process risk; param risk; winner’s curse; PAT; ambiguity; morale hazard; info asymmetry
get the outcome get the price know the price do not know the price (i.e., E[L])
“Should anyone know of any other factors that influence risk let them speak now or forever hold their peace.” = pure PAT; get it all one the table for the P.
What does risk margin cover? * event risk/cat risk, generally manifest through a RA capital requirement * reserve capital consumption -> NO, this is risk over time, SA <= total risk * II on Pol Holder funds: casualty reserves are ph funded; cat capital is sh funded * classification plan for risk; profit relativities
Quant * Production (premium) relative to plan * LR/ER/CR/OR history: plan vs. actual * Reserve leverage * Reserve development history * Largest individual losses * SP/RA capital [VS NATURAL ALLOC?] [prem/reserve/cat/asset components] * Outwards * Tail and 1/20 year * COGS and minimum required margins based on SP/other capital views
Prop vs Cas with same vol, 1 year vs n year payout. 1 calendar year cas risk \(\le\) prop because SA risk measure. BUT, after the year you are done with prop and still have run off for cas. Not more risk: just sliced differently. But impedes your ability to react to interim information.
Review conference calls!
Bodoff (2021)
Thesis: management is worried about things that makes them look bad in front of investors. Like reserve development. Like a loss bigger than peers. Like mis-estimating a cat. Consistent with article’s suggestion that Addesso was canned because of 2017 loss and subsequent development led investors to lose confidence.
This strategy [writing cat] paid off for a while, but the stock returns started lagging with a consistent impact from catastrophe losses and increased investor skepticism.
A pattern of larger-than-anticipated losses and reserve adjustments on prior losses emerged. For example, in 2018, 2017 losses adversely developed by another $250mn by Q2 2018. This pattern led to an expectation from within the franchise and outside that change was coming. And, on cue, the company announced that it was conducting a search for Addesso’s replacement.
The advent of outside capital has compressed the high returns once available in [the cat] space. Further, a recent uptick in natural catastrophe activity has exceeded the anticipated catastrophe budget of 6 to 7 points on the reinsurance side. Investors have also gotten wary of this volatility over the past few years, which have also witnessed meaningful merger activity.
Tomorrow, Everest Re’s CEO, Juan Andrade, will update us on Everest Re’s year-end result and its journey since laying out the objectives outlined in its investor day in June of last year. But as we get ready for Andrade’s presentation, another name comes to mind. Ralph Jones III. Some of the readers might remember the name related to Everest Re. Many might not. But the story here – and the broader Everest story of the past decade or so – serves to illustrate that sometimes the path diverges from the direction initially expected.
In 2010, Jones was named CEO and assumed the role from Joe Taranto, who retired and became chairman. However, without dredging up the past, Jones did not assume the position, and the mantle fell to CFO Dom Addesso at that time.
Addesso took the top job under the long shadow of Taranto. Everest Re was at the time predominantly a casualty reinsurer with whispers of some reserving challenges, but the firm banked towards a property-catastrophe, short-tail book of business under Addesso. After Hurricane Sandy, there was an acceleration towards these lines.
This strategy paid off for a while, but the stock returns started lagging with a consistent impact from catastrophe losses and increased investor skepticism. The chart below shows the stock getting rangebound in the mid-250s or so. This underperformance led to another attempt to tweak the catastrophe exposure from 2017 onwards.
A pattern of larger-than-anticipated losses and reserve adjustments on prior losses emerged. For example, in 2018, 2017 losses adversely developed by another $250mn by Q2 2018. This pattern led to an expectation from within the franchise and outside that change was coming. And, on cue, the company announced that it was conducting a search for Addesso’s replacement.
The conventional expectation, which the firm had telegraphed, was that an internal candidate was likely from one of the business units (more likely reinsurance). However, observers were surprised when the firm announced outsider Andrade, a Chubb executive, as the next CEO.
Since Andrade’s arrival and as further outlined at Everest’s investor day last year, the Chubbification of Everest Re has accelerated as the company moves toward US and international insurance to balance its portfolio, and other changes are pushed through. The chart below shows some personnel changes and the management brought in. These replaced several legacy leaders such as Jonathan Zaffino, president and CEO of Everest Insurance; John Doucette, president and CEO of reinsurance; and Craig Howie, CFO, to name a few.
