M 8 -0 ar M 07 ar M 6 -0 ar M 5 -0 ar M 4 -0 ar M 03 ar M 2 0
2.00 1.80 1.60 1.40 1.20 1.00 0.80
ar
ar
11 nJu 0 1 nJu 9 0 nJu 8 0 nJu 7 0 nJu 6 0 nJu 5 0 nJu 4 0 nJu 3 0 nJu 2 0 nJu
11 nJu 0 1 nJu 9 0 nJu 8 0 nJu 07 nJu 6 0 nJu 5 0 nJu 4 0 nJu 03 nJu 2 0 nJu
129
16 April 2012
130
Price Target
$74
Div. Yield
2.8%
13E
$5.50
P/E 12E
10.3
13E
10.6
Investment Thesis
Potential Catalysts
Travelers is one of the best positioned propertycasualty insurers, in our view. Long term, the company has delivered superior book value per share growth as well as ROE, and has one of the lowest-risk investment portfolios among peers. The companys focus on small- and middle-market commercial insurance as well as personal lines addresses its severity exposure to major industry catastrophe events, and as a result, reduces earnings volatility. Travelers is one of the most aggressive repurchasers of shares among P&C insurers, which generates strong EPS and attractive book value per share growth. The pace of share buybacks at TRV could slow through 2013, although share buybacks could still be faster than other P&C insurers.
Risks
Top-line growth could be stronger than anticipated as P&C insurance rates rise and exposures grow as the economy improves. TRV is raising P&C prices and its premium growth could be above peers based in part on strong partnerships with independent agents. Share repurchase activity could continue, although the pace of share buybacks could slow. TRVs loss reserve position appears strong and the company could continue to release reserves, although perhaps at a slower pace.
Valuation
Similar to other property/casualty insurers, TRV faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, and rising interest rates. Reserve releases have been significant, which could mean TRV has less reserve redundancy from prior years. Also, a slowdown or reversal in the companys substantial loss reserve releases could mean our EPS expectations are too high. TRV has exposure to workers compensation insurance and surety insurance, although the companys results have been stronger than the industrys over time.
Since 2000, TRV has traded at a median trailing price to stated book value of 1.25x, with a range of 0.80x2.05x. Since 2008, the median is 0.95x. Our $74 price target is based on 1.1x YE12 estimated book value per share of $67, and a P/E of 13x our 2012 EPS estimate of $5.65. TRV currently trades at 0.93x 2011 book value and 10.3x 2012E EPS of $5.65, which is mostly in line with the sector average.
Travelers, headquartered in New York, is the second-largest writer of commercial U.S. property-casualty insurance, and is the second largest writer of U.S. personal lines insurance through independent agents.
16 April 2012
131
Total Net Written Premiums FY 2011: $22.2 billion Personal Insurance, 35%
$8.00 $7.00 $6.00 $5.00 $4.00 $3.28 $5.83 $6.89 $6.21 $5.23 $6.29 $6.26 $5.65 $5.50
$3.00 $2.00 $1.00 $0.00 2005 2006 2007 2008 2009 2010 2011 2012E 2013E
110% 105%
Book Value $80 Book Value Per Share $70 $60 $50 $40 $30 $20 $10 $0
20 05
20 06
20 08
20 10
20 07
20 09
20 11 20 12 E
20 13 E
Combined Ratio
16 April 2012
20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 E 20 13 E
132
Operating ROE
100%
40% 20%
1.5
0% -20%
1.0
-40% -60%
0.5
1 -1 ov N 10 ov N 09 ov N 08 ov N 07 ov N 06 ov N 05 ov N 04 ov N 03 ov N 02 ov N 01 ov N 0 -0 ov 9 -9 ov N N
2.50 2.30 2.10 1.90 1.70 1.50 1.30 1.10 0.90 0.70
ec -9 8 ec -9 9 D ec -0 D 0 ec -0 D 1 ec -0 D 2 ec -0 D 3 ec -0 D 4 ec -0 D 5 ec -0 D 6 ec -0 D 7 ec -0 D 8 ec -0 D 9 ec -1 D 0 ec -1 1 D D
40.0 30.0 20.0 10.0 0.0
N N N N N N N N N ov N ov -0 0 9 -9 N ov N ov 1 -0 N ov -0 3 2 -0 ov ov -0 4 ov ov ov ov ov ov -0 -0 -0 -0 -0 -1 -1
-80%
1 -1 ov N -10 ov N -09 v No -08 v No -07 ov N -06 v No -05 v No -04 ov N -03 ov N -02 ov N -01 ov N -00 ov N -99 v No
ec -0 0
ec -0 2
16 April 2012
ec -0 8
ec -9 8
ec -0 4
ec -0 6
0.7% 2.2% 2.2% 3.4% 7.5% 5.9% 7.1% 13.8% 10.9% 14.5% 139.6 $0.21 $42.22 NA 17.4% $35.56 $41.23 17.8% 5,316 56.6% 30.8% 87.4% 0.8% -0.9% 0.9% -3.4% -2.5% 90.1% 19.4% 22.2% 0.9 25.8% 73,867 3.6% 5.1% 56.2 $2,959
-1.5% 0.3% 0.3% 0.5% -21.1% -2.3% -29.0% -22.0% -24.1% 2.1% 140.3 $0.23 $43.12 NA 12.3% $36.19 $43.37 12.5% 3,135 59.4% 32.5% 91.9% 6.5% 0.3% -7.5% -7.1% 92.5% 19.5% 22.4% 1.0 22.7% 74,183 0.4% 3.8% 45.6 $2,150
-2.3% -1.6% -1.6% -0.7% -0.4% -5.3% 12.7% 20.2% 20.2% 21.8% 139.2 $0.24 $52.54 NA 13.7% $44.94 $48.96 14.2% 4,231 57.3% 31.9% 89.2% 2.1% 0.0% 0.9% -7.1% -6.2% 93.3% 20.3% 23.2% 0.9 23.3% 73,099 -1.5% 3.8% 69.4 $3,300
0.1% 1.4% 1.4% 0.1% 7.8% -3.7% -15.5% -0.5% -0.5% 11.3% 139.3 $0.29 $58.47 NA 11.5% $49.57 $54.19 12.4% 3,054 60.9% 32.2% 93.2% 5.2% -0.1% 0.7% -6.5% -5.8% 93.9% 21.9% 25.1% 1.1 24.7% 71,560 -2.1% 4.3% 95.7 $5,000
2.5% 2.6% 2.6% 3.1% -5.6% -6.0% -54.3% -47.7% -47.7% 6.6% 143.6 $0.34 $62.32 NA 5.6% $52.65 $55.01 6.2% 2,169 72.9% 32.2% 105.1% 11.6% 0.0% 1.0% -4.3% -3.2% 96.7% 23.4% 27.1% 1.2 -7.2% 70,447 -1.6% 4.1% 51.0 $2,900
3.0% 3.1% 3.1% 2.2% 3.9% 2.3% 57.0% 72.5% 72.5% 7.0% 146.7 $0.39 $66.70 NA 9.0% $56.15 $58.59 10.2% 1,598 67.4% 32.1% 99.6% 2.9% 0.0% 0.7% -2.4% -1.8% 98.5% 23.8% 27.6% 1.2 16.8% 68,257 -3.1% 4.4% 32.8 $2,000
3.7% 3.7% 3.7% 3.3% -3.0% 0.3% -9.7% -2.7% -2.7% 5.8% 151.5 $0.43 $70.60 NA 8.2% $59.33 $61.93 9.4% 2,336 68.2% 32.4% 100.6% 3.1% 0.0% 0.6% -1.4% -1.0% 98.5% 24.0% 27.9% 1.2 14.5% 68,930 1.0% 4.2% 23.1 $1,500
2.7% 3.5% 3.5% 2.7% 2.0% -6.5% 30.9% 56.0% 56.0% 12.0% 34.9 $0.08 $59.91 2.5% $46.55 $55.59 633 62.2% 32.6% 94.7% 3.4% -4.4% -4.4% 95.8% 22.0% 25.2% 1.1 13.0% 70,771 -2.6% 4.4% 18.9 $1,100
2.5% 2.3% 2.3% 3.1% -1.8% -6.4% NM NM NM 7.1% 35.8 $0.09 $59.62 -0.5% $50.48 $54.28 268 92.7% 32.4% 124.9% 30.3% 0.9% -3.9% -3.1% 97.8% 22.5% 25.9% 1.1 49.5% 70,476 -1.1% 4.3% 3.9 $237
3.7% 3.8% 3.8% 3.4% -6.0% -6.1% -61.3% -56.4% -56.4% 3.1% 36.4 $0.09 $60.98 2.3% $51.74 $54.63 917 72.9% 31.6% 104.5% 10.8% 3.1% -6.4% -3.3% 97.0% 22.7% 26.1% 1.1 -0.6% 70,474 -0.6% 3.9% 7.3 $375
1.0% 0.5% 0.5% 3.1% -16.0% -5.1% -29.5% -21.6% -21.6% 6.6% 36.5 $0.09 $62.32 2.2% $52.65 $55.01 351 63.7% 32.3% 96.0% 1.8% 0.0% -2.2% -2.2% 96.4% 23.4% 27.1% 1.2 20.3% 70,067 -1.8% 3.7% 20.9 $1,188
2.0% 1.8% 1.8% 3.7% -1.7% -1.4% -27.6% -20.7% -20.7% 6.1% 36.2 $0.09 $63.57 2.0% $53.69 $55.97 146 66.3% 32.1% 98.4% 2.0% -2.4% -1.8% 98.3% 23.5% 27.1% 1.2 18.0% 68,113 -3.8% 4.4% 8.2 $500
2.8% 2.6% 2.6% 1.9% 1.0% 0.0% NM NM NM 8.5% 36.5 $0.09 $64.71 1.8% $54.62 $56.94 654 66.4% 32.4% 98.8% 2.5% -2.4% -1.8% 98.1% 23.6% 27.2% 1.2 17.4% 68,131 -3.3% 4.4% 8.2 $500
3.3% 4.0% 4.0% 1.1% 6.7% 5.4% 32.3% 45.4% 45.4% 7.4% 36.8 $0.10 $65.52 1.3% $55.20 $57.58 626 69.6% 32.3% 101.9% 4.1% -2.5% -1.7% 99.5% 23.8% 27.5% 1.2 14.3% 68,388 -3.0% 4.3% 8.2 $500
3.8% 4.1% 4.1% 1.9% 10.8% 5.4% -7.8% 1.4% 1.4% 7.0% 37.2 $0.10 $66.70 1.8% $56.15 $58.59 171 67.3% 31.8% 99.1% 2.9% -2.4% -1.8% 98.1% 23.8% 27.6% 1.2 16.8% 68,396 -2.4% 4.3% 8.2 $500
16 April 2012
134
Price Target
$85
13E
$5.80
Div. Yield
0.0%
P/E 12E
14.5
13E
13.6
Investment Thesis
Potential Catalysts
We expect strong operating results at Berkshire Hathaway to continue, although earnings growth could slow, barring a large acquisition. Also, we view Berkshire shares as attractively valued. Berkshires five largest non-insurance businesses reported record profits in 2011. Unless the economy weakens, each of its five largest non-insurance businesses should report higher earnings in 2012. Long term, CEO succession remains a risk, although less so since Warren Buffetts management succession plans are now in place.
Risks
Berkshire could repurchase stock if its valuation falls to 1.1x book value, which we believe provides a strong support level. Notably, the company has made no mention of plans to pay a shareholder dividend. Berkshire is seeking acquisitions in the $5bn-$20bn range, which appears reasonable based on $34bn of current cash holdings and likely little interest in issuing stock for deals. Berkshire remains committed to holding at least $20bn in cash, which means it has about $14bn of deployable cash currently. Rising equity markets could result in faster than anticipated book value growth.
Valuation
Similar to other property/casualty insurers, Berkshire faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, and rising interest rates. CEO Warren Buffett is 81 years old. Berkshire has high exposure to equity market volatility due to its large and concentrated stock investments as well as its derivatives exposures. Berkshires ability to effectively acquire new businesses could result in slower earnings growth and ROE pressure.
Since 2000, BRK has traded at a median trailing price to stated book value of 1.53x, with a range of 1.10x1.99x. Since 2008, the median is 1.31x. Our $85 price target for BRK.B is based on a sum-ofthe-parts methodology that applies a P/E of 12.5x BNSF, 9x the Manufacturing, Service & Retail unit, 14x MidAmerican, 8x unrealized appreciation of investments, and 6x Finance, and also based on 1.1x YE12 estimated book value per share of $76. Berkshire currently trades at 1.19x 2011 book value and 14.5x 2012E EPS of $5.45 per B share, which is above other P&C insurers, although we believe this is warranted based on the companys strong track record.
Berkshire Hathaway, based in Omaha, Nebraska, and its subsidiaries engage in diverse business activities including property and casualty insurance and reinsurance, utilities and energy, freight rail transportation, finance, manufacturing, retailing and services.
16 April 2012
135
Insurance 28%
$6.00 $5.00 $4.02 $4.00 $3.25 $3.00 $2.00 $1.00 $0.00 2006 2007 2008 2009 2010 2011 $4.16 $4.15 $4.52
Book Value $90 $75 Book Value Per Share $60 $45 $30 $15 $0
8%
4%
2012E 2013E
16 April 2012
Operating ROE
136
1 -1 ec D 0 -1 ec D 9 -0 ec D 8 -0 ec D 7 -0 ec D 6 -0 ec D 5 -0 ec D 4 -0 ec D 3 -0 ec D 2 -0 ec D 1 -0 ec D 0 -0 ec 9 -9 ec D
Note: AOCI is used instead of net unrealized gains/(losses) for the first, second, and third quarters of 2009 and 2010. Source: FactSet, Barclays Research.
N ov
N ov -9 9
N ov 0 -0
N ov -0 1
N ov 2 -0
N ov -0 3
N ov 4 -0
N ov -0 5
ov
ov
ov 7
ov
ov 6
-1
-1
-0
-0
-0
-0
16 April 2012
137
0.0% 94.3%
0.0% 97.8%
10 0.1% 93.1%
0.0% 89.7%
0.0% 93.3%
0.0% 94.8%
0.0% 95.0%
35.7% 10.2% -0.3% 20.2% NM 20.2% 11.9% -13.1% 3.8% 3.3% 11.0% 32.7% 17.1% $58,698 $94,183 5.1% $90,343 $6,373 $4,123 $7,177
-21.7% 2.9% -6.7% 67.0% NM 67.0% 1.9% -23.4% 3.3% -0.2% -9.6% 26.1% 19.3% $58,488 $98,046 5.0% $77,793 $7,171 $4,630 $5,114
10.1% 11.5% -8.8% -48.4% NM -48.4% -48.8% -15.3% -27.3% -21.6% 19.8% 30.6% 16.5% $63,441 $104,019 5.2% $98,475 $3,853 $2,484 $10,909
11.0% -5.8% 3.5% 0.7% NM NM NM 5.5% 54.8% 39.0% 13.0% 29.4% 18.2% $65,832 $110,229 4.7% $89,631 $9,693 $5,926 $11,444
4.0% -8.2% -30.5% 7.8% 31.3% 24.3% 17.9% 12.3% -0.5% -3.7% 4.6% 29.8% 22.9% $70,571 $112,772 4.2% $93,233 11,533 $6,990 $12,285
5.5% -11.1% 17.3% 3.1% 18.1% 14.2% 29.6% 0.1% 19.0% 25.3% 14.2% 29.0% 20.6% $132,486 3.2% $111,109 $13,820 $8,372 $12,666
-3.5% 0.0% -5.3% 0.7% 13.5% 10.5% 11.7% 0.0% 6.0% 6.4% 10.1% 29.0% 19.1% $156,425 2.7% $123,969 $15,351 $9,299 $13,989
0.4% -1.7% NM 14.2% NM NM 14.8% 40.5% -26.8% -30.5% 8.6% 28.2% 22.0% $69,000 $107,358 4.7% $92,909 $2,457 $1,491 $2,444
33.5% -6.0% -36.9% -5.3% NM NM 14.0% 14.2% -11.3% -12.1% 13.9% 32.8% 21.7% $71,000 $109,560 5.1% $95,376 $2,799 $1,696 $4,939
-17.2% -14.8% 79.4% 17.5% NM NM 17.5% 5.0% 36.8% 36.4% 6.7% 28.3% 23.4% $70,000 $112,795 3.7% $89,317 $3,085 $1,868 $3,999
6.9% -11.1% -52.1% 2.3% 42.1% 31.2% 24.9% 3.9% -4.6% -11.6% 4.6% 28.3% 22.9% $70,571 $116,983 3.5% $93,233 $3,378 $2,046 $903
11.6% -16.7% NM 1.3% 34.7% 24.0% 40.7% 0.0% 99.5% NM 9.0% 29.0% 21.9% $122,493 3.4% $102,192 $3,092 $1,873 $3,166
-8.1% -25.2% 5.7% 9.4% 15.3% 13.9% 36.3% 0.0% 17.7% 23.9% 9.9% 29.0% 21.4% $129,155 3.3% $105,143 $3,409 $2,065 $3,166
11.9% 1.2% -55.0% -0.2% 12.8% 9.1% 33.1% -0.7% -15.2% -12.6% 14.8% 29.0% 21.0% $135,817 3.1% $108,116 $3,621 $2,194 $3,166
9.1% 2.7% 58.1% 3.9% 13.6% 11.6% 11.4% 0.7% 19.9% 30.5% 14.2% 29.0% 20.6% $142,479 2.9% $111,109 $3,697 $2,240 $3,166
16 April 2012
138
Price Target
$85
13E
$6.00
Div. Yield
2.2%
P/E 12E
11.8
13E
11.6
Investment Thesis
Potential Catalysts
Chubb has a strong franchise in high-end personal lines, as well as specialty commercial insurance. Underwriting results have remained solid over time, the investment portfolio is low risk, and share repurchase activity is aggressive. CEO John Finnegan (age 63) is closing in on CBs mandatory retirement age of 65. The company recently elevated two business leaders to join the CFO on the executive committee. CBs valuation is above other P&C insurers, although we believe this is warranted based on its strong track record.
Risks
CB could be one of the most aggressive P&C insurers in terms of share buybacks based on its substantial excess capital position. CBs top-line growth could benefit from improving P&C prices and rising insured exposure growth as the economy recovers. The companys outlook for 2012 EPS could be conservative based on CBs strong reserving position. CEO John Finnegan is expected to retire in 2014.
Valuation
Similar to other property/casualty insurers, Chubb faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation. CB has higher exposure to D&O/E&O lines than other P&C insurers, although losses from the financial crisis appear to be manageable. Chubbs earnings have benefited from substantial loss reserve releases including in specialty lines such as D&O and E&O. If the company were to suffer adverse loss reserve development, out EPS estimates would likely be too high.
Since 2000, CB has traded at a median trailing price to stated book value of 1.46x, with a range of 0.96x2.20x. Since 2008, the median is 1.13x. Our $85 price target is based on 1.4x YE12 estimated book value per share of $60, and a P/E of 14x our 2012 EPS estimate of $5.90. Chubb currently trades at 1.22x 2011 book value and 11.8x 2012E EPS of $5.90, which is above other P&C insurers, although we believe this is warranted based on the companys strong track record.
Chubb is a top property/casualty insurer with a worldwide presence. The companys segments include Personal Insurance, Commercial Insurance, and Specialty Insurance.
16 April 2012
139
$6.41 $5.58
$6.14
$5.90 $5.12
$5.85
$6.00
Book Value
95%
90%
85%
80% 2006
$0
2007
2008
2009
2010
2011
2012E 2013E
16 April 2012
140
Fe b99
Fe b01
Fe b03
Fe b05
Fe b07
Fe b09
Fe b9 Fe 9 b0 Fe 0 b0 Fe 1 b0 Fe 2 b03 Fe b0 Fe 4 b0 Fe 5 b0 Fe 6 b0 Fe 7 b0 Fe 8 b0 Fe 9 b1 Fe 0 b1 Fe 1 b12
16 April 2012
Fe b11
1 -1 ov N 10 ov N 9 -0 ov N 08 ov N -07 ov N 06 ov N 05 ov N 04 ov N 03 ov N 02 ov N 01 ov N 00 ov N 99 ov
2.30 2.10 1.90 1.70 1.50 1.30 1.10 0.90
N D
1 -1 ov N -10 ov N -09 ov N -08 ov N -07 ov N -06 ov N -05 ov N -04 ov N -03 ov N -02 ov N -01 ov N -00 ov N -99 ov
141
1 -1 ec D 10 ec D 09 ec D 08 ec D 07 ec D 06 ec D 5 -0 ec D 04 ec D 03 ec D 02 ec D 01 ec D 00 ec D 99 ec
16 April 2012
142
Price Target
$77
13E
$7.50
Div. Yield
3.6%
P/E 12E
8.3
13E
8.9
Investment Thesis
Potential Catalysts
PREs recent results have been challenged by large catastrophe losses and the company losing its AA rating. However, PRE benefits from its diversified operations in terms of product lines and geography, and we believe the stock is poised for a recovery once it generates several quarters of consistent earnings. PartnerRe is among the worlds largest reinsurers after its acquisition of ParisRe, which significantly expanded its European presence. PREs capital position was impacted by the 2011 catastrophe losses, although the company maintains a modest excess capital cushion and views share buybacks as attractive at current valuations.
