The insurance business is hard for many people to understand, but even insurance experts often get confused about the reinsurance business that Montpelier Re Holdings (UNKNOWN:MRH.DL) and its peers pursue. Nevertheless, what reinsurance boils down to is finding the most lucrative potential business available, and then charging the best possible premium to provide risk protection to its clients.
Even though Montpelier Re's headline numbers indicate that its earnings fell short of expectations, there are many other indicators that smart investors need to look at to assess the reinsurance company's health. Let's take a closer look at how Montpelier Re did last quarter.
Boosting business, but missing profits
What most investors will focus on is the fact that Montpelier Re's earnings fell short of what they had hoped to see from the reinsurance company. Operating income came in at $40 million for the quarter, which equates to $0.86 per share, or $0.03 per share below the consensus expectation for the company. When you add in investment losses and foreign-exchange impacts, net income was just $35 million, or $0.75 per share.
Yet, Montpelier Re reported some encouraging results on the top line. Adjusted net premiums written in the company's third quarter climbed by 13%, which was a much faster pace of growth than Montpelier Re had seen during the first half of 2014. Earned premiums, which reflect how much of its revenue Montpelier Re has actually provided risk coverage for, climbed by 8%, also a slightly higher growth rate than earlier in the year. Moreover, book value climbed just more than 2%, despite a slight negative total return on its investment portfolio.
What really hurt Montpelier Re, though, were its higher losses this year. Current-year losses and loss-adjustment expenses soared more than 58% from the third quarter of 2013, sending its combined ratio up 20 percentage points, to 74%. Still, given that the combined ratio reflects the costs of claims and administrative expenses, any figure less than 100% indicates that the company is earning a profit on the business that it writes. By that measure, Montpelier Re still looks healthy.
What should Montpelier Re investors expect ahead?
Montpelier Re was pleased with its results, even if it isn't happy about some of the issues it's facing from its peers. As CEO Christopher Harris noted: "Our underwriting teams executed well in a competitive market environment during the third quarter. ... We are well positioned to navigate a challenging market by building on our strengths as a long-term partner for our investors and clients."
Moreover, Montpelier Re is putting its money where its mouth is, with enough optimism to justify making share repurchases of its own stock. During the quarter, Montpelier Re spent about $57.5 million buying back 1.85 million shares of stock at an average price of just more than $31 per share.
With shares having closed Monday about $1.30 per share above that level, Montpelier Re's investment has already paid off. In the process, the insurance company has reduced its share count by more than 10% just since the beginning of 2014, which should help boost its earnings per share, and give ongoing investors a larger stake in the overall company.
Nevertheless, investors need to understand the inevitable cycle of the reinsurance business. After the horrible back-to-back years of hurricane disasters like Sandy, the Atlantic storm cycle has been unusually benign. That's good for profits in the short run, but eventually, competition starts driving premium income down during favorable times in the business cycle -- and that will leave Montpelier Re scrambling to keep its pricing up as much as possible. Inevitably, when the next major disaster hits, Montpelier will face losses that will surprise those who aren't familiar with that cycle -- but the resulting drop in share prices often presents an opportunity for those who can look forward to better premium pricing after a major loss event.
Montpelier Re's numbers aren't exactly what investors were looking for. But overall, they're consistent with the state of the insurance industry right now. As long as the company can keep executing on its overall mission to keep losses down and underwriting standards up, then Montpelier Re looks well-positioned to stay strong in reinsurance.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Montpelier Re Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.