Trisura Group (OTCPK: TRRSF) is a small Canadian specialist property and casualty (P&C) insurer. I have held it since June 2017 when it was spun off from Brookfield Corporation (BN). The scoreboard is awesome – ~37% annual IRR or almost sevenfold in equity multiples.
The company was growing in high double-digit or even triple-digit profit without a single setback until the fourth quarter of 2022, when Trisura made a bad signing mistake that cost it a significant cut. After his report, the stock fell in early 2023 and went nowhere for the rest of the year. However, it resumed its climb in early 2024 and bounced back after reporting a successful fourth quarter 2023 that put its signature mistake in the rearview mirror.
We will begin by reviewing this error and its consequences, then continue by reviewing Trisura’s operations, and conclude by analyzing how attractive stock is at current levels.
We will exclusively use Canadian dollars for all currency items.
Trisura reports in two segments – Canada and the US. The Canadian segment consists primarily of traditional specialty P&C operations that will be discussed in the next section. Here we will focus only on the American segment which consists exclusively of the fronting business. I described this business in detail in my previous posts (here is the latest one “Trisura: My Most Successful Insurance Investment”) but I have to partially repeat myself below.
A frontal insurer uses its license to write a policy that is immediately ceded in full or almost in full to third-party reinsurers (or some other form of alternative reinsurance capital) in exchange for a ceding fee (or “upfront”) which is usually it is 5-6% of the gross premium. Most or all of the underwriting risk is transferred in this way and the frontal insurer retains the fees. Provided the first insurer has secured a ready and substantial commitment of reinsurance capital, the business can be quite profitable. However, there are many issues to be negotiated between the frontline insurer and reinsurers, most of which should center around the use of capital (collateral, how much, in what form), insurance lines, distribution, cash flow management, claims . treatment, appointment of counsel, assessments, local regulatory matters including licensing on a state-by-state basis, and so on.
Once negotiated, these details, specific to each reinsurance contract, make for a program that can run smoothly for many years. By the end of 2022, Trisura was running about 70 programs and one of them had failed. The damage was devastating on the scale of Trisura: it had to write down $82 million of recoverable reinsurance assets on its balance sheet, which was close to 15% of the company’s equity. The malfunctioning program was supposed to go into a runoff that lasted until the fourth quarter of 2023, when most of the claims related to the program were resolved.
In its 2022 annual report, Trisura gave the following explanation:
The settlement in the fourth quarter related to a dispute over obligations under a quota reinsurance contract. The program included captive participation and required catastrophe reinsurance making it unique in our portfolio. Higher catastrophe reinsurance costs impacted collateral depletion and contributed to impairment. This program had a long history with Trisura, and a unique mix of factors fueled the experience this year. The reinsurer does not participate in any other program. We firmly believe this is an isolated event and remain confident in our ability to scale the platform over the long term.
Let me decipher the last paragraph. After taking out a policy, Trisura assumes a legal responsibility to compensate for losses, even if the policy has been fully assigned to another party. However, in the event of a loss covered by the policy, the expectation is that reimbursement will come from the reinsurer’s resources. The specified amount that the reinsurer is expected to insure is recorded as a reinsurance recoverable item on the balance sheet. In particular, this entry is supported by collateral (especially for a non-rated reinsurer) to prevent the reinsurer from evading its contractual commitments.
Due to several distinctive factors specific to this program (more on that later), the collateral in place was insufficient to cover the losses. As a result, Trisura had to write down reinsurance recoverables and move the program into a phase of managed decline (termination).
This single event left Trisura investors guessing whether it was a fluke or the tip of the iceberg of systemic neglect. The aliens could only answer the last dilemma probabilistically. For the following three reasons, I treated it as a one-off and did not sell the stock.
When the error occurred, Trisura had reported 22 quarters of the American segment. Systematic neglect was likely to show up earlier.
Second, the malware was truly unique. To begin with, it required cat reinsurance in addition to frontline operation reinsurance. He made the program quite large in terms of risk exposure and required more collateral than Trisura appreciated. When the cat risk materialized, the collateral proved insufficient.
The malware was managed by an MGA (managing general agent) which is a standard go-to-market solution for the specialty insurance industry. However, in this case, the reinsurer behind the program was a captive of the same MGA. This may have led to a conflict of interest unfavorable to Trisura.
