Aspen Holdings Insurance (AHL)
All figures from 6/23/2011
Company: Based in Bermuda, AHL operates as an insurer and reinsurer, providing services in the property, casualty, surplus and liability insurance lines for clients around the world. For the year ending Dec 31, 2010 they generated $2,076.8million from premiums.
Thesis: AHL is a fundamentally sound, undervalued business trading well below book value. It is my hypothesis that current myopic beliefs have kept this business at a suppressed valuation. A combination of low interest rates, a soft insurance cycle, and numerous catastrophic events have investors extrapolating losses ad infinitum. An investor with patience though should see that AHL offers an attractive margin of safety and a well-defined upside. Seeing Zeke Ashton, David Einhorn, and Whitney Tilson pile into it too gives me confidence as well (perhaps a bit of confirmation bias).
Summary Information:
Table 1. Relative Valuations for Reinsurance companies
As can be seen above AHL is trading at a considerable discount to its peers despite a history of prudent risk management (combined ratio <100%) and good business practice (13% BV growth rate). Despite this, a steep discount is being offered helping mitigate and reduce the down side of a potential investment.
Collectively we can see that the industry as a whole is trading under BV. Currently the industry is in a soft cycle and a perfect storm of low interest rates, low premium rates, residual hangover from the financial crisis, and numerous natural catastrophes have suppressed valuations. There is considerable evidence though that these will not become permanent fixtures and eventually a hard insurance market will prevail.
Typically it has taken major catastrophes and sharp reduction in surpluses to induce a hard market. As can be seen on the next table the last two hard markets could have been caused by a “Black Swan” style catastrophe. Catastrophe related insurance losses were unsurpassed. Perhaps numerous smaller, but still expensive events, could perform the same action? For all of 2010 total losses due to catastrophe cost $40B, in just Q1 of 2011 losses exceeded $35B (2011-10K).
Table 2. Insurance Cycles
Obviously a two point analysis doesn’t justify an end all belief that a hard market is around the corner. It does lend some credence to the fact that bad things have happened before and the industry has survived. There are some expectations that premiums will increase by 50% over the next 1-4 years1 due to the catastrophes of this year. The Deepwater Oil Rig explosion gave way to rate increases averaging 20% within AHL’s Energy &Energy Liabilities division.
Aspen has taken all of the aforementioned issues and still managed to be consistently profitable and shareholder friendly since going public in 2003.
Business: AHL’s business lines are split very equal along reinsurance and insurance. 40% of all premiums are written to cover the US&Canada. With a five year combined ratio average at 88% the business has been profitable and managed to avoid underwriting at a loss to gain growth or access to float. 2008 was considered a soft year, 2009 a somewhat hard year and 2010 returned softer.
Table 3. Premiums for Reinsurance and Insurance
Twelve Months Ended | Twelve Months Ended | Twelve Months Ended | ||||||||||||||||||||||
