atakan
Greenlight Capital Re, Ltd. (NASDAQ:GLRE) is a unique specialist property & casualty reinsurer, based in the Cayman Islands, Ireland and the UK and listed on the NASDAQ market. The company is incorporated under the laws of the Cayman Islands, and it has been operating since 2004. The company conducts reinsurance operations through two licensed and regulated entities – Greenlight Re based in the Cayman Islands, which provides reinsurance globally and GRIL based in Dublin, Ireland, which is focused on the European market.
There are three pillars to the company’s business – traditional property and casualty reinsurance underwriting, risk innovation and strategic partnerships, and the investment strategy.
Greenlight Re
The underwriting business focuses on short and medium tail risks where they can compete with larger peers. The company’s small scale allows for a consistent and targeted review of the risks to allocate capital to the best opportunity set. The company will act as either the lead or in a syndicate placement, depending on the ability of the underwriters to properly evaluate the risk and the particular circumstance.
In the insurance industry, the success or profitability of the underwriting business is measured by the “Combined Ratio”, which is the sum of the Loss Ratio (LR), Acquisition Cost Ratio (ACR) and the Underwriting Expense Ratio (UER). The ratios are calculated as follows:
LR = Net loss and loss adjustment expenses incurred ÷ Net premiums earned
ACR = Net acquisition costs ÷ Net premiums earned
UER = Underwriting expenses ÷ Net premiums earned
CR = LR + ACR + UER
Investors should look for a CR with a value less than 100%, indicating that the underwriting business is profitable. Conversely, a CR greater than 100% indicates that the underwriting business is losing money. For Greenlight, there has been improvement in the profitability of the underwriting business when looking at the results over the past 7 years:
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | |
| Loss ratio | 74.2% | 80.3% | 71.6% | 80.3% | 74.2% | 69.5% | 67.4% |
| Acquisition cost ratio | 26.2% | 25.8% | 28.6% | 24.2% | 24.0% | 26.9% | 30.5% |
| Underwriting expense ratio | 3.2% | 2.5% | 2.6% | 2.4% | 2.2% | 4.5% | 4.4% |
| Combined Ratio | 103.6% | 108.6% | 102.8% | 106.9% | 100.4% | 100.9% | 102.3% |
Click to enlarge
Despite the moderate improvement in the underwriting business, the company has basically been in the middle of the pack when compared to their peers.
Greenlight Re
Management will be the first to tell you, however, that these results are not acceptable. However, management has a very optimistic outlook for the underwriting business over the near term. In fact, Simon Burton, CEO of Greenlight Re said as much in the company’s 4th quarter earnings press release:
…in 2023 we are experiencing some of the best underwriting conditions we have ever seen. Our near to medium term prospects are excellent.
The company has reported that the January renewal season saw broad pricing improvements in the aviation, war and terror, and marine classes, with even higher pricing increases in the property catastrophe rates. These conditions are the most favorable they have been in at least a decade.
The next pillar in their strategy is the strategic partnerships, or Innovations, as the company has it branded. Launched in March of 2018, this is somewhat similar to a venture capital strategy, whereby the company makes investments in related insurance businesses to influence the business, provide diversification for their capacity and generate long-term investment gains. The company uses technology, data and new risk transfer delivery mechanisms to provide better quality products, services and solutions to customers and the partners. The company recognizes that technology is evolving at such a fast pace that this unit will be able to partner with many innovators in this “insurtech” space. Furthermore, this approach is designed to help the company develop their risk products to generate fee income, additional underwriting opportunities and investment upside.
Since its inception in 2018, the company has committed approximately $21 million to these partners, which has a carrying value of over $60 million, for a return of 49.5% (as of September 30, 2022).
Greenlight Re
Management has indicated that the purpose is to not necessarily generate investment returns, but rather to drive high-quality underwriting opportunities with these partners. As of late last year, the company had investments in 29 portfolio companies. The company partners with firms that have similar risk profiles and views on underwriting. The average investment is about $700,000, and the premiums generated by the Innovations partners was about 18% of net written premiums in 2022.
