Zacks_Analysts' Blog : Tower Gains on Higher Revenues - Analyst Blog

Tower Group Inc. (TWGP) fourth quarter 2010 operating income of 84 cents per share was a penny ahead of the Zacks Consensus Estimate of 83 cents. Earnings surpassed management’s guidance range of 75 to 80 cents and also exceeded prior-year quarter earnings of 74 cents.

Strong fourth quarter results were primarily driven by the significant increase in Tower’s Personal Lines business, resulting from the acquisition of the OneBeacon Insurance Group, Ltd. (OB) Personal Lines division at the outset of the third quarter and its continued expansion into Specialty Commercial business.

Revenue of $420 million beat the Zacks Consensus Estimate of $400 million. On a year-over-year basis, revenues rose 55%, led by an increase in premiums written, higher net realized investment gains and improved net investment income, partially offset by lower commission and fee income.

Operating income in fiscal 2010 stood at $111.2 million as compared with $119.8 million in fiscal 2009, while operating earnings per share came in at $2.55 versus $3.03 in 2009

Gross premiums written surged 33% year over year to $434 million, led by an overall 3% hike in renewal rates for both the Commercial and Personal segments. Most of the premium increase resulted from the acquisition of OneBeacon in July, which accounted for $95 million of fourth quarter premiums, and to a lesser extent, from the 2009 Specialty Underwriters’ Acquisition, which closed in November 2009.

Excluding these transactions, Tower would have experienced modest organic growth in fourth quarter 2010.

Net investment income for the quarter was up 40% year over year to $30 million, led by higher invested asset base, partially offset by low investment yield.

Tower continued to maintain underwriting and cost discipline, as demonstrated by the 91.7% combined ratio for the fourth quarter, consisting of a loss ratio of 59.9% and an expense ratio of 31.8%.

Acquisitions

During the quarter, Tower acquired the renewal rights to the commercial auto liability and physical damage business of AequiCap Program Administrators and its affiliate, TransPro Solutions, based in Florida.

In January 2011, Tower also acquired the renewal rights to the middle market commercial package and commercial auto business underwritten through NAV PAC division of Navigators Group. This transaction will expectedly contribute $25 million to gross premiums written on an annualized basis.

During the conference call, management commented that it continued to seek acquisitions and also expected to include strategic investments and joint ventures as added business tools to achieve growth.

In addition, Tower is also eying organic growth through expansion into specialized classes of business which are less vulnerable to pricing competition. It is also focusing on customizing products for key customers.

Moreover, Tower is simplifying its business by reorganizing the business structure into smaller entrepreneurial units to be headed by business leaders, who will be accountable for all aspects of product delivery to the customers in their respective target markets.

Segment Performance

Tower’s Commercial segment witnessed a 2.8% increase in gross premiums written to $277.4 million and a 69.8% increase in net premiums written to $246.7 million compared with the same period in 2009. As the company continued to maintain pricing and underwriting discipline, premium volume declined and market conditions became more competitive, including some of program business that did not meet the company’s underwriting standards.

Most of the growth in the commercial segment was due to the SUA acquisition. The net combined ratio leaped 2.4 basis points from the year-ago quarter to 94.7%. Loss ratio improved 5.2 points, driven mainly by a decision to strengthen the segment’s reserves.

Tower’s Personal segment gross written premiums increased about 1.5–3 times to $$156.5 million compared with $98.9million in the comparable period of 2009. The acquisition of OneBeacon Personal Lines accounted for $95.4 million of this increase. While the acquisition has enhanced the segment’s product capability and scale, it has also provided a more diversified product mix.

The remaining increase was attributable to a general growth in the personal lines business. Net premiums written grew approximately 2.5 times to $114.9 million from $46.6 million in the prior-year period. The net combined ratio was 86.4% compared with 107.4% in the fourth quarter of 2009. The lower combined ratio in this segment is attributable to lower expense and loss ratios.

The Insurance Services segment revenues soared to $10.1 million from $0.9 million due to $10.3 million in management fees earned by Tower for underwriting, claims, investment management and other services provided to the Reciprocal Exchanges, pursuant to a management services agreement with the Reciprocal Exchanges.

Book value per share increased 12.3% to $26.22 from 2009 end. Annualized operating return on shareholders' equity improved to 13.1% in 4Q10 as compared with 12.9% in 4Q09.

During the fourth quarter, it repurchased 161,000 shares for $4.2 million at an average price per share of $25.84. Since the inception of the buyback program in the first quarter of 2010, 4 million shares of Tower common stock have been purchased in an aggregate consideration of $88 million at average costs of $21.78 per share. This leaves $12 million outstanding in availability under the 2010 program.

2010 Outlook

Earnings per share (EPS) is expected in the range of $2.70 to $2.90 for fiscal 2011, which is up approximately 10% from 2010 level at the midpoint. Management expects earnings in 2011 to be negatively impacted as a result of a continuing decline in the yield on its investment portfolio.

Deferred acquisition costs are also likely to reduce earnings. Expense ratio is expected to be above the 2010 level owing to investments expected to be made for upgrading and expanding technology.