Recently, a friend of mine from Canada came to stay with me.  We talked about a wide number of things, but when we talked about investing, I described insurance investing to him, giving my usual explanation on reserving.

Classical life insurance reserves are a science.  Death happens with regularity, it is only a question of when.  Short-tail P&C, health, etc, are almost a science — the claims come quickly, and the reserves get adjusted rapidly.  Long-tail Casualty and Liability is a dark art at best.  Mortgage, financial, and title insurance reserving is not even an art; there is no good theory behind them, as is true of life insurance products with secondary guarantees, particularly those dealing with variable products.

As an example of long-tail P&C, I told my friend about Berkshire Hathaway and asbestos — I mentioned to him how BRK has become the reinsurer of choice for insurers with uncertain asbestos liabilities.  Buffett has reinsured White Mountains, AIG, CNA, Equitas. and many others, the most recent being Liberty Mutual, which happened after the talk with my friend.

This is retroactive reinsurance, where an insurer purchases insurance from a reinsurer to cover business previously written.  This is an uncommon form of insurance, and most commonly used when the amount of claims is very uncertain.

Quoting from the Bloomberg article:

Liberty Mutual Group Inc. issued $750 million of bonds to help finance a payment to a unit of Warren Buffett’s Berkshire Hathaway Inc. (BRK/B) for covering the insurance company’s liabilities tied to asbestos.

The 4.85 percent, 30-year notes were sold to yield 160 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. Standard & Poor’s increased Liberty Mutual’s rating one level to BBB from BBB- after Berkshire’s National Indemnity Co. agreed last week to provide as much as $6.5 billion of coverage for the insurance company’s liabilities for asbestos, environmental and workers’ compensation policies.

“This agreement covers Liberty Mutual’s potentially volatile U.S. A&E liabilities and largely mitigates potential risks from future adverse reserve developments,” Tracy Dolin, an S&P analyst, said in a statement.

Berkshire, which has grown over the last five decades by investing insurance premiums in stocks and takeovers, has assumed billions of dollars in asbestos risk from insurers including American International Group Inc. and CNA Financial Corp.

Liberty Mutual paid Omaha, Nebraska-based National Indemnity about $3 billion for the coverage, according to a July 17 company statement.

This is similar to the other deals, where the premium paid is roughly half the amount of what BRK could have ot pay out at maximum.  Note that BRK has capped its exposure to the claims.   If asbestos claims against Liberty Mutual exceed $6.5 Billion, Liberty Mutual will have to pay the excess.

I don’t think there is another American insurance company with more asbestos exposure than BRK.  That’s not necessarily a bad thing, though.  Let me quote from BRK’s recent 10-K:

We are exposed to environmental, asbestos and other latent injury claims arising from insurance and reinsurance contracts. Liability estimates for environmental and asbestos exposures include case basis reserves and also reflect reserves for legal and other loss adjustment expenses and IBNR [DM: Incurred But Not Reported] reserves. IBNR reserves are based upon our historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities.

The liabilities for environmental, asbestos and other latent injury claims and claims expenses net of reinsurance recoverables were approximately $13.7 billion at December 31, 2013 and $14.0 billion at December 31, 2012. These liabilities included approximately $11.9 billion at December 31, 2013 and $12.4 billion at December 31, 2012 of liabilities assumed under retroactive reinsurance contracts. Liabilities arising from retroactive contracts with exposure to claims of this nature are generally subject to aggregate policy limits. Thus, our exposure to environmental and other latent injury claims under these contracts is, likewise, limited. We monitor evolving case law and its effect on environmental and other latent injury claims. Changing government regulations, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations and other factors could result in significant increases in these liabilities. Such development could be material to our results of operations. We are unable to reliably estimate the amount of additional net loss or the range of net loss that is reasonably possible.

Long tail P&C reserves are roughly 20% of the total gross P&C reserves of BRK, and this deal with Liberty Mutual increases it.  Again, that’s not a bad thing, necessarily.  Given the premium paid, even if BRK pays out the maximum on average 10 years from now, the deal is a winner if BRK earns more than 8% per year.  If 15 years 5.3%.  If 20 years, 4%.  Given the long period before the ultimate payment of claims, BRK can make money in most scenarios.

That said, if anything bad ever did happen to BRK, such that its solvency was impaired, there would be a lot of insurance companies hurting as a result.  BRK is critical to the payment of asbestos claims.  There is not a better company to entrust with this task.

Full Disclosure: Long BRK/B for myself and clients — we own the equivalent of one “A” share.