December 31, 2010 | December 31, 2009 | December 31, 2008 | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Written | Written | Written | ||||||||||||||||||||||
Reinsurance | Premiums | % of Total | Premiums | % of Total | Premiums | % of Total | ||||||||||||||||||
($ in millions, except for percentages) | ||||||||||||||||||||||||
Australia/Asia | $ | 95.6 | 8.2 | % | $ | 71.2 | 6.1 | % | $ | 57.7 | 5.2 | % | ||||||||||||
Caribbean | 4.3 | 0.4 | % | 1.9 | 0.1 | % | 2.2 | 0.2 | % | |||||||||||||||
Europe | 96.9 | 8.3 | % | 64.3 | 5.5 | % | 76.1 | 6.8 | % | |||||||||||||||
UK | 23.8 | 2.0 | % | 26.8 | 2.3 | % | 40.5 | 3.6 | % | |||||||||||||||
US& Canada(1) | 564.5 | 48.6 | % | 659.3 | 56.1 | % | 648.1 | 58.2 | % | |||||||||||||||
Worldwide excluding US(2) | 55.4 | 4.8 | % | 67.3 | 5.7 | % | 70.1 | 6.3 | % | |||||||||||||||
Worldwide including US | 291.9 | 25.1 | % | 273.3 | 23.2 | % | 201.6 | 18.1 | % | |||||||||||||||
Others | 29.8 | 2.6 | % | 11.9 | 1.0 | % | 18.0 | 1.6 | % | |||||||||||||||
Total | $ | 1,162.2 | 100.0 | % | $ | 1,176.0 | 100.0 | % | $ | 1,114.3 | 100.0 | % | ||||||||||||
December 31, 2010 | Dec 31, 2009 | December 31, 2008 | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Written | Written | Written | ||||||||||||||||||||||
Insurance | Premiums | % of Total | Premiums | % of Total | Premiums | % of Total | ||||||||||||||||||
($ in millions, except for percentages) | ||||||||||||||||||||||||
Australia/Asia | $ | 6.2 | 0.7 | % | $ | 13.2 | 1.5 | % | $ | 12.7 | 1.5 | % | ||||||||||||
Caribbean | 3.6 | 0.4 | % | 0.6 | 0.1 | % | 0.8 | 0.1 | % | |||||||||||||||
Europe | 7.7 | 0.8 | % | 14.5 | 1.6 | % | 26.7 | 3.0 | % | |||||||||||||||
UK | 117.8 | 12.9 | % | 104.8 | 11.8 | % | 147.6 | 16.6 | % | |||||||||||||||
US & Canada(1) | 275.0 | 30.1 | % | 265.2 | 29.7 | % | 278.6 | 31.4 | % | |||||||||||||||
Worldwide excluding United States(2) | 90.6 | 9.9 | % | 83.3 | 9.3 | % | 42.8 | 4.8 | % | |||||||||||||||
Worldwide including United States(3) | 381.4 | 41.7 | % | 386.5 | 43.4 | % | 351.8 | 39.6 | % | |||||||||||||||
Others | 32.3 | 3.5 | % | 23.0 | 2.6 | % | 26.4 | 3.0 | % | |||||||||||||||
Total | $ | 914.6 | 100.0 | % | $ | 891.1 | 100.0 | % | $ | 887.4 | 100.0 | % | ||||||||||||
A big part of insurance is setting aside appropriate reserves for losses. Too much you're just limiting returns and being overly conservative, too little and impairment may occur. AHL has had a cumulative redundancy has been run every single year since 2002 consistently and with no deficit. Leaders of insurance including RenaissanceRe holdings have also run a positive, consistent cumulative redundancy. RNR has an average cumulative redundancy of 5.7% of total assets and AHL comes in at 3.5%. This to me suggests that, while major differences in business may be present at the very least AHL is doing a respectable job of estimating loss reserves.
Expenses have stayed consistent and the expense ratio of premiums written has been consistent at ~30%, in line with other insurers and reinsurance companies.
Investments: The 800lb gorilla is the black box of float what AHL is doing with it. Aspen returned 4.8% on its investments in 2010 compared to 6.1% in 2009. Approximately 70% of the portfolio is fixed income investments carrying an average maturity of 2.9 years (2.5 years unaudited Q1 10Q 2011), down from 3.3 years in 2009.
