Everest Re Group, Ltd. — Q2 2012 Form 10-Q
Business and period: The filing is for the quarter and six months ended June 30, 2012. The registrant is Everest Re Group, Ltd., a Bermuda-based group principally engaged in reinsurance and insurance in the U.S., Bermuda and international markets. Unless stated otherwise, amounts below are U.S. dollars.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Gross written premiums | $909.0m | $987.9m | $1,955.5m | $2,052.8m |
| Premiums earned | $1,037.8m | $1,039.8m | $2,035.8m | $2,051.3m |
| Net investment income | $149.3m | $158.6m | $301.8m | $337.3m |
| Income (loss) before tax | $239.4m | $140.8m | $582.2m | $(200.8)m |
| Net income (loss) | $214.6m | $131.3m | $519.3m | $(184.6)m |
| Diluted EPS | $4.08 | $2.41 | $9.79 | $(3.40) |
| Combined ratio | 89.0% | 98.0% | 89.0% | 124.3% |
| Operating cash flow | $138.8m | $150.6m | $304.5m | $338.7m |
- Profitability and comparison: First-half net income recovered from the prior-year loss, primarily because catastrophe losses were substantially lower. First-half incurred losses and LAE fell 39% to $1,210.3m; the loss ratio improved to 59.5% from 96.8%. Q2’s loss ratio was 58.6%, versus 70.8%. Commission and brokerage costs rose, and the commission ratio increased to 25.6% for Q2 and 24.7% year to date.
- Underwriting by segment: First-half underwriting gains were $155.9m International, $38.9m U.S. Reinsurance, $23.9m Bermuda and $5.3m Insurance. International and Bermuda results improved sharply year over year, principally reflecting fewer catastrophe losses in 2012; U.S. Reinsurance moved to a gain, while Insurance remained modestly profitable.
- Investment results: Net investment income declined 5.9% in Q2 and 10.5% year to date, attributed to lower fixed-income reinvestment rates and lower limited-partnership income year to date. Realized capital results were a $16.6m loss in Q2, but an $82.1m gain for the first half, including fair-value remeasurements and security-sale gains. The Q2 derivative loss was $16.3m.
- Balance sheet and capital: At June 30, investments and cash were $16.03bn; total assets $18.90bn; loss and LAE reserves $9.89bn; total debt $818.1m; and shareholders’ equity $6.42bn, up from $6.07bn at year-end 2011. Book value per share was $123.75, versus $112.99. The company repurchased 2.37m shares for $225.0m in the first half and declared dividends of $0.96 per share.
- Liquidity: Cash was $398.9m and short-term investments $947.6m, totaling $1.35bn. Management stated that liquid investments, maturing securities and operating cash flows provide ample near-term liquidity. Operating cash flow was lower year over year despite higher net income. The company reported $818.1m of debt and no revolving borrowings; credit facilities totaled $1.25bn, with letters of credit outstanding under facility tranches. It was in compliance with facility covenants.
Material changes, outlook and risks
- Gross written premiums fell 8.0% in Q2 and 4.7% year to date. The principal factor was non-renewal of a large Florida quota-share reinsurance contract; insurance premium reductions also reflected runoff or termination of casualty programs. International growth and catastrophe-related rate increases partly offset declines.
- The much lower 2012 catastrophe burden drove the year-over-year underwriting improvement. First-half 2011 catastrophe losses included major Japan, New Zealand and Australia events; 2012 catastrophe losses were primarily U.S. storms. Management cautioned that reserve estimates remain subject to potentially significant variation and may increase.
- Management described insurance and reinsurance markets as highly competitive, particularly U.S. casualty, while noting profit opportunities in some catastrophe markets. It expects positive operating cash flow near term absent unusual catastrophe activity; no specific earnings or premium guidance was provided.
- Investment risks include interest-rate, equity-price and foreign-currency movements. The company held $788.7m of European sovereign securities, concentrated mainly in the U.K., France and Austria, and reported no sovereign exposure to Portugal, Italy, Ireland, Greece or Spain. It also held unhedged equity-index put options with a $79.9m fair-value liability; the theoretical maximum present-value payouts were disclosed as $293.8m for S&P 500 contracts and $32.3m for the FTSE contract.
- Moody’s affirmed operating-subsidiary ratings in January 2012 but changed the outlook from stable to negative. Management said a one-notch downgrade was not expected to materially harm the business, but the outcome was uncertain.
- A deferred-tax-asset understatement was corrected through a $9.3m Q2 tax benefit; the total first-half adjustment was $21.7m. Management considered the out-of-period adjustments immaterial to the current and prior periods and did not restate prior results. New acquisition-cost accounting also accelerated expense recognition, including $6.2m of previously deferrable costs in the first half.
- Ordinary-course insurance and reinsurance disputes and arbitrations continue; the company reported no other material litigation. Separately, it has contingent exposure if certain annuity providers cannot make payments. The filing reports no material risk-factor changes and no subsequent events to report.
Key facts for investors to verify
- How sustainable are the improved combined ratio and earnings once catastrophe losses normalize, given the unusually high prior-year comparison?
- What are the adequacy and sensitivity of loss reserves, including asbestos and environmental reserves, and the potential for adverse prior-period development?
- How much of first-half earnings depended on realized investment gains, the tax-account correction and other non-underwriting items?
- Can the company offset lower investment yields and premium declines while maintaining underwriting discipline in competitive markets?
- What are the potential collateral and payout implications of the unhedged equity-index options, and how could a ratings change affect collateral requirements or business?