Everest Group: Underwriting Results Continue to Disappoint

Everest Group shares (NYSE:EG) have risen moderately over the past year, although they have largely been in the $360 to $400 range, even as the company has benefited from a quiet catastrophe environment. I last covered Everest Group in Mayrating the stock maintained because I needed to see more evidence of progress in risk assessment. Since this article, the stock is up 4%, lagging the market’s 7%. In a mild hurricane season, I could see a run to $400, which we’re approaching now as we enter the heart of hurricane season. I remain cautious on the stock.

Second-quarter earnings were seasonally high

In the second quarter, Everest earned $16.85, beating the consensus estimate by $0.21. Gross premiums rose 13% to $4.7 billion, with a heavy focus on reinsurance. The company issued stock last year to facilitate growth, which remains a capital allocation decision that I am not enthusiastic. In particular, in my opinion, we still do not see Everest delivering the expected results in insurance.

Now, looking at the results, it is also important to note that EG has seasonality in its earnings as it is exposed to hurricane risk. These catastrophe losses are mainly concentrated in Q3 and may spill over into Q4. There is limited risk in H1. As such, we should see the company generate higher earnings in H1 than in H2, which is something to keep in mind. For the full year, Everest is targeting a combined ratio of 89-91% with a 6% catastrophe loss.

In Q2, Everest had a 90.3% overall combined ratio, which translated to $358 million in underwriting profits. This was now in line with the midpoint of the target range. However, as noted, catastrophe losses are lower in H1. In Q2, EG had $135 million in pre-tax catastrophe losses. This was up from the incredibly low $27 million last year, but still resulted in a catastrophe charge of 3.3%.

Essentially, EG only hit its target because catastrophe losses were half of the full-year projection. With a normal catastrophe rate, its combined rate would have been closer to 93%. Of course, for the full year, catastrophe losses could drop below 6% and boost profits. It’s hard to tell at this point because it depends on what happens during the hurricane season.

I don’t see Q2 cat results as being inconsistent with the 6% full year result, given that most of the losses occur within 3 months. Management is also now focusing on its “combined attritional ratio”, which came in at 86.6%. It defines attritional as excluding catastrophes, one-offs and prior year events. Again, with an average cat load of 6%, we need to see this closer to 84% for EG to hit its target.

Reinsurance delivered solid results

Drilling down into the results, we see a breakdown of results by division. The reinsurance unit is doing better. Everest has grown this unit faster, as gross premiums have increased by 16.5% to $3.2 billion. While this unit does increase profitability, it does involve greater catastrophe risk, which can be more volatile and result in lower earnings multiples from investors.

This unit earned $303 million in underwriting profits, about 85% of total underwriting profits. It had an 88.9% actual combined ratio and an 84.4% attritional combined ratio, 30 basis points better than last year. Again, this unit’s performance ultimately depends on how it handles the hurricane season, but second-quarter results were solid.

Insurance performance remains weak

On the other hand, its insurance unit continues to perform below average. In insurance, gross premiums rose 6% to $1.5 billion, and underwriting profit came in at just $54 million. Management said prices were outpacing losses, but its combined ratio remained high at 94.4%. In the second quarter, it had a combined loss ratio of 92.8%. That’s well above target.

Unfortunately, it was also 0.2% higher than a year ago. This is a surprising result given that the underwriting environment remains very healthy, which is why we see other insurers such as Arch Capital (ACGL) and Chubb (CB) reporting strong results. In 2021/22, insurer profits have been squeezed by inflation rising faster than premiums. Given that insurance contracts last between 6 and 12 months, they will take time to adjust to higher inflation.

As insurers have raised rates over the past year, this has presented them with a prime opportunity to recoup lost margin during the pandemic, an opportunity that Everest largely missed based on its second-quarter results. In addition, the gap between premiums and inflation has narrowed since we moved to a repricing in June 2023. While there is still a small gap, I believe it is more likely to allow the industry to maintain current margins than to significantly exceed them. Ultimately, this makes me skeptical about whether Everest can generate sufficient underwriting profits to meet its profitability goals in an average catastrophe environment.

Higher interest rates have a positive impact on investment income

While underwriting performance is down, the investment portfolio has taken the baton, as Everest is a major beneficiary of higher rates. Its Q2 investment income of $528 million was a record, up from $357 million a year ago. It has a portfolio of $39.1 billion. It is diversified across sectors and has an average quality of AA-, which should minimize potential credit losses.

This portfolio has an average duration of 3.4 years, which means it will take some time for the portfolio to recover and for interest rate changes to shift investment income. Even if the Federal Reserve starts cutting rates in September, as I expect, it will likely see expiring bonds at yields below market levels for at least another 12 months. As such, I expect net investment income to continue to grow, albeit at a declining rate.

Potential growth catalysts unclear

In May, I was expecting earnings of $53-$56 in 2024, although I thought the run rate was closer to $51-$53. The company has generated $33 in H1 earnings so far, which should be about 60% of normal annual earnings, which translates to about $55 in earnings in 2024. Now, with a normal catastrophe load, EG would face another loss of about $2.40, hence I would not annualize earnings per share in Q2. After these results, I still see the company generating about $55 in earnings per share in 2024, assuming a normal catastrophe environment.

From a purely tactical perspective, investors also need to consider whether now is a good time to buy a catastrophe-prone reinsurer. The severity of the U.S. hurricane season is likely to be a major factor in stock performance over the next two months. Weather is inherently unpredictable, and there is no way to predict where or when storms will strike. In my view, stocks are already pricing in a quieter season, so I see more downside risk from a more devastating storm than upside risk from a quieter season.

Stocks may remain “cheap”

At ~7.2x earnings, EG is not a pricey stock, but with so much of its earnings tied to the Q3 storms and the underlying insurance numbers continuing to disappoint, I have a hard time seeing a reason to significantly increase the multiple. Indeed, with reinsurance growing faster, the business becomes less diversified and potentially more exposed to catastrophe. I still think its $349 book value, excluding unrealized gains and losses, is a reasonable level, but short of a very mild hurricane season, I don’t see a catalyst for further growth, especially as we enter a rate-cutting cycle.

While not as cheap, ACGL and CB are trading below 12x with much better momentum and less volatile earnings. Sometimes it’s better to invest in a less expensive stock in a better performing company than in the cheapest stock in the sector. I still think so in this case. For long-term investors, I don’t see a need to sell at this multiple, but given the hurricane risk and poor insurance, I see a case for tactical selling and reconsideration after the summer. I’d like to see the stock trade closer to book value before I become a buyer.