Endurance writes marine insurance. Image: Endurance Specialty Holdings.

Insurance doesn't always work the way people expect. For insurance specialist Endurance Specialty Holdings (NYSE:ENH), a lengthy period of below-average property and casualty losses might seem like the perfect recipe for profit. Yet even though not having to play as much in claims is always a good thing for an insurer, Endurance also has to deal with rising competition for business that tempts companies in good times to loosen up on their underwriting standards or else risk seeing premium revenue fall. Coming into its third-quarter financial report, Endurance investors had expected substantial declines in net income due in part to that trend, but the magnitude of the earnings decline was even greater than most were looking to see. Let's take a closer look at Endurance Specialty and whether its recent performance is anything that anyone else needs to worry about.

A mixed quarter for Endurance Specialty
Endurance Specialty's third-quarter results demonstrated how volatile the insurance industry can be. Gross premiums written rose almost 3% to $642.6 million, but net premiums dropped almost 14% to $336.7 million, completely missing expectations for a 19% jump in net premiums. Net income to common shareholders of $43.6 million was down by more than a third from year-ago levels, and that produced earnings of $0.73 per share, missing the consensus forecast among investors by $0.08 per share.

A closer look at the results shows countervailing factors in both directions. Book value climbed 6% from year-earlier levels to $65.02 per share. Combined ratios were generally lower than in the third quarter of 2014, with an overall ratio of 87.9% down more than two percentage points. An 18-point drop in the insurance business' combined ratio was especially impressive, but a six percentage point drop for the reinsurance market was also beneficial to Endurance Specialty's balance sheet. Also noteworthy was the fact that the combined ratio includes 11 to 12 percentage points of headwinds from the Montpelier reacquisition.

From an industry perspective, Endurance's insurance segment found growth within regular casualty lines as well as specialty professional lines of business. The property, marine, and energy areas remained fruitful even as agriculture continued to hold back Endurance's results. In the reinsurance segment, growth in casualty and professional lines wasn't enough to overcome negative impacts from property, catastrophe, and specialty business lines.

CEO John Charman took the results in stride. "Against a backdrop of relentless global competition coupled with extremely challenging investment market conditions," Charman said, "I am very pleased with our ability to generate an attractive third-quarter annualized operating return on equity, excluding one-time transaction costs, of 12.3%." Charman also reported that the integration of Montpelier is essentially complete, with the expectation that Endurance Specialty will reap the expected synergy rewards from the deal.

Can Endurance Specialty keep growing?
Still, Endurance Specialty faces the same troubling environment that has hurt some of its peers. For the quarter, Endurance's fixed maturity and short-term investment portfolio had average credit quality of AA- and a duration of 2.63 years, reflecting its unwillingness to bear substantial interest rate risk despite the sacrifice in income yield that such a decision requires. The ending book yield for the portfolio fell to just above 2%, down almost two-tenths of a percentage point from 2014's third quarter.

Insurance giant Travelers (NYSE:TRV) is just one example of how other insurance companies have had to address a tough fixed-income environment. In its third-quarter report, Travelers said that net investment income fell due primarily to lower returns in both fixed income and nonfixed income portfolios. On the fixed-income side, lower reinvestment rates weighed on Travelers' ability to invest premiums effectively, holding back what in more normal environments is a major source of income. Endurance Specialty has many of the same issues.

Endurance shares gave back some of their recent gains following the announcement, but the long-term picture for the insurance company is far more important than any near-term trade-related move. With so much dependent on the future direction of macroeconomic trends and whether claims experience worsens in the future, Endurance Specialty will have to stay vigilant and be smart about its underwriting practices in order to keep itself in a solid position going forward.