If you make a comparison to Seabright which was taken out by Enstar and put into runoff:
-Taken out at $252mm or 0.71x book value of $354mm
-This was a 34% premium to where it was before or $186mm or 0.53x book
-Loss reserves & UEPR before takeout was $665mm, so market was penalizing 0.47x of book value before takeout, pricing in about $166mm of underpricing or $166/$665 = 25% underpricing
-Trading at 0.4x book
-$3.5bn loss reserves & UEPR, about a $1bn in book value
-Market is trading at $480mm or 0.48x book
-Penalizing for 0.52x book or $520mm or $520mm/3.5bn = 15% underpricing
This doesn't account for some reinsurance stuff in liabilities.
Workers' comp in 2012 written was $419mm or 24% of $1.766bn written. So if you assumed all the underpricing was workers' comp (which is unlikely), then 24% of $3.5bn loss reserves & UEPR is $840mm. So haircut that by 25% and you get $210mm. So what's left is $310mm of underpricing ($520 minus $210) by the market on remaining $2.66bn of loss reserves & UEPR ($3.5bn minus $840mm), which is 12% underpricing. Does this make sense? Maybe I also need to account for funds held for reinsurance, not sure.
I am only 12 so please let me know what you think.
Yea it's a margin call. A sale by the bank (Citi) holding the shares as collateral. Same thing happened with McClendon of Chesapeake. It might be a sign of overly aggressive mentality by a CEO, but my sense is a lot of CEO's and even retail investors do it. If you trade on margin on Scottrade, you have to maintain a certain trading value in your account.
Takeout value in a runoff situation could be much higher than current market value. Seabright was trading at 0.5x book and taken out at a 34% premium at 0.7x book and put into runoff by the acquirer. Seabright was 100% workers' comp, TWGP is not. I am not saying your call is wrong, as insurance accounting is mostly made up as Buffett once said. You may end up being right. But you'll be right in the same way those dudes who think their favorite football team won because they screamed at the TV loud enough.
Did you also know that insurance companies don't go into Chapter 11 bankruptcy first? There's an entirely separate creditor, court restructuring regime where they are on watch by regulators to protect policyholders, then potentially in rehabilitation, conservatorship, then liquidation. Chapter 11 filing could happen at any of the stages mentioned and the order of the stages can be accelerated.
Hi twhite113- No it did not. But Tower goodwill if I remember correctly was about 200-250mm, bringing tangible book value down to about a $1bn. Seabright was 100% workers' comp, concentrated especially in California, with high exposure to the real estate/construction markets. You are right about the higher premium, but I think it's more relevant if it was a business slated to write more new policies, to take on new risk as an ongoing concern. Enstar bought Seabright and put it into runoff - a runoff acquirer pays a premium that's a function not so much of the specialty expertise of the ongoing business, but whether the premium paid to old shareholders is less than what the acquirer can squeeze out of the existing assets over liabilities.
For example, say a company has BS of $200mm assets, $100mm liabilities, $100mm book value. if something is trading at 0.5x book (book value $100mm, market cap $50mm) and you take it out at 0.7x ($70mm) and put it into runoff, that means if the actual runoff losses eat into 0.3x of book value, you will breakeven, because book value will now be equal to what you paid for it ($200mm assets, $130mm liabilities, $70mm book value). If they think that liabilities will only grow to $120mm, that leaves book value of $80mm, a $10mm gain on their $70mm investment. But if the target is in specialty lines, a runoff acquirer may pay less because it doesn't have that expertise in that type of claims management. But if the acquirer thinks it itself has the expertise to manage the claims of those specialty lines and maybe reduce them, then that could drive the premium higher vs. what others who do not have claims expertise in that line of business may pay.
Yes. I will thank you and envy the secret sauce that you have. Can the secret sauce be replicated over and over on numerous future trades? Like Coca Cola making billions of cans of Coke from its secret recipe? If so, you should sell your secret recipe and make a lot of money. But if it's an inherent skill that you have and can't explain, I'm really jealous =(
Tower Group has bowed to the pressure of a precipitous fall in its share price amid uncertainty about a black hole in its reserves by appointing JP Morgan to sell the business, The Insurance Insider can reveal.
Tower's share price has declined by more than 60 percent since the 7 August after it delayed its second quarter results.
According to multiple sources, JP Morgan has approached a number of legacy and live markets about a sale of the company.
I don't think it'll be liquidation value b/c there is uncertainty with regards to the liability reserves. Question is how big of a haircut will it be.
They don't need to survive for there to be value. It can be a take under to book value but above market value. If you're right, it will be a take under to market value.
Well clearly everyone here is an expert but I need to run the numbers again but I initially think 600mm is a doable deal for someone like Fairfax or Berkshire. It is a valuation that wouldn't enable the co to go on because risk to surplus ratio would be too high, risking regulatory action and definitely a loss of decent AM Best rating. But as a runoff it could have a lot of value at that price for an acquirer. To plug the hole with a capital raise and new money would be too risky for investors. Should I keep adding my commentary or would people rather hear rambling. Maybe people like hearing their own views reinforced without any support. Does anyone have any original thought? I think a long position is very risky at this point but a short is even riskier. I think asymmetric returns are skewed to the upside at the moment and my initial analysis says the floor is near these levels. But do your own work and my numbers will probably change as I study it more. Let me ask you this, would JP Morgan take on an assignment if there was egregiously fraudulent accounting by their client? I am not sure, but I would doubt it. Maybe it was really bad underwriting - so a big hole but not an Enron hole.
