William R. Berkley – Chairman & CEO
W. Robert Berkley, Jr. – President & COO
W.R. Berkley Corporation (WRB) Goldman Sachs US Financial Services Conference 2011 December 6, 2011 1:10 PM ET
I think we are going to get started here. Thanks everyone for joining us today. Also want to extend a special thanks to Bill and Rob Berkeley for joining us as well. So for those who don’t know, W. R. Berkeley is a $4.6 billion international specialty insurance company that started out in Bill Berkeley’s college dorm room a few years ago. WRB became a public company in 1973 and Bill has served as Chairman and CEO throughout that time period. The industry has obviously undergone many cycles and changes throughout those tenure which gives him a unique vantage point and perspectives that I hope to benefit – we can all benefit from today.
Before I turn it over to Bill, let me also introduce Robert Berkeley; WRB’s President since 2009 who will be available to answer questions following Bill’s presentation.
And with that let me turn it over to Bill.
Good afternoon. So that tells you that I would love to read these. If you ever read the Safe Harbor you wouldn’t pay any attention to anything I said.
Basically we’ve been in the business now for 38 years. It’s a cyclical business; we’ve been through three complete cycles going on to the fourth. It’s a business that changes not because of a lack of capital but because of a lack of profitability. Capital levels ultimately follow profitability, but the cornerstone of succeeding and surviving in this business is understanding how to take advantage of those changes in the cycle and paying attention to what to do and what are the signs that give you the signals.
The first and most important thing to remember is companies get into trouble in this business through problems with loss Reverse. Inadequate loss Reserves are the cornerstone as to why companies get into business or are unable to take advantage of a changing cycle. You need to build a strong balance sheet and have that strong foundation so you can move ahead.
You need to be able to put yourself in a position to take advantage of the opportunities of a hardening market. That means when everyone else has problems and is worried more about their problems than future opportunities, you have to have the courage to move ahead. You have to a contrarian.
And you have to find ways to optimize your growth when prices are at their best and then give great service and build relationships so the business sticks to you and you don’t have to compete totally on price as the cycle changes.
Ultimately value creation happens for your shareholders because you grow your book value by having a higher return on capital and people pay you more as a multiple of book value over time and as the cycle changes. You optimize that by having increasing valuations at the same time you are growing.
We think – in light – in the current cycle we think we are just at the beginning of price increases.
Two years ago – actually two and a half years ago, I thought the cycle was going to change because I expected AIG not to get the degree of help from the government that it did. I was incorrect, the government, as we all know – in fact we bailed out AIG which delayed the inevitable. It wasn’t that prices were bad two years ago, they were. But by allowing AIG to hold on, AIG continued to be able to cut prices and held the market in check.
Prices started to turn the end of last year, the beginning of this year and we are definitively in a hardening market. The beginning of this year I told people that I expected 5% to 8% price increases by the end of the year, I would still expect that to be the case. But we are really just at the beginning of that happening and along with price hardening, terms and conditions are changing which lets the business you write become more profitable.
When you look at the industry and combine ratio and understand today the industry’s combined ratio is about 110. And when you look at those lines, if you have a 2% return, it’s really hard. In fact almost impossible to have any consequential return on capital. Even at a 4% new money yield, it’s really hard to have an adequate return. At a 6% return today at 110, you are not getting very much return. And at 8% which is obviously is far from where we are today, even then you are barely getting where you need to be.
So the industry is in a tough shape. No real returns by and large most companies are not making any profits other than from what they carry forward from prior years. There are a few exceptions, but if you look at the industry average, you choose the number for what you think new money yields are depending on duration of their portfolio, but by and large the industry has negative to 1% or 2% returns.
We think we are perfectly positioned. First of all, we are still in the positive area of returns because our combined ratios just around 100 and maybe I say it less.