Risks
PREs treaty reinsurance renewal premiums increased slightly y/y at the January 2012 renewals (which accounts for 60% of its total annual non-life treaty business). Meanwhile, PRE reduced its catastrophe exposure, which should result in a higher modeled ROE. PRE has a conservative approach to setting loss reserves. As a result, loss reserve releases could continue, particularly if loss cost trends remain benign. PRE could resume share buybacks in 2012.
Valuation
Similar to other property/casualty insurers, PartnerRe faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates, increased inflation and changes to Bermuda tax advantage. PREs long-term ROE goal of 13% over the course of the cycle could be optimistic in a lower interest rate environment. PREs earnings have benefitted from substantial loss reserve releases, and earnings could face headwinds if this benefit slows.
Since 2000, PRE has traded at a median trailing price to stated book value of 1.20x, with a range of 0.61x1.62x. Since 2008, the median is 0.92x. Our $77 price target is based on 0.8x YE12 estimated book value per share of $96, and a P/E of 10x our 2012 EPS estimate of $8.10. PartnerRe currently trades at 0.79x 2011 book value and 8.3x 2012E EPS of $8.10, which is below other P&C insurers due to its recent challenges including outsized 2011 catastrophe losses.
PartnerRe, based in Bermuda, is a leading global reinsurer providing multiline reinsurance to insurers. Risks reinsured include property, casualty, motor, agriculture, aviation/space, catastrophe, and others
16 April 2012
143
$14.59
$8.10 $6.29
$7.50
Catastrophe, 13%
-$5.00 -$10.00
-$9.50
130% 120%
Book Value Per Share
Book Value $120 $105 $90 $75 $60 $45 $30 $15
Operating ROE 25% 20% 15% 10% 5% 0% -5% -10% -15% Operating ROE
$0
2007
2008
2009
2010
Combined Ratio
16 April 2012
144
1.85 1.65 1.45 1.25 1.05 0.85 0.65 1.15 0.65 2.15 1.65
ec -0 0
ec -0 6
ec -0 8 D
ec -9 8
ec -0 0
ec -0 2
ec -0 4
ec -0 6
ec -0 8
ec -1 0
16 April 2012
ec -1 0
ec -9 8
ec -0 2
ec -0 4
1 -1 ov N 10 ov N 09 ov N -08 ov N 07 ov N 6 -0 ov N 05 ov N 04 ov N 03 ov N -02 ov N 01 ov N 00 ov 9 -9 ov N
2.65
1 -1 ov N -10 ov N -09 ov N -08 ov N -07 ov N -06 ov N -05 ov N -04 ov N 03 ov N -02 ov N -01 ov N -00 ov N -99 ov
145
16 April 2012
146
Price Target
$25
13E
$2.20
Div. Yield
2.1%
P/E 12E
10.1
13E
9.6
Investment Thesis
Potential Catalysts
XL's P&C business has stabilized and its balance sheet looks strong. The company is well positioned to generate profitable growth in an improving environment and is our top value pick within P&C insurance. XLs 2012 earnings should benefit from continued topline growth opportunities, accident year underwriting margin expansion versus 2011, and share buybacks. Our sense is the 2012 consensus EPS outlook for XL is too low. XLs ROE should improve measurably in 2012 and rise to attractive levels in 2013 (long-term ROE goal is 15%, but it faces likely downward pressure in a low interest rate environment).
Risks
XL appears confident it can improve its underlying underwriting results in 2012, especially in the U.S. and International Insurance businesses. XL plans to increase its operating expenses by $100mn in 2012 vs $1.1bn in 2011 as it invests in the business, although XL can reduce this increased spend by nearly half if margin expansion does not materialize. Share buybacks could exceed our outlook and the company likely has several billion dollars of excess capital. The companys debt/capital ratio is in line with its target, which provides increased flexibility for share buybacks. We estimate XL could repurchase at least $400mn of stock in 2012.
Valuation
Rising interest rates could have an outsized impact on XLs book value versus peers. Similar to other property/casualty insurers, XL faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation. XL still has significant structured credit and other exposures in its investment portfolio relative to its capital base. XL has higher D&O/E&O exposure than other P&C insurers, although this risk appears manageable.
Since 2000, XL has traded at a median trailing price to stated book value of 1.39x, with a range of 0.19x2.45x. Since 2008, the median is 0.70x. Our $25 price target is based on 0.8x YE12 estimated book value per share of $33, and a P/E of 12x our 2012 EPS estimate of $2.10. XL currently trades at 0.71x 2011 book value and 10.1x 2012E EPS of $2.10, which is below other P&C insurers.
XL Group is domiciled in Dublin, Ireland, and has substantial operations in Bermuda, the United States, and Europe. The company writes commercial P&C insurance and reinsurance.
16 April 2012
147
Reinsurance 30%
Insurance 64%
$4.00 $2.00
$3.49
$2.91
$2.40 $0.28
$2.10
$2.20
110%
100%
$40 $30 10% $20 $10 5% 0% 2006 2007 2008 2009 2010 2011 2012E 2013E
90%
80% 2006
2007
2008
2009
2010
2011
2012E
2013E
$0
Combined Ratio
16 April 2012
148
50%
-50%
-100%
1 -1 ov N -10 ov N -09 ov N -08 ov N -07 ov N -06 ov N -05 ov N -04 ov N -03 ov N -02 ov N -01 ov N -00 ov N -99 ov N
16 April 2012
ec -1 0
149
ec -0 0
ec -0 2
ec -0 8
ec -9 8
ec -0 4
ec -0 6
16 April 2012
150
Price Target
$85
13E
$7.50
Div. Yield
1.4%
P/E 12E
9.2
13E
10.0
Investment Thesis
Potential Catalysts
Renaissance Re is a disciplined property catastrophe reinsurer with a growing presence in specialty reinsurance and Lloyds. The company has one of the best long-term track records in terms of both book value per share growth and returns on equity. We could become more favorable in our outlook for RNR shares if its valuation became more attractive. RNR invests heavily in its catastrophe modelling capabilities resulting in lower-than-peer claims costs in major industry loss events and above-peer ROEs.
Risks
RNR could benefit from higher U.S. property catastrophe reinsurance rates, although we expect property catastrophe reinsurance rate increases at the mid-year 2012 renewals increase about 5-10%, which is likely less than many investors are hoping for. RNR has opportunities to write additional business in the U.S. for nationwide covers and stressed regional insurers, as well as in its retrocessional, Lloyds and specialty reinsurance business. Despite large 2011 catastrophe losses, the companys capital position remains strong and its total capital managed inclusive of joint ventures approaches $7 billion, which is significant versus peers. RNR is unlikely to repurchase stock until after the 2012 hurricane season.
Valuation
Similar to other property/casualty reinsurers, RNR faces risks if property catastrophe reinsurance price increases do not persist, as well as from catastrophes and other large losses. RNRs earnings have benefitted from favorable loss reserve development, and earnings could face headwinds if this slows. Also, RNR faces the risk of adverse development from catastrophe losses, although its track record in estimating catastrophe losses is strong. Over half of RNRs IBNR reserves are related to earthquake claims and could be volatile because these losses are slower to develop than hurricanes. RNRs investment returns can be volatile due in part to its alternative investment exposure.
Since 2000, RNR has traded at a median trailing price to stated book value of 1.52x, with a range of 0.99x2.63x. Since 2008, the median is 1.17x. Our $85 price target is based on 1.3x YE12 estimated book value per share of $67, and a P/E of 10x our 2012 EPS estimate of $8.15. RNR currently trades at 1.26x 2011 book value and 9.2x 2012E EPS of $8.15, which is above other P&C insurers due to its strong track record.
RenaissanceRe, based in Bermuda, was established in 1993 to write principally property catastrophe reinsurance and today is a leading global provider of reinsurance and insurance coverage and related services.
16 April 2012 151
$3.04
140% 120%
Book Value $80 $70 Book Value Per Share $60 $50 $40 $30 $20 $10
Operating ROE 50% 40% 30% 20% 10% 0% -10% Operating ROE
100% 80% 60% 40% 20% 2006 2007 2008 2009 2010 2011 2012E 2013E
Combined Ratio
16 April 2012
152
Fe b07
Fe b01
Fe b9 Fe 9 b0 Fe 0 b0 Fe 1 b0 Fe 2 b0 Fe 3 b0 Fe 4 b0 Fe 5 b0 Fe 6 b0 Fe 7 b0 Fe 8 b09 Fe b1 Fe 0 b1 Fe 1 b12
16 April 2012
Fe b03
Fe b99
Fe b05
Fe b11
Fe b09
N ov
N ov 9 -9
N ov 0 -0
N ov 1 -0
N ov 2 -0
N ov 3 -0
N ov 4 -0
N ov 5 -0
N ov 7 -0
N ov 6 -0
N ov 8 -0
N ov 1 -1 0 -1
1 -1 ov 0 N -1 ov N 09 ov N 08 ov N 07 ov 6 N -0 ov N 05 ov N 04 ov 3 N -0 ov N 02 ov N 01 ov N 00 ov 9 -9 ov N
ov
9 -0
153
$10.24 $2.31 $7.93 $0.88 68.9 70.5 1.3 71.8 $41.03 NA $40.38 27.7% 28.1% $40.99 33.6% 17.9% 7.8% 25.7% 59.3% 11.6% -16.4% 64.0% 14.2 $0.20 -6.9% -6.9% -6.2% -6.9% 26.5% 7.4% -9.2% 1.0% -7.6% -7.3% 19.3% 6,489 6.2% -3.1% 3.3 $189 $1,810 $0 $1,810
$3.04 ($3.25) ($0.21) $0.92 61.5 62.5 0.9 63.4 $38.74 NA $37.52 7.4% 7.6% $37.54 54.8% 15.4% 8.8% 24.2% 79.0% 19.9% -16.9% 76.1% 13.9 $0.22 -4.1% -7.0% -5.7% -2.6% -94.0% 58.7% -16.2% 26.4% -73.8% -70.3% -5.6% 6,338 0.4% 1.9% 7.9 $428 $1,736 $54 $1,682
16 April 2012
154
Price Target
$100
13E
$10.50
Div. Yield
2.1%
P/E 12E
8.2
13E
8.9
Investment Thesis
Potential Catalysts
Everest Res operating performance has been uneven in our view driven by the impact of largest catastrophe losses as well as underwriting losses in its primary insurance business. The company has over $7bn in capital, which gives it enough scale to effectively compete as a global reinsurer. RE has a diversified business model across both business lines and geographies. The company has a strong reinsurance business with a smaller primary insurance presence. Chairman and CEO Joseph Taranto is expected to remain in his current role through perhaps 2012 as a search for his successor continues. CFO Dom Addesso was promoted to President in June 2011. The company has been impacted by loss reserve strengthening in 2010 and 2011, which perhaps signals less of a reserve cushion than peers.
Risks
RE has about a $650mn share repurchase authorization. We estimate the company has about $600mn of excess capital which could be used for share buybacks. RE plans to grow in property reinsurance and crop insurance. Its workers' compensation insurance business is mostly in California and benefits from rate increases. The company plans to reduce its casualty reinsurance exposure. RE could benefit from elevated U.S. property catastrophe reinsurance rates resulting from large catastrophe losses, although property catastrophe reinsurance price increases appear to be slowing. REs primary insurance business has suffered from deteriorating underwriting results and reserve strengthening, and it is unclear how quickly the company can achieve improved results in this segment.
Valuation
Similar to other property/casualty reinsurers, RE faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses. Potential changes to Bermuda tax advantage could negatively impact REs earnings. Adverse loss reserve development is a risk and RE could have less of a reserve cushion than other P&C insurers.
Since 2000, RE has traded at a median trailing price to stated book value of 1.23x, with a range of 0.66x2.08x. Since 2008, the median is 0.82x. Our $100 price target is based on 0.8x YE12 estimated book value per share of $127, and a P/E of 9x our 2012 EPS estimate of $11.35. RE currently trades at 0.83x 2011 book value and 8.2x 2012E EPS of $11.35, which is mostly in line with other Bermuda reinsurers.
Everest Re, based in Bermuda, writes diversified primary insurance and reinsurance business in both the U.S. and international markets.
16 April 2012
155
$12.52
$12.21
$2.00
US Reinsurance, 33% Specialty Reinsurance, 0%
$0.00 -$2.00 -$4.00 2006 2007 2008 2009 2010 2011 2012E 2013E -$1.73
130% 120%
Book Value Per Share
2007
2008
2009
2010
2011
2012E
2013E
Combined Ratio
16 April 2012
156
1.5
0% -20%
1.0
-40% -60%
0.5
N
2.40 2.20 2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60
-80%
1 -1 ov N 10 ov N 09 ov N -08 ov N 7 -0 ov N 06 ov N 5 -0 ov N 04 ov N 03 ov N -02 ov N 01 ov N 00 ov N 99 ov N 1 -1 ov N -10 ov N -09 ov N -08 ov N -07 ov N -06 ov N -05 ov N -04 ov N -03 ov N -02 ov N -01 ov N -00 ov N -99 ov
2.40 2.20 2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60
Fe b9 Fe 9 b0 Fe 0 b0 Fe 1 b0 Fe 2 b0 Fe 3 b0 Fe 4 b05 Fe b0 Fe 6 b0 Fe 7 b0 Fe 8 b0 Fe 9 b1 Fe 0 b1 Fe 1 b12
25.0 23.0 21.0 19.0 17.0 15.0 13.0 11.0 9.0 7.0 5.0
16 April 2012
1 -1 ec D -10 ec D -09 ec D -08 ec D -07 ec D -06 ec D -05 ec D -04 ec D -03 ec D -02 ec D -01 ec D -00 ec D -99 ec
1 -1 ov N -10 v No -09 v No -08 ov N -07 v No -06 ov N -05 ov N -04 ov N -03 ov N -02 ov N -01 v No -00 ov N -99 v No
157
16 April 2012
158
Price Target
$75
13E
$6.00
Div. Yield
2.2%
P/E 12E
9.8
13E
11.5
Investment Thesis
Potential Catalysts
Allied World has delivered consistently strong results since its 2001 inception. The company has a growing franchise in commercial P&C insurance and reinsurance, and is building an onshore primary insurance platform. However, we are concerned about the sustainability of the companys loss reserve releases. The company was unsuccessful in merging with TRH, which raises questions about AWHs future strategic plans. Allied Worlds expense ratio has increased as it builds out its U.S. platform. If the U.S. business does not achieve adequate scale, the company may need to reduce its presence. In terms of deploying excess capital, Allied World appears unlikely to pursue a large acquisition after it was unsuccessful in acquiring Transatlantic. The company has excess capital and views share buybacks as compelling.
Risks
Allied Worlds earnings have benefitted from a substantial pace of loss reserve releases. If this trend slows, it could result in difficult earnings comparisons, although the company believes loss cost inflation could remain low resulting in continued reserve releases. Underwriting results in AWHs Insurance business could improve as it achieves scale, although it is unclear how long this could take. Share buyback activity could persist driven by future earnings generated. AWH does not appear interested in a large acquisition. AWH could benefit from higher P&C prices.
Valuation
Similar to other property/casualty insurers, AWH faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation. A slowdown in reserve releases could be a headwind to earnings. AWHs expense ratio is elevated due in part to buildout of U.S. Insurance business.
Since 2006, AWH has traded at a median trailing price to stated book value of 0.83x, with a range of 0.68x1.37x. Since 2008, the median is 0.81x. Our $75 price target is based on 0.8x YE12 estimated book value per share of $87, and a P/E of 11x our 2012 EPS estimate of $7.00. AWH currently trades at 0.86x 2011 book value and 9.8x 2012E EPS of $7.00, which is mostly in line with other Bermuda reinsurers.
Allied World, based in Bermuda, also has offices in the U.S. and Europe. The company writes commercial lines P&C insurance as well as reinsurance with a focus on specialty lines.
16 April 2012
159
Reinsurance , 37%
$8.00
$7.64
US Insurance, 42%
$2.00
100%
95%
2007
2008
2009
2010
2011
2012E
2013E
0%
Combined Ratio
16 April 2012
160
1.50 1.40 1.30 1.20 1.10 1.00 0.90 0.80 0.70 0.60 0.50
9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5
6 l -0 Ju
16 April 2012
7 l -0 Ju
0 l -1 Ju
1 l -1 Ju
8 l -0 Ju
9 l -0 Ju
06 gAu
07 gAu
08 gAu
09 gAu
10 gAu
11 gAu
161
16 April 2012
162
Price Target
$28
13E
$2.75
Div. Yield
2.2%
P/E 12E
9.2
13E
10.1
Investment Thesis
Potential Catalysts
Aspen has a strong franchise in the U.K., U.S., and Bermuda commercial insurance and reinsurance markets. Over the past several years, the company has a good track record of returning excess capital to shareholders in the form of share repurchases, and presently appears to have little appetite for large acquisitions. The company has over $3bn in total capital, which most likely means it has adequate scale to effectively compete. AHL expects its business mix to shift to 60-65% insurance/35-40% reinsurance over the next few years as the company seeks to reduce volatility and price increases persist. AHLs CFO recently departed to pursue other opportunities and the company is searching internally and externally for a replacement.
Risks
AHL could benefit from improved P&C insurance and reinsurance prices. AHL believes it is appropriately capitalized and appears unlikely to repurchase stock until after the 2012 hurricane season. AHL believes its loss reserve position is conservative despite reserve strengthening in its Insurance business in 2010. The companys reserves are currently $400mn (10%) above the actuarial mean best estimate, which is the highest level ever. AHL expects its U.S. insurance business to achieve adequate scale in about two years.
Valuation
Similar to other property/casualty insurers, AWH faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation. Further adverse prior year loss reserve development could lead to lower than expected earnings. AHL believes it is appropriately capitalized, although it appears to have a less robust capital cushion than other P&C insurers.
Since 2004, AHL has traded at a median trailing price to stated book value of 1.04x, with a range of 0.60x1.69x. Since 2008, the median is 0.77x. Our $28 price target is based on 0.7x YE12 estimated book value per share of $41, and a P/E of 9x our 2012 EPS estimate of $3.00. AHL currently trades at 0.72x 2011 book value and 9.2x 2012E EPS of $3.00, which is below other Bermuda reinsurers.
Aspen, based in Bermuda, is a specialty property-casualty insurer and reinsurer. company has a diversified platform by product line and geography.
The
16 April 2012
163
Insurance, 43%
Reinsurance, 57%
$1.44
-$1.26 -$2.00 2006 2007 2008 2009 2010 2011 2012E 2013E
120% 110%
$20 5% $10 $0 2006 2007 2008 2009 2010 2011 2012E 2013E 0% -5%
2007
2008
2009
2010
2011
2012E
2013E
Combined Ratio
16 April 2012
164
Fe b04 M ar -0 5 M ar -0 6 M ar -0 7 Fe b08
0%
9.0
6.0
3.0
D 1 -1 ec D 0 -1 ec D 9 -0 ec D 8 -0 ec D 7 -0 ec D 6 -0 ec D 5 -0 ec D 4 -0 ec D 3 -0 ec
16 April 2012
11 Fe b12
165
09 ar -
10 ar -
ar -
1 -1 ec D 0 -1 ec D 9 -0 ec D 8 -0 ec D 7 -0 ec D 6 -0 ec D 5 -0 ec D 4 -0 ec D 3 -0 ec
1 -1 ec D 0 -1 ec D 9 -0 ec D 8 -0 ec D 7 -0 ec D 6 -0 ec D 5 -0 ec D 4 -0 ec D 3 -0 ec
1 -1 ec D 0 -1 ec D 9 -0 ec D 8 -0 ec D 7 -0 ec D 6 -0 ec D 5 -0 ec D 4 -0 ec D 3 -0 ec
16 April 2012
166
Price Target
$20
13E
$1.50
Div. Yield
2.2%
P/E 12E
11.7
13E
12.9
Investment Thesis
Potential Catalysts
Montpelier Re has a strong franchise in property reinsurance and is exiting its subscale U.S. primary insurance business, recently announcing the sale of the unit to Selective. MRHs results are mostly driven by its property catastrophe reinsurance business, and could benefit from higher property catastrophe reinsurance rates, although the pace of increases could slow. Long term, we anticipate increased consolidation among reinsurers with less than $3 billion in capital to achieve increased scale and diversification. In the meantime, MRH is right-sizing its balance sheet by repurchasing shares to match (re)insurance market opportunities.
Risks
MRH benefits from higher U.S. property catastrophe reinsurance rates as well as increased demand resulting from large catastrophe losses and changes to the RMS model although the pace of property reinsurance rate increases appears to be slowing. Consolidation activity in the sector over the long term could provide a catalyst, as Bermuda reinsurers seek to achieve scale. MRH has a modest excess capital position and can deploy up to $50mn plus future earnings for share repurchases.
