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We have shortlisted an insurance company that looks to have very little chance of escaping a compression if the business in the Euro zone implodes. It is the first company mentioned in the professional subscriber document released last week (Insurance cos. EU exposure 11-2011).The company has both global macro risk and operational risk, but its operational risk did not land it on the retail subscriber short list released last week (Insurance Cos. Operational Stress). All subscribers should expect forensic report on this company within two weeks and a new short list of REITs and related companies by that time as well. I’m packing the research pipeline for the new year.
In reviewing why this company was chosen, we need to review the post that outlines the insurance business and its cyclical nature - also penned last week - You Can Rest Assured That The Insurance Is In For Guaranteed Losses…
Remember, the insurance industry is short to medium term bust because it is:
1. extremely cyclical,
2. prone to booms and busts (the fodder of BoomBustBlog),
3. and relies as much, if not more, on investment income borne from bonds (primarily sovereign debt [whaaaat?] and bank/financial institution debt [whoa!!!??] for earnings as much as their core business of underwriting risk.
The combined ratio of the subject company is just under 100, which means that its underwriting profits less its expenses are nearly ZERO, as in zilch. Of course, the unique aspects of the insurance industry float allows it to profit - even in the face of negative net underwriting earnings. As a matter of fact, under the right circumstances, an insurer can post some very significant positive net income despite markedly negative underwriting profits.
Of course, this unsaid implicit leverage works both ways. Under the wrong circumstances (ex. the circumstances that we are currently experiencing) insurance companies negative underwriting profits can be exacerbated to the point where the company has to be either bailed out or shut down - ex. AIG. I implore interested parties who are not knowledgeable in the insurance industry to review the BoomBustBlog insurance primer - You Can Rest Assured That The Insurance Will Take Guaranteed Losses...
The forensic analysis subject we shortlisted has all of the qualifications we listed to be an ideal short in times of volatility and dislocation. The model has turned out to be a bit more complicated than we expected, hence the delay in producing the report but trust me... It will be more than worth it. I should have a summary report out midweek as well as a short list of real estate exposed companies early next week. The double whammy serves to make up for lost time.
The combined ratio of the subject company is nearly 100, while its accounting book value (often par), its politically espoused market value and losses allegedly to be booked, and the actual market value of the assets on balance sheet are ALL DRASTICALLY different! We have shifted over to a duration based analysis to outline risks in its EU debt holdings and trending in its equity holdings. We have also stepped through its more arcane derivative structures as well.
As of right now, marking this company's portfolio to market will result in a 24+% drop in shareholder equity. These very same bonds are rapidly trending downward in value, not up.