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CheapActuary 04-11-2017 06:15 PM

AmTrust Watch Thread



AmTrust has consistently underestimated ultimate losses for every accident year since 2009.

AmTrust has masked these accident year adverse developments by taking down the most recent accident years, and then pushing those very same AYs up later.

2015 Calendar Year adverse development of $34 million was masked by pulling down reserves by $150 million from the 2014 AY.

AmTrust Financial Services (NASDAQ:AFSI) is a property casualty insurance company that writes primarily small business commercial insurance. This company has grown faster and printed better numbers than anyone in the industry. Along with this success has been many calls that the numbers are extremely inflated. This author agrees that the numbers are inflated and this article will touch on the far and away most important aspect of AFSI's earnings, the P&C loss reserves.

With the massive drop in stock price over the past month because of the delay in the 10K filing, many value investors may be salivating over potentially very low earnings multiples. Unfortunately those earnings are highly sensitive to loss reserve estimates which management has large discretion to adjust.

For those individuals whom are not familiar with insurance accounting, it is markedly different than in other industries due to the cost of goods (insurance) not being known at the time of sale, but rather many years later. This leads to management's estimates of future losses having a large impact on a company's earnings from quarter to quarter and year to year.

With the recent 10K delay (which is the first year-end after the insurance regulators forced AFSI to get a new auditor), what we find through management disclosure is that they were having problems getting the easy stuff correct: not following very clear black and white revenue recognition rules. Given that they were very aggressive on accounting numbers where the rules were black and white, it would suggest to any rational investor that the company would be aggressive with the levers that aren't black and white and can -legally- be played around with (loss reserves).

For the optimists and AmTrust employees out there that think they played around with revenue recognition but were honest with their loss reserves, I present below the accident year reserve development triangle that is calculated directly from AFSI's 10K published in early 2016.


AFSI's 2015 Calendar Year adverse reserve development was $34 million, however they brought down their most recent accident year by $150 million, otherwise the charge would have been $184 million. There is a clear pattern, pull down the most recent accident year to smooth calendar year results, and then reverse that favorable development in later periods (this happened 4 years in a row!).

Author's humble opinion: Everything you see in this table is grossly outside the bounds of normal loss reserving.

AmTrust's prior auditor, BDO, is relatively unknown in the insurance world, which is why the insurance regulators forced AmTrust to get a new auditor (AFSI picked KPMG). AmTrust's loss reserves prior to this year were consulted out to a 3rd party named Huggins Actuarial Services, which is an unknown shop where AmTrust is their biggest P&C reserving client.

I have no idea whether Huggins is doing AFSI's reserves this year and don't care to look it up as I no longer follow this stuff closely (feel free to add this information to the comments).

And so where to go from here?

Author's speculation: What is likely at the center of discussions between AmTrust and KPMG is NOT revenue recognition or other miscellaneous accounting items, but rather those big elephants: loss reserves. Management's stated $65 million calendar year reserve charge in 2016 likely includes a MASSIVE offsetting pull down of the 2015 Accident Year reserves, just like we have seen in the table above.

Tower Group (NASDAQ:TWGP) ended because of one reason: PWC forced TWGP to push their reserves up.

What will KPMG do when faced with an even more exaggerated situation?

For investors looking to play the stock, right now this is purely a regulatory/accounting issue. With a stroke of a pen from KPMG this stock could move up or down 50%+. Even if the value ultimately is well below the current stock price, if AmTrust manages to release their 10K with no serious adverse development above the $65 million already disclosed, then this stock will likely see a large bump upward.

Unfortunately I do not know the moral code of the KPMG auditors tasked with auditing AFSI, so I don't have an investment recommendation for you. What we all should find interesting is that in the very moment when investors need the advice on whether to buy or sell as this is a highly volatile moment, several sell side analysts that previously were perma-outperform for many years have "suspended coverage" until they can see reliable financial statements.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

yoyo 04-11-2017 06:23 PM


yoyo 04-11-2017 06:26 PM

CheapActuary, can you post that article for us? I can't get past the registration nag screen on page 2 (of 3).

r. mutt 04-11-2017 06:49 PM

Having dealt extensively with part of their group in the past, I am neither surprised nor saddened.


Originally Posted by yoyo (Post 8934584)
CheapActuary, can you post that article for us? I can't get past the registration nag screen on page 2 (of 3).

Registering is both free and useful.

redearedslider 04-11-2017 06:51 PM

That is a pretty interesting triangle

Abelian Grape 04-11-2017 06:57 PM

We're already watching it in CS's group btw

YetAnotherCareerChanger 04-11-2017 07:55 PM


Originally Posted by Abelian Grape (Post 8934635)
We're already watching it in CS's group btw

Not everyone participates in social groups. Some of us know nothing about social groups.

Abelian Grape 04-11-2017 07:58 PM

How've u been

JMO 04-11-2017 08:03 PM


Originally Posted by Abelian Grape (Post 8934694)
How've u been

Shouldn't that be down in Cyberchat?

redearedslider 04-11-2017 09:03 PM


Originally Posted by Abelian Grape (Post 8934694)
How've u been

thanks, you too

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