The combination of the above circumstances seems rare in itself. After the big fall, the company analyzed all other programs to prevent something similar in the future. It seems impossible to me that any suspicious program will remain intact after this cleaning operation.
In 2023, when the bad program was in runoff mode, the US segment experienced higher reinsurance expenses and this led Trisura to report its results on both an IFRS and operating basis. The latter excluded the results of depreciation and run-off, in addition to realized and unrealized gains or losses on stocks in the investment portfolio.
Trisura has operated in Canada for 17 years with four current lines of business:
- Warranty. This line is growing at about 40% per year and growth is likely to continue unabated because the warranty business is in the process of expanding in the US. However, US security reports as part of the Canada segment. In 4 years or so, Trisura expects to have roughly equal business in the US and Canada. The company is just beginning to reap the benefits of the unified North American business.
- Corporate insurance consisting primarily of officers’ liability. The line grew 15% in 2023, but that growth could accelerate as Trisura just started expanding in the US with first premiums expected in 2024.
- Risk Solutions Guarantee. This line grows more slowly (to 10% in 2023) and at this point, a US expansion is not planned.
- Canadian Front. After its success with the US front, Trisura started replicating it in Canada with certain tweaks and the business has fared beyond expectations. In 2023, revenue increased by 44%.
In total, the Canadian segment grows by about 30% and is extremely profitable. Its combined ratio hovered around 81% for the past few years, including 2022 and 2023. The Canadian operations delivered an operating ROE of 29% and 28% in 2023 and 2022, respectively.
In order to estimate Trisura some assumptions must be made and some limitations accepted:
- The signature error was one time
- We will value the company on an operational basis excluding both write-off and leakage costs arising from the same underwriting error. On a forward-looking basis, operating results should be very close to IFRS results adjusted for stock gains and losses.
- In 2023, non-US insurers must adhere to two new accounting standards – IFRS 17 and IFRS 9 restating results by early 2022. Both new standards are quite important, especially IFRS 17 which dramatically changes the way insurers report. On the last earnings callTrisura’s CEO admitted that the company is still learning its way around IFRS 17. These new standards made previous years incompatible with 2023 and restated 2022 and we have to rely mainly on the last two years.
According to IFRS 17, the best way to measure an insurer’s growth is from insurance revenue which roughly corresponds to gross premium earned in GAAP terms with some adjustments. Under this lens, in 2023, Trisura in total grew by 38.4%. It is roughly comparable to the company’s growth in previous years under the old standard.
Operating earnings per common share were $2.34 and $1.86 in 2023 and 2022, respectively. The 26% jump in EPS is explained by increased insurance income, as well as rapid growth in net investment income. Operating ROE was 20.0% and 19.6% in 2023 and 2022.
At the time of writing, and after its post-earnings jump, Trisura is trading at ~$39 corresponding to a 39/2.34~16.7 P/E ratio. This ratio seems much lower than it should be based on Trisura’s growth and profitability rates.
In my opinion, it is still caused by a persistent flavor of the signature error. Without it, Trisura deserves at least a 20-25 P/E ratio or ~$47-$58 share price. This is nothing more than a guess, but we have a way to check how realistic it is.
In late 2022, before Trisura delayed its earnings call and discovered the underwriting error, it was trading at $40-45. Using 2022 operating EPS of $1.86, it corresponds to a P/E ratio of 22-24, which is in line with our estimate.
We have spent a lot of time reviewing the signature error because it is crucial to our assessment of Trisura’s business. Although this mistake now seems isolated, it will keep the price under pressure for another quarter or two. Subject to other mismatches, the stock price should continue to migrate higher due to the gradual expansion of the multiple and strong growth.
In an optimistic scenario, the combined effect of both factors could push the stock beyond $60 a year from now.
On the other hand, Trisura will remain a fairly small stock for at least a few more years (its current market cap is just under $2 billion) and will be subject to all the regular risks of small stocks , including but not limited to price movements and dependence on high values. growth rates.
However, current valuations are low enough, in my opinion, to make the stock quite promising.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. stock exchange. Please be aware of the risks associated with these stocks.