Insurance – Page 54 – The Aleph Blog

Beat, but not Beaten

Posted on 23 March 200722 June 2017 by David Merkel

Ugh. What a day. It’s 1:30AM as I begin to write this, and I have been going since 4AM after traveling to Manhattan to DC and back, with the usual difficulties. The two highlights of my day were meeting with the best operational management team in insurance, Assurant, and meeting up with my work colleagues for dinner to celebrate new members coming onto staff. The lowlight was not getting any time with my family.

Now, one of the nice things about my portfolio management style is that I can ignore the markets for short amounts of time, and 99% of the time, it doesn’t matter. I do 95-99% of all my trades through portfolio rebalancings and portfolio reshapings. Like Buffett, who I admire (though I don’t always agree with), I wouldn’t mind if the market were closed more frequently. So today my broad market portfolio was up 50 basis points in my absence. I am now ahead of where i was at 2/26, before the shock.? Maybe I should be absent more often. 🙂

While traveling, I put the finishing touches on six (yes) articles that will be published on RealMoney over the next month. One should be next week, and is a compilation of what I have written here on my recent portfolio reshaping, with a few bits taken out and another page of explanatory data added for greater clarity. The other five articles are a series that I have worked on for a while which I have informally entitled “The Excellent Analyst” series. It goes through the framework of questions that I ask when I have a management team all to myself. I don’t go for material nonpublic information; I also don’t go for earnings trivia, rather, I try to see how the management team thinks as businessmen. Another place where I agree with Buffett, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.”

With insurance, that comes natively to me, having done pricing, reserving, reinsurance, and corporate work as an actuary, having managed a small division of a company, with underwriting, marketing, and investment risk control. And my time managing insurance assets, mortgage bonds and then corporates, together with the derivatives. Having done all that, understanding insurance managements is second nature to me. I can sense a bad management team, and I delight in a great management team.

This brings me full circle to Assurant. Why are they the top operational insurance management team to me? This is a non-exhaustive list:

Few other companies in insurance have seriously thought about sustainable competitive advantage. Assurant does it well, being #1 or #2 in almost all of the businesses in which they choose to compete.
They invest in IT and customer relationships to create barriers to entry that are difficult to reverse engineer.
Few insurance companies figure out their core competencies so closely, and then look for adjacent markets to apply them to.
Few insurance companies look for “blue ocean” markets, where there is an unmet need and no competitors.
Excellent capital allocators.
Excellent at M&A, doing small infill acquisitions and growing them organically.
Understands the concepts in market segmentation, and applies it to pricing, reserving, customer service and risk control.
Executes almost flawlessly. What a great culture.

And if that’s not enough, they earn an ROE that is solidly in the top quartile for insurers, and I have no doubt that they will do the same next year. Progressive and AFLAC, move over. There is a new growth insurance name in town, and their valuation metrics are inexpensive, compared to what we are likely to get.

Full Disclosure: Long AIZ

He Who Pays The Piper Calls The Tune

Posted on 21 March 200723 March 2007 by David Merkel

There’s an article in the Wall Street Journal today entitled, “Credit-Ratings Firms Get Caught Up In Subprime Meltdown.” In some ways I anticipated this in my article at RealMoney, “Snarls in Insurance Investigation, Part 2.”

I experienced the difficulties that the ratings agencies had in 2001-2002 as a corporate bond manager. They are paid by the issuers, and have a conflict of interest. They can argue that they are zealous to protect their reputations, but in the short run, they get paid by issuers to rate deals. Only in times of crisis do they adjust their standards to meet the needs of the bond buyers.

In short, the problems with the ratings agencies are the same as the problems with auditors. He who pays the piper calls the tune. Except in crises, the ratings agencies are more beholden to the issuers than their subscribers. All the more reason to allow alternative ratings agencies into existence, to challenge their oligopoly.

Coverage in the Gulf

Posted on 20 March 200721 March 2007 by David Merkel

A reader posed this question to me a little less than a month ago:

With the financial markets providing such opportunities to transfer risk such as re-insurance and cat bonds how legitimate is it for the insurance companies to say that they must pull out of MS and LA? How much of that risk is transferred to other entities? Is it because the hedge funds and re-insurers refuse to play ball in MS and LA so the insurers are stuck? What other risk transfer mechanisms are available the insurers to spread risk to others?

Can you please do a piece on your blog that addresses how the cat risk is spread and how much remains on the insurers books? Thanks and yes I live in the Great State of Louisiana.

