Sunday, June 5, 2011

Reconsidering RAM's Business Line Wanderings

As the Oracle of Omaha is quoted: “If you offer an underpriced insurance policy and are sitting in a rowboat in the middle of the Atlantic Ocean, an insurance broker is going to find you.”

Bermuda, while not a rowboat, is also no hiding place from such brokers. RAM meanwhile is a specialized reinsurer that has never underwrote anything accept financial guaranty reinsurance. RAM consists of 1 direct hold co employee and about a dozen other full time contractors working for the holding and operating units via the RSSL agreement.

Against that backdrop we scrutinized David Steel's statement in the most recent quarterly release: "We are evaluating the adequacy and availability of our capital to support writing a limited amount of short-term, non-catastrophe, property/casualty reinsurance business in order to enhance overall shareholder value."

With neither a large contingent of analysts nor a specialty in the contemplated line(s), RAM considers writing business. Steel appears to recognize so much by choosing short-term, short-tail risks. The short-term determination also has the benefit of limiting the impediments to strategic alternatives that going down this road could have; the industry is after all known as monoline for a reason. If Ram does choose to underwrite a new type of risk, it appears it is pointing in the right direction with the proper "limited" quantity of risk.

This may not be a bad idea. The ability of one person to make adept insurance agreements is exemplified by the legend quoted at the start of this post. RAM certainly has managed the crisis in the financial guaranty industry better than most of its peers. Perhaps this relative track record is indicative of an intuition or common sense that can be applied across product lines, but we certainly can say that from our perspective that remains to be seen.

One more possible concern arises from the instigation for the contemplated action. As we have mentioned in our recent reconsideration of Syncora's common stock, typical adjusted book value measures should be treated like a zero coupon or capital appreciation bond under certain runoff conditions (basically if cash income and expenses net; or viewed from another angle if investment income, installment accretion and operating expenses including net loss adjustments net out. We should examine this further in its own post soon.) RAM's calculation of adjusted book value is further exaggerated due to its treatment of preferred stock; it wipes out the already deflated 2009 fair value of RAM Re's B shares and pays no mind to Hold Co's A shares. We mention these valuation metrics as it seems likely that someone is getting impatient with the accretion of value. This is not the correct reason to commence a heretofore unexplored line of business.

In risk taking, patience is a preeminent virtue. Steel embodies such virtue by focusing on "a limited amount of short-term; non-catastrophic" business. Depending on the opportunity, he might better embody it by putting these plans on the back burner. A ramping up of repurchase recoveries over the next couple years might just kick start a few other guarantors back into operation. At such a time, RAM could consider continuing its focus on financial guaranty reinsurance, sell itself, or an entry into the primary market  perhaps through MIAC, Connie Lee, BondFactor, or any other entity that might be put on the block.

All in, whichever course the company chooses, it seems unlikely to materially impair the value of the common stock. That is with the caveat that we believe the company will only dip a tenative toe into any new low-risk business line rather than swan dive into a high-risk calamity. We believe the values near ABV are attainable primarily through recoveries while new business can be supplemental and fictional valuations worthless.

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