On May 23, we are downgraded our recommendation on the shares of Tower Group International Ltd. (TWGP) to Underperform from Neutral on account of significant execution risk associated with the recently closed merger with Canopius.
Other Factors affecting the Downgrade
Tower generates a substantial portion of its revenues from Northeast United States, an area which is significantly vulnerable to catastrophes. Though Tower has reduced the number of polices in Massachusetts and Rhode Island, we believe the company runs a high catastrophe exposure in the region. Moreover, due to severe catastrophic events in the first half of the year, reinsurance rates might experience upward pressure, and thus the company’s operating margin could be suppressed in the upcoming months.
Weaker investment yield continues to be a concern for Tower. In response to this environment, management had implemented a strategy to purchase dividend paying common stocks during the fourth quarter of 2012 to enhance investment income. The company is also evaluating alternative investment classes to further enhance the investment income. Though management is trying out ways to offset pressure from low interest rates, we are not sure as to how successful this strategy will be.
Like other insurers, Tower has been affected by the soft property and casualty insurance market. Management believes that reduced capitalization, decreased new business ventures, increased business declines as well as negligible new home ownership will reduce the demand for small commercial and personal lines policies. Moreover, low pricing in homeowners and commercial property lines of business will restrict overall premium growth.
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