Number two, we continue to build our business and we build it by setting up new units and finding people with expertise. We think there’s lots and lots of opportunities to do that and we are continually sort after by the best underwriters in the business who believe our philosophy of underwriting profits lets them do their job in a way they are happy. We have low operating leverage; we have lots of capacity to expand. We continue to have strong earnings and we’ve avoided volatility, we don’t write classes of business that have high volatility, we don’t put out higher limits. We believe earnings’ need to be predictable and if you are going to give up that predictability, you need to get paid for it and in the current state of affairs in this industry; no one pays you enough for that volatility.
We have a strong balance sheet along with conservative volatility reserves, we have high quality assets, very conservative asset liability management and we don’t have many intangible assets.
The world, especially within the industry views us as a cautious underwriter and we are in the industry. We are not a financial service company, we are property cash and insurance industry and that attracts the best talent there is.
We’ve been doing this for a long time. What Michael didn’t mention is we went public the day of the first Arab oil embargo. We went public at 10 O’clock in the morning, at 1 O’clock; King Faisal announced the Arab oil embargo. So we immediately found out about volatility. Our stock was supposed to go public at 24 I might add, we ended up going public at 12, decision made the evening before and 60 days later the stock was 2. I might add so (inaudible) Davis Senior was the only person other than me who bought the stock. But we’ve done all occasions then. Our returns is good, is virtually anyone and they are consistent and we managed the business is a very consistent fashion.
A careful part of that is growing at the right moments in time. You grow when the business is available and it increase in prices. One of the interesting things about this business is at exactly the time you want to grow, there’s lots of business available because it’s when no one else wants to write the business because they are all overcome with fear and greed and been throwned aside. When everyone else is afraid, we are greedy; when everyone else is greedy we are afraid. So as you can see we are starting to get greedy as others are beginning to be more concerned. And each of those lines, that green line shows you how as the cycle has started to move up each time, we start to grow as much as we possibly could.
If you look at our total growth as compared to return in growth in book value, we have continually increased our tangible book value and there is absolute relationship between compound annual growth rate and total return. So our shareholders have done well.
Our shareholders do especially well at times such as the one we are in now. So if you look at what’s happened at every other turn in the cycle, it’s a pretty good measure of what we think would happen. We can go back to prior periods, we could actually go back to ‘70s, but the numbers were pretty small. But you can look at our returns, the only reason in 2008; we had that crummy return was we wrote off our preferred stock in Fannie and Freddie which was – although our income of that took our return down dramatically obviously.
But we think that we are a unique company in the industry, we continue to believe that we can deliver great returns, we think that we’ll be able to grow dramatically as the cycle changes, as we have in every cycle before this. We’ve always been able to dramatically exceed our target of returns and we think people appreciate it. We actually think we are approaching the point after 35 odd years that people might consider giving us a premium that lasts to the next softer market, but that we’ll have to wait and see.
In the meantime, we think the opportunities have never been as great for our company. We started 26 operating units in the past four and a half years. They barely scratch the surface of their potential. Many of the people running them in, multi-hundred million dollar units or because they were free to use our underwriting discipline. Today, they are only wearing $35 million or $40 million or $50 million waiting for prices to change. So we are excited, we think there are lots of opportunities and we think that the moment is here right as we speak.
Thank you very much for the opportunity. I guess one question, some industry participants have questioned the existence of pricing cycles today. And what would you say to the people that argue that availability of information and analytics have minimized the cyclical nature of the business today. I mean is that a fair point or is there something added to that?
I think that it’s unlikely that be the case. If that were the case then people wouldn’t be charging the prices they are now and losing money like I would. It’s hard to explain how people can dumb. But it’s continued for a long time in this business and it happens because you have to estimate the cost of your insurance policy before you know the real cause. And there are a lot of variables and there are a lot of people’s emotions as to optimism and pessimism and expected rates of inflation and how prior years’ losses would be settled.
So in fact, it’s very hard to get a single number and say this is what we did and that’s why you are seeing lots of redundancies. It wasn’t that all these companies have redundancies wanted to be conservative. It’s what they feel the results were going to be, and they were wrong. So if I were to accept what you say, that means that they shouldn’t have had all the redundancies that they’ve come out with over these many years. So no, I don’t think anyone has such brilliance. They should have it, but they don’t.