Valuation
Similar to other property/casualty insurers, MRH faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation. MRHs earnings have benefitted from favorable loss reserve development, and earnings could face headwinds if this slows. Also, MRH faces the risk of adverse development from catastrophe losses, although its track record is strong in estimating catastrophe losses since Hurricane Katrina in 2005. MRH has a modest excess capital position, although it appears to have a less robust capital cushion than other P&C reinsurers.
Since 2003, MRH has traded at a median trailing price to stated book value of 1.05x, with a range of 0.67x1.96x. Since 2008, the median is 0.81x. Our $20 price target is based on 0.8x YE12 estimated book value per share of $24, and a P/E of 12x our 2012 EPS estimate of $1.65. MRH currently trades at 0.85x 2011 book value and 11.7x 2012E EPS of $1.65, in line with other Bermuda reinsurers.
Montpelier Re, based in Bermuda, is a provider of global property and casualty reinsurance and insurance products.
16 April 2012
167
$0.00 -$1.00 -$2.00 -$3.00 2006 2007 2008 2009 2010 -$2.50 2011 2012E 2013E
135% 120%
$15 0% $10 $5 $0 2006 2007 2008 2009 2010 2011 2012E 2013E -10% -20%
2005
2006
2007
2008
2009
2010
Combined Ratio
16 April 2012
168
1 -1 ct O 0 -1 ct O 9 -0 ct O 8 -0 ct O 7 -0 ct O 6 -0 ct O 5 -0 ct O 4 -0 ct O 3 -0 ct O 2 -0 ct O
Ja n05 Ja n06
Ja n09 Ja n10
Ja n07 Ja n08
Ja n03 Ja n04
Ja n11 Ja n12
16 April 2012
Ja n03 Ja n04 Ja n05 Ja n06 Ja n07 Ja n08 Ja n09 Ja n10 Ja n11 Ja n12
1 -1 ct O 0 -1 ct O 9 -0 ct O 8 -0 ct O 7 -0 ct O 6 -0 ct O 5 -0 ct O 4 -0 ct O 3 -0 ct
2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60
2 -0 ct
1 -1 ov N 0 -1 ov N 9 -0 ov N 8 -0 ov N 7 -0 ov N 6 -0 ov N 5 -0 ov N 4 -0 ov N 3 -0 ov 2 -0 ov N
1 -1 ct O 0 -1 ct O 9 -0 ct O 8 -0 ct O 7 -0 ct O 6 -0 ct O 5 -0 ct O 4 -0 ct O 3 -0 ct O 2 -0 ct O
169
39.0 39.0 $0.65 $0.00 $0.00 $0.65 59.5 60.2 60.2 $0.11 51.3% 17.1% 13.8% 82.3% -9.9% 7.3% 0.0% 84.9% 1.5% 8.6% 1.5% -7.7% -3.0% -7.7% -8.7% -2.9% -68.7% -3.5% NM NM 1.1% 1.5 $0.03 $23.36 2.9% $23.36 $23.43 0.2% 0.2% 1.4% 0.0% 25.3% 1,885 85 3,049 2.2% 1.39 $25.0 258.0 258.0
23.4 23.4 $0.40 $0.00 $0.00 $0.39 58.1 58.8 58.8 $0.11 59.5% 17.6% 15.4% 92.5% -6.7% 13.4% 0.0% 85.8% -5.6% -3.7% -5.6% -4.3% 2.9% -4.3% -1.9% -0.6% -14.8% 0.2% 349.0% 373.3% 1.8% 1.5 $0.03 $23.78 1.8% $23.78 $23.85 1.5% 1.5% 1.5% 0.0% 25.5% 1,877 59 3,121 2.2% 1.39 $25.0 205.0 205.0
11.5 11.5 $0.20 $0.00 $0.00 $0.20 58.1 58.1 58.1 $0.12 66.5% 18.3% 15.7% 100.5% -6.8% 23.2% 0.0% 84.1% -7.7% -5.1% -7.7% -7.1% 2.8% -7.1% -5.5% 0.0% -29.3% 4.6% -146.4% -149.2% 7.2% 1.5 $0.03 $23.85 0.3% $23.85 $23.92 4.1% 4.1% 7.0% 0.0% 25.4% 1,882 10 3,156 2.2% $0.0 150.0 150.0
16 April 2012
170
Price Target
$9
13E
$0.70
Div. Yield
2.2%
P/E 12E
9.8
13E
10.5
Investment Thesis
Potential Catalysts
FlagstoneRe has a global property reinsurance platform. However, FSRs growth opportunities could be limited as it reduces exposures following large 2011 catastrophe losses. Also, the company could face increased dependence on retrocessional support and the need to hold increased capital. FSR is divesting its Lloyds and Island Heritage business (about one-quarter of premiums and no contribution to earnings) after two years of high catastrophe losses. FSRs BV declined by 30% y/y in 2011. FSR is currently rebalancing its portfolio and reducing overall risk by cutting international and North American exposure limits and reducing overall gross written premiums by 30%.
Risks
FSRs top-line growth could trail other Bermuda reinsurers as it reduces its exposure following large 2011 catastrophe losses. FSR is currently rated A- with a negative outlook by rating agencies. FSR says its rating agency capital adequacy measures are sufficient and will increase with the Lloyds and Island Heritage divestitures, although this outlook appears optimistic after FSR reported a net EPS loss of $4.65 for FY11.
Valuation
Similar to other property/casualty insurers, FSR faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation FSRs capital base is around $1bn, which is at the low end of peers. FSR strengthened reserves in 4Q11, which could mean it has a less robust reserve cushion than other P&C reinsurers.
Since 2007, FSR has traded at a median trailing price to stated book value of 0.81x, with a range of 0.54x1.10x. Our $9 price target is based on 0.8x YE12 estimated book value per share of $11, and a P/E of 12x our 2012 EPS estimate of $0.75. FSR currently trades at 0.68x 2011 book value (below other Bermuda reinsurers) and 9.8x 2012E EPS of $0.75 (in line with other Bermuda reinsurers).
Flagstone Re, domiciled in Luxembourg with major offices in Bermuda and Switzerland, is a global reinsurer focused on specialty, property catastrophe, and short-tail casualty reinsurance.
16 April 2012
171
Property 22%
-$3.98 -$5.00 2006 2007 2008 2009 2010 2011 2012E 2013E
160% 140%
Operating ROE 25% 15% 5% -5% -15% -25% -35% Operating ROE
Combined Ratio
16 April 2012
172
16 April 2012
07 Se p0 M 7 ar -0 8 Se p0 M 8 ar -0 9 Se p0 M 9 ar -1 0 Se p1 M 0 ar -1 1 Se p1 M 1 ar -1 2
ar -
M ar 07
M ar 08
M ar 09
M ar 10
M ar 11
1.30 1.20 1.10 1.00 0.90 0.80 0.70 0.60 0.50
M ar 07
ar 08
ar
ar
ar 09
ar 10
11
12
M ar 07
ar
ar 08
ar 10
ar
ar 09
12
173
11
16 April 2012
174
Price Target
$15
13E
$0.80
Div. Yield
5.7%
P/E 12E
16.3
13E
18.4
Investment Thesis
Potential Catalysts
Our 2-EW rating on OB is based on our view that earnings could meaningfully decline after the sale of nearly half of OB's business, underwriting losses from run-off business are a risk, and valuation appears extended. However, OB could seek strategic alternatives after selling half its business. OB has $50-$75mn of excess capital and will free up about another $50-$60mn of excess capital in 2012 as its legacy business runs off, but this should be used to support growth in the business. As a result, OB is unlikely to announce another special dividend in 2012.
Risks
OB could seek strategic alternatives after selling half its business. Potential run-off losses could result in lower than anticipated earnings. OB appears unlikely to repurchase its stock or pay future special dividends near term. Our EPS estimates are below consensus because OBs earnings power is compressed as a result of reduced premium volume and we are concerned run-off losses could persist.
Valuation
Similar to other property/casualty insurers, OB faces risks if P&C price increases do not persist, as well as from catastrophes and other large losses, rising interest rates and increased inflation. OBs premiums and earnings could shrink meaningfully going forward after the sale of its personal lines and non-specialty commercial lines business (45% of total NWPs). OB could experience losses in its run-off business.
Since 2007, OB has traded at a median trailing price to stated book value of 1.11x, with a range of 0.70x1.70x. Our $15 price target is based on 1.4x YE12 estimated book value per share of $11, and a P/E of 17x our 2012 EPS estimate of $0.90. OB currently trades at 1.27x 2011 book value and 16.3x 2012E EPS of $0.90, above other P&C insurers.
OneBeacon Insurance Group, Ltd. is a Bermuda-domiciled holding company with its headquarters located in Canton, MA. OneBeacon offers a range of specialty commercial insurance products sold through independent agents and brokers.
16 April 2012
175
$2.50 $2.00 $1.98 $1.93 $1.49 $1.50 $1.00 $0.90 $0.75 $0.51 $0.50 $1.90
$0.80
105%
100%
$20 $15 $10 $5 $0 2006 2007 2008 2009 2010 2011 2012E 2013E
95%
90%
85% 2006
2007
2008
2009
2010
2011
2012E
2013E
Combined Ratio
16 April 2012
Operating ROE
176
D 6 -0 ec
D 7 -0 ec
8 -0 ec
9 -0 ec
0 -1 ec
1 -1 ec
16 April 2012
ov -0 6 ay -0 N 7 ov -0 M 7 ay -0 N 8 ov -0 M 8 ay -0 9 N ov -0 M 9 ay -1 N 0 ov -1 M 0 ay -1 N 1 ov -1 1
N 7 -0 ov
N 7 -0 ov
N 8 -0 ov
N 9 -0 ov
N 0 -1 ov
N 1 -1 ov
1.80 1.60 1.40 1.20 1.00 0.80 0.60
N 6 -0 ov
N 8 -0 ov
N 9 -0 ov
N 0 -1 ov
N 1 -1 ov
6 -0 ov
7 -0 ov
8 -0 ov
9 -0 ov
0 -1 ov
1 -1 ov
177
16 April 2012
178
Price Target
$37
13E
$2.45
Div. Yield
2.8%
P/E 12E
14.8
13E
13.0
Investment Thesis
Potential Catalysts
We are constructive on MMC reflecting our outlook for the company to generate sustained improvement in organic revenue growth and modest margin improvement. MMC can generate margin improvement when organic revenue growth exceeds 3%, which we anticipate in 2012-13. The company appears confident in its ability to generate double-digit earnings growth for the foreseeable future (in line with our view). MMCs consulting unit should benefit from an economic recovery. MMCs is searching for a new CFO (current CFO is leaving to join Google) and will consider internal and external candidates.
Risks
MMC could benefit from higher P&C prices. MMC could continue to report best-in-class organic growth. MMC could generate double-digit earnings growth driven by mid-single digit organic revenue growth in Insurance Brokerage and modest margin improvement. MMCs Consulting unit plans to focus on improving margins by several percentage points (from 12% level currently) with new leadership at the Mercer unit. MMCs shareholder dividend could grow modestly, but the payout ratio could decline over time from 48% currently to the mid-30% range.
Valuation
MMCs earnings could face headwinds if P&C price increases slow or if the economy deteriorates. A weak economy impacts both Brokerage organic growth and Consulting results. Increased pension expenses are a risk, although we expect no major changes in the foreseeable future to MMCs pension plan (a drag on cash deployment). MMCs ability to effectively integrate small bolt-on acquisitions as it builds out its middle market insurance brokerage business could be a risk.
Since 2000, MMC has traded at a median forward P/E of 16.3x, with a range of 8.6x-29.5x. Since 2008, the median is 14.7x. Our $37 price target is based on a P/E of 17x our 2012 EPS estimate of $2.15. MMC currently trades 14.8x 2012E EPS of $2.15, in line with the insurance broker sector average.
Marsh & McLennan, based in New York, is one of the world's largest insurance and reinsurance brokers. The company also has a substantial presence in consulting through Mercer and Oliver Wyman.
16 April 2012
179
$3.00 $2.50
$2.15 $2.45
$2.00 $1.50
$1.77
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 R 06 20 R 05 20 R 04 20
20% 15%
15% 13% 10% 8% 10% 5% 0% -5% -10% -15% -10% -2% -1%-1%-2% 0% 2%
30% 25% 21% 5% 5% 6% 20% 15% 10% 5% 0% 13% 12% 9% 13% 19% 19% 19% 20% 22%
16 April 2012
E 13 20 2 E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
180
14.0
12.0
10.0
8.0
6.0
ec -0 2
ec -0 3
ec -0 4
ec -0 5
ec -0 1
ec -0 8
ec -0 6
ec -0 7
ec -0 9
ec -1 0 D
16 April 2012
ec -1 1
181
16 April 2012
182
(a) 2004: settlement with NYAG, restructuring and other charges, 2005: restructuring, regulatory and compliance costs, employee retention awards and other unusual items. (b) Includes Risk Capital Holdings in 1Q08 and prior.
Mercer Annual Earnings Model (Dollars in millions) Consulting Retirement Health & Benefits Other Consulting Outsourcing Investment Consulting & Mgmt Total Mercer Oliver Wyman Total revenue Operating expenses Goodwill amortization Total operating expenses Pretax operating income Unusual items (c) Total expenses ex unusual items Pretax operating income ex. unusual items Pretax margin as reported Pretax margin ex. unusual items Pretax margin ex. unusual items & goodwill 1 point margin effect on EPS (35% tax rate) Revenue Percent change Total Mercer Oliver Wyman Total revenue Expense Expenses ex unusual items Operating income ex unusual items Organic growth 2007 1,079 827 509 509 271 3,368 1,516 4,884 4,278 4,278 606 8 4,270 614 12.4% 12.6% 12.6% $0.06 11.5% 25.9% 15.6% 13.8% 14.4% 24.8% 10% 2008 1,178 898 555 702 309 3,642 1,554 5,196 4,641 4,641 555 40 4,601 595 10.7% 11.5% 11.5% $0.07 8.1% 2.5% 6.4% 8.5% 7.8% -3.1% 4% 2009 1,091 857 456 620 303 3,327 1,282 4,609 4,204 4,204 405 72 4,132 477 8.8% 10.3% 10.3% $0.06 -8.6% -17.5% -11.3% -9.4% -10.2% -19.8% -7% 2010 1,053 900 488 671 366 3,478 1,357 4,835 4,706 4,706 129 424 4,282 553 2.7% 11.4% 11.4% $0.06 4.5% 5.9% 4.9% 11.9% 3.6% 15.9% 4% 2011 1,071 940 576 733 462 3,782 1,483 5,265 4,677 4,677 588 31 4,646 619 11.2% 11.8% 11.8% $0.06 8.7% 9.3% 8.9% -0.6% 8.5% 11.9% 5% 2012E 1,215 970 560 760 465 3,970 1,560 5,530 4,859 4,859 671 4,859 671 12.1% 12.1% 12.1% $0.07 5.0% 5.2% 5.0% 3.9% 4.6% 8.4% 3% 2013E 1,350 1,000 590 775 490 4,205 1,655 5,860 5,122 5,122 738 5,122 738 12.6% 12.6% 12.6% $0.07 5.9% 6.1% 6.0% 5.4% 5.4% 10.0% 4% 1Q 281 237 117 176 111 922 339 1,261 1,133 1,133 128 3 1,130 131 10.2% 10.4% 10.4% $0.01 8.6% 10.8% 9.2% 9.0% 8.8% 12.9% 6% 2011 2Q 271 241 127 188 118 945 374 1,319 1,167 1,167 152 2 1,165 154 11.5% 11.7% 11.7% $0.02 12.8% 13.3% 12.9% -19.1% 11.9% 21.3% 5% 3Q 261 239 173 186 116 975 364 1,339 1,178 1,178 161 7 1,171 168 12.0% 12.5% 12.5% $0.02 10.7% 13.0% 11.3% 10.6% 10.6% 16.7% 6% 4Q 258 223 159 183 117 940 406 1,346 1,199 1,199 147 19 1,180 166 10.9% 12.3% 12.3% $0.02 3.3% 1.8% 2.8% 3.5% 3.2% 0.0% 2% 1Q 310 240 120 190 115 975 350 1,325 1,185 1,185 140 1,185 140 10.6% 10.6% 10.6% $0.02 5.7% 3.2% 5.1% 4.6% 4.9% 6.9% 3% 2012E 2Q 305 250 130 195 115 995 390 1,385 1,220 1,220 165 1,220 165 11.9% 11.9% 11.9% $0.02 5.3% 4.3% 5.0% 4.5% 4.7% 7.1% 3% 3Q 295 235 175 195 120 1,020 385 1,405 1,220 1,220 185 1,220 185 13.2% 13.2% 13.2% $0.02 4.6% 5.8% 4.9% 3.6% 4.2% 10.1% 3% 4Q 305 245 135 180 115 980 435 1,415 1,234 1,234 181 1,234 181 12.8% 12.8% 12.8% $0.02 4.3% 7.1% 5.1% 2.9% 4.6% 9.0% 3%
16 April 2012
183
Price Target
$44
13E
$3.20
Div. Yield
3.0%
P/E 12E
12.1
13E
11.0
Investment Thesis
Potential Catalysts
Willis is a pure-play insurance broker with a strong international franchise that should benefit from improved P&C prices. WSH expects organic growth excluding Loan Protector (forced-placed homeowners insurance for banks) to rise in 2012 as retention improves, P&C rates increase, and exposures stabilize. We anticipate mostly unchanged adjusted margin in 2012, although margin could expand in 2013 as organic growth accelerates. We expect this result in 2012/2013 should be good enough given WSHs currently depressed valuation, which is below other insurance brokers. WSHs CEOs contract expires in July 2013 and the succession decision is the boards. No internal successor is evident and an external candidate is an increasingly likely possibility, in our view. It is unclear to us if WSH could seek strategic alternatives.
Risks
Brokerage organic growth excluding Loan Protector could improve in 2012. WSH can generate about 4% organic growth in the current environment, although this result is unlikely to be achieved before late 2012 due in part to Loan Protector. Organic growth could be faster than 4% if P&C rates or exposure growth accelerates. WSH expects expense growth of 3%-4% in 2012, which means organic revenue growth of at least this level is needed for margin expansion. WSH is resuming share buybacks and could repurchase $100mn in 2012.
Valuation
WSHs earnings could face headwinds if P&C price increases slow or if the economy deteriorates. WSHs earnings and margins could face downward pressure if organic growth does not exceed expense growth of 3-4%. Loan Protector could continue to be a drag on WSHs earnings. WSHs retention faces headwinds from defections from its HRH acquisition, although the company has not seen further defections in the past 2-3 months.
Since 2002, WSH has traded at a median forward P/E of 13.3x, with a range of 8.6x-20.6x. Since 2008, the median is 11.2x. Our $44 price target is based on a P/E of 15x our 2012 EPS estimate of $2.90. WSH currently trades 12.1x 2012E EPS of $2.90, below other insurance brokers.
Willis Group Holdings plc, headquartered in London and New York, is the worlds third largest insurance broker.
16 April 2012
184
in $ bn 4.0 3.7 3.4 3.1 2.8 2.5 2.2 1.9 1.6 1.3 1.0 25% 20% 15% 10% 5% 0% -5%
$3.20
20 01 20 02 20 03 20 0 20 4 05 R 20 06 20 07 20 08 20 09 20 10 20 1 20 1 12 20 E 13 E
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 R 05 20 04 20
Total revenues
Growth rate
20% 15%
40% 35% 30% 25% 20% 15% 10% 5% 29% 21% 23% 24% 21% 22% 23% 22% 23% 23%
16 April 2012
E 13 20 2 E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 04 20 3 0 20 2 0 20 1 0 20 0 0 20
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
185
Ju n09
Ju n01
Ju n03
Ju n04
Ju n06
Ju n08
Ju n10
16 April 2012
Ju n11
Ju n02
Ju n05
Ju n07
1 l -1 Ju 0 l -1 Ju 9 l -0 Ju 8 l -0 Ju 7 l -0 Ju 6 l -0 Ju 5 l -0 Ju 4 l -0 Ju 3 l -0 Ju 2 l -0 Ju
15.0 13.0 11.0 9.0 7.0 5.0
11 nJu 0 1 nJu 9 0 nJu 8 0 nJu 7 0 nJu 6 0 nJu 5 0 nJu 4 0 nJu 3 0 nJu 2 0 nJu
186
770 $238 93 $331 40 171 27 1 26 16 (8) $34 (4) 193 $223 $0.20 $1.11 $0.00 ($0.02) $1.28 $0.04 $1.11 23.6% 0.0% 32.8% 57.9% 15.2% 74.7% 172 171 3 174 3.7% $0.26 $7 34% 8.2% -2.5% 7.1% 3.8% 3.8% -11.1% 3.7% 4% 14.8% 20.2% 2.7% 2.7% -20.9% -83.3% -83.7% 0.9% 47.7% 185.4% 275 2.9 $15.54 ($6.52) $0.06 -
16 April 2012
187
Price Target
$38
13E
$2.10
Div. Yield
3.8%
P/E 12E
19.3
13E
16.6
Investment Thesis
Potential Catalysts
AJG's Insurance Brokerage revenues and margins could grow as P&C prices increase and the economy improves. Roughly 80% of AJGs revenues are commissionbased, which means the company has significant leverage to higher P&C prices. AJGs risk management unit (Gallagher Bassett, a feefor-service claims management operation) could face improving revenue growth based on its economically sensitive business. AJG owns facilities that produce clean-burning coal that may qualify for tax credits. AJG could generate up to a $49-$56mn after-tax ($0.44-$0.50/shr) annual benefit over the next 10 years.
