If reinsurers go into a cyclical downturn, Fools might want to seriously consider scooping up shares on the cheap. RenaissanceRe's (NYSE: RNR ) results held up well in the fourth quarter of 2007, but the industry faces tough headwinds going forward.
Thanks to a general absence of catastrophes, and favorable loss development (previous losses were less than expected), RenaissanceRe's combined ratio (the percentage of each dollar of earned premiums expected to be paid out in claims and expenses) for the quarter decreased to 47.3% from 53.4% -- the lower the better. The reinsurance division, which is heavily exposed to catastrophe risk, was the main driver of that improvement.
Operating income (which excludes all unrealized, realized, and mark to market gains and losses) slipped a bit to $186 million for the quarter from $198 million a year ago. The primary culprit was soft industry pricing, which contributed to a 13% decline in fourth-quarter earned premiums. Low industry losses over the past couple of years and an excess of capacity has heated up competition for market share, which has eroded pricing power.
During the earnings call, management noted that the reinsurance market, in total, didn't grow for the first time since 2005. That's a bad sign for RenaissanceRe, as well as competitors, such as Stock Advisor pick Montpelier Re (NYSE: MRH ) , ACE (NYSE: ACE ) , and Axis Capital (NYSE: AXS ) .
RenaissanceRe's management also talked about how it categorizes catastrophe risk into three buckets: business that is expected to have negative returns, low returns, and acceptable returns. Due to eroding pricing pressure, the portion of the catastrophe insurance world that it classifies as presenting "acceptable returns" shrunk 5%-10% at January 1 (when catastrophe insurance contracts are signed or renewed).
RenaissanceRe, as well as PartnerRe (NYSE: PRE ) , suffered an embarrassing write-down of its equity stake in ChannelRe. RenaissanceRe's investment went from $126.7 million to $0, for example.
A little background: ChannelRe is a reinsurer to bond insurer MBIA (NYSE: MBI ) and has been inundated by losses thanks to the subprime debacle. Fortunately, RenaissanceRe's exposure here is limited to its initial investment, which is now worthless.
All in all, RenaissanceRe's results, notwithstanding the ChannelRe fiasco, held up relatively well in a difficult situation. The company is one of the more disciplined reinsurers out there, so it should weather the soft pricing environment better than most.
Nevertheless, it might be a good idea to wait to see if the insurance cycle turns sharply downwards before looking for an entry point.