Friday, March 11, 2011

Post Catastrophe Stock Picking

Warning:  I'm about to make a fool of myself. 

Another Warning:  I served on the Board of Directors of Flagstone Reinsurance.

Another Warning:  I bought Flagstone stock this morning.

With that, here goes...

The massive earthquake that struck Japan, the strongest in several hundred years, has caused damage that is difficult to assess.  That's about as far as I'll go.  Who knows, several hours into it.

Since trading opened this morning, Flagstone as underperformed just about every insurance company in the world.  (If you're curious, Triad Guaranty, a busted bond insurer is down 14%...but that's typical vol for Triad.)

Tokio Marine is down about 15%, versus Flagstone down more than 11%.  How can this make sense?

Tokio Marine is losing money on their liabilities (the things they insure) and they're losing money on their assets (let's just figure this cannot be good for their direct real estate holdings.)

Could Flagstone really face claims (capital adjusted) on the scale Tokio Marine will?  I seriously doubt it.  Interestingly, the WSJ notes that this could trigger losses on Flagstone's catastrophe bonds.  That's actually good for Flagstone shareholders--it means the bondholders pay on the Japanese losses, not the equity holders.  Cat bonds work like insurance for the reinsurance companies: Losses above some very high threshold become someone's problem, not theirs.

The other interesting issue: A massive quake in Japan will raise reinsurance prices in Japan.  This means that the forward looking prospects for the reinsurers are marginally better today than they were yesterday.  That is, assuming they haven't seriously impaired their capital.  Fortunately, this event doesn't seem to reach that level.  In fact, Flagstone in particular unlikely takes enough risk for a single even to cause a loss of more than a year's worth of earnings.

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