Risks
Organic growth could accelerate reflecting higher P&C prices and an improving economy. AJG could continue to aggressively pursue small bolton acquisitions to supplement its Brokerage organic growth. Claims activity could pick up, boosting results at Gallagher Bassett. AJGs potential benefit from clean coal investments could be higher than anticipated resulting in further upside to earnings. Healthcare reform could result in increased revenue opportunities in AJG's benefits brokerage business due to demand for advice and consulting services.
Valuation
AJGs earnings could face headwinds if P&C price increases slow or if the economy deteriorates. . Margin expansion could be challenging to achieve if organic growth deteriorates. AJGs clean coal investments could face volatility related to operational risk, supply chain risk, regulatory risk and displacement risk (for example the utility burns natural gas instead of coal and the plant sits idle).
Since 2000, AJG has traded at a median forward P/E of 16.2x, with a range of 12.8x-27.4x. Since 2008, the median is 16.8x. Our $38 price target is based on a P/E of 21x our 2012 EPS estimate of $1.80. AJG currently trades 19.3x 2012E EPS of $1.80, above other insurance brokers.
Arthur J. Gallagher & Co, based in Itasca, Illinois, is the fourth largest insurance broker.
16 April 2012
188
$2.50 $1.99
Risk mgmt, 26%
$2.00
Insurance Brokerage, 73%
$0.42
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
30% 20% 15% 10% 5% 5% 0% -5% -10% -2%-2%-2% 10% 5% 2% 2% 2% 3% 5% 5% 17% 14% 10% 20% 15% 25%
21% 17% 17% 16% 14% 16% 16% 16% 16% 18%
20 20 20 20 20 20 20 20 20 20 20 20 20 01 02 03 04 05 06 07 08 09 10 11 12 13 E E
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
16 April 2012
189
60%
26.0 22.0 18.0 14.0 10.0
11 vNo -10 v No -09 v No 08 vNo -07 v No -06 v No -05 v No -04 v No -03 v No -02 v No -01 v No 00 vNo -99 v No
20.0
16.0
12.0
8.0
4.0
Feb-02
Feb-03
Feb-04
Feb-05
Feb-06
Feb-07
Feb-08
Feb-09
Feb-10
Feb-11
16 April 2012
Feb-12
190
$11.51 ($3.77)
$11.90 ($2.97)
$11.23 ($4.39)
$11.33 ($4.14)
$11.50 ($3.91)
$11.51 ($3.76)
16 April 2012
191
(a) 2001 is estimated based on the avg. quarterly organic growth, weighted by quarterly brokerage rev. 2002 represents commission growth only, which accounted for 90% of Brokerage revenues in 2002.
Risk Management Segment (Dollars in millions, except per-share) 2007 Revenues Fees Interest-fiduciary funds Total revenues Expenses Compensation Other operating Depreciation Amortization Unusual items Total expenses Pre tax income Provision for taxes Net income Per diluted share EPS Cash EPS (ex. depr. & amort.) Percent change Fees Organic fee growth Total revenues Compensation expense Other expense Total expense Pre tax income Operating Ratios Pre tax margin ex unusual items Compensation expense ratio Other operating expense ratio Eff. tax rate 1 pt margin change $439.4 4.1 443.5 255.7 112.1 11.2 0.5 379.5 64.0 24.4 39.6 $0.41 $0.48 10.6% 11% 10.5% 9.7% 9.8% 9.1% 20.1% 13.8% 58.2% 25.5% 38.1% $0.03 2008 $461.1 3.8 464.9 280.6 126.3 11.6 0.5 419.0 45.9 17.7 28.2 $0.30 $0.38 4.9% 5% 4.8% 9.7% 12.7% 10.3% -28.3% 10.0% 60.9% 27.4% 38.6% $0.03 2009 $451.7 1.5 453.2 282.3 109.9 11.7 0.7 404.6 48.6 17.9 30.7 $0.31 $0.38 -2.0% -1% -2.5% 0.6% -13.0% -5.3% 5.9% 12.4% 62.5% 24.3% 36.8% $0.03 2010 $460.1 2.0 462.1 288.0 109.1 12.4 1.0 410.5 51.6 20.3 31.3 $0.30 $0.38 1.9% -3% 2.0% 2.0% -0.7% 1.5% 6.2% 12.7% 62.6% 23.7% 39.3% $0.03 2011 $546.1 2.7 548.8 344.1 135.8 14.2 2.3 496.4 52.4 19.1 33.3 $0.30 $0.39 18.7% 10% 18.8% 19.5% 24.5% 20.9% 1.6% 12.9% 63.0% 24.9% 36.5% $0.03 2012E $599.0 3.0 602.0 366.0 142.0 14.0 2.4 524.4 77.6 31.0 46.6 $0.42 $0.51 9.7% 11% 9.7% 6.4% 4.6% 5.6% 48.1% 12.9% 61.1% 23.7% 40.0% $0.03 2013E $640.0 3.0 643.0 396.0 146.0 14.0 2.4 558.4 84.6 33.8 50.8 $0.44 $0.53 6.8% 10% 6.8% 8.2% 2.8% 6.5% 9.0% 13.2% 61.9% 22.8% 40.0% $0.03 1Q $129.9 0.7 130.6 $82.7 32.7 3.3 0.6 119.3 11.3 4.4 6.9 $0.06 $0.08 18.0% 6% 18.2% 22.2% 35.1% 25.4% -26.6% 12.7% 63.3% 25.2% 38.9% $0.01
2011 2Q $132.9 0.6 133.5 $84.2 35.3 3.6 0.6 123.7 9.8 3.9 5.9 $0.05 $0.08 19.8% 6% 19.8% 26.2% 25.2% 26.2% -26.9% 11.9% 63.1% 26.6% 39.8% $0.01
3Q $138.3 0.7 139.0 $88.3 33.0 3.6 0.6 125.5 13.5 5.2 8.3 $0.07 $0.10 24.7% 13% 24.8% 21.8% 32.5% 24.8% 25.0% 13.4% 63.5% 23.9% 38.5% $0.01
4Q $145.0 0.7 145.7 $88.9 34.8 3.7 0.5 127.9 17.8 5.6 12.2 $0.11 $0.13 13.1% 13% 13.1% 9.6% 9.4% 9.5% 48.3% 13.7% 61.0% 24.0% 31.5% $0.01
1Q $142.0 0.7 142.7 $85.0 33.5 3.5 0.6 122.6 20.1 8.0 12.1 $0.11 $0.13 9.3% 11% 9.3% 2.8% 2.4% 2.8% 77.9% 14.1% 59.6% 23.6% 40.0% $0.01
2012E 2Q $145.0 0.8 145.8 $90.0 36.0 3.5 0.6 130.1 15.7 6.3 9.4 $0.08 $0.11 9.1% 11% 9.2% 6.9% 2.0% 5.2% 60.2% 10.8% 61.7% 24.8% 40.0% $0.01
3Q $152.0 0.8 152.8 $96.0 32.5 3.5 0.6 132.6 20.2 8.1 12.1 $0.11 $0.13 9.9% 11% 9.9% 8.7% -1.5% 5.7% 49.6% 13.2% 62.8% 21.4% 40.0% $0.01
4Q $160.0 0.7 160.7 $95.0 40.0 3.5 0.6 139.1 21.6 8.6 13.0 $0.11 $0.14 10.3% 11% 10.3% 6.9% 14.9% 8.8% 21.3% 13.4% 59.1% 25.0% 40.0% $0.01
$95.0 NA 16.0 2.0 113.0 (47.4) (50.1) 2.7 $0.03 105.7% 2.9
$13.1 $21.2 64.0 34.6 0.4 133.3 (68.8) (68.3) (0.5) ($0.00) NM NM
$13.6 $15.9 32.0 40.8 0.5 102.8 (73.4) (44.0) (29.4) ($0.26) NM NM
$2.4 $4.3 9.5 0.1 16.3 (16.9) (7.5) (9.4) ($0.09) 44.4% (8.8)
$1.4 $3.4 11.7 10.6 0.1 27.2 (18.4) (10.1) (8.3) ($0.07) 54.9% (8.5)
$5.0 $3.2 0.7 10.3 0.2 19.4 (17.5) (9.4) (8.1) ($0.07) 53.7% (8.1)
$4.8 $5.0 19.6 10.4 0.1 39.9 (20.6) (17.0) (3.6) ($0.03) 82.5% (3.6)
$3.2 4.0 19.6 10.0 36.8 (17.5) (14.0) (3.5) ($0.03) 80.0% (3.5)
$3.2 4.0 19.6 10.0 36.8 (17.5) (14.0) (3.5) ($0.03) 80.0% (3.5)
$3.2 4.0 19.6 10.0 36.8 (17.5) (17.0) (0.5) ($0.00) 97.1% (0.5)
$3.2 4.0 19.6 10.0 36.8 (17.5) (17.0) (0.5) ($0.00) 97.1% (0.5)
16 April 2012
192
Price Target
$28
13E
$1.45
Div. Yield
1.3%
P/E 12E
18.3
13E
16.4
Investment Thesis
Potential Catalysts
Brown & Brown is a pure-play insurance broker and nearly all of its revenues are commission-based, which means it has the highest leverage of the insurance brokers to improved P&C prices. Once organic revenue growth at BRO turns positive, the company could see significant positive operating leverage because two-thirds of each incremental dollar of organic growth should fall to the bottom line. BRO has a high-performance culture as evidenced by its 35% pre-tax margin that is the best among peers. Brown & Browns CEO Powell Brown (age 43) has taken a temporary leave of absence due to health reasons (details unknown). J. Hyatt Brown (age 73), Chairman of BRO and the companys prior CEO, will assume the interim CEO responsibilities. It is unclear to us what the health issue is, although Hyatt Brown provides a clear and strong backup on a temporary basis.
Risks
Organic growth and margin expansion could be faster than anticipated driven by improving P&C prices and economy. Notably, BROs organic growth in the 1H12 could face headwinds from market dislocations but turn positive by YE12. BRO could continue to actively make small bolt-on acquisitions that are immediately accretive and supplement organic growth. The return of CEO Powell Brown from a temporary leave of absence due to health reasons could be a positive catalyst. Approximately 30% of BROs revenues are from Florida, which is among the most economically challenged areas in the U.S. but could slowly improve. Also, BRO could benefit from a large hurricane impacting Florida. BRO is unlikely to be acquired, in our view, because it is a family-run business and the Brown family owns 15% of the stock.
Valuation
BROs earnings could face headwinds if P&C price increases slow or if the economy deteriorates. Margin expansion could be challenging to achieve if organic growth deteriorates. Contingent commissions could decline as P&C industry earnings deteriorate. BRO continues to collect highly profitable contingent commissions from insurers, which the largest brokers had to give up for several years. The Florida economy is weak, although BRO would likely benefit from a large hurricane impacting Florida.
Since 2000, BRO has traded at a median forward P/E of 20.0x, with a range of 13.7x-32.2x. Since 2008, the median is 17.0x. Our $28 price target is based on a P/E of 22x our 2012 EPS estimate of $1.30. BRO currently trades 18.3x 2012E EPS of $1.30, above other insurance brokers.
Brown & Brown, based in Daytona Beach, Florida, is the eighth largest U.S. insurance agency in the U.S.
16 April 2012 193
$1.45 $1.35 $1.30 $1.22 $1.17 $1.14 $1.13 $1.08 $1.08 $1.20 $0.93
20 0 20 0 0 20 1 0 20 2 0 20 3 0 20 4 0 20 5 0 20 6 0 20 7 0 20 8 0 20 9 1 20 0 1 20 1 12 20 E 13
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
Total revenues
Growth rate
20% 15% 11% 12% 11% 10% 5% 0% -5% -10% -3% -4% -5% -6%-6% 6% 4% 3% 4%
38% 37% 40% 37% 38% 35% 30% 25% 0% 1% 20% 15% 10% 5%
16 April 2012
E 13 20 2 E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
194
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
16 April 2012
Dec-11
195
$175.3 203.5 101.4 480.2 41.0 113.0 154.0 151.3 32.6 818.0 41.0 5.6 864.7 11.5 1.9 878.0 404.9 5.4 126.5 36.5 11.3 13.4 598.0 NA 280.0 107.7 172.4 $1.23 $1.22 $0.21 39.5% 335.3 38.2% 38.2% 35.2% 46.1% 14.4% 140.0 139.6 1.4 141.0 38.5% 225.2 4.9% 15.9% 25.1% 22.6% 10.8% 17.4% 11.5% 74.5% -49.5% 11.7% 4.0% 8.0% 19.8% 10.4% 14.7% 14.5% 13.4% 19.6% $6.64 19.3% 20.4% $0.04 0.0 0.0
$175.3 241.3 94.5 511.1 42.3 108.7 151.1 157.0 35.5 854.7 57.6 2.3 914.7 30.5 14.5 959.7 444.1 5.7 131.4 40.4 12.8 13.8 648.1 NA 311.6 120.6 191.0 $1.36 $1.35 $0.25 40.0% 371.5 38.7% 37.0% 34.1% 47.6% 14.1% 140.7 140.5 0.8 141.2 38.7% 215.3 6.4% -1.9% 3.8% 9.0% 4.5% 40.4% 5.8% 165.7% NM 9.3% -3.9% 9.7% 3.9% 8.4% 11.3% 10.8% 10.6% 17.2% $7.80 18.4% 18.8% $0.04 0.0 0.0
$168.6 294.6 98.3 561.4 43.4 122.5 165.9 150.0 32.1 909.6 56.4 0.0 966.0 6.1 5.5 977.6 485.8 7.3 137.4 46.6 13.3 14.7 705.1 NA 272.5 106.4 166.1 $1.18 $1.17 $0.29 36.3% 341.1 34.9% 34.9% 30.9% 49.7% 14.1% 141.5 141.0 0.6 141.6 39.0% 341.7 9.8% 9.8% -4.4% -9.5% 6.4% -2.1% 5.6% -80.1% -62.2% 1.9% -6.3% 9.4% 4.6% 8.8% -12.5% -13.0% -13.2% 17.0% $8.77 14.7% 14.2% $0.04 0.0 0.0
$156.1 308.7 98.7 563.5 44.2 134.1 178.3 142.1 32.7 916.5 47.6 0.7 964.9 1.2 1.9 967.9 484.7 7.4 143.4 49.9 13.2 14.6 713.1 NA 254.8 101.5 153.3 $1.11 $1.08 $0.30 35.1% 326.6 33.7% 33.7% 30.3% 50.1% 14.8% 142.1 137.2 0.3 137.5 39.8% 221.6 0.4% 7.4% -5.3% 1.7% 0.8% -15.6% -0.1% -80.9% -66.3% -1.0% -5.7% -0.2% 4.4% 1.1% -6.5% -7.7% -8.1% 15.4% $9.64 12.6% 11.7% $0.04 0.0 0.0
$151.5 313.7 93.9 559.1 41.7 124.1 165.8 140.7 46.3 911.9 54.7 0.0 966.7 1.3 5.2 973.2 487.8 6.8 135.9 51.4 12.6 14.5 709.1 -1.7 265.8 104.3 161.5 $1.17 $1.14 $0.31 36.1% 338.6 34.8% 34.8% 30.9% 50.1% 14.0% 142.1 137.9 1.4 139.3 39.3% 296.1 -0.8% -7.0% -1.0% 41.7% -0.5% 14.9% 0.2% 14.2% 183.3% 0.6% -4.8% 0.6% -5.3% -0.6% 4.4% 5.3% 5.4% 14.2% $10.60 12.2% 11.2% $0.04 0.0 0.0
$155.6 331.3 102.5 589.5 40.3 125.1 165.3 143.1 64.9 962.8 43.2 0.0 1,006.0 1.3 6.3 1,013.5 508.7 11.2 144.1 54.8 12.4 14.1 745.2 -2.2 270.5 106.5 164.0 $1.15 $1.13 $0.32 35.8% 350.6 34.6% 34.8% 31.9% 50.2% 14.2% 143.4 138.6 1.7 140.3 39.4% 237.5 5.4% -0.3% 1.7% 40.0% 5.6% -21.1% 4.1% -4.4% 20.3% 4.1% -3.0% 4.3% 6.1% 5.1% 1.8% 1.5% -0.5% 13.2% $11.47 11.6% 10.4% $0.04 0.0 0.0
$170.0 350.0 111.0 631.0 75.0 153.0 228.0 155.0 100.0 1,114.0 35.7 0.0 1,149.7 1.5 3.0 1,154.2 572.0 14.0 161.5 62.5 14.8 17.4 842.2 0.0 312.1 126.4 185.7 $1.34 $1.30 $0.34 36.5% 406.0 35.2% 35.2% 33.1% 49.6% 14.0% 141.3 138.4 1.9 140.3 40.5% 240.0 7.0% 37.9% 8.3% 54.1% 15.7% -17.4% 14.3% 18.4% -52.5% 13.9% 0.4% 12.4% 12.1% 13.0% 15.4% 13.2% 14.5% 12.6% $12.26 12.5% 11.0% $0.05 2.1 50.0
$190.0 385.0 120.0 695.0 80.0 170.0 250.0 170.0 105.0 1,220.0 35.0 0.0 1,255.0 1.5 3.0 1,259.5 623.0 15.0 174.0 66.5 15.0 17.4 910.9 0.0 348.6 141.2 207.4 $1.50 $1.45 $0.35 36.7% 447.5 35.5% 35.5% 33.7% 49.5% 13.8% 141.3 138.4 2.0 140.4 40.5% 264.8 10.1% 9.6% 9.7% 5.0% 9.5% -2.0% 9.2% 0.0% 0.0% 9.1% 1.0% 8.9% 7.8% 8.2% 11.7% 11.7% 11.9% 11.7% $13.37 12.9% 11.5% $0.05 0.0 0.0
$38.6 82.2 24.7 145.5 9.5 27.7 37.2 34.1 15.8 232.6 28.9 0.0 261.5 0.2 0.6 262.2 126.6 2.8 36.1 13.5 3.1 3.6 185.7 -0.1 76.7 30.4 46.3 $0.32 $0.32 $0.08 38.0% 96.6 36.8% 36.8% 29.0% 48.3% 13.8% 142.5 138.4 2.3 140.6 39.6% 51.6 6.2% -3.2% 1.0% 75.9% 6.6% -10.4% 4.4% -32.3% -56.5% 4.1% -2.3% 3.6% -0.7% 3.2% 5.3% 5.5% 3.8% 13.9% $10.83 12.0% 11.1% $0.01 0.0 0.0
$44.4 83.1 25.0 152.5 8.8 24.6 33.4 41.7 16.1 243.7 2.3 0.0 246.0 0.4 0.4 246.8 125.9 2.7 35.0 13.6 3.1 3.6 183.8 1.6 61.5 24.4 37.0 $0.27 $0.26 $0.08 34.2% 81.3 33.0% 33.0% 32.3% 51.0% 14.2% 142.9 138.4 1.6 139.9 39.7% 72.0 4.2% -10.2% 0.8% 65.7% 3.9% -64.7% 2.0% 13.6% -80.6% 1.3% -4.8% 3.7% 4.0% 4.3% -9.6% -10.1% -7.5% 13.7% $11.01 11.6% 10.6% $0.01 0.0 0.0
$34.8 87.3 26.7 148.8 11.5 38.6 50.2 34.5 16.5 249.9 7.2 0.0 257.2 0.3 2.9 260.4 126.9 2.9 38.4 13.7 3.1 3.6 188.5 -0.8 72.7 28.5 44.2 $0.31 $0.30 $0.08 36.8% 92.8 35.7% 36.7% 34.8% 48.7% 14.8% 143.4 138.7 1.8 140.4 39.2% 77.6 5.2% 1.9% 1.1% 41.4% 5.7% -25.2% 4.5% -8.1% NM 5.2% -2.4% 4.0% 22.8% 8.1% -0.5% -0.3% -1.0% 13.4% $11.27 11.9% 10.3% $0.01 0.0 0.0
$37.8 78.7 26.2 142.7 10.4 34.2 44.6 32.8 16.5 236.5 4.8 0.0 241.4 0.3 2.4 244.1 129.4 2.9 34.6 14.0 3.1 3.4 187.3 -2.9 59.7 23.2 36.5 $0.26 $0.25 $0.09 34.0% 79.9 32.7% 32.7% 31.4% 53.0% 14.2% 143.4 138.8 1.8 140.5 38.9% 36.3 6.2% 8.8% 4.5% 3.2% 6.2% -24.7% 5.4% 9.5% NM 6.2% -0.6% 5.8% 0.0% 4.8% 14.9% 13.5% 13.4% 13.2% $11.47 11.7% 10.4% $0.01 0.0 0.0
$40.5 87.0 26.0 153.5 16.0 33.0 49.0 36.0 22.0 260.5 25.0 0.0 285.5 0.4 0.8 286.6 143.0 3.5 40.2 15.6 3.7 4.4 210.4 0.0 76.3 30.9 45.4 $0.33 $0.32 $0.09 36.1% 99.7 34.8% 34.8% 28.6% 49.9% 14.0% 142.9 138.4 2.3 140.6 40.5% 58.9 5.5% 31.8% 5.7% 39.0% 12.0% -13.4% 9.2% 67.4% 35.9% 9.3% -0.5% 13.0% 11.4% 13.3% -0.5% -2.0% -1.4% 13.0% $11.66 11.3% 10.2% $0.01 0.4 10.0
$47.5 89.0 28.0 164.5 16.0 30.5 46.5 45.5 24.5 281.0 2.3 0.0 283.3 0.4 0.8 284.4 142.0 3.5 38.0 15.6 3.7 4.4 207.2 0.0 77.3 31.3 46.0 $0.33 $0.33 $0.09 36.7% 100.7 35.4% 35.4% 34.9% 49.9% 13.4% 142.5 138.4 1.6 139.9 40.5% 59.5 7.9% 39.1% 9.1% 52.0% 15.3% 1.1% 15.2% -4.6% 70.5% 15.2% 0.3% 12.8% 8.6% 12.7% 25.7% 24.1% 24.1% 12.9% $11.87 11.8% 10.5% $0.01 0.4 10.0
$38.0 92.0 29.5 159.5 22.0 48.0 70.0 37.0 24.3 290.8 7.4 0.0 298.2 0.4 0.8 299.3 144.0 3.5 42.8 15.6 3.7 4.4 213.9 0.0 85.4 34.6 50.8 $0.36 $0.35 $0.09 37.6% 108.8 36.4% 37.2% 35.6% 48.1% 14.3% 141.9 138.7 1.8 140.4 40.5% 64.4 7.2% 39.5% 7.2% 47.4% 16.3% 2.3% 15.9% 18.3% -74.2% 14.9% 0.7% 13.5% 11.2% 13.5% 17.4% 15.0% 15.5% 12.7% $12.09 12.1% 10.7% $0.01 0.6 15.0
$44.0 82.0 27.5 153.5 21.0 41.5 62.5 36.5 29.3 281.8 1.0 0.0 282.8 0.4 0.8 283.9 143.0 3.5 40.5 15.7 3.7 4.4 210.8 0.0 73.1 29.6 43.5 $0.32 $0.30 $0.09 35.4% 96.7 34.1% 34.1% 33.8% 50.4% 14.3% 141.3 138.1 2.0 140.1 40.5% 57.1 7.6% 40.3% 11.1% 77.5% 19.1% -79.2% 17.2% 12.6% -68.9% 16.3% 1.0% 10.5% 17.1% 12.5% 22.5% 19.2% 21.6% 12.6% $12.26 12.5% 11.0% $0.01 0.6 15.0
16 April 2012
196
Price Target
$53
13E
$4.05
Div. Yield
1.3%
P/E 12E
13.3
13E
11.8
Investment Thesis
Potential Catalysts
Aon could benefit similar to other insurance brokers from improving P&C prices and exposure growth once the economy improves, although the companys Brokerage organic growth trails MMC. The company acquired Hewitt for $5bn in 2010, which doubled Aons revenue mix from consulting to onethird in a business with structurally lower margins than insurance brokerage. Aon recently moved its corporate headquarters to the U.K. from the U.S to structurally improve its tax rate, unlock excess cash flow, and be at the center of the global insurance market.
