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We are downgrading XL Group plc (XL - Analyst Report) to Neutral from Outperform as its underwriting profitability was impacted by cat losses.  The stock carries a Zacks Rank #3 (Hold).

Why the downgrade?

XL has substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. Underwriting profit declined 28.8% year-over-year in the second quarter with combined ratio deteriorating 300 basis points. The downside resulted from catastrophe losses, which included flooding in Europe, Argentina and Canada, and tornadoes and hailstorms in the United States.

Net investment income at XL Group has been on a declining trend for the past few years, and the second quarter was no exception. It experienced lower cash outflows from the investment portfolio and unfavorable foreign exchange movements affecting net investment income. With performance closely linked to credit markets, the exposure to these assets can further cause volatility in investment earnings.

Additionally, XL Group’s operating expenses have been on a rising trend over the last few years.

On a positive note, XL Group’s second quarter earnings breezed past the Zacks Consensus Estimate as well as year-ago earnings. Increase in affiliate earnings was offset by higher level of catastrophe losses inducing flat year-over-year comparison. However, the bottom line increased year-over-year due to lower share count. XL Group has successfully maintained the trend of delivering positive earnings surprises. The reported quarter marked the sixth consecutive quarter of positive surprise.

Nevertheless, based on the company’s conservative underwriting practices and repositioned P&C portfolio, we expect XL Group to fare well going forward. XL Group continues to enhance shareholder value through share buybacks and dividend hikes.

Other stocks to consider

Property and casualty insurer Everest Re Group Ltd. (RE - Analyst Report), Global Indemnity plc (GBLI), HCI Group, Inc. (HCI - Snapshot Report) carry a Zacks Rank #1 (Strong Buy) and are worth considering.

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