Before I start, thanks to all those who e-mailed me over my “sorted weekly tweets.”  I am likely to continue doing them.  That will start next week, because I have had a flood of new clients, and other obligations.

On Fixed Payment Annuities

How often do you run into articles in quality publications talking about annuities that will pay a fixed sum over your life, or over your life if you live past a certain age?  Not often, right?  Right.  Well, today I got two articles on the same day:

Longevity insurance is an important topic, and everyone should consider getting an income that they can’t outlive.  That said, there are two problems with this:

  • Inflation, and
  • Credit risk (will the insurer survive to make the payments?)

It is possible to buy inflation-protected annuities, but at a cost of a lower initial payment.  With credit risk, consider what the state guaranty funds will cover in insolvency, and realize that any payments over that amount could be lost due to insurer insolvency.  If you have a large payment, only buy from strong insurers.

Then there are the deferred fixed payment annuities.   You are 50 years old, and you want a payment stream that kicks in when you are 80, should you live so long.  You can buy a lot of income that far out, which will help you if you survive, subject to the same two main risks: inflation and credit risk.  I am not aware of any deferred inflation-adjusted payment annuities.

Now, you can think of your annuity as a replacement for long-dated fixed interest bonds.  A portfolio of fixed payment annuities, cash, maybe some commodities/gold, and stocks could be very stable, balancing the risks of inflation and deflation, and of high and low real rates.

There is the added benefit of the regular income which is useful to average people, who are okay with budgeting, but really don’t understand investments.  Just beware inflation and credit risk.

One more note: most insurance agents will never suggest immediate annuities to you because when you buy one, that’s the last commission the agent ever gets.  They would rather you buy a deferred annuity, where they can gain another commission when the surrender charge period is up, and roll you to a new product.


Longevity insurance is good, but be sure you avoid credit risk, and have other assets to compensate for potential inflation risk.

I am grateful that risk managers inside banks have more clout these days.  That said, I want it to persist, and the best way to do it is to have risk managers beholden to an ethics code, like actuaries or CFAs.

This is valuable, because the risk manager can point to a body of ethics that says to his manager, “I am sorry, but those of my discipline say that this action is unethical,” when line managers complain that the risk manager is killing business by insisting that certain risk standards should be maintained.

Actuarial risk models cover the life of the business, unlike Wall Street models that measured risk in terms of days.  Cash flows mater, and the ability to meet the demand for cash matters.  Long-term risk models tend to surface risks better than short-term models because an intelligent businessman can ask what are the odds that we will have a crisis over the duration of our existing business?

Once on a task force of the Society of Actuaries, when discussing non-traditional actuaries going to Wall Street, I said, “Great idea, but the line managers will eventually kill anyone that gets in their way.  They don’t want people who have an ethics code.  It inhibits business.”  After that, there were some nervous chuckles on the phone, and the conversation moved on.

Ethics codes are needed when the disparity of knowledge between the designers and ultimate consumers/investors/regulators is so great that there are many ways that the consumers/investors/regulators could be cheated.

My view is controversial but simple.  Every professional in investing and finance needs to have an ethics code, making them more sensitive to their clients.  The easy solution is that every investment/finance professional needs to hold a CFA charter.  The three exams are pretty minimal, and can be passed by most people with some study.  Give the actuaries a pass, their exams are far harder — far, far, far harder.

But set some boundary for ethics and examinations of competence, to clean up finance and send the flim-flam men to the edges of the market, where they belong.



There are several reasons to avoid illiquidity in investing, and some reasons to embrace it.   Let me go through both:

Embrace Illiquidity

  • You are offered a lot of extra yield for taking on a bond that you can’t easily sell, and where you are convinced that the creditor is impeccable, and there are no sneaky options that you have implicitly sold embedded in the bond to take value away from you.
  • An unusual opportunity arises to invest in a private company that looks a lot better than equivalent public companies and is trading at a bargain valuation with a sound management team.
  • You want income that will last for your lifetime, and so you take some of the money you would otherwise allocate to bonds, and buy a life annuity, giving you some protection against longevity.  (Warning: inflation and credit risks.)
  • In the past, you bought a Variable Annuity with some good-looking guarantees.  The company approaches you to buy out your annuity at a 10-20% premium, or a 20-30% premium if you roll the money into a new variable annuity with guarantees that don’t seem to offer much.  Either way, turn the insurance company down, and hold onto the existing variable annuity.
  • In all of these situations, you have to treat the money as money lost to present uses.  If there is any significant probability that you might need the money over the term of the asset, don’t buy the illiquid asset.

