Hi T23Done some pawing(sic) over the CIX numbers. The COR at 102...

Hi T23

Done some pawing(sic) over the CIX numbers. The COR at 102 appears partly supported by the reinsurance arrangements (an economy of scale, of sorts, in what could have been a bad year if the cat-cover didn't kick in) and partly supported by the quota share. What worries me, though, is that Kirk stated that the lower valuations were offset through increased techical fund income that resulted from duration matching of liabilities. Now assume that this is correct; then why, when you run a duration matches approach over the entire asset base, is the number what it is? - it should be, by my calcs, around $3mm higher...

The only explanation I can come to, after taking into account the close-out loss in equities in Q1/08, was that the shareholder fund investments (the portion not committed to joint ventures) was not fully duration matched. That, and this portion of income was partly eroded by credit spread losses.

Where am I going with this? It appears, by looking at their disclosures, that Kirk and the team have outsourced their investment portfolio into some sort of vehicle where their net duration is actually the same for technical liabilities and shareholders funds - that is, the investment vehicle for both sets of funds is the same. This is ok when rates are falling, however when credit spreads are volatile and the long end of the curve is swaying around more than a one legged man on the deck of the titanic, this increases delta risk at a time when incurance risk is increasing [kind of like accellerating just as you hit the corner of a road].

Bottom line - unless Kirk can control his consolidated delta risk (which he simply can't if he continues to use this portfolio approach, which is what I am guessing he is doing) he runs the risk of having a massive swing in investment income in the following year. This worries me as investment income played a significant part of the 2008 result in that it underpinned (read: underwrote) the 2008 net result. Unless COR can come in sub 97 in the 2009 year Kirk may have a struggle topping $10mm net income if he doesn't try a different duration and credit strategy over the coming 12 months.

I still think CIX has tremendous upside, and it a buy (strong buy in my books) at anything under 42-44 cents per share in the current environment. That said, I think Kirk needs to really think about his current investment strategy and make it public what this is, if he is going to have any hope of keeping that EBIT line moving upwards. Yes, its nice to frank dividends, but you can only pay them out of current year's earnings and need an EBIT track record before you can start to think about long term share price growth as well.

I also wonder why the bank debt wasn't paid down slightly (out of profits). One of a few things I guess - either (a) they have a great deal from the bank and paying it down means giving up "gains" against the replacement cost, if required, or (b) they are reserving capital and cash for further acquisitions. I am hoping it is option (c) though - i.e. both of the above!

Sorry for rambling - still scratching my head as to why any insurer would use a portfolio approach to investments - very dangerous imo (ok - it worked this year, but please Mr Kirk, think very carefully about 2009!). Perhaps Kirk should think about shortening duration by throwing a bit back at the equity market: think of it as "peer investment" or "peer hedging"!


Best regards
Kit