I didn’t write about this sooner because I was just getting started blogging, and had other goals. That said, he has a valid question. Property insurance, by its nature tends to be a high severity business. If there are enough uncorrelated property exposures, an insurer or reinsurer can write business, knowing that there might be bad years, but that nothing will kill them.

Unfortunately, the southeast coast of the US is a large part of the global property insurance market and not very diversifiable, because it would be a large percentage of the total premium for property coverages globally. Recently, the odds of disaster have been estimated higher by catastrophe modelers, and then by reinsurers and insurers. That has led insurers and reinsurers to ask for higher premiums or tighter terms. To the extent that state insurance departments will not allow for this, shortages occur.

I don’t derive any direct income from the P&C insurance industry. In general, I feel that allowing market forces to work yields the best overall result; it may take as many as three years for competition to do its work.

Life in Warren’s World is Still Expensive

Posted on 10 March 200710 March 2007 by David Merkel

Last year, I wrote and ill-timed piece at RealMoney entitled, ?Life in Warren’s World Is Expensive,” and a follow-up, ?Buffett the Businessman.” I claimed that Berkshire Hathaway was overvalued. It has since risen by 15-20%. I am eating my crow, and wish that I had more salt.

Trouble is, I think that my thesis is still correct. I view Berkshire Hathaway as an insurance company that uses its liability structure to fund its operating businesses. To me, the performance of the insurance enterprises is a critical aspect of whether Berkshire is a good or bad investment.

In 2006, Berky wrote some of the riskiest coverages that the rest of the insurance industry would not touch on the property side of the business. Then came a ?no catastrophe? year. Is it any surprise that the stock is higher? Give Buffett credit for the AAA balance sheet that allowed him to be the last man standing in writing risky property coverages. Even in this year?s letter, he says he is willing to lose $6 billion in a single event. Pricing is slipping, and I have no doubt the Berky won?t chase the pricing down below levels where they can?t make their profit on average. That may mean that Berky will have a lot of idle cash.

Warren has changed his tune regarding retrocessional coverages in the last few years. In the 2007 letter, he explains how it can be used to ameliorate the risks of other insurers. This is a good and proper use of retro. In years 2005 and prior, he would crow about his riskless deals, which no doubt passed accounting muster, even if they missed the spirit of the regulations.

Berky has $50-70 billion to put to work. I don?t see how they can do that easily. Berky?s acquisition pattern over the past few years is to scrape up a few distressed companies, and a few companies where the owner was willing to sacrifice on price to preserve the culture. Outside of bold moves like acquiring ConocoPhilips outright, I don?t see how they can deploy that much capital.

Give Buffett credit for staying in enough of his foreign currency trade to draw a profit from it. I agree with Buffett over the state of our national finances, and think the dollar is headed lower over the intermediate term. That said, I increased my size of the trade when he lightened up in 2006.

Finally, they are looking for a successor to Buffett. Whoever that man may be, he will have to reckon with a few realities. If the objective is to grow long term book value, what is he best way to do that? Hold onto cash and wait for a crisis? Buy reasonably priced operating businesses with a hope of growth? Wait for utilities to go on sale? Behave like Magellan, Contrafund, or any other large mutual fund? (Not Buffett?s way.)

In summary, I can?t see Berky doing that well over the next twelve months because of the weak pricing environment for insurance, and the difficulty the Buffett will have in deploying the free cash of Berky. It is a more competitive environment for investments, which means that Berky will not deploy much cash.

Full Disclosure: Long COP

The Major Article List is Live!

Posted on 7 March 20077 March 2007 by David Merkel

Though it is something that will grow, the major article list section of this blog is now up-to-date. It is a complete index of my long-term writings at RealMoney (primarily).

The one thing that would make it better would be to index my long term Columnist Conversation posts. It is my favorite part of RealMoney, and that is why I have concentrated there, even though I don?t get paid for cc posts. (sad that) What would be interesting would be to scour my cc posts for long term value, though I have over 1500 cc posts. I?m not doing that anytime soon. 80% of my cc posts are ephemeral, and I?m not sure it is worth the effort to get the other 20%.

Eat Dessert First?

Posted on 26 February 200726 February 2007 by David Merkel

I want to give credit to Roger Nusbaum on his brief commentary on Dow Chemical. Too many people think short term about investing, and don’t consider how much a company might be worth over time, versus a buyout today.