Avoid Illiquidity

  • Often the premium yield on an illiquid bond is too low, or the provisions take value away with some level of probability that is easy to underestimate.  Wall Street does this with structured notes.
  • Why am I the lucky one?  If you are invited to invest in a private company, be skeptical.  Do extra due diligence, because unless you bring something more than money to the table (skills, contacts), the odds increase that they are after you for your money.
  • Often the illiquid asset is more risky than one would suppose.   I am reminded of the times I was approached to buy illiquid assets as the lead researcher for a broker-dealer that I served.
  • Then again, those that owned that broker-dealer put all their assets on the line, and ended up losing it all.  They weren’t young guys with a lot of time to bounce back from the loss.  They saw the opportunity of a lifetime, and rolled the bones.  They lost.
  • We tend to underestimate how much we might need liquidity in the future.  In the mid-2000s people encumbered their future liquidity by buying houses at inflated prices, and using a lot of debt.  When everything has to go right, the odds rise that everything will not go right.
  • And yet, there are two more more reason to avoid illiquidity — commissions, and inability to know what is going on.


Illiquid assets offer the purveyor of the assets the ability to pay a significant commission to their salesmen in order to move the product.   And by “illiquid” here, I include all financial instruments that carry a surrender charge.  Do you want to know how much the agent made selling you an insurance product?  On single-premium products, it is usually very close to the difference between the premium you paid, and the cash surrender value the next day.

Financial companies build their margins into their products, and shave off a portion of them to pay salesmen.  This not only applies to insurance products, but also mutual funds with loads, private REITs, etc.  There are many brokers masquerading as financial advisers, who do not have to act strictly in the best interests of the client.  The ability to receive a commission makes them less than neutral in advising, because they can make a lot of money selling commissioned products.  In general, it is good to avoid buying from commissioned salesmen.  Rather, do the research, and if you need such a product, try to buy it directly.

Not Knowing What Is Going On

There are some that try to turn a bug into a feature — in this case, some argue that the illiquid asset has no volatility, while its liquid equivalents are more volatile.  Private REITs are an example here: the asset gets reported at the same price period after period, giving an illusion of stability.  Public REITs bounce around, but they can be tapped for liquidity easily… brokerage commissions are low.  Some private REITs take losses and they come as a negative surprise as you find  large part of your capital missing, and your income reduced.

What I Prefer

In general, I favor liquid investments unless there is a compelling reason to go illiquid.  I have two private equity investments, both of which are doing very well, but most of my net worth is tied up in my equity investing, which has done well.  I like the ability to make changes as time goes along; there is value to being able to look forward, and adjust.

No one knows the future, but having some slack capital available to invest, like Buffett with his “elephant gun,” allows for intelligent investing when liquidity is scarce, and yet you have some.  Many wealthy people run a liquidity “barbell.”  They have a concentrated interest in one company, and balance that out by holding very safe cash equivalents.

So, in closing, avoid illiquidity, unless you don’t need the money, and the reward is very, very high for making that fixed commitment.

Every hundred or so posts, I take a step back, and try to think about broader issues about blogging about finance.  Tonight, I want to explain to new readers what the Aleph Blog is about.

There have been many new followers added to my blog recently,  through e-mail, RSS, and natively.  This is because of this great article at Marketwatch, which builds off of this great article at Michael Kitces’ blog.

I am humbled to be included among Barry Ritholtz, Josh Brown, and Cullen Roche, and am genuinely surprised to be at number 4 among RIAs in social media influence.  Soli Deo Gloria.

What Does the Aleph Blog Care About?

I’m writing this primarily for new readers, because I’ve written a lot, and over a lot of areas.  I write about a broader range of topics than almost all finance bloggers do because:

  • I’m both a quantitative analyst and a qualitative analyst.
  • I’m an economist that is skeptical about the current received wisdom.
  • I like reading books, so I write a lot of book reviews.
  • I’m also a skeptic regarding Modern Portfolio Theory, and would like to see it discarded from the CFA and SOA syllabuses.
  • I believe in value investing, in both the quantitative and qualitative varieties.
  • I believe that risk control is a core concept for making money — you make more money by not losing it.
  • I believe that good government policy focuses on ethics, not results.  The bailouts were not fair to average Americans.  What would have been fair would have been to let the bank/financial holding companies fail, while protecting the interests of depositors.  The taxpayers would have been spared, and there would have been no systematic crisis had that been done.
  • I care about people not getting cheated.  That includes penny stocks, structured notes, private REITs, and many other financial innovations.  No one on Wall Street wants to do you a favor, so do your own research and buy what you want to own, not what someone wants to sell you.
  • Again, I don’t want to see people cheated, so I write about  insurance.  As a former actuary, and insurance buy-side analyst, I know a lot about insurance.  I don’t know this for sure, but I think this is the blog that writes the most about insurance on the web for free.  I write as one that invests in insurance stocks, and generally, I buy the stocks because I like the management teams.  Ethical, hard working insurance management teams do the best.
  • Oddly, this is regarded to be a good accounting blog, because as a user of accounting statements, I write about accounting issues.
  • I am a skeptic on monetary and fiscal policy, and believe both of them tend to sacrifice the future to benefit the present.  Our grandchildren will hate us.   That brings up another issue: I write about the effects of demographics on the markets.  In a world where populations are shrinking in developed nations, and will be shrinking globally by 2040, there are significant economic impacts.  Economies don’t do well when workers are shrinking in proportion to those who are not working.  (Note: include stay-at-home moms and dads in those who work.  They are valuable.)
  • I care about the bond market.  There aren’t that many good bond market blogs.  I won’t write about it every day, but I will write about i when it is important.
  • I care about pensions.  Most of the financial media knows things are screwed up there, but they do not grasp how bad the eventual outcome will likely be.  This is scary stuff — choose the state you live in with care.

Now, if you want my most basic advice, visit my personal finance category.

If you want my view of what my best articles have been, visit my best articles category.

If you want to read about my “rules,” read the rules category.

Maybe you want to read some of my most popular series:

My blog is not for everyone.  I write about what I feel most strongly about each evening.  Since I have a wide array of interests, that makes for uneven reading, because not everyone cares about all the things that I do.  If that makes my readership smaller, so be it.  My blog expresses my point of view; it is not meant to be the largest website on finance.  I want to be special, even if that means small, expressing my point  of view to those who will listen.

I thank all of my readers for reading me.  I appreciate all of you, and thank you for taking the time to read me.

As one final comment, I need to say this.  I note people unfollowing my blog at certain times, and I say to myself, “Oh, I haven’t been writing about his pet issue for a while.”  Lo, and behold, after these people leave, I start writing about it again.  That is not intentional, but it is very similar to how the market works.   People buy and sell investments at the wrong times.

To all my readers, thank you for reading me.  I value all of you, and though I can’t answer all e-mails, I read all e-mails.

In summary: the Aleph Blog is about ethics and competence.  I want to do what is right, and do what gives the best investment performance, in that order.


Miscellaneous questions post — here goes:

Thank you very much for your blog! I am hooked since I found it and have been getting smarter by the day!

I like Safety Insurance Group, found it through your blog, noticed you were no longer long. They don’t do life insurance, just cars and houses – I know you say not to mix because they are sold and underwritten differently. They had a rough Q1 but a good 2013, seems like the winter Mass weather might have done it. They are over Book of 1 so there are other insurers that are cheaper, but they look like a good compliment to NWLI (also found through you and like very much) in the auto space, in a small (and thus dominate-able) market. 

Am I missing something about SAFT? 

Many sincere thanks David!

I like the management team at Safety Insurance.  When I met with them years ago, they impressed me as bright businessmen competing well in one of the most dysfunctional insurance markets in the US — Massachusetts.  Most major insurers did not write auto and home insurance there as a result.  But then the state of Massachusetts began to loosen up their tight regulations, and some of the bigger insurers that stayed away have entered — GEICO, MetLife, Liberty Mutual, etc.

When the market was more closed, SAFT had strategies that allowed them to profitably take market share Commerce Group [now Mapfre].  With more competition in Massachusetts, Safety’s earnings have suffered.  I can’t get excited about a short tail P&C insurer trading above book at 13-14x forecast earnings.

Maybe people are buying it for the 4%+ dividend.  I don’t use dividend yield as an investment criteria, for the most part.  I would avoid Safety Insurance.  It’s well-run, but the price of the stock is too high.  If it drops below $35, it would be a compelling buy.

Hi David,

I was interested in your comment on Normalized Operating Accruals as an indicator of accounting quality.

Why is this?

I tend to view changes in accruals as an indication of the underlying strength of a business, but would appreciate your insight on this.


The idea behind net operating accruals is that accrual entries represent future cash flows, which are less certain than cash flows that have already happened.  Companies that report high levels of accounts receivable, inventories, etc., as a fraction of assets or earnings, tend to offer negative earnings surprises, because many of those accruals will not convert to cash as expected.