Risks
Organic growth could benefit from higher P&C prices and an improving economy. Aons Consulting business could benefit from an improving economy, although we are concerned about potential integration issues from the Hewitt acquisition. Expense savings in Aons insurance brokerage business are mostly complete, which means Aon needs to generate positive operating leverage to expand margins in this segment. Aon targets a 26% margin in Insurance Brokerage, although our sense is this could take 3-5 years to achieve. Aon has $1.2bn remaining in its share repurchase authorization. Aon does not currently plan to do another large acquisition.
Valuation
Aons earnings could face headwinds if P&C price increases slow or if the economy deteriorates. A weak economy impacts both Brokerage organic growth and Consulting results. Execution risks related to Hewitt acquisition. Increased pension expenses Low interest rates
Since 2000, AON has traded at a median forward P/E of 13.3x, with a range of 8.9x-17.8x. Since 2008, the median is 12.7x. Our $53 price target is based on a P/E of 15x our 2012 EPS estimate of $3.60. Aon currently trades 13.3x 2012E EPS of $3.60, which is below MMC but above WSH.
Aon Corporation, based in London, is a leading global provider of risk management services, insurance and reinsurance brokerage, and human capital consulting. In 2010, Aon acquired Hewitt, which substantially expanded is presence in consulting.
16 April 2012
197
$4.50 Consulting, 33% $4.00 $3.50 $3.00 $2.50 Insurance Brokerage, 67% $2.00 $1.50 $1.00 $0.50 $0.00
$2.31 $1.74$1.76 $2.87 $2.30
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
40% 35% 30% 25% 20% 15% 10% 5% 14% 15% 20% 20% 20% 20% 21% 18% 18% 19%
0%
16 April 2012
E 13 20 2 E 1 20 1 1 20 0 1 20 9 0 20 8 0 20 7 0 20 6 0 20 5 0 20 4 0 20 3 0 20 2 0 20 1 0 20 0 0 20
E 13 20 E 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20
198
N 1 -0 ov
Ja n00 Ja n01
Ja n02 Ja n03
Ja n04 Ja n05
Ja n06 Ja n07
Ja n08 Ja n09
Ja n10 Ja n11
Ja n12
9 -9 ov
3 -0 ov
5 -0 ov
7 -0 ov
9 -0 ov
1 -1 ov
199
280 3 277 15.1% 18.1% 15.1% 27.1% $0.82 $0.15 $0.97 $0.00 $0.83 $1.16 $0.15 18.3% 324 326 12 338 (395) 35.6% 793.6% 35.6% $25.03 11.9% 12.3% $0 3.0% 16.7% 2.9% 2.3% 19.4% 15.2% 22.0% 2%
16 April 2012
200
$738 $654 $365 15 $1,772 1,772 1,757 15 1,014 439 1,453 319 14 1,439 333 18.0% 18.8% 33 366 20.7% 57.2% 15.3% 9.9% 1.1% 10.0% 10.1% 0.0% 9.3% 8.9% 13.1% 14.8% 2% $0.03
(a) 2000: Restructuring costs (BTP) 2001: Restructuring Costs (BTP), 9/11 Charges, 2002: Reversal of prior BTP charges, WTC insurance recoveries, 2004: settlement with NYAG, 2005-2006 restructuring costs. Note: Updated 2Q04 to remove discontinued operations
HR Solutions (Dollars in millions) Benef., comp., mang., & communications rev. Human resources rev. Other - Intersegment Net investment income Total consulting revenue Net consulting revenue ex. investment inc. Investment income Compensation & benefits Other expenses Hewitt restructuring costs Total expenses Pretax income Unusual items (a) Pretax income excl. unusual items Pretax margin as reported Pretax margin excl. unusual items Amoritization of intangible assets Pretax income ex unusual items and amortization of Pretax margin excl. unusual items and amortizati Salaries & benefits/revenues Year over year change Benef., comp., mang., & communications rev. Human resources revenues Total consulting revenue Operating expenses Operating expenses ex unusual items Pretax income Pretax income excl unusual items Organic growth 1 point margin effect on EPS (35% tax rate) 2007 $1,107 236 9 $1,345 1,336 823 340 NA 1,156 189 11 200 14.1% 14.9% NA NA 11.4% 61.2% 12.7% -20.0% 4.9% -0.5% 0.3% 57.5% 42.9% -1% $0.03 2008 $1,139 214 5 $1,356 1,356 815 331 NA 1,143 213 18 231 15.7% 17.0% NA NA 15.2% 60.1% 2.9% -9.3% 0.8% -1.1% -1.7% 12.7% 15.5% 3% $0.03 2009 $545 191 1 $737 737 493 144 NA 637 100 11 111 13.6% 15.1% 111 15.1% 66.9% -52.2% -10.7% -45.6% -44.3% -44.4% -53.1% -51.9% -5% $0.02 2010 $821 731 (8) 1 $1,545 1,545 1,041 383 NA 1,424 121 76 197 7.8% 12.8% 40 237 15.3% 67.4% 50.6% 282.7% 109.6% 123.5% 115.3% 21.0% 77.5% 0% $0.03 2011 $1,532 2,272 (23) $3,781 3,781 2,286 1,147 94 $3,433 348 95 443 9.2% 11.7% 233 676 17.9% 60.5% 86.6% 210.8% 144.7% 141.1% 147.6% 187.6% 124.9% 1% $0.07 2012E $1,631 2,308 2 $3,941 3,939 2,270 1,204 81 $3,555 386 81 467 9.8% 11.8% 251 718 18.2% 57.6% 6.5% 1.6% 4.2% 3.6% 4.1% 10.9% 5.4% 1% $0.08 2013E $1,751 2,365 2 $4,118 4,116 2,286 1,274 81 3,641 477 30 507 11.6% 12.3% 244 751 18.2% 55.5% 7.4% 2.5% 4.5% 2.4% 3.9% 23.6% 8.6% 1% $0.08 1Q $367 556 (8) $915 $915 563 269 23 832 83 24 107 9.1% 11.7% 60 167 18.3% 61.5% NM NM NM NM NM NM NM -1% $0.02 2011 2Q 3Q $362 $400 550 561 (6) (4) $906 $957 $906 $957 531 279 31 810 96 26 122 10.6% 13.5% 58 180 19.9% 58.6% NM NM NM NM NM NM NM 0% $0.02 587 304 26 891 66 34 100 6.9% 10.4% 58 158 16.5% 61.3% NM NM NM NM NM NM NM -1% $0.02 4Q $403 605 (5) $1,003 $1,003 605 295 14 900 103 11 114 10.3% 11.4% 57 171 17.0% 60.3% -1.5% 4.3% 2.2% -3.3% 3.1% 106.0% 106.0% 4% $0.02 1Q $393 570 1 $964 $963 576 280 20 876 87 20 108 9.1% 11.2% 63 171 17.7% 59.8% 7.1% 2.5% 5.3% 5.3% 5.9% 5.1% 5.1% 1% $0.02 2012E 2Q 3Q $388 $426 565 575 1 1 $954 $1,002 $953 $1,001 549 279 20 848 105 20 126 11.0% 13.2% 63 189 19.8% 57.6% 7.2% 2.7% 5.2% 4.7% 5.6% 9.6% 9.6% 1% $0.02 577 324 20 921 80 20 101 8.0% 10.0% 63 164 16.3% 57.6% 6.5% 2.5% 4.6% 3.4% 5.1% 21.6% 21.6% 1% $0.02 4Q $424 598 1 $1,023 $1,022 568 321 20 909 113 20 134 11.1% 13.1% 62 196 19.1% 55.6% 5.2% -1.2% 1.9% 1.0% 0.0% 10.0% 10.0% 1% $0.02
(a) 2000: Restructuring costs (BTP), 1Q01 & 2Q01: Restructuring costs (BTP)
Corporate and other (Dollars in millions) ENH warrant appreciation/(depreciation) Equity interest in Endurance Specialty Interest income Other corporate revenue (inv. inc.) Total investment income Auto finance rev. Total revenue Interest expense Other expenses Total expenses Pretax income Unusual items (a) Pretax income excl. special charges 2007 100 100 100 138 130 268 (158) 15 (143) 2008 94 94 94 126 165 291 (197) 51 (146) 2009 22 49 71 71 122 126 248 (176) (4) (180) 2010 15 15 15 177 202 379 (364) 70 (364) 2011 18 18 18 245 156 401 (383) 3 (383) 2012E 20 20 20 240 152 392 (372) (372) 2013E 1Q 6 6 6 63 33 96 (90) (90) 2011 2Q 4 4 4 63 36 99 (95) (95) 3Q 4 4 4 60 44 104 (100) (100) 4Q 1Q 5 5 5 60 38 98 (93) (93) 2012E 2Q 5 5 5 60 38 98 (93) (93) 3Q 5 5 5 60 38 98 (93) (93) 4Q 5 5 5 60 38 98 (93) (93)
16 April 2012
201
Price Target
$24
13E
$1.55
Div. Yield
1.8%
P/E 12E
15.6
13E
14.6
Investment Thesis
Potential Catalysts
Progressive Corp. is one of the largest automobile insurers in the U.S. We view PGR as one of the bestrun companies in the P&C insurance industry as evidenced by its focused and differentiated auto insurance product offerings, consistent earnings, and superior ROE. PGR is gaining profitable market share through its direct sales operation from exclusive agency insurers State Farm and Allstate. Loss frequency trends have been favorable resulting in strong margins, although it is unclear if this will persist as the economy improves. Also, physically damage loss severity trends are increasing.
Risks
Loss frequency trends have been favorable due to reduced miles driven in a weak economy, although it is unclear if this will persist as the economy improves. Auto insurance prices are rising but the pace of increases is slowing due to competition. PGR has excess capital and could continue to repurchase its stock. We expect PGR to continue to gain market share, particularly in its direct business. PGRs commercial auto insurance growth could increase as the economy improves.
Valuation
Progressives profitability is tied to the U.S. auto insurance market since it is a pure play auto insurer. Progressive could benefit if the personal auto market tightens and auto insurance prices rise. If loss frequency or severity trends rise, PGRs margins could face headwinds. Slowing growth especially in direct sales.
Since 2000, PGR has traded at a median trailing price/stated book value of 2.64x, with a range of 1.50x-4.17x. Since 2008, the median is 2.16x. Our $24 price target is based on 2.3x YE12 estimated book value per share of $10, and a P/E of 17x our 2012 EPS estimate of $1.45. PGR currently trades at 2.21x 1Q12 book value and 15.6x 2012E EPS of $1.45, which is above other P&C insurers, but we believe this is warranted based on its strong ROE with low volatility.
Progressive Corp., based in Mayfield Village, Ohio, is the fourth largest insurer of automobiles in the United States.
16 April 2012
202
$1.50
$1.00
$0.50
$0.00 2006
Combined Ratio & CR Ex Cats and PY Development
2007
2008
2009
2010
2011
2012E 2013E
100%
$12
Book Value
97%
$10
$8 $6 $4 $2
2007
2008
2009
2010
2011
2012E 2013E
$0 2006 2007 2008 2009 2010 2011 2012E 2013E
Combined Ratio
16 April 2012
Operating ROE
94%
203
ec -9 8
ec -0 0
ec -0 2
ec -0 4
ec -0 6
ec -0 8 D
06
00
98
02
04
08
10
ec -
ec -
ec -
ec -
ec -
ec -
ec -
16 April 2012
ec -1 0
204
1 -1 ec D 10 ec D 9 -0 ec D 08 ec D 07 ec D 06 ec D 5 -0 ec D 04 ec D 03 ec D 02 ec D 01 ec D 00 ec D 99 ec
4.90 4.40 3.90 3.40 2.90 2.40 1.90 1.40 0.90
1 -1 ov N 10 ov N 09 ov N 08 ov N 07 ov N 06 ov N 05 ov N 04 ov N 03 ov N 02 ov N 1 -0 ov N 00 ov N 99 ov
1 -1 ov N -10 ov N -09 ov N -08 ov N -07 ov N -06 ov N -05 ov N -04 ov N -03 ov N -02 ov N -01 ov N -00 ov N -99 ov
16 April 2012
205
Price Target
$32
13E
$3.75
Div. Yield
2.6%
P/E 12E
8.5
13E
8.6
Investment Thesis
Potential Catalysts
We remain concerned about Allstates loss of auto market share to direct writers as well as changes needed to achieve adequate multi-year returns in its homeowner's and life insurance businesses. ALLs acquisition of Esurance and Answer Financial is expensive for a business that has historically generated weak results. The Allstate-brand standard automobile insurance policies-in-force (PIF) is declining due to market share gains by PGR and Geico, which is a trend we expect to persist. Homeowners insurance earnings at ALL have been challenging due to large catastrophe losses. The company is raising prices but it could take several years to improve. The companys life insurance operation has been a drag on the companys overall capital position due to high exposure to stressed credit investments.
Risks
ALL's long-term financial goal is for an ROE of 13% by 2014, which appears optimistic to us based on an increasingly competitive auto insurance market as well as challenges in homeowners insurance. A recovery in auto insurance policies-in-force growth could be slower than anticipated. Auto insurance loss frequency trends have been favorable due to reduced miles driven in a weak economy, although it is unclear if this will persist as the economy improves. Allstate announced several internal leadership changes that we do not view as resulting in a change in Allstate's strategy. Matt Winter, formerly the CEO of Allstate Financial (life insurance) unit, will become President--Allstate Auto, Home and Agencies. Don Civgin, who was previously CFO, will become head of Allstate Financial. Steve Shebik, who has held several senior finance roles, will become CFO.
Valuation
ALL has substantial exposure to natural catastrophe losses, owing to its large homeowners insurance business. Rising interest rates and higher credit spreads could reduce ALLs book value. Personal auto claims inflation is mostly benign, but could rise if the economy improves and miles driven increases. Rates are above lost costs inflation in homeowners but remain inadequate after several years of large underwriting losses. It remains to be seen how quickly ALL could improve the profitability of the Esurance and Answer Financial businesses. The acquisition could also create channel conflict.
Since 2000, ALL has traded at a median trailing price/stated book value of 1.41x, with a range of 0.67x-1.89x. Since 2008, the median is 0.90x. Our $32 price target is based on 0.8x YE12 estimated book value per share of $40, and a P/E of 8x our 2012 EPS estimate of $3.80. ALL currently trades 0.87x 2011 book value and 8.5x 2012E EPS of $3.80, below other personal lines insurers.
Allstate, based in Northbrook, IL, is the second largest insurer of autos and homes in the U.S. The companys Allstate Financial unit offers life insurance and savings products.
16 April 2012 206
Other, 9%
Homeowners, 24%
$4.00 $3.00
Personal Auto, 67%
$3.22
$3.80
$3.75
2011
2012E 2013E
110% 105% 100% 95% 90% 85% 80% 75% 2006 2007 2008 2009 2010 2011 2012E 2013E
Book Value Per Share
Book Value $45 $40 $35 $30 $25 $20 $15 $10 $5 $0
Combined Ratio
16 April 2012
Operating ROE
207
1 -1 ov N -10 ov N -09 ov N -08 ov N -07 ov N -06 ov N -05 ov N -04 ov N -03 ov N -02 ov N -01 ov N -00 ov N -99 ov
16 April 2012
Fe b9 Fe 9 b0 Fe 0 b0 Fe 1 b0 Fe 2 b0 Fe 3 b0 Fe 4 b0 Fe 5 b0 Fe 6 b0 Fe 7 b0 Fe 8 b0 Fe 9 b1 Fe 0 b1 Fe 1 b12
208
16 April 2012
209
Price Target
$41
13E
$3.75
Div. Yield
3.0%
P/E 12E
9.9
13E
10.6
Investment Thesis
Potential Catalysts
THGs ROE is expected to remain below its cost of capital and its results have been negatively impacted by elevated catastrophe losses. THGs acquisition of Chaucer increases exposure to high severity business and expands THGs business outside its core personal lines and small/middle market commercial lines.
Risks
THGs EPS and ROE volatility could increase due to the Chaucer acquisition THG could benefit from higher P&C prices. THG is unlikely to repurchase stock in 2012. THG does not appear overly concerned about profitability in its workers compensation business, because its business mix shifted to lower hazard risks, although we are less optimistic. Surety results could continue to face headwinds from a weak economy and stress in the contractor business.
Valuation
The Hanover has catastrophe exposure due to its concentration on the U.S. East coast, Southeast, and to a lesser extent the Midwest. The Chaucer acquisition increases THGs catastrophe exposure to high severity international losses. THG is entering the international market through its acquisition of Chaucer and expanding outside its core personal lines and small-to-middle market commercial lines business. Similar to other property/casualty insurers, THG faces risks if P&C price increases do not persist.
Since 2004, THG has traded at a median trailing price/stated book value of 0.85x, with a range of 0.26x-1.50x. Since 2008, the median is 0.85x. Our $41 price target is based on 0.7x YE12 estimated book value per share of $59, and a P/E of 10x our 2012 EPS estimate of $4.00. THG currently trades 0.71x 2011 book value (below other personal lines insurers) and 9.9x 2012E EPS of $4.00 (below PGR but above ALL).
The Hanover Insurance Group, Inc., based in Worcester, Mass., is a "super-regional" P&C insurer focused on commercial lines and personal lines P&C insurance through independent agents. The Hanover ranks among the top 30 property-casualty insurers in the United States. The company acquired Chaucer in the U.K. in 2011.