Table 4. Fixed Income portion of AHL
As at December 31, 2010 | ||||||||||||||||
Cost or | Gross | Gross | Estimated | |||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
($ in millions) | ||||||||||||||||
U.S. Government Securities | $ | 701.5 | $ | 25.5 | $ | (1.6 | ) | $ | 725.4 | |||||||
U.S. Agency Securities | 278.7 | 23.6 | — | 302.3 | ||||||||||||
Municipal Securities | 31.1 | 0.4 | (0.8 | ) | 30.7 | |||||||||||
Corporate Securities | 2,208.4 | 121.0 | (3.7 | ) | 2,325.7 | |||||||||||
Foreign Government Securities | 601.0 | 16.9 | (1.0 | ) | 616.9 | |||||||||||
Asset-backed Securities | 54.0 | 4.8 | — | 58.8 | ||||||||||||
Non-agency Commercial Mortgage-backed Securities | 119.7 | 8.4 | — | 128.1 | ||||||||||||
Agency Mortgaged-backed Securities | 1,126.4 | 48.7 | (2.6 | ) | 1,172.5 | |||||||||||
Total Fixed Maturities — Available for Sale | $ | 5,120.8 | $ | 249.3 | $ | (9.7 | ) | $ | 5,360.4 | |||||||
As at December 31, 2009 | ||||||||||||||||
Cost or | Gross | Gross | Estimated | |||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
($ in millions) | ||||||||||||||||
U.S. Government Securities | $ | 492.1 | $ | 17.4 | $ | (2.0 | ) | $ | 507.5 | |||||||
U.S. Agency Securities | 368.6 | 20.7 | (0.2 | ) | 389.1 | |||||||||||
Municipal Securities | 20.0 | — | (0.5 | ) | 19.5 | |||||||||||
Corporate Securities | 2,178.1 | 90.3 | (3.8 | ) | 2,264.6 | |||||||||||
Foreign Government Securities | 509.9 | 13.9 | (1.5 | ) | 522.3 | |||||||||||
Asset-backed Securities | 110.0 | 5.1 | — | 115.1 | ||||||||||||
Non-agency Residential Mortgage-backed Securities | 34.2 | 8.6 | (0.6 | ) | 42.2 | |||||||||||
Non-agency Commercial Mortgage-backed Securities | 178.5 | 2.5 | (1.0 | ) | 180.0 | |||||||||||
Agency Mortgage-backed Securities | 1,172.9 | 40.2 | (3.5 | ) | 1,209.6 | |||||||||||
Total Fixed Maturities — Available for Sale | $ | 5,064.3 | $ | 198.7 | $ | (13.1 | ) | $ | 5,249.9 | |||||||
All fixed income, less the 119M of non-agency backed MBS, is rated AA or higher. I take this with a grain of salt. There were no Level 3 investments as of 3/31/2011.
Management: Management for AHL includes industry veterans from Lloyds, White Mountain and other respectable insurance companies. The top brass including CEO, CRO, CFO have all been with the company since founding and becoming a publically traded company in 2003. Insider ownership is present, but in my opinion, not at the levels or methods desired. CEO Christopher Kane age 54, is an industry veteran and owns 1.292m shares. Total director/executive ownership represents 3.3% of shares outstanding; most have been acquired through option based compensation which is based upon ROE numbers. Higher ROE= higher compensation. Bonuses start at 7% ROE and taper off at 20%. The companies targeted ROE is 12%. I see no material conflict of management that could result in a permanent loss of capital.
A large block of shares (5.7million) were bought at prices estimated at 12-25% higher than currently being traded(Q4 2010 range 28-31.50).This was followed up by a purchase of 542,736 shares concluding March 14, 2011. Clearly management things the shares are undervalued. As a bonus dividends are consistently paid at 0.60/year yielding 2.4% as of 6/23/11.
Valuation:
I conclude that historical valuations and reversion to the mean will allow us to estimate intrinsic value for AHL. Current BV is 43.22 per share, while fully diluted is 38.90. After several 10Q/K's there seems to be nothing terrible on the balance sheet. Since becoming a public traded company in 2003 the average P/BV for AHL has been 0.9(Morningstar). Based upon that simple valuation the upside is 72%, 55% fully diluted. Compared to other insurers though AHL has traded at a reduced P/BV, with most insurers trading at a slight premium to stated BV.
With an average BV growth of >13% over the past five years and trading at 0.59 stated BV there is significant upside to AHL, I estimate at least fully diluted BV at 38.90/share for intrinsic value. This makes no account for a rise in interest rates, a firming of premiums, or significant share buybacks/increase in BV. Even with a 15% reduction in BV there still stands plenty of upside at today’s current depressed price.
To show the true depressed levels that the share price exists at consider this. If all assets were converted to cash (or something with zero return) they would stand at $9298 million. If total liabilities, currently $6247 million, were to increase by 10% annually, it would take two years for BV to decrease to current market price. This (admittedly) simple exercise shows with no additional premiums (which historically have generated a 12% profit), and no interest on any investment (no chance for default either) and increasing liabilities compounding we could then achieve appropriate valuation. I do not think this will happen, the simple math was done to show what could occur in a reasonable time to achieve appropriate valuation as based on today’s price.
