A Guide to Fundamental Analysis of a Reinsurance Company
Reinsurance is often called "insurance for insurance companies." Reinsurers take on a portion of the risk that primary insurance companies have underwritten, which helps these insurers manage their capital and remain solvent, especially after a major catastrophe. Analyzing a reinsurer like the former PartnerRe requires a focus on specific metrics that differ from a standard company.
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| A Guide to Fundamental Analysis of a Reinsurance Company |
1. Quantitative Analysis: Key Financial Metrics
For a reinsurer, standard revenue and profit metrics are less important than specialized financial ratios that reveal the company's underwriting performance and financial strength.
Combined Ratio: This is the most crucial metric in reinsurance. It's a measure of underwriting profitability, calculated by adding the loss ratio (incurred losses to earned premiums) and the expense ratio (underwriting expenses to earned premiums).
A combined ratio below 100% indicates that the company is making a profit from its underwriting activities.
A combined ratio above 100% means the company is paying out more in claims and expenses than it is collecting in premiums.
Book Value Per Share: This is the net asset value of the company divided by the number of shares outstanding. For a reinsurer, a growing book value per share over time is a key indicator of shareholder value creation.
Underwriting Profit: This is the profit generated from the company's core business of selling reinsurance policies, before considering investment income. A consistent underwriting profit demonstrates a disciplined approach to risk selection and pricing.
Investment Income: Reinsurers invest the premiums they collect before they need to pay out claims. The returns on these investments are a major source of income. A fundamental analysis should consider the quality and performance of the company's investment portfolio.
2. Qualitative Analysis: The Business & Market
Beyond the numbers, a fundamental analysis of a reinsurer must consider the company's business strategy and the broader industry dynamics.
Underwriting Discipline: A strong reinsurer is not one that writes the most business, but one that writes the right business. This means having a disciplined approach to risk selection and pricing, even if it means losing market share in the short term.
Diversification: The company's portfolio of risks should be well-diversified across different geographic regions and types of insurance (e.g., property, casualty, life, and specialty lines). This helps to mitigate the impact of a single catastrophic event.
Market Cycle: The reinsurance market is highly cyclical. When capital is abundant, competition is high, and premium prices fall. After a major catastrophe, capital is depleted, prices rise, and profitability improves. An analyst must understand where the market is in this cycle.
Regulatory Environment: Reinsurers operate in a heavily regulated environment. Changes in capital requirements or solvency rules can have a significant impact on their business model.
By combining these quantitative and qualitative factors, you can build a comprehensive understanding of a reinsurance company's financial health, competitive strengths, and long-term prospects. This will enable you to make a more informed investment decision, but always remember to consult with a financial professional.
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