16 April 2012
210
Chaucer, 12%
$2.00
$1.00 $0.32
Book Value
100%
$40 $30 $20 $10 4% 2% 0% 2006 2007 2008 2009 2010 2011 2012E 2013E
95%
90% 2006
2007
2008
2009
2010
2011
2012E
2013E
$0
Combined Ratio
16 April 2012
211
Operating ROE
$50
16 April 2012
ec -0 D 1 ec -0 D 2 ec -0 D 3 ec -0 D 4 ec -0 5 D ec -0 6 D ec -0 7 D ec -0 8 D ec -0 9 D ec -1 0 D ec -1 1
1 -1 ec D 0 -1 ec D 9 -0 ec D 8 -0 ec D 7 -0 ec D 6 -0 ec D 5 -0 ec D 4 -0 ec D 3 -0 ec D 2 -0 ec
11 cDe 0 1 cDe 9 0 cDe 8 0 cDe 7 0 cDe 6 0 cDe 5 0 cDe 4 0 cDe 3 0 cDe 2 0 cDe
212
Net written premiums Unearned premiums Net premiums earned Paid claims Change in loss reserves Policy benefits, claims, losses ex py developmt & cats Prior year reserve development (favorable) unfavorable Pre-tax catastrophe losses Loss adj expense ex py reserve development Policy acquisition expenses and other u/w expenses Policyholders' dividends GAAP underwriting profit (loss) Net investment income Other income Other operating expenses P&C P/T segment income Interest expense Total segment income before taxes Federal income tax expense on segment income Total segment income A/T Net realized investment gains, net of amoritization Other non-segment items Federal income tax benefit (expense) on non-segment income Income from continuing operations, net of tax Income from discontinued variable & life annuity business, net o Loss from discontinued accident and health business Gain (Loss) on sale A/T Income (loss before cumulative effect of accounting chg Other Cumulative effect of accounting chg, net of tax Net income (loss) Earnings Per Share Basic Segment EPS Fully Diluted Segment EPS Income from continuing operations Income from discontinued operations Loss on disposal variable life & annuity business Income (loss) before cumulative effect of accounting chg Cumulative effect of accounting chg Net income (loss) Ending shares outstanding Basic Average shares Dilution Fully diluted average shares Underwriting Ratios Losses excluding catastrophe losses (a) Catastrophe losses Loss Development Loss adj expenses Policy acquisition expenses and other u/w expenses Policyholders' dividends Combined Ratio Combined Ratio ex cats and reinstatement premiums PY development Unusual items CR ex cats, reinstmt prem & py development Year-over-year percentage change Net premiums written Net premiums earned Investment income P&C P/T segment Income Life P/T segment income Total segment income A/T Operating EPS Book value per share P&C book value per share A-T impact of 1% change in C/R Per Share P&C book value per share Life co book value per share Total fully diluted book value per share Linked qtr % change in book value per share Total Return on average equity Tangible book value per share Operating ROE ex AOCI Shareholder's dividend Total Cash flow from operations Balance Sheet Total Book value per share ex. FAS 115 Property-liability premiums/surplus Debt/capital # of shares repurchased $ amount of shares repurchased Average invested assets Pre-tax yield
$2,307.1 (87.9) 2,219.2 1,459.2 (76.2) 1,157.6 (128.6) 107.2 246.8 760.8 0.5 74.9 227.4 65.5 (39.7) 328.1 (39.9) 284.3 (88.2) 196.1 (3.5) (2.8) 191.7 0.0 (22.0) 169.7 0.6 170.3 $3.80 $3.76 $3.68 $0.00 ($0.42) $3.25 $0.01 $3.26 51.1 51.6 0.6 52.2 52.2% 4.5% -5.3% 11.0% 34.3% 0.0% 96.7% 92.2% -5.3% NA 97.5% 7.3% 2.7% 8.8% NM -79.1% NM NM 7.7% 11.5% 14.4 $0.28 $32.90 $6.22 $39.10 NA 9.9% $36.75 9.7% $0.26 41.8 $39.88 1.6 20.3% 4.0 200.3 $4,045 5.6%
$2,415.3 (43.3) 2,372.0 1,522.3 (65.4) 1,293.7 (152.7) 65.2 250.7 786.6 0.5 128.0 246.3 64.9 (56.9) 382.3 (39.9) 342.4 (113.7) 228.7 (0.9) 0.5 228.3 15.7 8.3 252.3 1 253.1 $4.42 $4.36 $4.36 $0.30 $0.16 $4.81 $0.00 $4.83 51.8 51.7 0.7 52.4 54.5% 2.7% -6.4% 10.6% 33.2% 0.0% 94.6% 91.9% -6.4% -0.3% 98.6% 4.7% 6.9% 8.3% NM NM NM NM 13.5% 15.6% 15.4 $0.29 $38.04 $6.34 $44.37 NA 10.6% $41.95 10.5% $0.34 73.3 $44.77 1.4 18.2% $4,485 5.5%
$2,518.0 (33.1) 2,484.9 1,712.3 (87.7) 1,347.6 (153.3) 169.7 260.6 825.4 1.6 33.3 258.0 46.3 (35.7) 300.6 (39.9) 260.7 (86.3) 174.4 (97.8) 0.0 82.9 (63.4) 0.0 19.5 (0.5) 19.0 $3.40 $3.37 $1.60 ($1.23) $0.00 $0.38 $0.00 $0.37 50.9 51.3 0.4 51.7 54.2% 6.8% -6.2% 10.5% 33.2% 0.1% 98.7% 91.8% -6.2% NA 98.0% 4.3% 4.8% 4.8% -21.4% NM -23.7% -22.7% -16.4% -6.6% 16.2 $0.31 $35.54 $1.53 $37.08 NA 8.3% $33.74 7.6% $0.45 209.5 $44.64 1.6 22.0% 1.0 43.3 $4,616 5.6%
$2,608.7 (62.3) 2,546.4 1,759.4 (121.2) 1,419.9 (133.1) 96.1 255.3 878.3 1.0 28.9 251.7 38.6 (49.5) 269.7 (34.7) 235.0 (77.5) 157.5 1 6 187.8 0 12 200.0 200.0 $3.11 $3.09 $3.68 $0.01 $0.23 $3.91 $0.00 $3.91 47.4 50.6 0.5 51.1 55.8% 3.8% -5.2% 10.0% 34.5% 0.0% 98.9% 95.1% -5.2% NA 100.3% 3.6% 2.5% -2.4% -10.3% NM -9.7% -8.3% 34.1% 39.9% 16.6 $0.32 $49.72 $0.00 $49.72 NA 7.4% $46.11 6.8% $0.75 91.6 $49.11 1.5 15.5% 3.6 148.6 $4,784 5.3%
$3,048.0 (207.0) 2,841.0 1,816.4 38.9 1,488.9 (88.5) 160.3 294.6 1,002.9 1.0 (18.2) 247.2 38.9 (40.2) 227.7 (44.3) 183.4 (61.2) 122.2 30 (2) 3 153.2 0 0 1 154.7 154.8 $2.71 $2.64 $3.31 $0.01 $0.02 $3.34 $0.00 $3.34 44.9 45.1 1.2 46.3 52.4% 5.6% -3.1% 10.4% 35.3% 0.0% 100.6% 95.0% -3.1% NA 98.1% 16.8% 11.6% -1.8% -15.6% NM -22.4% -14.7% 10.1% 10.1% 18.5 $0.40 $54.74 $0.00 $54.74 NA 5.1% $50.75 5.2% $1.50 83.6 $51.92 1.7 19.8% 3.0 130.6 $5,105 4.8%
$3,593.4 5.2 3,598.6 N/A N/A 2,292.5 (103.3) 361.6 NA 1,231.1 0.0 (183.3) 258.2 51.9 (54.3) 72.5 (55.0) 17.5 (2.9) 14.6 28 (23) 13 32 5 37.1 37.1 $0.32 $0.32 $0.70 $0.00 $0.00 $0.81 $0.00 $0.81 45.2 45.2 0.6 45.8 63.7% 10.0% -2.9% NA 34.2% 0.0% 105.1% 95.0% -2.9% NA 97.9% 17.9% 26.7% 4.4% -68.2% NM -88.1% -87.9% 1.5% 1.5% 23.4 $0.51 $55.57 $0.00 $55.57 NA 0.6% $51.46 0.6% $1.13 221.7 $52.16 2.3 26.6% 0.6 21.7 $6,211 4.2%
$4,152.0 $4,342.8 (49.3) (103.9) 4,102.6 4,238.9 1,850.0 1,825.0 792.2 911.0 2,530.2 2,564.5 (80.0) (5.0) 192.0 176.5 NA NA 1,417.8 1,480.0 (0.1) (0.1) 42.8 23.0 285.8 285.8 63.0 66.0 (45.0) (44.5) 346.6 330.3 (64.0) (65.0) 282.6 265.3 (98.9) (92.8) 183.7 172.4 183.7 172.4 183.7 172.4 183.7 172.4 $4.07 $4.00 $4.00 $0.00 $0.00 $4.00 $0.00 $4.00 45.2 45.2 0.8 46.0 61.7% 4.7% -1.9% NA 34.6% 0.0% 99.0% 94.3% -1.9% NA 96.2% 15.5% 14.0% 10.7% NM NM NM NM 5.8% 5.8% 26.7 $0.58 $58.76 $0.00 $58.76 NA 7.1% $54.66 7.6% $1.20 1071.2 $54.43 2.3 25.8% $7,792 3.7% $3.82 $3.75 $3.75 $0.00 $0.00 $3.75 $0.00 $3.75 45.2 45.2 0.8 46.0 60.5% 4.2% -0.1% NA 34.9% 0.0% 99.5% 95.3% -0.1% NA 95.4% 4.6% 3.3% 0.0% NM NM NM NM 4.4% 4.4% 27.6 $0.60 $61.36 $0.00 $61.36 NA 6.4% $57.60 6.9% $1.20 1230.9 $57.03 2.2 25.0% $8,943 3.2%
$749.9 11.8 761.7 481.7 29.3 489.8 (28.5) 49.7 NA 260.2 NA (9.5) 60.4 9.7 (13.5) 47.1 (10.4) 36.7 (12.5) 24.2 3.3 (2.5) 3 27.9 1.4 29.3 29.3 $0.54 $0.53 $0.61 $0.00 $0.00 $0.64 $0.00 $0.64 45.2 45.1 0.9 46.0 64.2% 6.5% -3.7% NA 33.7% 0.0% 100.7% 94.2% -3.7% NA 97.9% 3.4% 14.3% -1.1% -18.4% NM -24.4% -20.8% 6.7% 6.7% 5.0 $0.11 $55.06 $0.00 $55.06 0.6% 3.9% $51.10 $0.28 24 $52.06 1.7 18.4% $5,093 4.7%
$815.4 (44.9) 770.5 539.0 78.5 476.1 (15.3) 156.7 NA 259.6 NA (106.6) 61.0 10.2 (11.4) (46.8) (10.8) (57.6) 19.5 (38.1) 13.4 (15.5) 8 (32.4) 0.6 (31.8) (31.8) ($0.84) ($0.84) ($0.70) $0.00 $0.00 ($0.70) $0.00 ($0.70) 45.2 45.2 0.2 45.4 61.8% 20.3% -2.0% NA 33.2% 0.0% 113.3% 93.0% -2.0% NA 95.0% 1.7% 10.4% -1.3% NM NM NM NM 4.5% 4.5% 5.0 $0.11 $54.96 $0.00 $54.96 -0.2% -6.1% $51.00 $0.28 79 $51.12 1.9 25.7% $5,199 4.7%
$1,051.0 (32.4) 1,018.6 722.2 12.7 664.1 (28.8) 99.6 NA 357.2 NA (73.5) 67.8 14.6 (16.5) (7.6) (17.4) (25.0) 6.5 (18.5) 8.2 (1.9) 3 (9.7) (9.7) (9.7) ($0.41) ($0.41) ($0.21) $0.00 $0.00 ($0.21) $0.00 ($0.21) 45.2 45.2 0.1 45.3 65.2% 9.8% -2.8% NA 34.6% 0.0% 106.8% 97.0% -2.8% NA 99.8% 30.8% 39.9% 10.6% NM NM NM NM -0.5% -0.5% 6.6 $0.15 $54.98 $0.00 $54.98 0.0% -3.0% $49.85 $0.28 184 $50.89 2.0 26.9% 1 20 $6,354 4.3%
$977.1 70.7 1,047.8 N/A N/A 662.5 (30.7) 55.6 NA 354.1 NA 6.3 69.0 17.4 (15.6) 77.1 (16.4) 60.7 (15.5) 45.2 3.2 (0.7) (2) 46.1 3.2 49.3 49.3 $1.00 $1.00 $1.02 $0.00 $0.00 $1.09 $0.00 $1.09 45.2 45.2 0.1 45.3 63.2% 5.3% -2.9% NA 33.4% 0.0% 99.0% 93.7% -2.9% NA 96.6% 36.3% 39.9% 9.5% NM NM 3.4% 4.8% 2.7% 2.7% 6.8 $0.15 $56.24 $0.00 $56.24 2.3% 7.3% $51.46 $0.30 (65) $52.16 2.0 26.6% 0 2 $7,294 3.8%
$989.2 29.1 1,018.4 462.5 192.1 639.7 (20.0) 34.9 NA 350.3 NA 13.5 71.2 15.5 (13.3) 86.8 (16.0) 70.8 (24.8) 46.1 46.1 46.1 46.1 $1.02 $1.00 $1.00 $0.00 $0.00 $1.00 $0.00 $1.00 45.2 45.2 0.8 46.0 62.8% 3.4% -2.0% NA 34.4% 0.0% 98.7% 95.2% -2.0% NA 97.2% 31.9% 33.7% 17.9% 84.4% NM 90.3% 90.4% 2.9% 2.9% 6.6 $0.14 $56.63 $0.00 $56.63 0.7% 7.3% $52.53 $0.30 222.9 $52.30 1.9 26.5% $7,368 3.9%
$1,056.2 (37.8) 1,018.5 462.5 193.0 642.6 (20.0) 32.9 NA 352.3 NA 10.7 71.2 15.5 (10.8) 86.6 (16.0) 70.6 (24.7) 45.9 45.9 45.9 45.9 $1.02 $1.00 $1.01 $0.00 $0.00 $1.00 $0.00 $1.00 45.2 45.2 0.8 46.0 63.1% 3.2% -2.0% NA 34.6% 0.0% 98.9% 95.7% -2.0% NA 97.7% 29.5% 32.2% 16.7% NM NM NM NM 4.3% 4.3% 6.6 $0.14 $57.34 $0.00 $57.34 1.3% 7.1% $53.24 $0.30 288.0 $53.01 1.8 26.3% $7,623 3.7%
$1,088.4 (60.7) 1,027.7 462.5 211.5 618.4 (20.0) 75.6 NA 352.0 NA 1.7 72.2 15.6 (9.9) 79.5 (16.0) 63.5 (22.2) 41.3 41.3 41.3 41.3 $0.91 $0.90 $0.90 $0.00 $0.00 $0.90 $0.00 $0.90 45.2 45.2 0.8 46.0 60.2% 7.4% -1.9% NA 34.3% 0.0% 99.8% 92.5% -1.9% NA 94.4% 3.6% 0.9% 6.5% NM NM NM NM 5.4% 0.0% 6.7 $0.15 $54.98 $0.00 $57.95 1.1% 6.3% $53.85 $0.30 323.8 $53.62 1.8 26.1% $7,929 3.6%
$1,018.2 19.9 1,038.1 462.5 195.6 629.5 (20.0) 48.6 NA 363.3 (0.1) 16.9 71.2 16.6 (11.0) 93.6 (16.0) 77.6 (27.2) 50.5 50.5 50.5 50.5 $1.12 $1.10 $1.10 $0.00 $0.00 $1.10 $0.00 $1.10 45.2 45.2 0.8 46.0 60.6% 4.7% -1.9% NA 35.0% 0.0% 98.4% 93.7% -1.9% NA 95.6% 4.2% -0.9% 3.2% 21.5% NM 11.7% 10.0% 4.5% 4.5% 6.7 $0.15 $58.76 $0.00 $58.76 1.4% 7.7% $54.66 $0.30 236.6 $54.43 2.3 25.8% $8,209 3.5%
16 April 2012
213
COMPANY SNAPSHOT
ACE Limited
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 15,372 16,432 17,576 N/A Net investment income (NII) ($mn) 2,242 2,225 2,225 N/A Underwriting income ($mn) 1,917 2,131 1,869 N/A Operating income ($mn) 2,376 2,580 2,359 N/A Net income ($mn) 1,585 2,780 2,359 N/A 18.0 18.0 N/A Tax rate (%) 17.0 Combined ratio (%) 94.6 93.0 95.3 N/A Combined ratio (ex cats & py development) (%) 91.9 92.3 92.2 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
CAGR N/A N/A N/A N/A USD 94.00 N/A Upside case N/A ACE could benefit from improving P&C pricing and favorable reserve releases. We view ACEs upside scenario as $94 based on 1.2x 2012E BV of $80. CAGR N/A Downside case USD 62.00 N/A Risks include rising interest rates, large catastrophe N/A losses and intergration risks related to recent N/A acquistions. We view ACE's downside case as $62 (0.8x 2012 BV of $80). Average 0.6 Upside/downside scenarios 4.0 14.7 Average 62.00 0.9 ( - 15.1% ) 1.1 Downside Case 1.0 10.2 13- Apr- 11 11- Apr- 12 2.6 Source: FactSet Fundamentals 9.6 10.4 Book Value and ROE N/A
$100 $80 $60 $40 $20 $0 2010A 2011A 2012E 2013E BVPS Operating ROE
Investment case Why a 1-Overweight? ACE has one of the strongest global property-casualty insurance franchises and benefits from a solid balance sheet and strong management, in our view. ACE also stands to benefit from recent positive pricing momentum in the commercial P&C market.
123 105 88 70 53 35
94.00 ( 28.7% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
214
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
11,796 12,708 13,779 400 400 400 4,303 4,760 5,114 912 1,071 866
CAGR N/A N/A N/A N/A USD 48.00 N/A Upside case N/A ACGL is expected to release loss reserves and could gain market share, resulting we believe in strong EPS, BV growth, and a solid ROE. We view ACGL's upside CAGR scenario as $48 based on 1.4x our 2012E BV of $35, N/A near the high end of its historical range since the N/A financial crisis. N/A N/A Downside case USD 34.00
Investment case Why a 1-Overweight? We view ACGL as one of the best managed P&C franchises, with a balanced presence in both primary commercial insurance and reinsurance. ACGL has a strong management and its impressive track record of book value growth and ROEs should continue in our view.
Similar to other P&C insurers, Arch capital faces risks from a return to a soft P&C market, catastrophes and other large losses, and rising interest rates. We view ACGL's downside case as $34 (1.0x 2012E BV of $35), which is near the low end of its historical range.
Average Upside/downside scenarios 1.1 1.1 62 53 1.1 34.00 44 15.4 ( - 10.2% ) 36 0.0 Downside 27 7.6 Case 18 7.4 12- Apr- 12 8.4 13- Apr- 11
Source: FactSet Fundamentals
48.00 ( 26.8% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
215
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
CAGR N/A N/A N/A N/A N/A Upside case USD 82.00 N/A Upside to our price target exists if the pace of share buybacks is faster or if P&C pricing continues to CAGR improve. We view TRV's upside scenario as $82 N/A based on our 1.2x 2012E BV of $67, which is near the N/A high end of TRV's valuation range since the financial N/A crisis. N/A Downside case USD 57.00 Downside exists if P&C pricing softens or if there is greater than anticipated deterioration in underlying underwriting results. We view TRV's downside case as $57 (0.9x 2012E BV of $67), at the low end of TRV's historical range since the financial crisis.
Investment case Why a 1-Overweight? TRV shares are attractively valued in our view given the companys strong balance sheet and solid ROE. TRV has one of the strongest P&C franchises in the sector and appears to be well capitalized. We view TRV as being more aggressive than competitors in its efforts to raise commercial P&C insurance rates.
