WR Berkley – The Rare Combination Of Both Able Operators And Allocators

We buy back stock when we think it’s attractively priced relative to our assessment of the intrinsic value of the enterprise.

– Robert Berkley on the 1Q2020 conference call.

The business:

WR Berkley (NYSE: WRB) is an insurance and reinsurance company. They do mostly business like excess and surplus lines and specialty insurance. These lines of insurance are less standardized and hence less competition compared to the “regular” P&C. The downside is that pricing is more difficult to estimate. Berkley has a volatile reinsurance segment, but that is just 10% of the premiums written.

The majority of the premiums come from their domestic market (USA), but management has gradually over the years diversified into about 60 countries. The runway is still long as Berkley only writes about 1% of the premiums in the US.

Why I like WR Berkley:

Since the IPO in 1974 the share price of WR Berkley has increased 17% annually, much more than the S&P 500. There are reasons for that and I expect it to outperform over the next 1-2 decades based on these arguments:

  • Skin in the game: WR Berkley was founded in 1973 by William Berkley. He has stepped down as CEO to become chairman of the board. His son Robert Berkley took over as CEO in 2015. William Berkley owns 37 million shares, almost 20% of the outstanding shares. Robert Berkley owns 1.1% of the shares. This means alignment between the main shareholder, management and outside shareholders.
  • Berkley has proven to be very good operators: Profitable underwriting requires discipline and The Berkleys have managed to do this over many business cycles, both hard and soft markets. Very few underwriters have the discipline and culture to do this repeatedly. When opportunities are slim, Berkley stay away from unprofitable underwriting. The combined ratio over the last 15 years looks like this:
WR Berkley’s combined ratio. Source: annual reports.
  • WR Berkley operates decentralized. Each business unit is run with owners who both have skin in the game and accountability. All senior directors are required to own shares.
  • Pretty diversified operations both in terms of lines of insurance and geography.
  • Berkley is operating in niche markets where they have developed knowledge, expertise and brand over many decades.
  • WR Berkley is one of the very few companies that has a clear plan and discipline in capital allocations. They have paid a very small dividend for 43 years, currently at 12 cents a share per quarter. The rest is ether redeployed into the business or used for value enhancing buybacks or special dividends.
  • Their buyback history from 2007 clearly shows they have bought shares after a drop in the share price.
  • During the pandemic in 2020 they spent 200 million on buybacks, about 2% of the company. They walk the talk (see the quote starting this article). Likewise, major buybacks were done in the second half of 2008 when the share price dropped.
  • It seems management believes intrinsic value are at about 1.6-1.7 times book value, as rarely any buybacks have been done above that level.
  • However, the main priority is organic growth, not shareholder distributions.
  • Any acquisitions are usually small, thus avoiding potentially ruinous M&A.
  • Management and owners are long-term.
  • The insurance business is reasonable recession proof. People and businesses don’t stop paying for insurance in a downturn. The share price dropped 28% in 2008/09, while book values only dropped 5.3% in 2008 (and gained 22% in 2009).

Valuation:

WR Berkley always trade on the expensive side due to its good historical operational performance:

WR Berkley 10-year CAGR of book value. Source: Annual reports.

Currently it trades at about 1.6 times book value, the lowest level since 2015.

Risk:

We can expect a lot of litigation against insurers after the Covid-19 mess in the coming years, one of the reasons insurance companies have suffered recently. This is what Robert Berkley said about this issue during the 1Q2020 earnings call:

Many people are looking to the insurance industry for a solution. And unfortunately, they are looking for the solution even when the product they purchased does not provide one. Much of the plaintiff bar with the support of the litigation funding vehicles that are out there seem to subscribe to the unfortunate idea of never letting a crisis go to waste. Some seem to be unencumbered by what the words and a policy says and are very skilled at managing the media. While I think it is unlikely that  these groups will achieve broad success, it is important to note, it is important to recognize that any success that they achieve will ultimately come at a price to society overall. Insurance is fundamentally nothing more than a tool or a mechanism, if you like, to spread risk. If loss costs go up, insurance pricing ultimately goes up. If politicians and courts allow much of the plaintiff bar to get what they are seeking and disregard the words in the contract or the policy then it is very likely that society will pay a dear price because ultimately, the cost of insurance will be going up.

The low interest rates are also a problem for the insurance industry as a whole (less income from the “float”). Likewise, a sudden surge in inflation is very detrimental.

Conclusion:

The Berkley-family has proven themselves to be both good operators and capital allocators, a very rare breed in the corporate world. I’m long WR Berkley since the pandemic. I expect to own WR Berkley for many years and add on meaningful pullbacks. I expect 8-12% yearly return, more than I expect from the overall market over the next decade.

 

Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.  

(This article was published on the 13th of July 2020.)

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