Fair enough. If anyone in the audience has any questions please raise your hand or otherwise I’ll just keep on going. Question right here in the front please.
So if you find in a year – so you’ve got four opportunities and you’ve got capital. What do you do with the capital?
I will just repeat the question here for Billy. A year from now you see that you have more opportunities in capital. What do you plan to do with that capital? Is that …?
Yeah. Do you raise more capital or do?
First of all, in a year or two, I can’t imagine I am being taste because one of the things you have to remember is our returns will go up dramatically, so we are going to be generating capital if you go back historically at the rates of 25% plus. So we’ll have to grow tremendously. Second of all, at that level of profitability plus the capacity we have within the company, we could grow with probably 50% and rating agencies would look not only at how much we grow in terms of dollars, but in terms of exposure. So if our policy count and units of exposure don’t grow very much just the premium we charge, there are going to be a lot more understanding. They are interested in the exposure units more than they are in just dollars. So I don’t really think that’s a problem, but raising capital is always an option, it’s not my favorite option, but less attractive would be turning away good business. So my guess is we probably try to find temporary capital that would carry us over a bridging period of time or we’d find some way to use or obtain inexpensive capital with people we’ve done business with.
What is your capacity today? It used to be back in the dark ages assume sort of logically what, 200%?
Well, when I got in the business in 1974 you could write three times your capital. Last time the cycle they allowed you to go to two. I would say it also depends as they say how much exposure you take, not only your premium. And the other thing you have to remember is, your reserves don’t go up at the same pace your premiums go up and reserves today account for much of the surplus required by rating agencies. So in the short run you could probably write at one and a half, maybe even one and three quarters to one plus your capital base growing. So my guess is that’s why I would not think we would have a problem. You extend that out for two years at which point you’re starting to generate more capital and compounding that capital. It’d be surprising to me.
On equity capital?
Yeah, it’s on equity capital but you’re going to get the benefit of the leverage so you also could add a little bit of leverage at that point in time also.
Could you discuss your reserving process at the end since the last – the beginning of the last venture and what changed since then?
Sure. Go ahead, Rob.
Robert Berkley, Jr.
Our reserving process over the past several years has continued to be refined, just to give you a sense of what we do on an individual operating unit basis. So of the 46 operating units in that group we looked at each one individually as opposed to just solely in the averaging. And then on a quarterly basis, we’re looking at each one individually with at least two independent set of eyes. Both set of eyes at the home office if you will or the parent company and then at each one of the operating units we have an extra that’s dedicated to that organization. So we’re looking at it at least with two sets of eyes and in some cases three separate sets of eyes. So we’re reasonably comfortable that we have our finger on the pulse.
I think we even would go further than that too and that is we have a whole different level of actuarial strength now. We probably have 100 actuaries within the company having –15 years ago probably having five and we have a whole measure of enterprises management that looks at everything in the aggregate. So it’s a much different company from the point of view of that stuff.
I understand that you want to minimize volatility. However it sounds like that the international property CAT market, especially outside the US with all these Thai floods and Japanese earthquakes, there seems to be opportunity there. Can you comment on what you see?
Still inadequate pricing or extreme volatility. The prices, you have to understand the evolution of global CAT pricing. The evolution of global CAT pricing came about because we had Andrew first and then Katrina and all these companies went off to Bermuda to set up tax free reinsurance companies. But they were writing business in the US and after Katrina, all the rating agencies got tougher on how much capital they needed to have and they couldn’t write enough business for that capital to be fully utilized and therefore if you didn’t generate return. So what they did at that point was think well, why don’t we diversify and they tried to write CAT business all over the world. The end result of that was inadequately priced global CAT business and U.S CAT prices that were at least adequate for the most part and they paid for that in Chile. They paid for that in New Zealand. They paid for that in Japan. They paid for that in China and now they’ve paid for that again in Thailand where you’ll probably have $20 billion of flood losses. And what’s really happening is prices were so inadequate, even now by most judge – people I know in their judgments. It’s still not attractive to write, at least from our point of view. Lots of volatility, lots of risk and we’re not interested.