Here is how I measure Net Operating Accruals:

(Total assets – Cash  – (Total liabilities – Short-term debt – Preferred stock – Long-term debt))/Total assets (or earnings)

An apology here, because the term commonly used is “net operating accruals” and I messed up by calling it “normalized.”

Companies with conservative accounting (fewer accruals) tend to have stronger earnings than those that are more liberal in revenue recognition.

Dave, you and I are too old school. We need to move into this century. The way that most people seem to get into the investment industry has nothing to do with what you talk about. It is far easier to become a “financial advisor” that pushes annuities on the 60+ crowd. You don’t really have to learn anything about investing. All you need to know is about salesmanship. Offer a free lunch/dinner and reel them in!

I honestly think that more folks are going this route instead of the “hard way” you have outlined. . .

Maybe you can do a sarcastic post: “How to NOT be valuable, but make a lot of money in the Investment Business.”

Personally I find the annuity and non-traded REIT pushers very repulsive. At the same time, I know several of them that have done very well . . .

There are two factors at work here — yield and illiquidity.  The need for yield is driven by monetary policy.  Particularly with a sizable increase in retirees, many of whom can’t make enough “income” when interest rates are so low, they take undue risks to get “income,” not realizing the risks of capital loss that they are taking.

When I was an analyst/manager of Commercial Mortgage Backed Securities, there was a key fact one needed to understand: safe mortgages do not depend on whether the businesses leasing the properties operate well or not.  Safe mortgages have no operational risk, and thus avoid theaters, marinas, etc.  Stick to the four food groups: Multifamily, Retail, Office, and Industrial.

There will be negative events with insecure investments offering a high yield.  You may not get the return of your money, as you try to get a high return on your money.

Then there is the illiquidity — that is what allows the sponsors the ability to pay high commissions to those who sell the annuities and non-traded REITs.  Because the investors can’t leave the game, the income stream of the sponsor is very certain.  They take a portion of the anticipated income stream, and pay it in a lump sum to their agents as a commission.  And that is why the agents are so highly motivated.

Eventually, the demand for yield will be disappointed.  Uncertain yields will fail in a crisis, and reset much lower.  Income that stems from dividends, preferred dividends, MLPs, junk bonds, structured notes, etc., is not secure in the short-to-intermediate run.  It is far better to invest to grow value than to invest for income.  They can pay you a yield, sure, but if the underlying value is not growing, you will eventually get capital losses, and after that, much less yield.

Look for safety in yield investments.  If you are going to take risks in investing, take risk, but ignore the income component.  Don’t stretch for yield.

Tuesday, a subsidiary of Eurohold Group, Euroins Insurance Group, announced a $3.75 bid for Tower Group.  I think it is bogus.  Here’s why:

  • At the price they are paying, they are offering more than their net worth to buy Tower Group $215MM vs $190MM.
  • They would pay a 2x+ premium over book to buy Tower when they trade at ~70% of book.
  • They have no overlapping lines, geographically.  It would be cheaper for Eurohold to buy a Bermuda shell and poach some talent, if what they want to do is diversify.
  • TWGP isn’t even worth the $2.50 that ACP Re is offering.
  • The language in the “offer” is weaker than that of many “letters of intent” I have read, much less a binding offer.

Now, let me take one step back, and say that the numbers I calculated above derive from documents written in Bulgarian that I have translated mechanically.  I may have made mistakes.

Also, a fool and his money are soon parted.  If Eurohold is foolish, a bid could be made where economics doesn’t matter.  After all of my dealings with foreign insurers, I have seen many ill-thought-out deals.

Kudos to the guy who sold near $3 on Tuesday.  He got the best outcome out of this sordid mess.  Opposite for the one that bought.

As for me, I have no position.  I rarely short, and there is no significant margin of safety in owning TWGP.  The odds of the operating subsidiaries as a group having not enough surplus to exceed the relevant company action level risk based capital  for the group as a whole is not high, but is not zero.  That is the one condition that can break the $2.50 deal with ACP Re.

Now let’s see how the first quarter earnings come in.  That will say a lot.

As an aside, the bonds of Tower Group offer about as much upside, and less downside than the equity does, if the ACP Re deal is the only real deal.


I get a lot of interesting letters — here is another one:

First, let me say how much I appreciate your blog. I started my career in sellside research covering life insurers (after interning in insurance M&A). Your posts on insurance investing were invaluable in developing my understanding of the industry. My superiors did not have time to teach me the basics – I would have had a hard time getting started without your blog. 