I faced the same problem on National Atlantic Holdings. I believe it is more valuable as a going concern than as a buyout candidate at present. I was happy when the Commerce Group negotiations broke down, because Commerce wouldn’t pay up!

I don’t have to get all of my gains today. So long as I do well enough over the next 3-5 year period, I will be happy enough. I don’t have to make a killing today. Having slightly better than average performance over a moderate period of time is reward enough.

Long DOW NAHC (the firm I work for owns 17%)

Time To Take Allstate Private

Posted on 26 February 200726 February 2007 by David Merkel

I remember once being at a First Boston Insurance conference and talking to the (now former) CEO Ed Liddy afterwards. I mentioned that we were shareholders and that I thought the stock was cheap (then around $40). He looked at me intently and said that he could not figure out why the market valued Allstate so cheaply. It was an incredible free cash flow machine.

With the hurricanes of 2004 and 2005 after that, one can see that the performance since then has been superb. But now we are in a soft pricing environment; profits will not rise rapidly, if at all. But even if profits remain level, Allstate looks cheap. EV/EBITDA is near 5x.
That should attract private equity. If one can take over Texas Utilities, Allstate should be easier. Here’s why: one can sell the life arm, Allstate Financial for $5 billion to one of the major life insurers. Along with that, the private equity buyers can lever up the holding company balance sheet to a BB- rating, which would leave the operating entities at a marginal investment grade of BBB-. The private equity buyers would use the free cash flow to repay the bank debt incurred, and five years from now, would IPO Allstate at a higher valuation.

Though I am not crazy about all of the increased leverage, a scenario like this could happen. It is just another ramification of interest rates that are too low.
Long ALL (the funds I work for and me personally)

It Was A Pretty Good Week

Posted on 23 February 200723 February 2007 by David Merkel

The broad market fund was up 85 basis points this week, against a disappointing 25 bp loss for the S&P. My balanced mandates were up 40 basis points, also good. In general, my cyclical and foreign names outperformed.

On the insurance side, Conseco reported that it would be taking some middling charges — the reaction in the stock market was muted. My own estimate of reserve insufficiencies is higher than what they took, so if this cleans it all up, this is a net plus. I’m still waiting to hear back from Conseco IR, so I can’t really tell what is going on yet. From my recent conversation with James Prieur, the CEO, I think the company is on the right track; the only real question is how bad the old long term care [LTC] block is.

Lincoln National increased its buyback today. I appreciate the shareholder-friendly actions of many insurers. Rather than being hyper-competitive, many companies are returning capital in the soft part of the pricing cycle, and that is the right thing to do.

Long LNC CNO

Understanding How I View Insurance Stocks

Posted on 23 February 200723 February 2007 by David Merkel

Insurance stocks are tricky for several reasons. There are probably more unique accounting rules for insurance, then any other industry. Why? The cost of goods sold is not known at the issuance of a policy. Every dollar into an insurance company is equal, but every promise made is not equal. Over time, estimates of cost become more accurate, but with long-tailed lines the progress is often fitful at best.

Life reserving is a science (please ignore the new funky investment derivatives inside some policies). Short-tailed P&C reserving is close to a science. Long-tailed P&C reserving is an art, and a dark art. I’m not sure that even the internal actuaries reserving the long-tailed lines can be that comfortable with the accuracy of the reserves.

This is why it pays to stick with conservative and competent managements that have shown that they can manage the soft part of the cycle. I may miss some speculative gains managing this way, but for the most part, I will miss out on the losses. To give you further insight into my philosophy, here’s a presentation that I gave to the Southeastern Actuaries Club. (I am available for other speaking engagements if I can show my employer a business purpose.)

Insurance Notes

Posted on 23 February 200723 February 2007 by David Merkel

1. Hartford increases its buyback authorization by a billion dollars. Well good. Like Allstate, they are oozing free cash flow in this environment, and don’t have as many reinvestment opportunities; they ought to be returning cash to shareholders, but cautiously, buying only on dips.

2. How do you lower personal lines insurance premiums, if you are a state regulator? Oddly, the answer is to not panic and create mandates for insurers in the state, but to allow free entry and exit for the insurers. Premium rate filings should either not be required, or be “file and use.” If a regulator does that, the insurers will trust the regulator, and there will be no lack of insurance companies seeking business in the state. Premium rates will fall.

Immature regulators place demands on insurance companies (leaving aside fraud issues). Mature regulators focus on fraud, and let the market do its work.

Long ALL HIG