Another Letter From a Reader

From reader after last night’s post.

I hope you are well. I think your blog is fantastic, thanks so much for sharing the time and wisdom for so little :)

I was wondering whether you could elaborate a bit more on the bad business models existent in the insurance field. If there would be a simple rule of thumb or similar it would be useful, but I’m guessing it has to be something (difficult  to analyze) like chasing growth when premiums are insufficient, hiding leverage through subsidiaries, etc.

This was your comment:

Now, let me list for you the companies I would avoid on this list: IFT, GLRE, AGO, AEL, CNO, AIG, XL, MBI, LNC, FBL, AHL, ING, AXAHY, AFG, GNW.  That does not mean that I endorse the others.  In general, those that I say to avoid have poor underwriting skills or a bad business model.

(AIG is the biggest position in my portfolio.)

And secondly, I was wondering whether the fact that some are based in Bermuda gives them (or the LT investor) a competitive advantage when it comes to compounding (t)BV over time, because they are paying a lower tax-rate, aren’t they?

[normally, investors have to suffer a double whammy for taxes: the companies they invest in are taxed when they have profits –the US has one of the highest tax rates internationally–; and then they are taxed when realizing the capital gains / receiving dividends. Which led me to think that if one would be investing in Bermuda-based cos. through a ROTH IRA account, he would be avoiding both fronts, right?

Thanks so much for your time David.

I know it was a long email, and I apologize for that, couldn’t make it shorter…

Okay, let me take it piece-by-piece.  I have biases, which I think are well-informed, but they are biases, ways of foreshortening the deluge of data, so that I can avoid making big errors.

1) I don’t believe that financial and mortgage insurers have an actuarially valid business model, and the last crisis proved me right.  Thus I am not interested in AGO and MBI.

2) I don’t believe that long-term care is insurable, and so I am not interested in CNO and GNW.

3) With AIG, I don’t think that all of the reserve strengthenings are done for them.  They have always been aggressive in reserving.  I am not sure that has changed.

4) I think the business that IFT is in is unethical, and difficult if legal.

5) I think the takeover of AHL will fail, and the stock price will fall.

6) I think that many common life insurance reserving practices are liberal, and so I don’t like AEL, LNC, FBL, ING, and AXAHY.

7) With XL, GLRE and AFG, I don’t respect the management.  Maybe with a few more years, that might change.

This explains my views on these companies.  Other questions, let me know.

4 Comments

  • tspare says:

    Thank you for sharing your expertise. One question I have regarding insurance company is how do you know they are reserving conservatively or aggressively? Do you look at their worst case losses in the past?

  • bbarberayr says:

    David,

    I wouldn’t dismiss ING as an investment possibility based on the weakness in underwriting their life business.

    They are in the process of splitting the business into a banking company and an insurance company.

    The banking company will be the larger and far more valuable piece of this and where most of the value in the stock is. It is well capitalized, will pay back the Dutch government this year and start issuing dividends soon, which should cause a bump in the stock. They are one of the strongest European banks in the growing mobile banking area and have a very good banking franchise in the Netherlands and surrounding countries.

    The insurance company will be “appropriately capitalised at IPO” and “All operating entities adequately capitalized”, so would expect the regulators will take the opportunity to ensure any weaknesses in capital structure are addressed before IPO. I’m not sure what you think about their P&C underwriting, but their P&C business is a good size as well and will represent much of the value in the insurance company.

    The stock here is cheaply valued and I think the split and dividend resinstatement will provide catalysts for the stock to further increase. Even assuming their life underwriting is poor, I think the overall value of the banking franchise, plus the broad insurance company will provide for good returns.

    They have a good summary year-end presentation at: file:///C:/Users/Brent/Downloads/ING_Group_Media_Presentation_4Q2013%20(1).pdf