Average 0.9 Upside/downside scenarios 1.1 1.0 106 13.1 88 57.00 3.1 70 ( - 3.6% ) 53 7.6 Downside 35 8.6 Case 18 N/A
13- Apr- 11 12- Apr- 12
Source: FactSet Fundamentals
82.00 ( 38.7% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
216
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
2011A 2012E 2013E 2014E N/A N/A N/A N/A 4,725 4,200 4,200 N/A 248 1,635 1,325 N/A 10,775 13,504 14,370 N/A 10,254 13,504 14,370 N/A 29.0 29.0 N/A 29.8 99.6 95.5 96.3 N/A 100.4 98.1 98.9 N/A CAGR N/A N/A N/A N/A N/A N/A N/A N/A
4.35 5.45 5.80 0.00 0.00 0.00 66.57 76.02 83.72 45.08 54.53 62.23 2,474.2 2,476.2 2,476.2 59.44 64.80 70.61
CAGR N/A N/A N/A N/A USD 103.00 N/A Upside case Berkshire could benefit if the P&C insurance market N/A hardens, the economy improves or equity markets rise. We view Berkshire's upside case as $103 based CAGR on 1.4x 2012E BV of $76, near its historical high N/A valuation since the financial crisis. N/A N/A Downside case USD 70.00 N/A Berkshire faces risks from declining equity markets, deterioration in the economy or soft P&C pricing. We Average view Berkshire's downside risk as $70 based on 0.9x N/A 2012E BV of $76, its all-time historical low valuation. 3.4 20.8 Upside/downside scenarios Average 130 1.1 111 1.5 70.00 92 ( - 12.6% ) 1.2 74 Downside 15.6 56 Case 37 0.0 7.2 13- Apr- 11 12- Apr- 12 8.3 Source: FactSet Fundamentals 9.2
103.00 ( 28.7% )
Investment case Why a 1-Overweight? Led by Warren Buffett, we expect Berkshire Hathaway to generate impressive results in Manufacturing, Service & Retail, as well as the Burlington Northern railroad operations, with stable results in Insurance (Berkshires largest business) and Utilities, with perhaps volatile investment results.
Upside Case
16 April 2012
217
COMPANY SNAPSHOT
Chubb Corp.
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 11,758 12,254 12,884 N/A Net investment income (NII) ($mn) 1,562 1,512 1,512 N/A Underwriting income ($mn) 574 803 712 N/A Operating income ($mn) 1,491 1,597 1,538 N/A Net income ($mn) 1,678 1,597 1,538 N/A 23.4 22.9 N/A Tax rate (%) 22.0 Combined ratio (%) 95.3 93.2 94.1 N/A Combined ratio (ex cats & py development) (%) 93.0 93.7 93.8 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
Investment case Why a 1-Overweight? CB has a strong franchise evidenced by robust underwriting results, excess CAGR capital and redundant loss reserves. N/A USD 93.00 N/A Upside case N/A Upside to our price target could exist if share N/A buybacks or reserve releases accelerate, or if P&C N/A pricing continues to improve . We view CB's upside N/A scenario as $93 based on 1.6x 2012E BV of $60, which is near the high of its valuation range since the financial crisis. CAGR N/A Downside case USD 62.00 N/A Our price target could have downside risk if there is a N/A significant slowdown in reserve releases or P&C N/A pricing softens. We view CB's downside case as $62 (1.0x 2012E BV of $60), which is the low end of its Average historical range. 0.9 4.0 Upside/downside scenarios 18.8
113 Average 94 1.2 62.00 75 ( - 12.1% ) 1.2 56 1.3 Downside 38 Case 12.5 19 2.3 13- Apr- 11 12- Apr- 12 10.3 Source: FactSet Fundamentals 10.9 N/A Book Value and ROE
$75 $60 $45 $30 $15 $0 2010A 2011A BVPS 2012E 2013E Operating ROE
85.00 ( 20.6% ) Price Target 93.00 ( 31.9% )
Upside Case
16% 12% 8% 4% 0%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
218
COMPANY SNAPSHOT
PartnerRe Ltd.
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 3,689 3,883 4,178 N/A Net investment income (NII) ($mn) 629 630 630 N/A Underwriting income ($mn) -974 267 179 N/A Operating income ($mn) -642 511 427 N/A Net income ($mn) -520 576 492 N/A 13.0 13.0 N/A Tax rate (%) -3.4 Combined ratio (%) 125.4 93.0 95.6 N/A Combined ratio (ex cats & py development) (%) 94.9 95.7 95.4 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
-9.50 8.10 7.50 2.35 2.48 2.75 84.82 96.23 104.71 75.85 86.17 93.65 67.6 63.1 56.9 77.94 86.15 93.62
16,630 16,892 17,020 750 750 750 5,574 5,637 5,582 616 532 573
Investment case Why a 1-Overweight? PREs results are challenged recently due to large catastrophe lines, however, PRE CAGR benefits from its diversified operations in terms of N/A product lines and geography, conservative N/A management, and AA-rated balance sheet. N/A USD 86.00 N/A Upside case PRE could benefit from higher property catastrophe N/A N/A reinsurance rates. We view PRE's upside scenario as $86 based on 0.9x 2012E BV of $96, which is near the low end of PRE's valuation range since the financial CAGR crisis. N/A N/A Downside case USD 60.00 N/A PartnerRe faces risks from a return to a soft N/A property/casualty market, catastrophes and other large losses, rising interest rates, and changes to Average Bermuda tax advantage. We view PRE's downside 0.7 case as $60, (0.6x 2012E BV of $96), which is at the 3.8 low end of PRE's historical range. 13.9 Upside/downside scenarios Average 0.7 86.00 106 77.00 0.8 ( 27.2% ) 88 ( 13.9% ) 60.00 0.8 71 ( - 11.3% ) 8.7 Upside Price 53 Downside Case Target 3.7 35 Case 2.4 18 13- Apr- 11 12- Apr- 12 2.4 4.0 Source: FactSet Fundamentals Book Value and ROE
$120 $100 $80 $60 $40 $20 $0 2010A 2011A BVPS 2012E 2013E Operating ROE 15% 10% 5% 0% -5% -10% -15%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
219
COMPANY SNAPSHOT
XL Group plc
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 5,796 6,050 6,354 N/A Net investment income (NII) ($mn) 1,138 1,082 1,082 N/A Underwriting income ($mn) -397 148 144 N/A Operating income ($mn) 89 646 636 N/A Net income ($mn) -475 646 636 N/A 13.0 13.0 N/A Tax rate (%) -14.2 Combined ratio (%) 107.5 97.4 97.5 N/A Combined ratio (ex cats & py development) (%) 98.5 96.2 95.4 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
CAGR N/A N/A N/A N/A N/A Upside case USD 28.00 N/A XL could benefit from higher US property catastrophe reinsurance rates resulting from large cat losses and CAGR changes to the RMS model. We view XL's upside N/A scenario as $28 based on 0.9x 2012E BV of $33, N/A which is near the high end of its valuation range since N/A the financial crisis. N/A Downside case USD 18.00 XL could face risks if P&C prices soften and interest rate rises. We view XL's downside case as $18 (0.6x 2012E BV of $33), which is at the low end of XL's historical range since the financial crisis.
Investment case Why a 1-Overweight? XL's P&C business has stabilized and its capital position is strengthening. While managements expectation for substantial ROE improvement from current levels could be overly optimistic, we believe the companys reserve position is strong, meaningful share buybacks could continue, and the valuation is attractive.
Average Upside/downside scenarios 0.7 0.7 35 0.7 30 32.2 25 18.00 ( - 16.2% ) 20 2.2 Downside 15 4.8 Case 10 5.0 13Apr11 12Apr12 N/A
Source: FactSet Fundamentals
28.00 ( 30.4% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
220
COMPANY SNAPSHOT
RenaissanceRe Holdings
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 1,013 1,134 1,254 N/A Net investment income (NII) ($mn) 118 140 120 N/A Underwriting income ($mn) -177 490 462 N/A Operating income ($mn) -162 422 373 N/A Net income ($mn) -92 422 373 N/A 1 1 N/A Tax rate (%) 1 Combined ratio (%) 118.6 55.9 61.3 N/A Combined ratio (ex cats & py development) (%) 46.9 51.2 51.1 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
-3.22 8.15 7.50 1.04 1.08 1.12 59.27 66.84 72.66 58.45 66.00 71.78 51 52 50 59.05 65.94 71.71
6,359 6,538 6,973 354 354 354 3,055 3,381 3,500 459 508 254
CAGR N/A N/A N/A N/A USD 90.00 N/A Upside case N/A RNR could benefit from higher US property catastrophe reinsurance rates although it is unclear how long this could last. We view RNR's upside CAGR scenario as $90 based on 1.3x 2012E BV of $67, N/A which is near the high end of its range since the N/A financial crisis. N/A N/A Downside case USD 74.00
Investment case Why a 2-Equal Weight? Renaissance Re is a disciplined property catastrophe reinsurer with a growing presence in specialty reinsurance and Lloyds. The company has one of the best long-term track records in terms of both book value per share growth and returns on equity.
Risks include a softening in property cat reinsurance pricing, large cat losses, adverse development on cat losses and volatile investment returns. We view RNR's downside case as $74 (1.1x 2012E BV of $68), near the low end of its valuation range since the financial crisis.
Average 1.1 Upside/downside scenarios 1.2 119 1.2 105 9.6 74.00 90 ( - 1.6% ) 1.4 75 6.3 60 Downside 6.4 Case 45 N/A
13- Apr- 11 12- Apr- 12
Source: FactSet Fundamentals
90.00 ( 19.7% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
221
COMPANY SNAPSHOT
Everest Re Group
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 4,109 4,232 4,408 N/A Net investment income (NII) ($mn) 620 660 620 N/A Underwriting income ($mn) -774 95 79 N/A Operating income ($mn) -94 606 550 N/A Net income ($mn) -80 606 550 N/A 15.0 15.0 N/A Tax rate (%) 61.1 Combined ratio (%) 118.9 97.7 98.2 N/A Combined ratio (ex cats & py development) (%) 87.1 90.1 90.6 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
15,250 16,030 17,116 818 818 818 6,071 6,675 7,024 781 1,085 660
CAGR N/A N/A N/A N/A N/A Upside case USD 108.00 N/A RE could benefit if EPS and book value growth is better than anticipated or from international growth CAGR and underwriting results. We view RE's upside N/A scenario as $108 based on 0.9x 2012E BV of $127, N/A which is near the high end of RE's valuation since the N/A financial crisis. N/A Downside case USD 90.00 RE faces risks from a return to a soft P&C market, catastrophes and other large losses, rising interest rates, and the risk of reserve strengthening. We view RE's downside case as $90, (0.7x 2012E BV of $127), which is at the low end of of RE's valuation since the financial crisis.
Investment case Why a 2-Equal Weight? Everest Res operating performance has been uneven in our view driven by the impact of large catastrophe losses as well as underwriting losses in its primary insurance business. The company has over $5 bn in capital, which gives it enough scale to effectively compete as a global reinsurer.
Average 0.8 Upside/downside scenarios 0.8 0.8 138 8.6 121 2.0 90.00 104 ( - 4.5% ) 5.3 86 5.8 Downside 69 Case N/A 52
13- Apr- 11 12- Apr- 12
108.00 ( 14.5% )
Upside Case
Source: FactSet Fundamentals Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
222
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
4.63 7.00 6.00 0.75 1.50 1.60 80.11 88.84 94.20 71.91 80.11 85.12 39.7 37.8 36.2 79.74 86.52 91.79
7,389 8,058 8,899 798 798 798 3,149 3,281 3,344 819 995 548
CAGR N/A N/A N/A N/A N/A Upside case USD 80.00 N/A AWH could benefit from better than expected EPS and book value growth. We view AWH's upside CAGR scenario as $80 based on 0.9x 2012E BV of $89, N/A which is near the high end of AWH's valuation range N/A since the financial crisis. N/A N/A Downside case USD 66.00
Investment case Why a 2-Equal Weight? Allied World has delivered consistently strong results since its 2001 inception. The company has a growing franchise in commercial P&C insurance and reinsurance, and is building an onshore primary insurance platform. However, we are concerned about the sustainability of loss reserve releases.
Soft casualty insurance and reinsurance pricing could present headwinds for AWH in terms of premium growth and combined ratio improvement. We view AWH's downside case as $66, (0.7x 2012E BV of $89), which is at the low end of AWH's historical range.
Average 0.8 Upside/downside scenarios 0.9 107 0.8 91 66.00 12.1 76 ( - 4.7% ) 1.8 61 6.9 Downside 46 Case 7.0 30 7.9
13- Apr- 11 12- Apr- 12
Source: FactSet Fundamentals
80.00 ( 15.5% )
Upside Case
16 April 2012
223
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
-1.26 3.00 2.75 0.60 0.60 0.60 38.43 41.26 44.36 38.16 40.98 44.23 70.7 72.4 69.1 32.58 35.11 37.86
6,035 6,617 7,324 499 499 499 2,818 2,884 2,935 723 807 344
CAGR N/A N/A N/A N/A N/A Upside case USD 33.00 N/A AHL could benefit from higher US property catastrophe reinsurance rates resulting from large cat CAGR losses and changes to the RMS model. We view N/A AHL's upside scenario as $33 based on 0.8x 2012E N/A BV of $41, which is within its valuation range since N/A the financial crisis. N/A Downside case USD 25.00 AHL could be impacted by soft insurance and reinsurance P&C market conditions or large catastrophe losses. We view AHL's downside case as $25 (0.6x 2012E BV of $41), which is at the low end of AHL's historical range.
Investment case Why a 2-Equal Weight? Aspen has a strong franchise in the U.K., U.S., and Bermuda commercial insurance and reinsurance markets. Over the past several years, the company has a good track record of returning excess capital to shareholders in the form of share repurchases, and presently appears to have little appetite for large acquisitions.
Average 0.7 Upside/downside scenarios 0.7 43 0.8 38 9.8 25.00 33 2.1 ( - 10.7% ) 27 3.7 22 Downside 3.8 16 Case 3.2
13- Apr- 11 12- Apr- 12
Source: FactSet Fundamentals
33.00 ( 17.9% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
224
COMPANY SNAPSHOT
Montpelier Re Holdings
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 624 576 617 N/A Net investment income (NII) ($mn) 69 68 68 N/A Underwriting income ($mn) -193 48 37 N/A Operating income ($mn) -154 97 85 N/A Net income ($mn) -124 97 85 N/A 0.0 0.0 N/A Tax rate (%) 0.4 Combined ratio (%) 129.4 91.8 93.8 N/A Combined ratio (ex cats & py development) (%) 83.5 84.2 78.8 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
-2.50 1.65 1.50 0.41 0.45 0.49 22.71 24.13 25.35 22.71 24.13 25.35 61.8 58.8 56.8 22.77 24.20 25.42
2,850 2,970 3,122 328 328 328 1,399 1,420 1,428 120 152 167
Investment case Why a 2-Equal Weight? Montpelier Re has a strong presence in property catastrophe reinsurance while CAGR expanding to become a diversified, specialty insurer N/A and reinsurer. As part of this strategy, MRH has built N/A out its Lloyds and U.S. primary insurance platforms. N/A USD 22.00 N/A Upside case MRH could benefit from higher US property N/A N/A catastrophe reinsurance rates although it is unclear how long this could last. We view MRH's upside scenario as $22 based on 0.9x 2012E BV of $24, CAGR which is near the high end of MRH's valuation since N/A the financial crisis. N/A N/A Downside case USD 18.00 N/A Risks include large catastrophe losses, soft prepricing, as well as execution risk as the company Average begins to diversify. We view MRH's downside case as 0.4 $18 (0.7x 2012 BV of $24), which is the low end of 2.3 MRH's historical range since the financial crisis. 25.2 Upside/downside scenarios Average 0.8 22.00 26 20.00 0.8 ( 13% ) 23 18.00 ( 2.7% ) 0.8 ( - 7.6% ) 20 12.4 Upside 16 Price Downside Case 2.3 Target 13 Case 0.9 10 12- Apr- 12 0.9 13- Apr- 11 N/A Source: FactSet Fundamentals Book Value and ROE
$26 $25 $24 $23 $22 $21 2010A 2011A BVPS 2012E 2013E 15% 10% 5% 0% -5% -10% -15%
Operating ROE
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
225
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
-3.98 0.75 0.70 0.16 0.16 0.16 10.90 11.47 11.86 10.90 11.47 11.86 70.1 70.4 70.4 11.08 11.65 12.04
1,524 1,277 1,042 251 251 251 789 831 869 -140 -247 -235
Investment case Why a 2-Equal Weight? The company has a global property reinsurance platform in our view. However, CAGR we are concerned FSRs franchise will be increasingly N/A dependant on retrocessional support, which could N/A limit its growth opportunities. N/A USD 10.00 N/A Upside case FSR could benefit from higher US property cat N/A N/A reinsurance rates resulting from large cat losses although it is unclear how long this could last. We view FSR's upside case as $10 (0.9x 2012E BV of CAGR $11), which is near the high end of FSR's valuation N/A range since the financial crisis. N/A N/A Downside case USD 7.00 N/A Risk include the softening in property catastrophe reinsurance pricing. We view FSR's downside case as Average $7 (0.6x 2012E BV of $11), which is towards the low 0.8 end of FSR's historical range. 2.0 23.0 Upside/downside scenarios Average 12 0.7 10 0.7 7.00 9 ( - 6.5% ) 0.6 7 Downside 10.3 5 Case 2.1 3 -5.6 13- Apr- 11 12- Apr- 12 -5.5 Source: FactSet Fundamentals -6.3 Book Value and ROE
$20 $15 $10 $5 $0 2010A 2011A BVPS 2012E 2013E Operating ROE 10% 0% -10% -20% -30% -40%
10.00 ( 33.5% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
226
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
0.51 0.90 0.80 1.84 0.84 1.05 10.53 10.59 10.34 10.53 10.59 10.34 94.8 95.1 95.0 10.65 10.71 10.45
2,651 2,550 2,466 270 270 270 1,000 1,006 982 -21 16 -118
Investment case Why a 2-Equal Weight? OB appears positioned to return excess capital to shareholders, although CAGR earnings power is compressed as a result of reduced N/A premium volume, underwriting losses from run-off N/A business are a risk, and valuation appears extended. N/A USD 18.00 N/A Upside case OB could benefit if it seeks strategic alternatives after N/A N/A selling half its business. We view OB's upside scenario as $18 based on 1.7x 2012E BV of $11, which is near the high end of OB's valuation range CAGR since the financial crisis. N/A N/A Downside case USD 13.00 N/A Risks include the soft primary P&C market conditions N/A and potential run-off losses. We view OB's downside case as $13 (1.2x 2012E BV of $11), which is near the Average low end of OB's historical range since the financial 1.0 crisis. 2.7 21.3 Upside/downside scenarios Average 23 1.4 20 1.4 13.00 17 ( - 12.2% ) 14 1.4 11 Downside 21.3 Case 8 8.4 7.5 13- Apr- 11 12- Apr- 12 7.4 Source: FactSet Fundamentals 6.8 Book Value and ROE
$12.5 $12.0 $11.5 $11.0 $10.5 $10.0 $9.5 2010A 2011A BVPS 2012E 2013E Operating ROE 10% 8% 6% 4% 2% 0%
18.00 ( 21.5% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
227
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
Investment case Why a 1-Overweight? MMC appears among the best positioned of the insurance brokers to generate positive operating leverage in each of its businesses over the next few years even in a slow-growth macro environment. Upside case USD 43.00 MMC could benefit if P&C prices increase or the economy recovers faster than anticipated. We view MMCs upside scenario as $43 based on 20x 2012E EPS of $2.15, which is near the high end of MMC's valuation since the financial crisis. Downside case USD 28.00 Downside exists if pricing in commercial P&C and reinsurance deteriorates. We view MMC's downside scenario as $28 based on 13x 2012E EPS of $2.15, which is at the low end of MMC's historical range since the financial crisis. Upside/downside scenarios
43.00 ( 34.3% )
33.0
31.9
30.5
Average N/A 31.8 Average 15.4 N/A N/A 2.9 12.6 N/A
52 43 35 26 17 9 13- Apr- 11
Upside Case
11- Apr- 12
Adjusted EPS
$3.00 $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 2010A 2011A EPS 2012E 2013E % change 25% 20% 15% 10% 5% 0%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
228
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
Investment case Why a 1-Overweight? Willis is a pure-play insurance broker with a strong international franchise that should benefit from improved P&C prices. Recent results have been challenged although a recovery could be evident by late 2012. Upside case USD 46.00 WSH could benefit if P&C prices improve or the economy recovers. We view WSH's upside scenario as $46 based on 16x 2012E EPS of $2.90, which is near the high end of its historical range since the financial crisis. Downside case USD 34.00 Risks include weak P&C pricing environment, slow exposure growth, reduced opportunities to reduce expenses and slowdown in new business. We view WSHs downside case as $34 (12x 2012E EPS of $2.90), which is the low end of its historical range since the financial crisis. Upside/downside scenarios
56 50 44 38 31 25 13- Apr- 11
46.00 ( 30.1% )
48.5
46.4
44.1
N/A
Upside Case
11- Apr- 12
Adjusted EPS
$3.40 $3.20 $3.00 $2.80 $2.60 $2.40 2010A 2011A EPS 2012E 2013E % change 12% 10% 8% 6% 4% 2% 0% -2%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
229
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
Investment case Why a 1-Overweight? AJG's Insurance Brokerage revenues and margins could improve modestly in 2012 if the economy improves, although the stocks valuation appears expensive versus peers. However, AJGs valuation multiple appears poised to expand as P&C prices rise. Also, the companys dividend yield is robust. Upside case USD 43.00 AJG could benefit if P&C prices or the economy improves. We view AJG's upside scenario as $43 based on 24x 2012E EPS of $1.80, which is near the high end of its valuation range since the financial crisis. Downside case USD 31.00 Risk include the potential for pricing in commercial P&C and reinsurance to deteriorate and margin expansion could be challenging to achieve if organic growth is negative. We view AJG's downside case as $31 (17x 2012 EPS of $1.80, which is the low end of its historical range. Upside/downside scenarios
55 46 37 28 18 9 13- Apr- 11
43.00 ( 22.6% )
35.2
34.3
33.0
N/A
Upside Case
11- Apr- 12
Adjusted EPS
$2.50 $2.00 $1.50 $1.00 $0.50 $0.00 2010A 2011A EPS 2012E 2013E % change 60% 40% 20% 0% -20% -40%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
230
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
Investment case Why a 1-Overweight? Our 1-Overweight rating on BRO reflects our outlook for sustained improvement in organic growth as the economy recovers, as well as modest margin expansion that should result in EPS growth. Improved P&C pricing will also lead to stronger EPS growth and improved margins. Upside case USD 30.00 BRO could benefit as P&C pricing increases or if the economy recovers. We view BRO's upside scenario as $30 based on 23x our 2012E EPS of $1.30, which is near the high end of BRO's valuation since the financial crisis. Downside case USD 21.00 Risks to our thesis include reduced top line growth due to a weak economy and the potential for P&C pricing increases to slow. We view BRO's downside case as $21 (16x 2012E EPS of $1.30), which is towards the low end of BRO's historical range. Upside/downside scenarios
39 32 26 20 13 6 13- Apr- 11
30.00 ( 25.4% )
13.2
12.6
11.7
N/A
Upside Case
11- Apr- 12
Adjusted EPS
$2.00 $1.50 $1.00 $0.50 $0.00 2010A 2011A EPS 2012E 2013E % change 20% 15% 10% 5% 0% -5%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
231
COMPANY SNAPSHOT
Aon Corporation
Income statement Revenue ($mn) Brokerage organic growth (%) EBITDA ($mn) EBIT ($mn) Pre-tax income ($mn) Net income (adj) ($mn) Net income ($mn) . Salaries and benefits (% revenue) Other operating expenses (% revenue) .. EBITDA margin (%) EBIT margin (%) Pre-tax margin (%) Net margin (%) Per share data EPS (adj) EPS (reported) ($) Diluted shares (mn) DPS ($) Balance sheet and cash flow ($mn) Cash and equivalents Short and long-term debt Net debt/(funds) Shareholders' equity Tangible equity Total invested capital Cash flow from operations Balance sheet metrics Total debt/capital (%) Valuation metrics P/E (reported) (x) EV/EBITDA (x) Price/cash EPS Dividend yield (%) ROIC (operating) Net ROE (operating) 2011A 2012E 2013E 2014E 11,287 11,969 12,754 N/A N/A N/A N/A N/A 2,432 2,609 2,774 N/A 1,850 1,978 2,178 N/A 1,605 1,738 1,918 N/A N/A 1,122 1,198 1,326 1,010 1,162 1,340 N/A CAGR N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
Investment case Why a 2-Equal Weight? We expect AON to benefit from higher P&C prices, but we see a longer road to achieve improved organic growth and margin expansion compared to the other insurance brokers. Upside case USD 55.00 AON could benefit if the economy or P&C prices improve. We view AONs upside scenario as $55 based on 15x 2012E EPS of $3.60 which, is near the high end of AONs valuation since the financial crisis. Downside case USD 44.00 Risk include execution risks related to Hewitt acquisition, P&C prices could deteriorate, and a sluggish economy. We view AON's downside case as $44 (12x 2012E EPS of $3.60), which is the low end of its historical range since the financial crisis. Upside/downside scenarios
68 60 52 45 38 30 13- Apr- 11
55.00 ( 13.4% )
272 272 272 4,492 4,492 4,107 4,220 4,220 3,835 8,120 8,517 9,169 -3,926 -3,529 -2,877 12,612 13,009 13,276 1,018 1,624 1,764
Upside Case
35.6
34.5
30.9
N/A
11- Apr- 12
Adjusted EPS
$5 $4 $3 $2 $1 $0 2010A 2011A EPS 2012E 2013E % change 14% 12% 10% 8% 6% 4% 2% 0%
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
232
COMPANY SNAPSHOT
Progressive Corp.
