Bermudian run-off reinsurer Alea expects to make a loss of between $200 million and $240 million for 2005, thanks to storm losses, reserve strengthening and run-off costs. The size of the loss estimate has surprised some and prompted negative reaction from investors, equity analysts and rating analysts.
The company expects run-off charges to cost it between $95 million and $105 million for the year, storm losses between $108 million and $125 million, and reserve strengthening $95 million. The overall loss estimate for the year includes the effect of the renewal rights sales it completed at the end of 2005 and other income, such as investment income.
Rating agency AM Best downgraded Alea's financial strength rating to B from B++ on the news. The agency said the company's risk-adjusted capital had deteriorated greatly because of its worse-than-expected performance in 2005. It has subsequently withdrawn the ratings at the company's request.
Investment bank Numis Securities has lowered its recommendation on Alea's shares to sell from hold. "The shares have fallen around 50% since August last year and now trade close to what we previously considered fair value under a run-off scenario," said Numis's insurance team in a trading update. "However, the position the group has outlined today [Jan. 30] is worse than the bear-case scenario we had anticipated."
Alea is expecting its net asset value to be between £1.45 ($2.58) and £1.58 a share for 2005. The Numis team said this is £0.70 a share less than the bank's previous estimate. It added that Alea's net asset value at June 30 was £2.36 a share.
The team said it now expects the fair value of Alea's stock to be around £0.60 a share, but added: "We think the shares may trade below this level as there are few positives to attract buyers."
Investors seem equally unimpressed with Alea's expected results. The company's share price fell to £0.65 on Jan. 30, the day of the announcement, from £0.85 on Jan. 27. By Feb. 1, the price had fallen even further to £0.56.
One of the most important parts of Alea's announcement was the reserve strengthening, says Miles Trotter, an analyst at AM Best. "That has always been one of our principal concerns with Alea," he says. "The company has a record of reserve deficiencies but the magnitude has increased. We believe there is potential for further adverse development. This was an important factor driving the downgrade."
Alea expects to incur at least $69 million in reserve charges in its results for the second half of 2005 on an undiscounted basis. It had already taken a discounted reserve charge of $34.7 million in the first half of the year. Once discounting of the second-half reserve strengthening and other variables are taken into account, the company expects the total reserve strengthening for the year to be $95 million.
Of the $69 million reserve strengthening in the second half, $38 million is for reinsurance and $31 million for insurance. Unlike many firms' recent reserve strengthening, Alea's was not confined to the period between 1997 and 2001. Some $8 million was for Alea Europe business written between 2000 and 2004, and $28 million was for business written by Alea's London operations between 2001 and 2004.
The insurance team at Numis felt this was further cause for concern. "The loss includes second-half reserve strengthening of $60 million (after discounting), made up of deteriorations on both the soft market years pre-2001 and, worryingly, on more recent years which have seen more favourable rating conditions," it said in the trading update.
There could be more trouble to come for Alea. The firm says that if its 2005 losses are towards or above the higher end of its estimated range, it will be in breach of a covenant in its bank credit agreement. The company says it will work with its bank lenders to manage the effect of any potential breach of covenant.
Alea also confirmed that it went into run-off in the fourth quarter of last year and outlined its run-off plan. It plans to manage its remaining liabilities proactively so it can return money to shareholders after it has met its obligations.
But it is not yet clear whether Alea will be successful. "Given the group's long-tail book of business we think [the run-off] is likely to take at least five years to complete," said the Numis trading update. "However, the process is complicated by regulatory and other hurdles, which makes the final outcome and ultimate value uncertain at this stage."
