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ReAC shares were marked down from $3.36 on 23 December 1998 to $1.80 by the end of February 1999. Worse still, the company had barely finished raising $60m in a placement at $3.45 per share, when the year-end result was actually reported as a $48.2m loss on 1 March.
A risk industry
There followed a further slide and before long the share price was down to $1.00. Then the next bombshell hit - GIO's huge $759m loss won't have done much to improve ReAC's standing either. All of which goes to show how risky reinsurance can be.
Reinsurance is basically insurance for insurance companies, used to insure themselves against claims from their own customers. A reinsurance company like ReAC assumes, from other insurance companies, the risks that they aren't willing to bear themselves – for a price, of course. And thankfully, because few insurable disasters actually come to pass, reinsurance can be very profitable. Indeed, ReAC was profitable every year from 1993, its first full year of business, until 1997.
Then, in 1988, disaster struck with an exceptional number of natural disasters, including ice storms in Canada, floods in China and Hurricane Georges in the Caribbean, all of which took a heavy toll in lost lives and destroyed property. The annual bill for the insurance companies came to around $15bn, the fourth highest ever.
Getting worse?
This tale of woe got worse with thanks to the hand of man, not God, with the crash of a Swissair jet in mid-1998 and a record number of commercial satellite losses. By and large, the reinsurance companies pick up the tab, and the sheer volume of the losses strained resources and prompted an industry shakeout. Now added to the death toll was the only other listed reinsurer on the ASX, New Cap Re, placed in administration in April 1999. For ReAC, these disasters meant an underwriting loss (that is, a loss on insurance business) of $123.3m, which led to the December 1998 profit warning.
It's not clear, either, just how bad 1998 will prove to have been for ReAC. The company announced that it was making a $60m provision against further claims on 23 April, but since claims for a disaster don't come in all at once, ReAC may have to make further provisions.
That's the bad news, but there's some good news too. Firstly, ReAC is in a very strong position to weather the storm. It's debt free and has close to $950m in investments, giving it around $500m in net tangible assets, or $2.60 per share, way above the present share price. The American insurance rating agency, AM Best, has given ReAC a rating of 'A-/Excellent', placing it among the better-capitalised reinsurance firms around.
Secondly, ReAC should be able to take advantage of rising premiums. At the moment, premiums have been weak due to increased industry competition. Like flies around a honey pot, several good years for the reinsurance industry meant that reinsurance 'capacity' – the amount of risk the reinsurance companies are able to underwrite – increased markedly from 1996.
While premiums haven't increased much in 1999, the spate of disasters should provoke a shakeout as companies leave the industry through bankruptcy or retrenchment. This means that the premiums for the survivors should improve from 2000.
Strong upside
Finally, ReAC's management has responded to the downturn by becoming more conservative, indicating that its premium income will be 15% lower in 1999 as the company writes less business but with less risk. With the appointment in May 1999 of Nick Steffey as CEO, former MD Mike Kelly, ReAC boss since 1994, has been assigned to concentrate on managing the company's underwriting business – he formerly combined the roles of Chief Underwriter and Managing Director. We're confident this will see ReAC better manage its exposures as Kelly comes from an underwriting background, and the company has indicated it will reduce its Caribbean exposure ahead of the hurricane season.
This being high-stakes investing, we feel that, at current prices, ReAC shares have already factored in any further potential downside. On the basis that you buy on bad news and sell on the good, we recommend them as a SPECULATIVE BUY.