Apart from the above-disclosed hires, Everest recently hired former Chubb executives Jason Keen and Adam Clifford to spearhead the buildout of the international insurance franchise.
Hiring and management reshuffling is only one part of the story. Taking a step back, what differentiates Chubb from its peers is the ownership and accountability that runs through the business, and the execution of its leaders. If you deliver, you are also handsomely rewarded.
Andrade, and the growing cadres of former Chubb leaders he is assembling, are retooling the culture at Everest and slowly developing a higher Chubb-like standard for its underwriting leaders.
The company now has a culture that is willing to make meaningful changes depending on market opportunities and which can look one way while the peer group looks another. We anticipate tomorrow’s call will delve deeper, and we would not be surprised to see a continued meaningful reduction in cat exposure when the company discloses its 1 January renewal book.
There is likely to be a more significant cut to its risk appetite in catastrophe coupled with a better-than-expected primary growth as well as proportional non-catastrophe growth in the reinsurance segment. The Chubbification of Everest will continue over 2022 as Everest tries to build on rate momentum in other classes.
Andrade is also getting a helping hand from the marketplace, with rates remaining robust on the insurance side and relatively better than before in reinsurance. Below, we analyze Andrade’s performance at Chubb Overseas General Insurance, look at expectations set forth at the investor day, and revisit the changes afoot at Everest Re.
Finally, through this framework, we will consider the question: with the pricing tailwind, will the pivot towards insurance work? Or will the franchise face disappointment, as seen at Axis Capital which, after an attempted pivot away from reinsurance and towards insurance, has endured multiple years of 100%d combined ratios?
First, Chubb Overseas General results show material outperformance vs. Everest. Before joining Everest Re, Andrade headed the Overseas General Insurance segment at Chubb after serving as COO for Ace Overseas General before the Ace/Chubb merger. He joined Ace in 2010, having served as COO of P&C Operations at The Hartford after joining in 2006.
Analysts expected that his experience would play a significant role in improving Everest Re’s results. Therefore, it makes sense to revisit Chubb Overseas General Insurance’s performance vs. Everest Re over a similar time frame. The chart below shows the comparison.
Over 10 years, Chubb Overseas General Insurance’s results outperformed Everest Insurance by 15.4 points. Notice the volatility in the reinsurance book and the significant gap in its insurance book vs. Chubb. This is a big gap, and sustained improvement with a helping hand from market conditions will make this level of correction possible. Second, great expectations come with great responsibilities.
During its investor day Everest Re laid out ambitious targets, including an 11% total shareholder return near-term, growing to 13% in 2023. It also anticipates growing the top line by 10%-15% annually and maintaining a combined ratio for the group at 91%-93%. Our research has shown that stock prices have a closer correlation with book value growth over time in the property-casualty insurance space. So, companies might have great years and great earnings for a short period, but franchises that have consistently delivered on book value growth are typically valued higher.
This dynamic is true for Arch Capital, Renaissance Re, WR Berkley, and Chubb, to name but a few. Some companies lean on franchise-building through acquisitions, while others are astute deployers of capital. Some utilize both to get there.
Historically, apart from the Heartland Crop Insurance acquisition, Everest Re has mostly looked to grow organically. So, it will be interesting to see if this strategy changes with Andrade onboard in the longer term.
The chart below shows the publicly traded insurers and total shareholder return. Total shareholder return is the change in basic book value per share plus dividends (common and special). Although Everest Re ranks higher over a 15-year horizon, its rank slips towards the mid-bottom range when looking at results over the last five years. When the wind blows, it continues to blow.
Third, Everest Re’s evolution from a casualty reinsurer to a not-so-casualty reinsurer has involved many steps.
The chart below shows the business mix between insurance and reinsurance over time. Under Andrade what we will see is the third iteration of the insurance business. Prior attempts were via the program route, which evolved into in-house underwriters around the time of Jonathan Zaffino’s arrival as head of insurance in 2015.
Insurance has slowly crept from 20% or so in 2010 to 31% in 2020. So if Everest Re continues its growth path without any market hiccups, its 2023 business mix would be approximately 35%-65% insurance/reinsurance.
Due to the volatility, more capital is needed to write reinsurance resulting in lower premium to equity leverage. Insurance results are more predictable and can therefore be written with higher levels of leverage.
