XL Group Ltd. – ADR (OTC: XL-US, $36.10):
XL Fares Reasonably Well in a Difficult Environment
By: Jaclyn Godwin, AIM Student at Marquette University
Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.
Summary: XL Group Ltd. (OTC: XL-US) is a global insurance and reinsurance company that provides property, casualty, and specialty products to industrial, commercial, professional, and insurance firms. XL is a global enterprise that operates across continents with major business units in the Asia Pacific Region, the Americas, EMEA, the U.K. & London, and Bermuda. XL Group was founded in 1986 with its headquarters located in Bermuda.
· The property and casualty industry faced challenges in 2016, characterized by increased catastrophe losses, reduced margins, and lower premium rates.
· XL saw moderate success in the last couple quarters. The company is seeing an improvement in its cost and efficiency figures, while struggling with its top line premium figures. The reinsurance segment fared better than the insurance segment.
· Innovation efforts continue with the promotion of Paul Brand to lead the company initiative.
Key Points: XL Group was added to the portfolio in the spring of 2016 due to its innovation efforts, expected synergies from the Catlin acquisition, and share buyback/dividend program.
The macroeconomic environment remains challenging for property and casualty insurers (P&C). The year was characterized by larger catastrophe losses, reduced margins, and lower premium rates. The industry has felt downward pressure on margins due to pricing constraints and added competition. Lower rates for commercial property and casualty may signal an entrance into a period of lower margins. In 3Q16, XL experienced a 2% decline in rates, but the firm has confidence that the decrease has bottomed out. Some relief may be felt in 2017. A higher interest rate environment on the horizon may boost insurance returns. It is possible that P&C insurers may turn to M&A, as XL group recently did, to find areas for growth.
Despite a tough environment, 3Q2016 earnings offered respectable results. CEO Mike McGavick highlighted five key trends that are currently facing the company:
1) A rise in insurance submissions, increasing in quantity and variety.
2) Strong underwriting work.
3) An improving loss ratio.
4) Declining operating expenses, creating a more favorable combination ratio.
5) A continuation of the repurchase program in line with expectations
During the third quarter, the insurance segment saw moderate success. Due to the difficult environment, overall gross premiums were down by 2% on a year over year basis.
Submission flow was up 8%, with some improvement needed in the conversion process, down 4%. The company produced a combined ratio of 96.3%, an improvement from 97.2% in 2Q2015. It saw a decrease in its expense ratio which was reported at 18.3%, a 2.2 point decline.
In comparison, the reinsurance segment saw steady improvements from the prior year. During the third quarter, gross premiums were $566MM, compared to $459MM the year prior. The upswing was the result of new business and share repurchases. The segment produced a combined ratio of 86.5%, compared to 91.2% a year ago. Expenses declined due to expense synergies from the Catlin merger. It also showed an improved loss ratio of 54.9%, down from 56.7% in 2015.
The company continues to make progress with its strategic initiatives. During the 3Q2016 earnings call, McGavick announced a realignment of the P&C operating model. Following the Catlin acquisition, the firm combined the two entities with the intention of adjusting the model once the leadership team was able to better understand the business and market.
Since, the firm has decided to bring together the Insurance and Reinsurance segments into one P&S organization to create a more efficient and profitable model. In regard innovation, Paul Brand was promoted as Director of Accelerate, a new internal innovation team. A part of this development is the new partnership with Oxbotica, a leader in autonomous and artificial intelligence. These initiatives should be monitored moving forward/
What has the stock done lately?
XL’s stock price has remained largely stagnant. The trend is likely the result of the mediocre environment. Further, the firm is still in a transitionary period as it realigns its business model.
Past Year Performance:
As mentioned above, XL’s stock has seen little movement. XL was added to the portfolio at a price of $36.87 with a price target of $42.58. It is currently priced at $36.10, down 2% since it was added. It moved past the $36 mark in early November, possibly due to the addition of an employment practices liability for design professionals.
Insurers are operating in a difficult environment with a hit to premium growth and margin expansion. XL has compensated for a poor environment by focusing on cost and operational efficiencies. Given the environment, XL has fared reasonably well. The firm’s realignment plans and innovation efforts could propel the company forward in coming quarters. Investors should monitor its success with these efforts to determine if XL is a profitable investment.