Description

Everest Group is a leading reinsurer with sustainable and improving 15-20% ROEs. The stock trades at 1.2x book and 6x P/E.

The valuation implies a near-term cyclical downturn in pricing and profitability. But deterioration is unlikely to begin over the next 3 years due to accelerating casualty pricing, stable property-cat rates and higher attachment points, and only muted recent increases in industry capacity.

EG’s smaller primary insurance segment (26% of net premiums written) is inflecting to underwriting profitability after several years of losses and unfavorable development, as Everest Re did in 2019. Finally, EG’s securities book currently yields 4.7% but is increasing towards 5.5%, which adds several points to the recurring ROE all else equal. NII currently contributes 13 ROE % points, meaning forward financial performance will be better than historical numbers even at breakeven underwriting. But I believe EG can hit its 90 combined ratio target going forward across the cycle.

Therefore EG is more likely to trade >1.5x book in two years (as it did before an opportunistic May ’23 equity raise) than 1.0x, resulting in a low-risk 50% total return over the next two years. 

Everest

EG sells large enterprise and mid-market policies globally, with 3% reinsurance market share. The reinsurance premium mix is 50/50 property/casualty, while the insurance segment is primarily casualty/specialty and only 20% property. 1/4th of insurance segment premiums are in professional liability (primarily D&O) and workers comp lines, which are both experiencing soft pricing and more aggressive competition. Yet rates across the the rest of the book continue to increase double-digits. New business growth is particularly strong in APAC and LatAm.  

Like RNR, EG is building out a third-party capital fee income business, Mt. Logan, with $1bn AUM currently vs. RNR’s $7bn.

Reserves have proven trustworthy since 2020, when EG took an outsized $400m charge to recognize higher legal costs (social inflation) in casualty accident years 2015-2018, leading to a reported underwriting loss that year. Basically, an aggressive U.S. plaintiffs bar has used litigation financing, sympathetic juries, and bold fraud to win many more large and nuclear verdicts in general liability and auto lawsuits than ever previously. The larger losses disproportionately impacted reinsurers’ excess layers. But most underwriters ignored these trends until recently due to the industry’s classic agency problems, as Buffett has described many times. Casualty policies have 3-5+ year loss tails, yet most compensation plans reward premium growth without appropriately reflecting the duration of the risk.

Fortunately, a new EG CEO, Juan Andrade, who took over in 2020, was way ahead of the rest of the industry in recognizing these loss trend problems in older accident years, and then avoiding dumb casualty new business in 2020 and ’21. The big 3 European reinsurers (Munich, Swiss, Hanover) only began to take similar reserve charges 6 months ago. This is why the industry is bullish about casualty reinsurance rates accelerating going forward. 

Former CEO Joe Taranto has been Chairman for 30 years and owns >$100m. EG pays a small div and will primarily retain capital to grow fast during this hard market. The company repurchased somewhat aggressively during the last soft market until 2016. 

Reinsurance 

Insurance companies are probably the top beneficiaries of higher interest rates. Underwriters have not cut prices in most lines despite earning 2-3x more on their float now compared to 2021. Even crappy carriers with breakeven combined ratios and greater volatility can lock in decent financial returns for the next 3-4 years from longer-duration IG books yielding 5-6% and leveraged 2-3x. 

The better reinsurance underwriters were historically less consistent and lower-margin across the cycle than top specialty primary carriers. Reinsurance pricing is more of a pure commodity, declining quickly during prior soft markets (2014-16 and 2005-11) as activity is concentrated into January and mid-year renewals.

Over the last decade, excessive ILS cat bond issuance elevated industry capacity beyond demand, while hurricanes, convective storms, and nuclear jury verdicts became both more frequent and severe. As a result, aggregate reinsurance industry underwriting was unprofitable over the last 15 accident years. 

Combined with lower bond yields, the result was 4% average ROEs. Even Berkshire Hathaway Re lost money underwriting every year between 2017 and 2021, -$9.7bn in total, before rebounding in ’22 and ’23. Under prior management, EG performed slightly better than that but still disappointed. 

The negative conditions began easing after the Covid shock restored underwriting discipline, and the positive momentum accelerated in Q3’22.

Florida’s Hurricane Ian ended up as a positive catalyst for industry earnings in 2023 and ‘24 despite causing $50bn in losses. Large underwriters exited property-cat, and renewal rates increased up to 50% in January ‘23 before growing another 5-15% in ‘24 renewals. 

To take advantage of the dislocation opportunity, Everest raised $1.5bn equity (15% of its prior book value) 5/23 at $380/share. Yet unlike prior hard markets, there were no major new reinsurance entrants raising capital, nor a surge in catastrophe ILS issuance. (Cat ILS are bond-like instruments currently yielding 13% that lose principal after large storms to pay claims, and historically pressured reinsurance pricing due to over-issuance. These present less of a threat in a higher-rate world.) 

EG models a 1/100 year Florida hurricane (PML) as a 6-7% hit to book value, which is significantly lower than its exposure 5 years ago. EG reported a $205m operating loss in Q3’22 during Ian, but NII rates were lower at that point. With today’s higher yields, EG would be profitable during the quarter with a similar cat. EG's average cat load (I'm going with 6 points/year avg vs. 3 in no-big-hurricane '23 and 8 in '22) is going to be lower going forward than it was historically, as a result of more casualty line and geographic diversication, the higher attachments and tigher exclusions, and exreme recent property-cat pricing.  

See JasonMarx post on RNR from last year for more background. The biggest change since then has been the more recent acceleration in casualty pricing, which has lagged property this cycle. 

Taxes

EG is Bermuda based and previously paid an 11% all-in tax rate. This is now increasing to 15% by 2025 with Bermuda signing onto the global minimum rate. EG’s reported adjusted operating income excludes non-cash 1x swings tied to Bermuda tax change accounting, as well as paper investment gains/losses.

This was, financially speaking, a mediocre business until 2023. Now it is likely to be a great business quantitatively until at least 2026, then perhaps an above-average one.

Valuation

RNR is trading at a higher book multiple due to its larger third-party capital fee income, while ACGL is >2x. They’re all <10x P/E with excellent medium-term growth prospects. FFH trades at a similar multiple to EG, but you don’t have to worry about dumb Prem crap here. CB trades >1.7x, but despite brilliant management it is probably too big to outperform the industry like EG’s opportunity.

Catalyst

20% ROEs all day baby, earn back full market cap by 2028