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 15,147 16,082 17,030 N/A Net investment income (NII) ($mn) 466 444 454 N/A Underwriting income N/A N/A N/A N/A Operating income ($mn) 947 879 918 N/A Net income ($mn) 1,016 930 918 N/A 31.8 31.6 N/A Tax rate (%) 31.6 Combined ratio (%) 93.0 93.9 94.0 N/A Combined ratio (ex cats & py development) (%) 93.8 93.7 94.0 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
1.49 1.45 1.55 0.44 0.42 0.43 9.47 10.49 11.20 N/A N/A N/A 636.9 608.1 591.2 8.99 9.67 8.36
15,171 15,834 17,654 2,442 2,080 2,080 5,807 6,226 6,490 N/A 2,703 1,498
Investment case Why a 1-Overweight? We view PGR as one of the best-run companies in the P&C insurance industry as CAGR evidenced by its focused and differentiated auto N/A insurance product offerings, consistent earnings, and N/A superior ROE. N/A USD 28.00 N/A Upside case PGR could benefit if the personal auto market N/A N/A tightens, auto insurance prices rise, or loss cost inflation is lower than anticipated. We view PGR's upside scenario as $28 based on 3x 2012E BV of CAGR $10.49, which is at the high end of PGR's valuation N/A range since the financial crisis. N/A N/A Downside case USD 20.00 N/A PGR could be impacted if loss frequency trends rise as the impact of the recession eases, although we Average have yet to see this trend. We view PGR's downside 2.8 case as $20 (2x 2012E BV of $10.49), which is at the 3.0 low end of PGR's historical range since the financial 26.3 crisis. Average Upside/downside scenarios 2.2 38 N/A 33 2.5 20.00 27 15.1 ( - 11.5% ) 22 1.9 16 Downside N/A Case 11 17.3 11- Apr- 12 15.0 13- Apr- 11
Source: FactSet Fundamentals
28.00 ( 23.9% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
233
COMPANY SNAPSHOT
Allstate Corp.
Income statement 2011A 2012E 2013E 2014E Net written premiums ($mn) 25,980 26,906 28,058 N/A Net investment income (NII) ($mn) 1,201 1,200 1,215 N/A Underwriting income ($mn) -874 992 715 N/A Operating income ($mn) 689 1,876 1,742 N/A Net income ($mn) 788 1,876 1,742 N/A 28.9 28.2 N/A Tax rate (%) 14.7 Combined ratio (%) 103.4 96.3 97.4 N/A Combined ratio (ex cats & py development) (%) 89.2 90.1 88.4 N/A Per share data ($) EPS (reported) DPS BVPS BVPS (tangible) Diluted shares (mn) BVPS (ex unrealized gains/losses) Balance sheet and cash flow ($mn) Total investments Total debt Common shareholders' equity Cash flow from operations Balance sheet metrics Premiums/surplus (s'holders' equity) (%) P/T investment yield (%) Total debt/capital (%) Valuation metrics Price/BV (x) Price/BV (tangible) (x) Price/BV (ex unrealized gains/losses) (x) P/E (reported) (x) Dividend yield (%) ROE (operating) (%) ROE (operating ex AOCI) (%) ROE (%) CAGR N/A N/A N/A N/A N/A N/A N/A N/A
U.S. Insurance/Non-Life
CAGR N/A N/A N/A N/A USD 37.00 N/A Upside case N/A ALL could benefit if ALL Financial's ROE improves, if loss cost trends remain favorable, or if PIF improves. We view ALL's upside scenario as $37 based on 0.9x CAGR 2012E BV of $40, which is near the high end of ALL's N/A valuation range since the financial crisis. N/A N/A Downside case USD 29.00 N/A Downside exists if interest rates rise and credit spreads widen. The company has substantial Average exposure to catastrophe losses, owing to its large 2.2 homeowners insurance business. We view ALL's 3.2 downside as $29 (0.7x 2012E BV of $40), which is at 23.6 the low end of ALL's historical range. Average Upside/downside scenarios 0.8 50 0.9 43 0.9 29.00 36 ( - 11.8% ) 14.1 29 2.7 Downside 21 7.5 Case 14 8.1 12- Apr- 12 N/A 13- Apr- 11
Source: FactSet Fundamentals
Investment case Why a 2-Equal Weight? Why a 2-Equal Weight? Allstates balance sheet strength has improved from the depths of the financial crisis, although we remain concerned about the loss of auto market share to direct writers in ALLs existing business and the potential for loss cost trends to deteriorate.
37.00 ( 12.6% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
234
COMPANY SNAPSHOT
U.S. Insurance/Non-Life
0.32 4.00 3.75 1.13 1.20 1.20 55.57 58.76 61.36 51.46 54.66 57.60 45.8 46.0 46.0 52.16 54.43 57.03
7,256 8,328 9,558 911 923 923 2,510 2,654 2,772 222 1,071 1,231
CAGR N/A N/A N/A N/A N/A Upside case USD 46.00 N/A THG could benefit if it generates better than expected P&C ROE or accretion from the Chaucer acquisition is CAGR higher than expected. We view THG's upside N/A scenario as $46 based on 0.8x 2012E BV of $59, N/A which reflects concerns over the Chaucer acquisition. N/A N/A Downside case USD 38.00
Investment case Why a 2-Equal Weight? Why a 2-Equal Weight? THG has opportunities to improve its ROE over time by deploying excess capital and leveraging its expense base, but it is unclear to us how long this could take. The Chaucer acquisition increases its exposure to high severity business and expands THGs business outside its core capabilities.
Risks include THG catastrophe exposure, economic pressures, and entry into the international market through its acquisition of Chaucer. We view THG's downside case as $38 (0.6x 2012E BV of $59), which is towards the low end of THG's historical range since the financial crisis.
Average 0.7 Upside/downside scenarios 0.7 59 0.7 52 48.7 38.00 44 ( - 5.4% ) 2.9 37 4.7 Downside 30 5.0 Case 22 N/A
13- Apr- 11 12- Apr- 12
Source: FactSet Fundamentals
46.00 ( 14.6% )
Upside Case
Source: Company data, Barclays Research Source: Company data, Barclays Research Note:FY end Dec
16 April 2012
235
16 April 2012
236
ANALYST(S) CERTIFICATION(S)
We, Jay Gelb, CFA and Sarah DeWitt, CFA, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.
The Corporate and Investment Banking division of Barclays produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.
Primary Stocks (Ticker, Date, Price)
ACE Limited (ACE, 12-Apr-2012, USD 73.02), 1-Overweight/1-Positive Allied World Assurance Co. (AWH, 12-Apr-2012, USD 69.26), 2-Equal Weight/1-Positive Allstate Corp. (ALL, 12-Apr-2012, USD 32.87), 2-Equal Weight/1-Positive Aon Corporation (AON, 12-Apr-2012, USD 48.50), 2-Equal Weight/1-Positive Arch Capital Group Ltd. (ACGL, 12-Apr-2012, USD 37.86), 1-Overweight/1-Positive Arthur J. Gallagher & Co. (AJG, 12-Apr-2012, USD 35.07), 1-Overweight/1-Positive Aspen Insurance Holdings (AHL, 12-Apr-2012, USD 27.99), 2-Equal Weight/1-Positive Berkshire Hathaway Inc. (BRK.A, 12-Apr-2012, USD 120173.00), 1-Overweight/1-Positive Berkshire Hathaway Inc. (BRK.B, 12-Apr-2012, USD 80.06), 1-Overweight/1-Positive Brown & Brown, Inc. (BRO, 12-Apr-2012, USD 23.92), 1-Overweight/1-Positive Chubb Corp. (CB, 12-Apr-2012, USD 70.51), 1-Overweight/1-Positive Everest Re Group (RE, 12-Apr-2012, USD 94.29), 2-Equal Weight/1-Positive Flagstone Reinsurance Holdings Ltd. (FSR, 12-Apr-2012, USD 7.49), 2-Equal Weight/1-Positive Marsh & McLennan Cos. (MMC, 12-Apr-2012, USD 32.02), 1-Overweight/1-Positive Montpelier Re Holdings (MRH, 12-Apr-2012, USD 19.47), 2-Equal Weight/1-Positive OneBeacon Insurance Group (OB, 12-Apr-2012, USD 14.81), 2-Equal Weight/1-Positive PartnerRe Ltd. (PRE, 12-Apr-2012, USD 67.61), 1-Overweight/1-Positive Progressive Corp. (PGR, 12-Apr-2012, USD 22.59), 1-Overweight/1-Positive RenaissanceRe Holdings (RNR, 12-Apr-2012, USD 75.19), 2-Equal Weight/1-Positive The Hanover Insurance Group (THG, 12-Apr-2012, USD 40.15), 2-Equal Weight/1-Positive The Travelers Companies, Inc. (TRV, 12-Apr-2012, USD 59.10), 1-Overweight/1-Positive Willis Group Holdings Ltd. (WSH, 12-Apr-2012, USD 35.36), 1-Overweight/1-Positive XL Group plc (XL, 12-Apr-2012, USD 21.47), 1-Overweight/1-Positive
Materially Mentioned Stocks (Ticker, Date, Price)
AFLAC INC (AFL, 12-Apr-2012, USD 44.21), 1-Overweight/1-Positive MetLife Inc. (MET, 12-Apr-2012, USD 36.34), 1-Overweight/1-Positive Prudential Financial Inc. (PRU, 12-Apr-2012, USD 61.40), 1-Overweight/1-Positive
16 April 2012
237
The Corporate and Investment Banking Division of Barclays Bank PLC is acting as corporate broker to Catlin Group Ltd.
Guide to the Barclays Fundamental Equity Research Rating System:
Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the "sector coverage universe"). In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.
Stock Rating 1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon. 2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12month investment horizon. 3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon. RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where the Corporate and Investment Banking Division of Barclays is acting in an advisory capacity in a merger or strategic transaction involving the company. Sector View 1-Positive - sector coverage universe fundamentals/valuations are improving. 2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating. 3-Negative - sector coverage universe fundamentals/valuations are deteriorating.
Below is the list of companies that constitute the "sector coverage universe":
U.S. Insurance/Life
AFLAC INC (AFL) Delphi Financial Group (DFG) MetLife Inc. (MET) Prudential Financial Inc. (PRU) Torchmark Corp. (TMK)
U.S. Insurance/Non-Life
American International Group (AIG) Hartford Financial Services Group (HIG) Principal Financial Group (PFG) Reinsurance Group of America (RGA) Unum Group (UNM)
Ameriprise Financial (AMP) Lincoln National (LNC) Protective Life Corp. (PL) Symetra Financial Corp. (SYA)
ACE Limited (ACE) Aon Corporation (AON) Aspen Insurance Holdings (AHL) Brown & Brown, Inc. (BRO) Flagstone Reinsurance Holdings Ltd. (FSR) OneBeacon Insurance Group (OB) RenaissanceRe Holdings (RNR) Willis Group Holdings Ltd. (WSH)
Distribution of Ratings:
Allied World Assurance Co. (AWH) Arch Capital Group Ltd. (ACGL) Berkshire Hathaway Inc. (BRK.A) Chubb Corp. (CB) Marsh & McLennan Cos. (MMC) PartnerRe Ltd. (PRE) The Hanover Insurance Group (THG) XL Group plc (XL)
Allstate Corp. (ALL) Arthur J. Gallagher & Co. (AJG) Berkshire Hathaway Inc. (BRK.B) Everest Re Group (RE) Montpelier Re Holdings (MRH) Progressive Corp. (PGR) The Travelers Companies, Inc. (TRV)
Barclays Equity Research has 2280 companies under coverage. 42% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 54% of companies with this rating are investment banking clients of the Firm. 42% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 49% of companies with this rating are investment banking clients of the Firm. 13% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 38% of companies with this rating are investment banking clients of the Firm.
16 April 2012
238
Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock will trade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's price target over the same 12-month period. Barclays offices involved in the production of equity research: London Barclays Bank PLC (Barclays, London) New York Barclays Capital Inc. (BCI, New York) Tokyo Barclays Capital Japan Limited (BCJL, Tokyo) So Paulo Banco Barclays S.A. (BBSA, So Paulo) Hong Kong Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong) Toronto Barclays Capital Canada Inc. (BCCI, Toronto) Johannesburg Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg) Mexico City Barclays Bank Mexico, S.A. (BBMX, Mexico City) Taiwan Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan) Seoul Barclays Capital Securities Limited (BCSL, Seoul) Mumbai Barclays Securities (India) Private Limited (BSIPL, Mumbai) Singapore Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore)
16 April 2012
239
DISCLAIMER:
This publication has been prepared by the Corporate and Investment Banking division of Barclays Bank PLC and/or one or more of its affiliates (collectively and each individually, "Barclays"). It has been issued by one or more Barclays legal entities within its Corporate and Investment Banking division as provided below. It is provided to our clients for information purposes only, and Barclays makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays will not treat unauthorized recipients of this report as its clients. Prices shown are indicative and Barclays is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. Without limiting any of the foregoing and to the extent permitted by law, in no event shall Barclays, nor any affiliate, nor any of their respective officers, directors, partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss of anticipated savings or loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication or its contents. Other than disclosures relating to Barclays, the information contained in this publication has been obtained from sources that Barclays Research believes to be reliable, but Barclays does not represent or warrant that it is accurate or complete. Barclays is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference. The views in this publication are those of the author(s) and are subject to change, and Barclays has no obligation to update its opinions or the information in this publication. The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any other interests, including those of Barclays and/or its affiliates. This publication does not constitute personal investment advice or take into account the individual financial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for all investors. Barclays recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results. This communication is being made available in the UK and Europe primarily to persons who are investment professionals as that term is defined in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professional experience in matters relating to investments. The investments to which it relates are available only to such persons and will be entered into only with such persons. Barclays Bank PLC is authorised and regulated by the Financial Services Authority ("FSA") and a member of the London Stock Exchange. The Corporate and Investment Banking division of Barclays undertakes U.S. securities business in the name of its wholly owned subsidiary Barclays Capital Inc., a FINRA and SIPC member. Barclays Capital Inc., a U.S. registered broker/dealer, is distributing this material in the United States and, in connection therewith accepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019. Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permit otherwise. Barclays Bank PLC, Paris Branch (registered in France under Paris RCS number 381 066 281) is regulated by the Autorit des marchs financiers and the Autorit de contrle prudentiel. Registered office 34/36 Avenue de Friedland 75008 Paris. This material is distributed in Canada by Barclays Capital Canada Inc., a registered investment dealer and member of IIROC (www.iiroc.ca). Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financial services provider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South African Reserve Bank. This publication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person or entity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice Lane, Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays. In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated by the Financial Services Agency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143. Barclays Bank PLC, Hong Kong Branch is distributing this material in Hong Kong as an authorised institution regulated by the Hong Kong Monetary Authority. Registered Office: 41/F, Cheung Kong Center, 2 Queen's Road Central, Hong Kong. This material is issued in Taiwan by Barclays Capital Securities Taiwan Limited. This material on securities not traded in Taiwan is not to be construed as 'recommendation' in Taiwan. Barclays Capital Securities Taiwan Limited does not accept orders from clients to trade in such securities. This material may not be distributed to the public media or used by the public media without prior written consent of Barclays. This material is distributed in South Korea by Barclays Capital Securities Limited, Seoul Branch. All equity research material is distributed in India by Barclays Securities (India) Private Limited (SEBI Registration No: INB/INF 231292732 (NSE), INB/INF 011292738 (BSE), Registered Office: 208 | Ceejay House | Dr. Annie Besant Road | Shivsagar Estate | Worli | Mumbai - 400 018 | India, Phone: + 91 22 67196363). Other research reports are distributed in India by Barclays Bank PLC, India Branch. Barclays Bank PLC Frankfurt Branch distributes this material in Germany under the supervision of Bundesanstalt fr Finanzdienstleistungsaufsicht (BaFin). This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd. This material is distributed in Brazil by Banco Barclays S.A. This material is distributed in Mexico by Barclays Bank Mexico, S.A. Barclays Bank PLC in the Dubai International Financial Centre (Registered No. 0060) is regulated by the Dubai Financial Services Authority (DFSA). Principal place of business in the Dubai International Financial Centre: The Gate Village, Building 4, Level 4, PO Box 506504, Dubai, United Arab Emirates. Barclays Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence. Related financial products or services are only available to Professional Clients, as defined by the Dubai Financial Services Authority. Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporated outside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi (Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi).
Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLCQFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar Financial Centre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar. Related financial products or services are only available to Business Customers as defined by the Qatar Financial Centre Regulatory Authority. This material is distributed in the UAE (including the Dubai International Financial Centre) and Qatar by Barclays Bank PLC. This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office Al Faisaliah Tower, Level 18, Riyadh 11311, Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024. This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License #177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21. This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. For matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles Quay Level 28, South Tower, Singapore 048583. Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined by Australian Corporations Act 2001. IRS Circular 230 Prepared Materials Disclaimer: Barclays does not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. Copyright Barclays Bank PLC (2012). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request.
US08-000001