That's actually incorrect. Going under could mean several things. A buyer could see value in a runoff scenario. This is where the existing book is run off and the assets supporting that book of liabilities is used. No new business is being written so it's not a going concern - but it's not a liquidation or bankruptcy where there is no residual equity value left.
Ran some numbers (I looked up statutory filing numbers and used those surplus and liabilities as these are more conservative and used by regulators; $3.3bn of admitted assets and $888mm of statutory surplus as of 12/31/12), and then I adjusted statutory liabilities of $2.4bn upwards by $600mm based on the assumption that the existing book of policies is underpriced and understated by 20%. Then I discounted the liabilities by an average duration of about 2.2 years (the average number of years the existing book of policies is in force) at a 4% (low) and 5% (high) rate. Backing out this liability from assets, my Initial take is floor takeout valuation for equity is $450-$500mm with conservative upside to $500-$550mm. This is what an acquirer could pay to comfortably achieve an IRR of 10%-15% on its investment w/ very low risk. Additional upside would come from other net assets that are not admitted in the statutory filings and any tax benefits which I haven't taken into account. This is a rough calculation, but if the hole was potentially greater than $600mm that I've assumed based on the level of underpricing by other targets that were acquired and put into runoff, then I am not sure JPM would have taken on the assignment b/c it would be borderline fraudulent accounting (which is definitely possible). But that's a risk for sure that the hole could be greater than $600mm. But being long the stock at current levels is asymmetrically skewed to the upside w/ most of the realistic downside already priced in. I wouldn't be surprised if the actual takeout happens at a $600mm valuation or higher. Only my educated guess. Also, re: the Canopius deal/liabilities, I excluded them b/c I'm considering the net effect a wash as 60% of the adverse development was said to be from the U.S. based business which also enjoy 35% tax benefits that serve as offsets.
I think that's correct if he's trying to buy operating companies, except he also sees value in insurance float if he can acquire it or reinsure it at a very low price. See what he did with Equitas and its asbestos liability. He recently reinsured the CIGNA book of VA liabilities to get $3bn in investment funds he can play around with. Acquisition of float can be a cheap way of getting funds that he can use to invest in very good companies that you mentioned.
That's exactly right. I assumed a very low return profile which can be boosted by the right acquirer, say a financial sponsor or better manager of assets. However, the reserve deficiency is what terrifies me.
Thank you. You are right about smoke signals. I think Howard Marks once said there were two types of investors in this world. Those that say "I know" and those that say "I don't know". He quotes Mark Twain who said, "It ain’t what you don't know that gets you into trouble. It's what you know for sure that just ain’t so." So yea, I recognize that I really don't know how big the hole is; it is unknowable. It could be massive, and I could be very wrong in my valuation. So this is extremely risky and maybe a coin flip. But my bet is that it's not fraudulently massive (i.e. 50% reserve understatement), but that's a risk that I am taking. The hole was initially guided to $110mm, and I thought to myself that about 5-6x that amount would be terrible for the company (as other companies with 100% workers' comp had that level of reserve deficiency (i.e. 25%) and were put into runoff) and would not enable capital raising nor much less ongoing new business value creation (but runoff value is still there) but anything in the 9-10x (i.e. 50% reserve deficiency) amount would wipe out book value - a very possible scenario. My assumptions are too arbitrary and put too much faith in human beings. The risk for me is that the i-banks took on the hopeless assignment to sell the company b/c there's no downside for them if they can't. Another risk that I failed to account for enough was the reinsurance/cat loss risk from Hurricane Sandy. I thought that the company had as of Feb. 8 closed 89% of the 24,000 claims that its stock companies received as a result of the superstorm, which hit the Northeast and Mid-Atlantic in late October. But all of this could be misrepresentations by the company. Having said all that, I am still long!
There's an entirely separate creditor, court restructuring regime where they are on watch by regulators to protect policyholders, then potentially in rehabilitation, conservatorship, then liquidation. Chapter 11 filing could happen at any of the stages mentioned and the order of the stages can be accelerated. But ultimately the state regulator would have to sign off on and support a Ch. 11 plan I believe.
Did some more work on this and valuation took a big haircut that I bailed on my long position. I found they were doing a lot of the reinsuring themselves through an affiliate Castlepoint Reinsurance; about $900mm of their $1.7bn reinsurance recoverable is through an intercompany underwriting pool. This amount is not disclosed in the SEC filing but in the statutory filing in one line item. If you look at the 2012 schedule F for Tower Combined & Affiliates it shows they have a significant amount - about $921.319mm (bottom left pg 22) reinsurance recoverable from Castlepoint Reinsurance; it's the majority of the $1.7bn of all of Tower Group's reinsurance recoverable in column 15; GAAP shows for 2012 shows only $443.803 for reinsurance recoverable and this figure rose to $859.634mm and shows no disclosure about the majority of their
reinsurance recoverable being from an affiliate. It's not a scam but it doubles the risk/inherent leverage of the situation. Essentially the reason why someone sets up an intercompany underwriting pool is b/c it is a self reinsurance mechanism that you set up if you think you are able to price and reinsure your below-market risk in your primary book more effectively than a third party reinsurer so you can charge yourself lower reinsurance premiums. The problem is - these guys don't have a below market risk profile for their primary book (i.e. via geographic concentration, not low cost provider, etc.) so their original book is underpriced which is no surprise. But this is compounded by self reinsurance that's under-reserved in my opinion b/c you reinsured yourself with the presumption that you could charge yourself lower rates for lower risk and better risk management. So reinsurance is probably under-reserved too. I could be wrong but there's enough risk and unknowns related to the intercompany underwriting pool mechanism that I am willing to forego 50% or more upside unless valuations are at liquidation levels (around $50-$150mm).