 I’m now in equity research at a large mutual fund company, also covering insurers (and asset managers). However, I do not have an actuarial background. So I am very interested in why you think financial & mortgage insurers don’t have an actuarially sound business models. 

 And as a former life insurance analyst, I am curious what aspect of life insurance reserving you view as liberal – I’m guessing secondary guarantees on VAs? 

 Finally, to digress, do you have any views on medical malpractice insurance? I’ve been looking at PRA, and find it pretty compelling at first glance: massive excess capital, consistently conservative and profitable underwriting, and a relatively reasonable valuation. 90% of policies are claims made. There are headwinds: Obamacare, the reserve releases from mid-2000s accident years rolling off, and a diversifying business model (although PRA has historically proven competent at M&A). My only concerns are management continuing to underwrite at too low a level (currently writing at 0.32x NPW / Equity; regulators would be fine with up to 1.0x), and potentially squandering that capital. 

In the interest of full disclosure, I own no insurance stocks personally for compliance reasons.

Thanks for writing.  Let’s start with mortgage and financial insurance.  It’s not that there isn’t a good way to calculate the risk (in most cases), it is that they do not choose to use those models.  The regulators do not subscribe to contingent claims theory.  They do not look at default as an option, even if it is not efficiently exercised.  They should use those models, and assume efficient execution of default risk.

Even if they use approximations, the recent crisis should have forced reserves higher for mortgage credit, and other credit exposures.

Credit and mortgage insurers are bull market stocks.  When I was a bond manager, I sold away my few financial insurer bonds from MBIA and Ambac, and avoided the mortgage insurers.  The possibility of default was far higher than he market believed.

With respect to Life Insurers, it is secondary guarantees of all sorts, especially with variable products.  Options that have a long duration are hard to price.  Options that have a long duration, and involve significant contingencies where insureds may make choice hurting the insurer are impossible to price.

On Medmal, I have always liked PRA, but it has never been cheap enough for me to buy it.  Always thought they were the best of the pure plays.  They have survived many other companies by their clever management.  I would not begrudge them their conservatism, Medmal is volatile, and it pays to be conservative in volatile businesses.

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.

When I was writing at, I would often do little posts in the Columnists Conversation, and title them “Notes and Comments,” or something like that.  I don’t normally do that here, but I would like to tie up some loose ends.

1) I received the following e-mail six weeks ago, and I feel it is worthy to be shared with readers:

Hi David,

I follow the Aleph blog from time to time. I run value and special situations oriented hedge fund whose goal is to purchase businesses that sell for at least 50 cents on the dollar. It seems that we are like minded in investment terms. I have an extensive investment checklist which that I believe can add value to investors. It took me a few years and I derived it by reading stacks of annual reports from Buffett, Klarman, etc…

If it adds value to your readers, more than happy to share the 90+item investment checklist.



Pope Brar, Managing Partner/Founder

Brar Investment Funds

I’ve read through the checklist and it is a good one.  It has all of the elements of my processes (though I am not as rigorous) and much more.  His checklist is worth a read.  Have a look at it.

2) From last night’s post, a reader asked:

Lots of insurers here.  Given your expertise in that area, I’d be curious to know if you think this screen is turning up names that are on the riskier end of the spectrum.

I wrote a seven part series on this, and here are the summary ideas, and the links:

  1. Shrinking the share count
  2. Growing Fully Convertible Book Value per Share
  3. Price Momentum and Mean-Reversion
  4. On Conservative Management & Reserving
  5. Some Things Can’t Be Underwritten
  6. Analyzing Insurance Sub-Industries and the PB-ROE model
  7. Insurance Accounting and Miscellaneous Insurance Insights 

I’ve been decreasing my insurance shareholdings lately because:

  • Pricing is weak for most P&C coverages, and
  • I don’t trust the reserving for secondary guarantees in life and annuity policies.

