The hurricane season of 2005 was a painful way to learn that Motley Fool Hidden Gems pick Montpelier Re's (NYSE:MRH) models and practices weren't quite up to snuff. It certainly wasn't the only insurance company to get hit hard, but that hardly softened the blow. Does the company now have the right model for the new reinsurance world?
The first quarter was tough, but that was no surprise. Gross written premiums fell 27%, as an agreement with Aspen Insurance (NYSE:AHL) ended, the company quit the offshore marine business, and Montpelier Re generally tried to reduce risk exposure in peak zones and walk away from inadequately profitable business. The company also markedly increased the amount of reinsurance premiums it would cede, though that should decline from this quarter's likely peak.
All in all, it was no surprise to see underwriting income down 34% and operating earnings down about 30%. In the combined ratio, the loss ratio was good, but the expenses ratio was high -- though if I understood management's comments correctly, this was caused by some one-time items.
On the pricing side, things seem mighty interesting. International price increases have been moderate (up about 10% year to date), which I find surprising, given the flooding in Europe. But in the U.S. markets, increases have been on the order of 80% in this current second quarter (they were about 35% in the first quarter). What's more, it's possible that some buyers in certain areas won't be able to afford the premiums that insurers will charge for their risk.
Speaking of risk, management believes it has significantly altered its model for the better. Had these new standards been in place last year, the losses from the Gulf hurricanes would have been about 50% less. In addition, management believes that this model can provide 15% returns on equity over the cycle and returns in the 20% range in non-cat years. This all sounds good, but just remember that you never really know until the wind starts to blow.
Past performance and present guidance being what it is, Montpelier Re is deservedly cheap. But perhaps there's still a bargain to be found here -- particularly if you have confidence in the management team. Personally, I wish Arch Capital (NASDAQ:ACGL) were cheaper, since that's still my favorite, and I also like XL Capital (NYSE:XL). I still have some skepticism about MontpelierRe, but I've got to admit that today's prices are a little interesting.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
