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MegaEurope (< 20)

What is the short case against insurers?

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October 16, 2010 – Comments (5) | RELATED TICKERS: GLRE , CIA , MHLD

I have noticed that insurance is currently one of the more shorted sectors in the market.  Here are some of the heavily shorted stocks (trading below tangible book in bold):

Ticker     Days to Cover

NATL             33.7
CIA               26.6
BWINB           20.1
GLRE             18.6
NWLI              18.4
ESGR            16.2
AFSI             13.3
SUR               12.5

CINF             11.6
EMCI             11.1
FFG               10.7
WRB             10.1

Also over 5 days to cover: MHLD, ENH, ACGL, TWGP, FSR, AGII, CNA, ASI, FMR, PTP, ALTE, SFG, MIG, PRA, AGO, MRH, PRE, PL, TMK, RNR, HMN, NYM, OB, VR, etc.

Unlike some of the other most shorted sectors (small banks, healthcare providers, retail, China), I haven't heard much rationale behind shorting insurers.  I think it's important to get their side of the story (shortsellers are often pretty smart).  Here are some links I found.

Hedge funds shorting UK insurers, heading into the credit crunch

More UK insurance shorts

Bermudan tax risks

Shorting P&C around potential catastrophic events 

Here are some other possible short arguments:

1. Some insurers still have negative derivative exposure. The large majority of required write downs are over.  Most smaller insurers weren't as stupid as AIG.

2. Since a lot of insurance assets are in bonds, shorting insurers is another way to play interest rates eventually rising. True.  But there are better ways to play interest rates rising than shorting a profitable company trading below tangible book.

3. Tax benefits from Bermuda are going to disappear. Yes, industry tax rates may go up over the next few years and Bermuda's role in the industry may be reduced. But other places like Ireland, Dubai, etc. seem willing to compete with tax breaks for insurance.

4. Insurers are overcapitalized and pricing is going to get softer. My impression is we're somewhere in the middle of insurance pricing.  It could get worse but it could also get better.  Overcapitalization is not a terrible problem to have - it can result in more dividends, buybacks and M&A which would help firm up pricing.

5. When the market is going up, long-short hedge funds need to be long high-beta stocks and short low-beta stocks. In this case, it's basically just a tactical or technical position and not really indicative of long-term value, so it wouldn't bother me.

Anyone here heard any other short arguments against insurers?

Disclosure: I own shares of MHLD, FSR, FMR, ALTE, VR and AHL.

5 Comments – Post Your Own

#1) On October 17, 2010 at 11:00 AM, Valyooo (34.78) wrote:

Healthcare and other socialist type things are going to make them insure people they don't want to, that's the one I always hear.

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#2) On October 17, 2010 at 11:11 AM, lctycoon (< 20) wrote:

That doesn't apply to P/C insurance, which at least a few on those lists are.

The only real short case that I can think of is that insurers tend to own a lot of municipal bonds.  If those bets went terribly wrong, then insurers would lose billions of dollars in a hurry.  I somewhat doubt that this would happen that quickly, however.

The other one is that their book value may fall if and when interest rates go up.  This also doesn't look like it'll be a short-term concern though.

Maybe there's fear of a big hurricane or other cat losses?

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#3) On October 17, 2010 at 2:31 PM, MegaEurope (< 20) wrote:

None of these are healthcare insurers. I think those are generally grouped into the healthcare sector, not the insurance sector.

The assets held vary quite a bit among insurers.  GLRE and ALTE are heavier on equities through hedge funds, others like FSR and VR are heavier into Asian equities and bonds. My sense is that most insurers are very aware of the dangers of rates rising and are trying to protect themselves against it, by diversifying out of Treasuries and by going for shorter durations.  That is a good point about muni bonds though.

The insurance risk in the industry also varies widely.  There are life insurers like NWLI and PL, many property insurers (some more exposed to cat loss), and a few workers comp and specialty insurers with their own issues.

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#4) On October 17, 2010 at 4:25 PM, MegaEurope (< 20) wrote:

To be clear, I understand valuation and balance sheet shorts against companies like AIG, MTG, MBI, NFP, CISG, ERIE, AJG, BRO, AON, etc.  But the insurers listed above are more vanilla ones without signficant balance sheet and valuation problems in my opinion.

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#5) On October 17, 2010 at 10:36 PM, MegaEurope (< 20) wrote:

Ways to hedge against bonds falling, hurting some insurers:

1. Short ultra treasury funds like TMF and TYD.

2. Short bond CEFs trading over NAV.

3. Short other rate-sensitive financials like banks, insurance, homebuilders, commercial real estate and other highly leveraged companies.

I am using all 3.

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