This discrepancy means that the leverage effect can deliver a greater overall return even if running at a higher but stable combined ratio. So a pivot also allows it to build a more extensive insurance book.
This quarter’s pricing commentary has been solid on the insurance side, and this perceived tailwind could benefit Everest Re in achieving its preferred business mix sooner than discussed.
As shown below, leaning into the reinsurance segment and short-tail lines has come at a cost. The chart shows the level of catastrophe losses by segment and total losses as a percentage of prior years’ equity.
The advent of outside capital has compressed the high returns once available in this space. Further, a recent uptick in natural catastrophe activity has exceeded the anticipated catastrophe budget of 6 to 7 points on the reinsurance side. Investors have also gotten wary of this volatility over the past few years, which have also witnessed meaningful merger activity.
Besides Everest, most of the Bermuda public cohort has been acquired, with Axis Capital and RenaissanceRe among the small number of exceptions. Axis Capital faces its own moment of truth, trying to adapt similarly out of its beginning and facing the inherent challenges involved. Renaissance Re is perhaps one of the only remaining peers that have managed to survive the changing marketplace.
At the investor day, Everest Re highlighted the past volatility in its catastrophe book in the reinsurance segment, and its intention to dampen volatility. Only further reductions in its reinsurance book will achieve this goal, and tomorrow’s update will likely disclose this as highlighted in Insurance Insider last month.
The company continues to stress a decline in PML. As readers know, a PML analysis can be rife with misinterpretations. A PML calculation is susceptible to data input when developing the modeled simulated losses and evaluating the in-force book of business. A decline in PMLs equating to a reduction in catastrophe losses is an overarching simplification of the risk/return matrix.
With that caveat, Everest’s PML has declined over time. We expect further reductions in PML coupled with its 1 January disclosure tomorrow. But more important than this mathematical reduction in PMLs is that the true underlying risk characteristics of the book change to squeeze out volatility.
As noted above, a rebalancing towards insurance is afoot, which could ultimately make the group look dramatically different.
Will Everest Re be able to deliver on this rebalancing where many others have failed? If one looks at the state of the Bermuda market, many franchises have tried to adapt over the past 10 years. This shift was brought on by competition, losses, and the impact of ILS capital on cat reinsurance-focused models.
Formed initially to capitalize on property cat rates, many of the Bermudians attempted to diversify into insurance. Unfortunately, these forays often resulted in disastrous consequences.
Instead of diversification benefits, often, these franchises were susceptible to the vagaries of different business cycles. Sometimes these cycles combined to result in reserve hits on the primary side and catastrophe and non-catastrophe losses in the short-tail book. We covered this topic in detail in our note titled “Where have all the reinsurers gone?”
Will Everest Re be able to successfully pivot away from reinsurance and succeed in its insurance writings? If not, the fates of Axis, Aspen, Swiss Re and others are out there serving as reminders of what can go wrong.
Delving deeper into segmental expectations, for the reinsurance segment, Everest Re expects an 8%-12% GWP CAGR with a combined ratio of 91%-93%. Historically, the boom/bust of underwriting profits in its reinsurance arm is evident in the chart below. Notwithstanding the usual adjustments we see in non-GAAP number analysis, it might be a tough ask for the book to decline by 8 to 10 pts if the level of catastrophe and non- catastrophe losses continue to surprise the industry.
On the insurance side, Andrade and his team expect GWP growth of 18%-22% and a 91%-93% combined ratio.
Reinsurers and insurers have highlighted the primary market’s strength this earnings season. However, we are still not entirely sold on this thought process as a likely reversion in loss cost trends from social and broader inflation will end up throwing a spanner in the works of this thesis.
That said, if loss costs remain unchanged, the gap between rate and loss costs will result in greater returns and, consequently, Everest might even deliver better-than-expected shareholder returns.
In summary, although Everest Re is already showing positive changes from Andrade’s envisaged strategy, the road ahead is long and paved with unknown impediments. We have seen turnarounds at other franchises IAIG, CNA, and Axis Capital come to mind) take materially longer than expected – or fail to land altogether. Will Andrade be able to buck the trend? Stay tuned!
posted 2022-02-28 | tags: pricing, insurance, risk, underwriting