Tower Group Falls in Line

Tower Group Inc.'s (TWGP - Analyst Report) third-quarter earnings of 74 cents were in line with the Zacks Consensus Estimate. Results were affected favorably by an increase in premiums written due to the acquisitions of CastlePoint and Hermitage. Last year, the company had reported earnings of 79 cents per share.

Gross premiums written and produced increased 39.4% year-over-year to $283 million. Total revenues increased 96.1% year-over-year to $256.3 million. Net premiums earned of $223.9 million represented 87.3% of total revenues in the reported quarter, compared to 67.5% for the same period in 2008.

Net investment income increased 165.9% year-over-year to $21.7 million, with a tax-equivalent yield of 5.6% versus 5.5% in the year-ago period.

Total commission and fee income decreased 78.2% year-over-year to $8.1 million. Commission and fee income decreased primarily due to management's decision not to cede quota share brokerage premiums in 2009.

Segment results

Brokerage Insurance: Gross premiums written increased 25.8% to $205.6 million. Net combined ratio deteriorated to 87.6% from 80.5% in the prior year period.

Specialty Business: Gross premiums written increased 95.4% to $77.3 million, due to the acquisition of the reinsurer CastlePoint. Net combined ratio improved to 83.6% from 87.4% in the prior-year period.

Insurance Services: Revenues slumped to $0.2 million from $18.1 million in the prior-year period. Insurance services revenue decreased in the quarter because Tower ceased to produce business on behalf of CastlePoint Insurance Company subsequent to its acquisition.

Pre-tax net unrealized gains of $67 million during the quarter led to 8.6% growth in book value to $22.72 at Sep 30, 2009, versus $20.93 at June 30, 2009. Return on equity was 13.6% down from 23.1% last year.

The company forecast fourth-quarter operating earnings to be in the range of 86 cents to 96 cents. For the full year 2009, Tower projects operating earnings between $3.15 and $3.25 per diluted share. Tower Group also forecast operating earnings of $3.50 to $3.70 per share for 2010.

Strong premium growth, steady underwriting profitability and a favorable return on equity helped the company achieve expected results in the reported quarter. The CastlePoint and Hermitage acquisitions transformed the company from a regional player into a national one.

However, some factors offsetting the positives are the company's growth and acquisition strategy, reinsurance dependence, and historical dependence on external financing. Given its previous records (acquisitions of Empire, One Beacon, and Preserver), we are optimistic about the company's ability to realize the full benefits of its latest acquisitions. We adhere to our Neutral recommendation on the shares of this company.