Bill or Rob. Can you talk about pricing obviously as a relative measure versus loss trend? Where is pricing versus loss trend? Like maybe percentage of your book or parts of your book where you’re seeing that margin positive and widening or other areas where you’re seeing less?
Robert Berkley, Jr.
So typically, Mike, we don’t get into a lot of detail as to specific pricing by line of business. But some of the areas that continue to be the most concerning for the industry, the excess casualty lines, excess workers compensation, some of the excess professional liability lines in particular D&O. Our view in the aggregate, when you look at the pricing that we’re able to achieve and some of the trend factors that we include and how we figure out what our rates need to be. We think right now with what we have gotten so far this year it’s about push if you will. Maybe we’re doing a little bit better. Having said that, our expectations for what we hope to get in the fourth quarter and beyond would suggest that we’ll be not just keeping up the trend but beating trend if you will which obviously should enhance our margins.
One area that is getting a lot of attention now is workers’ comp. Obviously it’s a very large line of business, very different in different pockets of the country, California, outside California by size or whether it’s on a captive, written on an excess of loss based captive basis or just guaranteed first dollar. Can you kind of talk about areas of where you’re focused as where you feel like you can extract some opportunity maybe where other carriers are not as interested for whatever reason?
Robert Berkley, Jr.
Our focus, whether it be in workers compensation or any line of business tends to be where we think we can bring knowledge and skills, intellectual capital and use that as a way to differentiate ourselves. So we have primarily focused on two areas. One tends to be smaller and midsized accounts as it relates to workers compensation and then in addition to that, we’ve also focused on the excess markets as well. The excess market where you can bring analytics and technical expertise to there, and then of course the smaller accounts where service from a claims and loss control perspective can make a difference. Workers compensation is clearly a part of the overall P&C market that is in transition. It is facing the challenges that were referenced earlier in the presentation, that having to do with lack of available investment income and in addition to that, as we’ve discussed in the past, there is, with good reason, growing concern about frequency trend which is also very leveraged. As a result of that, it’s put a great deal of pressure on the largest piece of the commercial entity and C market and driving a change in behavior that in our opinion that change will continue to accelerate as far as pace goes.
I guess on that – California is a big market obviously. It runs very different from the rest of the country. Just kind of what you’re seeing there in terms of whether it’s medical loss trend or anything else that’s maybe changing very differently from the rest of the country.
Robert Berkley, Jr.
True. Some years ago there was a series of reforms that were put into place. As a result of that the available margin in the business changed dramatically and the business became far more profitable. Over the past couple of years those reforms have gradually been eroded and the consequences of that, along with the rate flashing that has gone on over the past several years, has led to a less attractive opportunity, in many cases a way for people to lose significant sums of money. At this stage the market, at least the California workers compensation market has recognized that and you’re starting to see a change in behavior. You’re seeing people looking for rate increases. The most aggressive are keeping rates flat. Others are trying to push for 10% plus rate increases, but undoubtedly that market is in the early stages of significant change.
One of the problems in workers compensation is new entrants won’t see losses very quickly. So when you see new entrants growing rapidly, they can show great results for a period of time and you won’t necessarily see the real results. Even for ordinary workers comp, it can take several years before you see it and if you’re growing at a rapid pace it could easily take four or five years before you start to see that adverse development. So that’s the negative side of workers comp, it’s a grey zone.
Bill, could you talk about your possible changes in investment strategy considering the current world we live in with these low interest rates and so forth?