Here’s the insurance companies from last might’s article in decreasing order of earnings yield:

Imperial Holdings, Inc.IFT0709 – Insurance (Life)United States 1.38 37.03 26.83
Greenlight Capital Re, Ltd.GLRE0715 – Insurance (P&C)Cayman Islands 0.90 19.45 21.61
Assured Guaranty Ltd.AGO0715 – Insurance (P&C)Bermuda 1.18 18.59 15.75
American Equity Investment LifAEL0709 – Insurance (Life)United States 0.86 16.77 19.50
Everest Re Group LtdRE0715 – Insurance (P&C)Bermuda 0.88 15.35 17.44
Validus Holdings, Ltd.VR0715 – Insurance (P&C)Bermuda 1.00 13.30 13.30
Axis Capital Holdings LimitedAXS0715 – Insurance (P&C)Bermuda 1.01 13.20 13.07
Endurance Specialty Holdings LENH0715 – Insurance (P&C)Bermuda 1.31 12.55 9.58
CNO Financial Group IncCNO0709 – Insurance (Life)United States 1.29 12.39 9.60
American International Group IAIG0715 – Insurance (P&C)United States 1.34 12.00 8.96
Montpelier Re Holdings Ltd.MRH0715 – Insurance (P&C)Bermuda 0.99 11.83 11.95
Allied World Assurance Co HoldAWH0715 – Insurance (P&C)Switzerland 1.00 11.73 11.73
XL Group plcXL0715 – Insurance (P&C)Ireland 1.12 11.72 10.46
Argo Group International HoldiAGII0715 – Insurance (P&C)Bermuda 1.27 11.55 9.09
Platinum Underwriters HoldingsPTP0715 – Insurance (P&C)Bermuda 1.02 11.25 11.03
Allianz SE (ADR)AZSEY0715 – Insurance (P&C)Germany 0.92 11.08 12.04
ACE LimitedACE0715 – Insurance (P&C)Switzerland 0.84 10.92 13.00
ProAssurance CorporationPRA0715 – Insurance (P&C)United States 0.87 10.86 12.48
MBIA Inc.MBI0715 – Insurance (P&C)United States 1.45 10.86 7.49
National Western Life InsurancNWLI0709 – Insurance (Life)United States 1.63 10.85 6.66
Partnerre LtdPRE0715 – Insurance (P&C)Bermuda 1.23 10.75 8.74
Old Republic International CorORI0715 – Insurance (P&C)United States 0.88 10.53 11.97
Employers Holdings, Inc.EIG0706 – Insurance (A&H)United States 0.93 10.46 11.25
United Fire Group, Inc.UFCS0715 – Insurance (P&C)United States 1.05 10.30 9.81
Maiden Holdings, Ltd.MHLD0715 – Insurance (P&C)Bermuda 0.93 10.11 10.87
EMC Insurance Group Inc.EMCI0715 – Insurance (P&C)United States 1.02 9.88 9.69
Investors Title CompanyITIC0715 – Insurance (P&C)United States 0.86 9.85 11.45
Protective Life Corp.PL0709 – Insurance (Life)United States 0.92 9.76 10.61
Lincoln National CorporationLNC0709 – Insurance (Life)United States 1.07 9.76 9.12
FBL Financial GroupFFG0709 – Insurance (Life)United States 0.96 9.73 10.14
Assurant, Inc.AIZ0709 – Insurance (Life)United States 1.00 9.67 9.67
Kemper CorpKMPR0715 – Insurance (P&C)United States 0.95 9.64 10.15
Aspen Insurance Holdings LimitAHL0715 – Insurance (P&C)Bermuda 1.12 9.61 8.58
Horace Mann Educators CorporatHMN0715 – Insurance (P&C)United States 0.91 9.60 10.55
Unum GroupUNM0709 – Insurance (Life)United States 0.98 9.55 9.74
WellPoint IncWLP0706 – Insurance (A&H)United States 0.89 9.52 10.70
ING Groep NV (ADR)ING0709 – Insurance (Life)Netherlands 1.14 9.46 8.30
Axa SA (ADR)AXAHY0709 – Insurance (Life)France 1.19 9.46 7.95
Hanover Insurance Group, Inc.,THG0715 – Insurance (P&C)United States 0.99 9.44 9.54
Baldwin & Lyons IncBWINB0715 – Insurance (P&C)United States 0.98 9.42 9.61
American Financial Group IncAFG0715 – Insurance (P&C)United States 0.87 9.15 10.52
Alleghany CorporationY0715 – Insurance (P&C)United States 1.01 9.15 9.06
American National Insurance CoANAT0715 – Insurance (P&C)United States 1.40 8.99 6.42
HCC Insurance Holdings, Inc.HCC0715 – Insurance (P&C)United States 0.82 8.92 10.88
Allstate Corporation, TheALL0715 – Insurance (P&C)United States 0.82 8.75 10.67
Symetra Financial CorporationSYA0709 – Insurance (Life)United States 1.23 8.64 7.02
Selective Insurance GroupSIGI0715 – Insurance (P&C)United States 0.90 8.51 9.46
White Mountains Insurance GrouWTM0715 – Insurance (P&C)Bermuda 1.07 8.49 7.93
Fortegra Financial CorpFRF0712 – Insurance (Misc)United States 1.28 8.18 6.39
Cna Financial CorpCNA0715 – Insurance (P&C)United States 1.10 8.15 7.41
Stewart Information Services CSTC0715 – Insurance (P&C)United States 0.83 7.96 9.59
Navigators Group, Inc, TheNAVG0715 – Insurance (P&C)United States 1.09 7.68 7.05
Reinsurance Group of America IRGA0706 – Insurance (A&H)United States 1.08 7.49 6.94
Safety Insurance Group, Inc.SAFT0715 – Insurance (P&C)United States 0.84 7.39 8.80
State Auto Financial CorpSTFC0715 – Insurance (P&C)United States 0.83 6.92 8.34
Genworth Financial IncGNW0709 – Insurance (Life)United States 1.72 6.87 3.99
First American Financial CorpFAF0715 – Insurance (P&C)United States 0.87 6.75 7.76

