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.
My Takeaway
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.
