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Insiders Place Chips on Two Insurance Companies
By Michael Brush
Exclusively for InvestorIdeas.com
April 05, 2007
It was a rocky first quarter. But that didn’t slow down the initial public offering (IPO) machine. All told, there were 67 IPOs in the first quarter worth $11.9 billion, compared with 56 new issues worth $10.7 billion in 2006, according to Dealogic.
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You have to have a lot of respect for any companies that came public in March -- when market jitters threatened to reduce demand, and pricing, on their deals. You can say the same about deals which saw a lot of insider buying on their launch.
That was the case with an insurance company called Flagstone Reinsurance Holdings (FSR), which began trading March 30. Insiders purchased a cool $2.3 million worth of stock on the IPO. That’s enough to serve as a particularly strong bullish signal for this Bermuda-based insurer.
Flagstone offers reinsurance for catastrophic events such as hurricanes, windstorms, tsunamis, severe winter weather, earthquakes, floods, fires and explosions. Reinsurance is used by primary insurers to lay off risks and help meet capital requirements. Flagstone also has specialty lines of insurance in areas like aviation, energy, accident and health, satellite, marine and workers' compensation.
Industry trends and overview
This may seem like a dumb time to be in insurance. After all, it seems like the number of big, weather-related catastrophes has increased in recent years. Despite a reprieve last hurricane season, the number actually is up. But in a perverse way, that’s good for insurance companies. Let’s take a quick step back a few decades to see why.
Throughout the 1980s and much of the 1990s, things were pretty calm for insurance companies. There weren’t many big disasters that forced them to fork out a lot of capital. So a lot of underwriting capacity built up in the business, competition was fierce and premiums sank.
All that began to change with the September 11, 2001 terror attacks, which caused more than $20 billion in property losses. Then came hurricanes Rita and Wilma in 2005, as well as the big one, Katrina. Katrina alone caused more than twice as much in insurance losses than the terror attacks. It caused $45 billion worth of insured damage.
This string of terrible disasters wiped out a lot of insurance underwriting capacity. It also made demand for coverage and reinsurance go up. Rating agencies set higher standards for insurers, which reduced the amount of catastrophe risk they could underwrite per dollar of capital. By now, you can guess where all this is going. Yep, higher premiums. Bad for customers; good for insurance companies.
It was in this environment, at the end of 2005, that Flagstone came on the scene. “We believe that the events of 2005 have resulted in fundamental and enduring changes in the property insurance and reinsurance markets,” the company says in its prospectus.
Demand outstripped supply especially for windstorm coverage in North America – the market that Flagstone mainly serves. (Flagstone also does business in Japan, Australasia and the Caribbean.) And judging by its success in its first year, it seems like the company positioned itself correctly. Flagstone took in gross premiums of $180 million in January, a particularly busy month for reinsurance. That was an increase of 150% compared to January a year before, its first full month of operations.
Besides being in the right place at the right time, there are other things to like about this reinsurance company. Here’s a quick look.
Sound underwriting
Flagstone has the kind of names you want to see associated with an IPO: Lehman Brothers (LEH), JP Morgan Chase (JPM), Citigroup (C) and Credit Suisse (CS). It’s also raising money for the right reasons. Flagstone will use the money to increase its underwriting capacity, rather than pull tricks that don’t help shareholders as much – like using proceeds to pay off original investors.
Decent financial strength
Flagstone is a new reinsurance company so its balance sheet is not weighed down by any of the recent disasters which cause premiums to go up so much. A.M. Best gives Flagstone a financial strength rating of "A-" which is the fourth highest of sixteen ratings.
International reach
Flagstone has a catastrophe modeling and risk analysis team in India, which I am guessing brings down costs. Flagstone uses its own proprietary risk assessment models and “prides itself on being at the cutting-edge where technology meets underwriting.” We’ll have to take them on their word on that one.
The disaster scenario
Of course, the disaster scenario is that too many catastrophes strike at once, the company is forced to exit investments quickly to cover obligations, and it can’t get good prices for those investments. To avert this scenario Flastone diversifies risks across business lines and geography, and it sets loss limits and caps on payouts. But its still a risk, if you own this stock.
Atlantic American (AAME)
Insurance was the only stand-out theme in insider buying last week, which also saw insiders pick up $280,000 worth of stock at Atlantic American (AAME). This is a tiny insurer that offers life, health, property, casualty and auto insurance. Two things look bullish about these purchases: Insiders bought on strength in the stock; and this is a fair amount of buying for such a small company. Atlantic American has a market cap of just $91 million.
The bottom line : Cycles can change quickly in the insurance sector and there is no guarantee that a few quiet years won’t increase capacity, lower premiums, and hurt these stocks. But many scientists believe global warming causes bizarre weather patterns. We got a break in last year’s hurricane season, but given the climate changes that might turn out to be more the exception than the rule. I’d buy both these names right here.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner:
http://www.investorideas.com/insiderscorner/.
InvestorI deas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp . InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.
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