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Investors reward profitability over book value growth

With more than half the year gone and two quarters of financial results to digest, investors have tended to reward outperformers on profitability rather than book value growth, analysis by The Insurance Insider shows.

Of the (re)insurers in our core markets of London, Bermuda and Europe, the Lloyd's trio of Amlin, Hiscox and Beazley lead the pack on year-to-date (YTD) share price performance (see graph).

All three have seen their share price climb by almost 30 percent for the YTD as investors have rewarded their profitability and reasonably positive narrative on the prospects for modest but sustained (re)insurance rate increases.

Amlin reported H1 return on equity (RoE) of 23.8 percent, while Hiscox and Beazley achieved figures in the high teens.

This was achieved against a backdrop of low bond yields, weak economic growth in developed countries, the Eurozone crisis and signs of slowdown in emerging markets.

Montpelier Re and Allied World, the leading Bermudians on annualised return on common equity for H1 (see page 13), are also among the outperformers on share price movement for the year.

Continental reinsurers have also been in vogue with investors during 2012, with Hannover Re, Swiss Re and Munich Re all up 25 percent or more. Lower catastrophe losses and improved reinsurance pricing over the previous 12 months have improved analyst sentiment on the group's RoE potential.

But despite impressing on profitability, the outperforming Lloyd's stocks' net tangible assets per share growth of around 5 to 8 percent for H1 puts them solidly middle of the pack against global peers on comparable measures.

Bermudian players are typically among the outperformers on book value per share growth due to their more aggressive capital management strategies (see graph).

This is partly explained by the fact that our Bermuda composite is trading at around a 20 percent discount to book value, making capital management a more attractive way of creating value for shareholders.

By comparison, the London market (re)insurers (with the exception of Novae) all trade at a relatively healthy premium to book value, limiting the power of share repurchases to boost shareholder returns.

And although Montpelier Re, RenaissanceRe and Everest Re lead the way on book value growth with 9.5 percent for H1 or higher, the (re)insurers have been rewarded in a mixed way by investors.

Everest Re has been the strongest performing Bermudian of the year with a gain of 27 percent for the YTD, while Montpelier Re has advanced 22 percent.

Yet RenRe is one of the worst-performing stocks for the year at up 4.3 percent - significantly underperforming the S&P 500's 11.7 percent YTD gain. However, it does remain the highest-valued stock in the sector, with a price to book of 1.2x.

Seventy percent of the reinsurance sector is currently trading below book value. But Robert DeRose, a vice president at AM Best, said investors in reinsurers were still well rewarded if they took a long-term view and factored in the effects of share buybacks and dividend payments.

"The current stock valuation is only reflective of the risks in the market at the moment - the volatility of the business, sustainability of favourable reserve releases and forward pricing movements," he explained.

"I don't think it's a bad business to invest in, you just have to recognise the natural cycles; take the rewards when they come and know when to exit," he added.

The trend of investors seeking profitability rather than book value growth could be seen in the noticeably volatile trading in companies with strong profitability in the last couple of quarters. Many firms saw rapid share price leaps immediately after publishing their accounts.

Nevertheless, the management at many of the Bermudian (re)insurers maintain that the ability to create value through share buybacks in the coming months could be a key differentiator if the nascent hardening of (re)insurance prices fades.

Alterra CEO Marty Becker succinctly summarised this view: "We expect to continue to use share repurchases as an important capital management tool for maximising shareholder value until rate increases enable us to more effectively deploy any excess capital in our underwriting operations."

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