I made a mistake in the last post. How could I possible hide some interesting data in an inconspicuous link at the end of a boring side comment? David Merkel deserves better than this (click to enlarge).
These are the historic reserve deficits of some large insurance and reinsurance companies with long tail risk. His main target was teflon Hank Greenberg that has been denying any responsibility in the AIG debacle. Some chutzpah given all the evidence indicating compromised underwriting standards, under-reserving, increased leverage and declining ROA under his reign. AIG Financial Products and its CDSs were the last consequence of Greenberg’s risk taking leadership and his nonnegotiable 15% ROE target: the ultimate yield hog
But that is old history, soon to be forgotten to become the foundations of the next bubble. Much more interesting for our own purposes is David’s heavy lifting in evaluating reserve practices of such interesting companies like Berkshire (BRK.A), Merkel (MKL), and White Mountains (WTM).
I know that David has liked PartnerRe (PRE) for a long time and now it is at a probably conservative 0.76x book value. Cincinatti Financial (CINF) is one that I have not analyzed either but it is priced at 0.88x book value. If you are interested, I suggest you check their investment record and current portfolio; if we are taking long tail risk please tell me that at least we are doing something interesting with that float. They do not have the investment reputation of a Berkshire or a Merkel but that just might be appearances.
Probably the most surprising for its chronic under reserving is White Mountains. For those that do not know, White Mountains has been a staple of value investing portfolios and they themselves were early investors and promoters of Michael Burry’s Scion Capital. And as David mentions, conservative accounting is something they talk about. Does anyone have absolute or confirming evidence?
As a passive investor, I tend to avoid long tail risk insurance companies like the plague. David’s work is rear view, an evaluation of past decisions, but you cannot be sure about their current ones in a soft pricing environment. Even risky banking construction and development loans have durations of just a couple of years, so many of the big bad C&D loans are probably behind us. That is not the same with long tail insurance and when things go sour, turning around an insurance ship with long tail inertia is Titanic work.
I am also a skeptical man, so how can I be at ease with an investment based on management’s pedigree when so much is at stake? It is not that I distrust them personally; it is about having seen from the inside that controlling the commercial areas is an almost impossible organizational act. If you want to know more about the gap of what is needed and what we have, you should read about how National Indemnity operates in Buffett’s letters.
Some well respected companies like Fairfax Financial (OTCQB:FRFHF) had their share of problems in the early 2000s and an old standing company like Lloyd’s was brought down to its knees by the weight of asbestos claims. Bad underwriting and reserving can bring down even short tail risk companies like Lincoln General: formerly part of Kingsway Financial (KFS), situation currently under litigation.
Not to detract from a beaten sector, but at current prices personally I am preferring other alternatives in the financial sector.
PD: If someone has done or seen similar analysis with Fairfax Financial, Montpelier RE (MRH), Greenlight RE (GLRE), Aspen (AHL) or others, could you be so kind as to share it with us mere mortals? Too busy analyzing other financials.
Disclosure: No position