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XL Group plc Message Board

  • greggbuttery greggbuttery Mar 19, 2008 9:12 PM Flag

    XL and SCA

    In addition, there are certain guarantees in place between the Company and SCA subsidiaries. It is important to note that the guarantees the Company has provided contain a dual trigger, such that losses are paid only if two events occur. First, the underlying guaranteed obligation must default on payments of interest and principal, and second, the relevant SCA subsidiary must fail to meet its obligations under the applicable reinsurance or guarantee. As of December 31, 2007, the Company’s total net par outstanding under these guarantees was $75.2 billion. Indirect consumer mortgages exposures as a result of these guarantee agreements totaled approximately $2.9 billion related to RMBS and $3.3 billion related to ABS CDOs with greater than 50% RMBS collateral. Again, it is important to note that SCA subsidiaries must fail to meet their obligations under the applicable reinsurance or guarantee before the Company would be required to respond to claims under these guarantees and as such, these exposures must be compared to the relevant SCA subsidiary’s current financial resources.

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    • And???

    • 1. XL is liable for some post-IPO obligations via facultative reinsurance arrangements. I am fairly certain that most of XL Capital's fourth quarter charge for RMBS related to post-IPO obligations. I do not know what types or percentage of post-IPO SF arrangements SCA ceded to XL Capital.

      2. For this question, see above, and beyond that I believe it is a timing issue based on checks SCA would have to cut for pre-IPO liabilities but is financially unable to.

    • Two questions I haven't seen answered directly?

      1. Is XL responsible for any SCA contracts written after the spinoff? I would assume not, but am not sure.

      2. Is XL protected against defaulting SCA contracts written after the spinoff? This is the trickier question, and may be why XL is part of the lawsuit. Here is an example using hypothetical numbers. Suppose SCA has $500M of capital. Contracts written prior to the spinoff have $400M in losses, after have $1B in losses. If the $500M is applied to losses prior to the spinoff, then you would say that XL is fully protected, they aren't responsible for the rest. But if the $500M is applied to the $1B first, then SCA has no money left and XL will be left to pay $400M.

    • You could have made the same 20% forecast for each of the last 10 years and yet they manage to deliver less than 10% over time.

    • It is nice to see some intelligent points being made.

      Tangible book value is one step better than unadjusted book value, but I am not a big fan of either as valuation metrics, because they tend to lag underlying economics by a few years for casualty underwriters. Nevertheless, it makes sense to look at tangible book value because it is used as a valuation barometer.

      Project the growth in tangible book value over the next two years beginning with the second quarter of 2008 (i.e., after SCA-related charges have fully recognized, more or less). What do you come up with assuming a 100% combined ratio? I come up with growth of around 20% (after adjusting for dividends). If you come up with a different range, let me know.

      Assuming that the market continues to soften gradually, 80% of tangible book seems like a fair valuation two years from now. If the market assigns this ratio (it would be an impressive sign of market discipline if it did), the annualized returns would still be 20%. However, even though it would not be justified, something closer to 125% seems more realistic after two years of 20% ROEs. After all, the market afforded a valuation of 85.67 (around 150% of tangible book) in the middle of 2007 based on just 18 months of solid earnings.

    • Growth in tangible book value per share plus dividends, the most comprehensive measure of a company's ability to add value over time, at XL was -5% for 2007, 9% for the last 5 years (a hard market) and 7% for the last 10 years. With that record and a soft market, XL is likely to sell at a discount to tangible book value ($40 before further write downs) in the foreseeable future.

    • If you have no faith in reserves, then it makes sense to be skeptical, because reserve leverage is high. If reserves are weak, there are problems. I was very skeptical of reserves after first post-9/11 charge, and somewhat skeptical before the 2005 charge, but am fairly comfortable now. I will take a closer look if I find time.

      It seems like a bad idea to invest based on hopes of an acquisition. However, I think your comment about acquisition premium in a soft market is rational, but not reflective of real market dynamics. Fear of potential market softening in the eyes of potential acquirers is one sign of a competitive but healty market. When acquirers pay premiums despite blatantly competitive market conditions (e.g., Munich Re acquisition of American Re, Berkshire acquisition of Gen Re), then you know the soft market has arrived.

      In any event, XL's current valuation has a lot of bad stuff baked in. If market conditions stabilize, it would be a nice bonus, but is not essential to justify the current valuation.

    • Some names would be good, but I can't blame you if you don't want to share them on a Yahoo message board.

      Writing business through a TPA does not guarantee poor results. Are these carriers allowing TPAs to write business essentially unchecked and are the TPAs writing horrible business?

      Growth of business "outsourcing" (including TPAs and MGAs)with reasonable controls seems pretty typical of a softening market (e.g., 1995). When people start to think money can be made by indiscriminately giving MGAs the pen, that's when trouble is near.

      Also, the 1990's was a long decade. The pricing was decent through 1995 at least, arguably 1996 (but one had to be very selective in 1996). It's funny, because your language reminds me of the griping I heard around 1995, when naive capacity was entering certain pockets, but decent margins could still be earned if you didn't fall asleep at the wheel.

    • Look at the new money in Bermuda and Cayman writing fronting business, putting up the capital, paying the commissions / TPA claim handling fees and taking all the risk.

      This is new competition to the US market and will only boost the values of those service providers.

      And, yes, I see 1990's pricing with naive capacity buying business.

    • As for international competition, Munich Re has stated it wants to expand its american operations.

      The last soft market losses were driven by adverse liability trends that did not (as usual) manifest until after several years of underpricing. Reinsurance rates were especially soft, hence the massive losses by Zurich Re:s US operations(RIP), ERC, American Re, Gen Re, etc., but those bad reinsurance losses substantially smoothed direct insurers' losses. This soft market is different to the extent that reinsurers have been much more disciplined and XL, being all commercial lines and mostly a direct writer, could have more volatility on the direct side. Also, some competitors such as Hartford with more diversified and more "main street" business could see less rate volatility. I believe analysts have stated that large premium accounts are seeing greater decreases - no surprise as it's more economical to shop a $100K premium renewal versus a $10K premium renewal. Again, XL seems quite exposed to large account business. Their reinsurance segment will provide some diversification with its cat. premiums. I have very little faith in their reserving as I believe they have had a few adverse reserve charges from hard market years. As for hardening due to the credit crunch that would appear logical, but we are talking about insurance companies.

      Note also that they have a large amount of RMBS in their investment portfolio, although many are AAA so the cash flow impairments might not be material.

      As for XL trading at a low valuation, I can't disagree but I would not expect to see any acquistion premium in their stock until greater clarity on CDO/RMBS losses occurs (by then the soft market will probably be so bad that nobody would acquire them due to p/c exposure). I also tend to agree that your estimate $1b of assumed contingent liability for CDO/RMBS exposure for pre-IPO liabilities appears reasonable (gut instinct only) and not cause, in and of itself, for undue concern.

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