Reinsurance firm earnings should moderate from last year's solid numbers, but the outlook for their stocks is still generally positive, according to two investment bank reports released today.
At Bear Stearns analyst David Small wrote that relatively cheap reinsurance stocks still remain attractive despite the fear that they will trade lower as the hurricane season approaches.
Bank of America Securities analyst Kevin O'Donoghue said reinsurance results should be weaker than most of 2006, "when reinsurers reported significant upside surprises due to lower than expected catastrophe losses and favorable prior-year development."
"We believe that the primary reason for earnings misses this quarter will be catastrophe losses that materially exceed what reinsurers have pre-announced from Windstorm Kyrill," Mr. O'Donoghue wrote.
Kyrill struck northern Europe earlier this year with losses estimated between $3.5 billion and $10 billion.
"The biggest source of positive surprises is likely to be higher than expected favorable prior-year development," Mr. O'Donoghue wrote, noting his assertions about reserve development were conservative.
Management commentary about reinsurance market conditions will likely be a key factor in how stocks respond to earnings announcements. "Key data points will be the results of the April 1 season and expectations for the June/July season," Mr. O'Donoghue wrote.
Bank of America Securities maintains a cautious view of the reinsurance group with good underwriting margins on casualty reinsurance and strong rate increases on the property acting as positive factors despite the expected growth declines this year and next, Mr. O'Donoghue wrote.
Mr. Small remains more optimistic about the sector, particularly since that April-May drag last year that received considerable attention "is not a historical event and was more likely caused by increased hurricane awareness following the active 2005 storm season."
After analyzing ten years of trends from 16 reinsurance stocks, Mr. Small said that on average reinsurance stocks do not underperform leading up to the season.
"For the most part, landfalling hurricanes have less impact on the stocks than the movement of the overall market," he wrote.
Moreover, reinsurance stocks tend to trade up during the latter part of the year--except during the heart of a soft cycle--as investors are relieved the hurricane season has passed and are looking forward to Jan. 1 renewals, according to Mr. Small.
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