I wanted to make some sort of "Towering Inferno" joke when talking about this quarter's earnings from Tower Group (Nasdaq: TWGP), but that might give the wrong impression. The situation at this small P&C insurer is far from a disaster.
Tower Group is doing what most P&C companies cannot do right now - they are growing. While a large part of that growth is clearly due to acquisitions, the company is growing organically as well. Gross premiums jumped almost 27% in the second quarter, with organic policies in force growing over 11%.
Even though this is a pretty soft market (meaning policy prices are weak), the company nevertheless saw premiums rise over 1% and had overall retention of 86%. If I understood management correctly on the conference call, retention could have been higher if management had been willing to accept softer premiums. Wisely, management declined to write that business.
Tower Group saw an overall combined ratio of 93, up from 84.6% in the second quarter. That is bad - and it was led mostly by a year-over-year increase of 6.4 in net loss ratio (58.6 v. 52.2). The expense ratio was not a source of good news either, rising 2 pts to 34.4. Tower's acquisitions have led to a somewhat inflated expense ratio, and management is guiding for lower expenses in the second half of the year.
All in all, the company did manage to boost book value by about 4% on a sequential basis - more than anything, casual investors can look to this as the "underlying" growth of the business, though it does ignore the future benefits of business being written today.
Looking ahead, management does seem pretty happy with the growth of the business, but they also did reduce guidance once again. While trimming guidance by $0.05 is not a big deal, it is actually a little worse than that since the company outperformed this quarter and the company has been buying back shares. If there is "good news" in lower guidance it is that much of this seems to be stemming from lower expected investment income, and that should improve over time.
I am still pretty optimistic about this company. I like the focus on small/medium-sized business, and I think the company's growing diversification of consumer and personal insurance will pay off in the future. Moreover, this is taking place with very little attention from Wall Street - this is a meaningfully "under-covered" company.
Assuming Tower Group can boost ROE up to 14% over time, the shares are worth over $32 a share and pretty significantly undervalued. Of course, for that to happen a few other things need to happen - rates need to start moving up such that the company can earn better returns from its investment portfolio, the combined ratio must improve, and overall market conditions need to get better as well. Given that this is pretty much the "perfect storm" of bad news in the P&C industry, though (bad yields, soft market, etc.), I am relatively optimistic that those things will happen over the next five years.
Insurance companies are not for everybody - the nature of their earnings is very different, as is the valuation methodology - but Tower Group is certainly a name worth considering. Since Arch Capital (Nasdaq: ACGL) is too expensive for me now and WR Berkley (NYSE: WRB) has less organic growth, Tower is pretty much my favorite idea in this space right now.
Disclosure - I own shares of Tower Group
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