Ratings agency A.M. Best has taken PartnerRe Ltd. (PRE) and its subsidiaries off of its radar, after placing it under review since January this year. The ratings agency was wary about the severity of catastrophe (CAT) losses, which had heavily battered the company’s financials in 2011.
A.M. Best’s review was backed by PartnerRe’s assessment of increased CAT losses in 2011. Under the review, the rating agency analyzed and compared the company’s capital position along with its risk-bearing and risk-management capacities going forward, as against its own historical financials and performance of its peers. The comparable metrics came out moderately favorable.
Consequently, with the final outcome of the review, PartnerRe had its issuer credit rating (ICR) of “a-” and debt ratings reaffirmed by A.M. Best, who also reassured the ICR of “aa-” and the financial strength rating (FSR) of “A+” (Superior) for Partner Reinsurance Co. Ltd. and its divisions.
However, the rating agency has assigned a negative outlook to PartnerRe and its subsidiaries, thereby downgrading it from the stable outlook affirmed in August last year. Nevertheless, any severe repercussion was pulled out of the equation given the company’s renewals data of January 2012, which reveal an improved risk profile with respect to its capital base.
A well-diversified business, both in terms of product and geography, as well as a strong franchise, should drive its growth once the market instability subsides. Moreover, moderate stability achieved so far in 2012 should provide some cushion to the risk exposure and equity capital.
CAT Losses Washed 2011 Profits
PartnerRe faced a drab exit from 2011 based on drastically higher CAT losses that gulped down all of the earnings of the company. Total pre-tax catastrophe losses mounted to $1.79 billion in 2011, way higher than $437 million in 2010, breakeven in 2009 and -$305 million in 2008. Subsequently, non-life combined ratio also deteriorated to 121.7% in 2011 from 94.6% in 2010.
We believe that such uncertainty and volatility in the magnitude of catastrophic losses not only reduces the financial flexibility and reserves of the company but also weakens the underwriting capacity, thereby draining out the earnings resources. Hence, A.M. Best is cautious about an unfavorable operating environment in future, which could also adversely impact its risk-adjusted capital.
Moody’s and S&P Show Agreement
Earlier, in February this year, other rating agencies also showcased their skepticism over PartnerRe based on the severity of CAT losses that has led to huge claims and unfavorable reserve development.
Accordingly, Moody’s Investor Service of Moody’s Corp. (MCO) demoted PartnerRe’s senior debt to “A3” from “A2”, subordinated debt to “Baa1” from “A3” and preferred stock to “Baa2” from “Baa1.” Additionally, the ratings agency relegated the insurance financial strength ratings (FSRs) of its principal operating subsidiaries by a notch to “A1” from “Aa3.” However, the ratings continue to reflect a stable outlook.
Besides, Standards & Poor’s (S&P) Ratings slashed PartnerRe’s credit and financial strength ratings by a nick to “A-” from “A,” while its preferred stock rating was lowered to “BBB” from “BBB+.” Moreover, the company’s operating subsidiaries’ credit and financial strength ratings weakened to “A+” from “AA-.”
The ratings downgrades also reflect its apparent apprehensions about PartnerRe’s business and risk profile. The extreme declines in primary growth metrics should have an adverse effect on the company’s financials at least through some part of 2012. Moreover, an adjusted financial leverage above 25% and gross underwriting leverage of above 3.0x are expected to hamper financials significantly.
While these factors are further expected to negate earnings volatility, PartnerRe’s conservative assessment of its risk profile reduces its competitive strength, owing to its magnitude of diversification, which is relatively quite low compared to its peers such as Everest Re Ltd. (RE) and W.R. Berkley Corp. (WRB).
Nevertheless, all the rating agencies believe that PartnerRe’s meaningful debt de-leveraging, conservative reserving practices and fair liquidity with decent operating cash flow and secure credit facilities should provide some cushion to the risk exposure and equity capital in 2012.
Overall, our near-term cautious outlook on PartnerRe remains in line with the rating agencies, on the back of concerns regarding the successful Paris Re integration and catastrophic losses, weak P&C market cycle and low underwriting profitability. In the long run, however, a stable rating outlook, improved pricing and market stability can help in mitigating the cyclical declines.
Hence, we maintain a Neutral recommendation on the stock in the long run, in line with the Zacks Rank #3, reflecting a short-term Hold recommendation.
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