Finally, what I think is most interesting about Greenlight Re is the investment portfolio, named Solasglas (full name is Solasglas Investments, LP or SLIP). Solasglas is managed by DME Advisors, a hedge fund founded by David Einhorn in 1996. DME Advisors has the contractual right to manage most of the company’s investable assets. The Solasglas portfolio follows the same general strategy as the hedge fund, albeit with some tighter investment guidelines specific to an insurance company and the industry’s requirements. The goal is to maximize total return by pursuing a value-oriented, long/short strategy focused on equities and distressed debt. This strategy is rather different from many other insurance companies, who invest their assets overwhelmingly in fixed income securities. In a year such as 2022, fixed income portfolios were down significantly as the Federal Reserve and other central banks raised interest rates to fight persistently high inflation.
DME Advisors is the general partner and owns about 26% of Solasglas. The investment portfolio represents about 50% of Greenlight Re’s adjusted surplus. The strategy has produced decent results, however, 2 years in particular, 2015 and 2018, have really hurt performance. For most of the past decade, a value-oriented strategy just did not perform well as investors piled into high P/E, mega cap, low profitability companies while interest rates were at or near zero. However, with interest rates rising and inflation taking hold around the world, value-based strategies are beginning to show signs of life. For a stock picker like David Einhorn, this is the type of environment in which he has a much better chance of outperforming his peers and the broader markets.
Greenlight Re
Since 2018, the fund has employed tighter investment guidelines and risk management. Gross and net exposures were reduced in 2022, and the short portfolio saw reduced single-name exposures due to the meme stock phenomenon. The fund manages short exposure through a combination of smaller positions and index/basket hedges. Finally, sector risk is reduced by hedging with baskets of highly correlated securities.
Einhorn spoke about passive vs active management fund flows during last year’s Investor Day meeting. He stated that increases in passive management causes overvalued stocks to become more overvalued and undervalued stocks to become more undervalued. Many value investors have left the business because of this dynamic, and today face much less competition.
So much money has left value investing as an industry, that it will likely never recover.
Einhorn believes that his firm is positioned to perform well in this type of an environment, and performance has been strong over the past 12-18 months. In terms of how Solasglas is positioned, the long side is focused on high expected cash returns, with turnover expected to be very low. On the short side, Einhorn looks at unprofitable companies and event driven situations. Exposures are managed tightly with plenty of liquidity available for the next opportunity. Furthermore, the fund employs a macro-overlay to protect from outside shocks. During the first part of 2022, the macro-overlay was a positive contributor to returns. The macro overlay has been in place since before the financial crisis.
The following tables from the company’s annual report show the sector and market capitalization allocations at year end:
Greenlight Re 10-K
Most of the portfolio’s net exposure was within the energy, consumer discretionary and financial sectors.
Greenlight Re 10-K
The portfolio was weighted toward mid cap and small cap equities.
Finally, here is a breakdown of the investment returns over the past five years:
Greenlight Re
Not great, but the environment for a value-oriented strategy has been terrible until very recently.
So how did each of these strategic pillars fare in 2022? The underwriting business probably performed the weakest of the three strategies. For the year, gross written premiums decreased 0.4% from 2021 to $563.2 million, mostly due to lower personal motor and workers’ compensation premiums within the Casualty business. Net premiums earned were $469.5 million, a decrease of 12.9% from the prior year period, mainly because of the amount and timing of net premiums written during the years.
The company reported a net loss and loss adjustment expenses incurred of $316.5 million in 2022, compared to $375.0 million in 2021. The company’s decision to reduce or terminate its participation in motor and workers’ compensation business was the primary driver for the decrease in both property and casualty losses during the year. The decrease in these losses was offset by higher losses incurred related to Hurricane Ian and growth in general liability and multi-line contracts.
