A chip off the old block: Equity analysts say hard market spurs property/casualty spinoffs. (Briefing).

Favorable market conditions and convergence factors unique to the property/casualty segment have encouraged financial-services giant Citigroup Inc. to spin off its property/casualty subsidiary, followed by speculation that General Electric Co. is considering doing the same with its reinsurance unit.

"These companies may be trying to capitalize on what is a good equity market," said Todd Bault, an equity analyst with Sanford C. Bernstein & Co. "Property/casualty is in a hard market, prices have gone up a lot, and results should be a lot better."

Bault said the reason for spinning off property/casualty insurers is similar to that behind the host of start-ups that have been formed in Bermuda after Sept. 11--demand is high, prices are rising and, therefore, property/casualty insurers should be able to deliver better returns to investors.

Ken Porrello, who leads Deloitte Consulting's North American insurance practice, agreed. "Over quite a number of years now, property/casualty returns have lagged those of life and other financial-services sectors, such as banking and securities," he said. "We've got a strengthened market in property/casualty, so it's probably time to look at divesting those assets. I think GE is a data point in this regard."

When Citigroup announced its plan to spin off Travelers Property Casualty, the motive was to make money for its shareholders, Sanford Weill, Citigroup's chairman and chief executive officer, said at the time. The spinoff positions Travelers Property Casualty to participate independently in the accelerating consolidation of the insurance industry, especially after the events of Sept. 11, said Citigroup management.

Neither Bault nor Porrello saw a negative motive behind such spinoffs, such as that conglomerates perceive property/casualty insurers as risky businesses after Sept. 11. "I don't find that kind of argument very convincing," said Bault. "If you didn't think the business was a core operation to begin with, you probably shouldn't have bought it. And if you did think it was a core operation, I'd be hard pressed to see why you'd come to the conclusion that this is not a good time to own a property/casualty insurer."

Credit Suisse First Boston equity analyst Michael Regan said GE had been thinking of spinning off Employers Reinsurance even before Sept. 11, and the terrorist catastrophe "was the last nail in the coffin."

Regan said the spinoff would remove some volatility from the bottom line in General Electric's GE Capital unit and would prevent GE Capital's earnings from becoming more than 45% to 50% of the parent company's earnings.

Don Luskin, chief investment officer of TrendMacrolytics, an economics research and consulting service that provides analysis to institutional investors, said the GE spinoff "is a very necessary idea."

"In the wake of Sept. 11, insurers are suddenly realizing that all these risks they were underwriting are suddenly bigger than they thought, and that there may, in fact, be no amount of premium they can collect that would compensate them for the risks they are taking," said Luskin.

Luskin said that since the detonation of one nuclear device in an urban area by terrorists could conceivably bankrupt the global property/casualty industry, "it's absolutely incumbent on companies such as General Electric to get these companies off their books."

Bault, however, said he doesn't buy the risk-avoidance theory for the spinoffs. He said the industry has "done quite a bit in a short period of time" to address its exposure to terrorism since Sept. 11, and another event on that scale is unlikely to hit insurers as hard. "In time, the market may gain more of an appetite for pricing those risks and become more efficient in doing so," he said. "I don't buy the argument that it's a 'gee, we don't know how to respond to this' thing these companies are saying."

GE's insurance operation had an estimated after-tax loss of $386 million related to Sept. 11 and has been hampered by decreased investment income and deteriorating underwriting results "reflecting higher property and casualty-related losses (principally as a result of adverse development relating to prior-year loss events) and the continued effects of low premiums in the property and casualty insurance/reinsurance industry," according to the company's annual report.

Those problems were compounded by increased catastrophe losses in 1999, primarily in Europe, and, to a lesser extent, adverse development on recent accident-year reserves in 2000, according to A.M. Best Co. reports. "While weak operating fundamentals in its property/casualty businesses have been tempered by a growing profit contribution from its life reinsurance operations, overall the group's operating performance has fallen below historically superior levels," A.M. Best noted.

Porrello's take is that property/casualty assets "just don't look strategic from a convergence perspective." The industry hasn't yet articulated a strong strategy around property/casualty and banking convergence, for example.

Porrello said he doesn't believe the spinoff of Travelers or the possible spinoff of Employers Re portend a move away from convergence.

"Four or five years ago, when we started to get excited about this, we were probably thinking in revolutionary terms about how convergence will transform the industry," he said. "Now, I don't think it's going to be any less transformational, but I think it's going to move in a slower pace than we initially anticipated."

RELATED ARTICLE: Employers Reinsurance Corp.

Primary Business: Treaty and facultative reinsurance; specialty property casualty and health-care insurance

2001 Financial Data

Net Premiums Written: $1.9 billion

Admitted Assets: $12.7 billion

Policyholders Surplus: $4.9 billion

Chief Executive: Ronald R. Pressman

Headquarters: Overland Park, Kan.