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.

3) Another letter from a reader, on a very different topic, the FOMC:

thanks again – I always look forward to this update.

My thoughts are, they are increasing their flexibility in one direction (towards “accommodation”).  While they did move the point about “after the purchase program ends” to a spot perhaps better suited to a discussion of that point, I also took it to mean that there may be less commitment to end QE.  (Although, so long as the deficit keeps declining, they really have no choice but to dial back purchases to keep the supply and the non-Fed demand in line.  This is the overlooked reason, I believe that long rates appear to be moving independently of Fed action.  Their demand is not the only variable).

 Final thought – to what extent do you think that the Fed’s great misunderstanding is their inherent bias towards lowest rates possible under any economic conditions: i.e. for any given level of inflation, that Fed policy is best that reflects the lowest level of non-inflationary interest rates [because this presumably encourages credit expansion and therefore economic growth]?

 To my way of thinking, the difficulty with this is that it assumes that credit always has to expand FASTER than the economy overall.  I don’t mean that credit expansion is not important, it is a big component of growth, just that credit can’t grow faster than income forever and at some point, we have to find a model that enables income to grow fast enough to increase living standards without overleverage.

 To me, this is the central policy challenge of the 21st century, because a) globally, credit has surged relative to national income and has reached a limit, b) populations are aging and must therefore favor lower levels of credit – and consumption – overall and c) the bills associated with 1 and 2 are now coming due.

 The Fed, however, seems stuck on the idea that their job should be to inflate rapid credit expansion regardless of the creditworthiness of the borrowers.  This strikes me as dumb, or perhaps more like wishful thinking that if credit expands, growth will drive incomes higher and somehow these will catch up (with some acceptable lag).

 Notice that no one at the Fed talks about things like the household savings rate any more?  I would be ok with QE if the Fed could explain that they were facilitating an orderly deleveraging: in which case Household Debt/Equity (which indicates potential for end-consumer final demand) would be a better metric than unemployment.

 As it is, I believe that what they are really targeting (large) bank balance sheets, and that QE is really a massive backdoor subsidy to money center banks to guarantee enough operating income to allow them to write off bad loans while increasing capital reserves to comply with Basel III.  (Full disclosure, I have a significant portion of my assets in a large US bank that was trading well below the strike price of the warrants issued against its shares to Berkshire Hathaway at the time I purchased the shares, which bank shall remain nameless).

 Politically, I suppose, saying, “well, we need to ensure banks are profitable so as to ensure the solvency of the payments system” looks disturbingly like a bailout for the 1% and is out of touch with a more populist America.

 Anyway, sorry for the diatribe, but curious to get your thoughts.  I think I am less reflexively sceptical about the efficacy of the Fed’s policy (but I fully agree with your view that they are not supporting employment with it).

 Thanks again for all the work you do.

The central idea I would like to comment on is that incremental easing has had less and less effect on the economy, at least in the short-run.  Aside from energy companies, willingness to invest in the business has been light, while willingness to buy back stock has been high.  That doesn’t produce growth in the economy.

The Fed doesn’t realize that it can’t stimulate the economy at the zero bound.  QE is ineffective, and may become fuel for high inflation if the banks start to lend aggressively.  Inflation is not the goal, and I think many policymakers are confused — the goal is real growth.

We can protect the payments systems by protecting the regulated subsidiaries of banks, and letting the holding companies bear the losses, which is what we failed to do in 2008-2009.

All that said, we have a punk economy, but what will happen if we get a large increase in bank lending, leading to inflation.  What will the Fed do then?