I believe based on past performance, management, and a shift in the industry that currently high combined ratios will settle back to their mean and offer profitable lines of insurance. If premiums begin to harden, interest rates rise, there aren't 800 catastrophes etc, there is good reason to believe net income could rise to previous levels and contribute to cumulative owners earnings in the form of increased book value, dividends, and share buybacks. In 2009 net income was $474m and I would consider this a very reasonable income achievement.
The company has been pushing to extend offices into Latin America and Asia. Capex has increased as a result but still remains low at under 2% of Premiums written. I have excluded growth from my analysis.
Risks:
1.
Poor investment decisions: I feel I can use history as a good proxy of the future. Investment income in 2008 was $139 million, while significantly reduced compared to 2009’s $248 million it gives a good proxy for income when the world is falling apart and the financial world as we know it is coming to an end. Currently only 14million of fixed income investments reside in PIIGS Euro-denominated bonds, all of which is invested in Spain. There is no direct exposure to either Greece or Portugal2.
Poor underwriting standards: AHL has been consistently profitable and attained combined ratios under 100 for the past five years. In 2005 a combined ratio of 122 occurred as they had significant exposure to Hurricane Katrina, the costliest natural disaster to date. In their Q1 2011 10Q it was stated Reinsurance premiums fell, some of the reason was pricing concerns, too low of a price to take the risk. It appears prudence is at least being attempted.
Premium rates stay low: There is indication already that rates have begun to increase, as shown in the 2011 10K concerning Energy & Energy Liabilities and discussed further by Chief Risk Officer Julian Cusack3
Decaying balance sheet: Since compensation is based on ROE it will be imperative to monitor debt levels. Currently total debt+hybrid securities represent 22.8% of capital. This number has remained consistent, in 2007 it was 21.8%(10K 2008). If that ratio rises it will be most prudent to examine quickly the cause as it may be management juicing its returns. They hold 1 billion in interest rate swaps, something to consider.
Poor underwriting standards: AHL has been consistently profitable and attained combined ratios under 100 for the past five years. In 2005 a combined ratio of 122 occurred as they had significant exposure to Hurricane Katrina, the costliest natural disaster to date. In their Q1 2011 10Q it was stated Reinsurance premiums fell, some of the reason was pricing concerns, too low of a price to take the risk. It appears prudence is at least being attempted.
Premium rates stay low: There is indication already that rates have begun to increase, as shown in the 2011 10K concerning Energy & Energy Liabilities and discussed further by Chief Risk Officer Julian Cusack3
Decaying balance sheet: Since compensation is based on ROE it will be imperative to monitor debt levels. Currently total debt+hybrid securities represent 22.8% of capital. This number has remained consistent, in 2007 it was 21.8%(10K 2008). If that ratio rises it will be most prudent to examine quickly the cause as it may be management juicing its returns. They hold 1 billion in interest rate swaps, something to consider.
These represent a few of the potential risks facing AHL and by no means represent an exhaustive list. Being an insurer, we (or more appropriately I) have little in way of knowing exactly what is going on inside. What risks are being taken (see AIG), and what investments are being made are not made inherently clear to all. With an appropriate margin of safety though one can surmise the potential downfalls are negated and the downside is protected. A.M. Best rates all AHL's subsidiaries "A", historically companies with an "A" rating have a 5.33% impairment rate for a 10 year period4. AIG had great ratings too, simply another measure for understanding.
Links:
Zeke Ashtons presentation: http://www.benzinga.com/life/hedge-funds/10/10/523209/neglected-hated-and-feared-zeke-ashtons-presentation-from-the-value-in
(4) http://www.ambest.com/ratings/methodology/impairment.pdf
6/27/2011: Threw in an order for the tax sheltered accounts. I feel this is a compelling buy with an adequate margin of safety. I also believe it adds strength overall to my portfolio. The position is about 3.8% for the accounts I manage. I'll reassess at under 21/share. There we will be about 1/2 TBV and a good time to add or eliminate. I'm going through other insurers and hope to post some thoughts soon. Long AHL.
6/27/2011: Threw in an order for the tax sheltered accounts. I feel this is a compelling buy with an adequate margin of safety. I also believe it adds strength overall to my portfolio. The position is about 3.8% for the accounts I manage. I'll reassess at under 21/share. There we will be about 1/2 TBV and a good time to add or eliminate. I'm going through other insurers and hope to post some thoughts soon. Long AHL.
