Reinsurer hybrids: Divergent paths lead to mixed near-term results
With mixed results in the reinsurance space, the specialty pivot remains a "show-me" story.
Last night’s Super Bowl game had it all. From the tried playbook to a quick update in strategy as the game progressed, eventually leading to the overtime with a tied score. Ultimately, the Chiefs dynasty prevailed over the 49ers, after a scrappy start.
The teams took a divergent path to the final game, but the winning team continued to lean into updating their strategy and creating openings to yet again win the Super Bowl. A similar story has played out for the hybrid reinsurers reporting last week, whose results reflect divergent strategies since their formation.
A quick segue. Last week, we discussed the prospect of casualty loss trends impacting the space somewhat unevenly. Industry participants continue to adjust prior period reserves for the soft-market years while offsetting some of this from reserve takedowns in recent years. A theoretical reserve addition, assuming AY 2015-2022 is deficient, could add tens of billions in adverse development.
When discussing this industry, we often highlight the issue of cost of goods sold and how ascertaining the direction of trends can prove tricky. To bolster our analysis, we have added two new charts below, which will also later tie into our thesis on the hybrids. The chart on the left shows paid-to-incurred for general liability lines with the commercial lines combined ratio overlaid on it in purple. The chart on the right shows reserve development for the general liability lines.
On recent earnings calls, we have heard about declining paid-to-incurred ratios, often a sign of reserving stability. However, we challenge that assertion when looking at longer term trends. We continue to posit that a declining paid-to-incurred ratio was primarily due to Covid and the associated courts shutdown.
As the chart below shows, paid-to-incurred ratios are at a historic low, and we anticipate this to snap back into 2025. We saw a similar trend coming out of the liability crisis of the 90s.
The chart on the right gives us additional confidence in our thesis. Recent years, as shown by the declining teal, which reflects lower adverse development, are an aberration, since workers' compensation has offset adverse development in other lines.
Additionally, when examining historical patterns, one can see the prior liability crisis rapidly worsening at the beginning of the 2000s. Apart from the massive spike in 2001, what is even more interesting is the continuation of that trend for several years. In other words, we don’t anticipate the reserving issue to be “one and done” in 2024. This is an unfortunate gift that may keep on giving.
So, how does this all tie into our piece on the reinsurer hybrids? We have covered how the prior classes of reinsurers have either been consolidated away or have continued to evolve to address prior challenges. But as is often the case, pivots take a long time to play out, and fixing a franchise is akin to turning around a slow-moving tanker. This earnings season is also bringing these efforts into a sharper focus, particularly when evaluating divergent results for Axis, Everest, and RenaissanceRe.
We have covered Axis in the past, as its CEO is trying to put the franchise back on course, which is proving to be a bigger challenge than anticipated, as seen with the recent charge. Last week, Everest joined the ranks of companies taking a reserve charge in its insurance book as well, which led to the stock falling nearly 8% and raising fresh questions on the quality of the book.
Like Axis, Everest has been pursuing a turnaround strategy and attempting to reduce the volatility in its results. Is it a case of diversification or “diworsification”? With the latest reserving adjustment at both Axis and Everest, the “show-me story” clock has been reset. The focus will be on results for the next few years without any additional reserving.
Rounding out the earnings was RenaissanceRe, fresh off the closing of its Validus Re acquisition, reporting one of the best years without much reserving noise.
The note below examines the changes in business mix, results, and valuation for the group.
The reinsurance sector has largely pivoted to specialty, but with different resulting business mixes
With the mounting catastrophe losses since 2017, the specialty space has looked increasingly attractive, especially with the incredible growth we have seen in recent years (21% CAGR over the past five years, per our previous note).
These drivers have led to the near-extinction of pure-play reinsurers, with RenRe being the closest thing we have left among publicly traded companies. The chart below shows this shift at the reinsurance/insurance level and some of the underlying lines.
While the move away from reinsurance for Axis is a key point in the chart, we would emphasize a few other things. Firstly, Everest is actually increasing in reinsurance faster than in insurance. Secondly, the RenRe numbers do not reflect the impact of Validus Re, which will add another ~20% to the top line.
Taking a step back, the business mix illustrates different paths to reduce the volatility in results. While two carriers have chosen to pursue different business lines, RenRe has effectively doubled down with the Validus acquisition. The next point will illustrate the relative success of these measures.
This quarter’s results show a divergence in performance
With the carriers taking different steps, in/out of reinsurance and in/out of longer tail lines, it’s no surprise that this has led to differing results in the current, volatile macro environment.
The chart below shows their combined and underlying combined ratios over recent years, along with catastrophes and prior-period development.
What is quite interesting in this analysis is that even though RenRe has faced meaningful catastrophe volatility vs Axis or Everest, in the longer term, its combined ratio is superior vs the rest.
Does this imply that companies should not diversify? We would be reluctant to make that simple assumption. What it does show is the historic strength of RenRe in risk selection and its attempt at leaning into it. For Axis and Everest, it’s more about franchise rebuilding, which always takes longer to play and also leads to unforeseen challenges.
The charts below give an additional view, showing how PPD and cat losses have trended over time. Note that Everest and Axis have had more surprises in past accident years.
Taking a step back, both Everest and Axis reflect corrective action. What remains to be seen is whether the overarching industry reserving challenge extends the timeline of these actions delivering superior results.
Long-term value creation is still the gold standard when evaluating company strategy
Looking at the chart below, we see an interesting story. Axis is at the low end for value creation, but Everest and RenRe are quite solid.
And so, an interesting pattern emerges. Franchises that have generally shown long-term operating success (using book value growth as a proxy) tend to trade at a higher multiple. With the current casualty climate, there could be a period where long-term value creators could lag in short-term value creation as they address reserving challenges. That said, reserving is a zero-sum game, and there is a price for kicking the can down the road.
In summary, the current casualty climate and the need to continue to watch the reserves create an overall layer of focus for reinsurers, which have evolved into insurance/reinsurance hybrids. The next few years will be crucial since we believe we haven’t heard the last of industry reserve adjustments.