Acquisition costs were down slightly to $143.1 million in 2022 from $145.0 million in 2021. The acquisition cost ratio, a component of the combined ratio, increased by 3.6% points.
The company did incur an underwriting loss of $10.7 million along with a combined ratio of 102.3%. The underwriting results were primarily due to losses related to the war in Ukraine, Hurricane Ian, Typhoon Nanmadol and wildfires in Tennessee. During the prior year, the company had an underwriting loss of $5.2 million and a combined ratio of 100.9%. It should be noted that the underwriting loss has become larger each of the past several years, and the combined ratio has trended in the wrong direction as well.
| 2020 | 2021 | 2022 | |
| Net underwriting loss ($m) | -$1.6 | -$5.2 | $-10.7 |
| Combined Ratio | 100.4% | 100.9% | 102.3% |
Click to enlarge
Management was very candid during their investor meeting last fall that the underwriting performance needs to improve. Despite the favorable pricing environment, the company is still not performing all that well from an underwriting perspective. However, as mentioned earlier, the prospects going forward look to be almost as good as can be expected given the pricing. Nonetheless, the war in Ukraine as well as global inflation and continued supply chain disruptions continues to present challenges for the business.
The results on the investment side looked much better for 2022. Total investment income was $69.0 million in 2022, compared to $50.2 million in 2021. Investment income from Solasglas was $54.8 million for the year, compared to $18.1 million in the prior year. The investment portfolio reported a gain of 25.3% (net of management fees), compared to an 18.1% loss for the S&P 500 index during 2022, and much improved upon the 7.5% (net of management fees) reported in 2021. The majority of the gains were generated by the short portfolio (+26.1%) while the macro overlay also contributed positively (+2.0%). The long portfolio was essentially flat for the year.
The Innovations partnerships contributed a net unrealized gain of $9.9 million as many of the invested companies completed new financing rounds. Finally, rising interest rates helped the company report interest income of $10.9 million on restricted cash and cash equivalents. It should also be noted that the company recently approved an increase to the allocation to Solasglas to 60% of surplus, up from 50%.
The company has a 4% convertible senior note due in August 2023. From time to time, the company repurchases some of the principal due on this note. Management stated during their Investor Day conference that the company intends to refinance all or part of this note before this time. The company will not reissue a convertible, but will use internally generated funds to repurchase as much as possible. Otherwise, they will use debt or a bank loan to pay off the remaining outstanding balance at that time. Management would like to see more stability in the underwriting business, resulting in more predictable results and favorable cash generation before either an increase in share repurchases or a dividend is considered. Until then, the company is focused on maintaining its financial flexibility and adequate capital structure to finance its underlying businesses.
So is the stock a good buy? Management focuses on the price to book ratio as measure of growth and overall success. The company has traded below book value for quite some time, mainly because the underwriting business has not been as consistent as desired and underwhelming investment returns in recent years.
Data by YCharts
Similarly, the company has traded at a discount to its peers. The average price to book value among this peer group is 1.3x:
Data by YCharts
Management believes that with more consistent underwriting results and a favorable investment environment for David Einhorn’s investment style, there is a tremendous amount of upside in the stock.
The company reported book value of $14.66 ($14.45 in this chart) at the end of the year. The stock currently trades at $9.54 ($9.57 in this chart).
Data by YCharts
Getting to the peer average of 1.3x book would represent a gain of getting to book value would represent a gain of nearly 100%. Getting to book value would represent a 50% gain, while getting halfway to book value would be a gain of over 25%.
I find this company rather interesting. I do not like how it does not pay a dividend. However, Greenlight Re is a niche player in the reinsurance industry, and it has become very successful partnering with technology minded insurance companies via the Innovations division. Additionally, its capital surplus is managed by a hedge fund veteran with a value-oriented investment style that might become more favorable over the near term. It is not every day that regular investors can have access to a hedge fund manager. If you are of a similar mindset to David Einhorn and his investment strategy, you may want to consider Greenlight Re as a Speculative Buy for your portfolio.
Source: seekingalpha.com