I think that first of all, we’re constantly searching for small niches that will allow us to invest better returns and unfortunately those niches only are open for a fairly short period of time. So high quality mortgages, New York City real estate first mortgages with very, very high equity were attractive for about three months and everyone else saw them. We’ve had to invest $150 million. Returns, let’s just say averaging 6.5%. Today they’re back down to 5.5%. So we’re constantly looking for things like that that are niches that appear for particular short periods of time where we can invest money and we’re looking all the time for that. We’re also looking to take other opportunities where we can give up a little liquidity which is not necessarily important to us and get a greater yield.
So we’ll buy a non-marketable security that’s a double A quality security, but no way out until the maturity. It doesn’t really matter to us especially it’s a two or three year maturity. We have lots of cash flow. We have lots of liquidity. So those are the kinds of things we’re doing. We also have invested for the first time probably $400 million in equities that are dividend-paying equities, and both the good news and the bad news is cash flow and growth is still moderate and that doesn’t put as much pressure on us. But as our cash flow is starting to increase now, it’s a greater concern and we clearly are – it’s a more difficult thing. I would say it’s our number problem that we’re facing today.
If you’re facing it others will face it too and that may – what may that do to the cycle? Will it make it more extreme or make it more developed or what?
It certainly puts a lot more pressure on everyone for improved underwriting results. We’ve never had such low returns as far as putting pressure on underwriting results. So I think there’s no doubt that this does force everyone to focus on underwriting results much more.
This one is for Rob. Can you talk about new versus renewal pricing and then also the balance between pricing increases and the impact on retention? Thank you.
Robert Berkley, Jr.
Sure. We effect both our new and renewal pricing. Obviously trying to get one’s head around new pricing trend is not so easy depending on the type of exposure. But generally speaking – where we are able to what we believe is effectively attract our new business pricing. We believe it’s generally speaking within some number of basis points in lock step if you will with our renewal pricing. We are – I think it’s reasonably widely known and understood that there are some significant participants in the marketplace that are willing to aggressively discount their pricing on new business in order to pick up market share and then they try and crank it up if you will on the renewal pricing. That’s not our model at all. We have a view as to what an accurate rate is and we are going to write new or renewal business at that rate or better, full stop.
As far as renewal retention ratio, as we had suggested at the end of the third quarter, our renewal retention ratio continues to sort of hang in there in the aggregate, around 80%. Obviously that varies depending on the line of business or the part of our business. For example the regional companies tend to run a little bit higher. The ENS companies tend to run a little bit lower. That’s the reality, through thick and thin, hard market, soft market. Having said that, given where the renewal retention is sitting and the rate that we have been able to achieve in Q3 and earlier in the year, it has continued to reinforce in our mind that pricing leverage is moving in our direction as opposed to away from us.
Would you describe your personnel policies compensation and your retention experience and do you lose many people or do you poach many people?
We’re always looking for the best people. We have no hesitation about trying to hire people from any place. We don’t lose many. I would have to say the best of my recollection, in the past probably 15 years we’ve only lost two people to competitors of a senior nature. Our most senior 75 people all have restricted stock that sort of keeps them for a year after they leave from keeping all that stock. If they go to work for a competitor they lose it. So it’s very good golden handcuffs, but the trade off is they hit rich. We do well. It’s the philosophy of old time investment banks and that is, you’re here, you’re an important part of the player and you get rich but you’ll do fine while you’re here and you’ll be rich when you retire. But I think that we pay competitively and incentives based on performance. We just – we have not historically well speaking.
Just one thing to follow up for me here. So you’re kind of talking about where you’re seeing improvement, where you’re not. In the D&O market you kind of mentioned that upfront. Do you think it’s possible to see the pricing improvement that you’ve kind of seen on the CAT side? Because again you’re also not focused on the property CAT side, so really if I’m understanding correctly, most of your comments here on pricing would be casualty business. Do you think it’s possible to continue to see the increases that you’re seeing without it rolling over into other areas of the market like professional lines?
I think that the issue of profitability is the determining factor. I think the business requires a combined ratio in the low 90s to get a reasonable return today. Which means you’re going to need substantial price increases compounded for at least a couple of years.
Great. We’ll do no more questions. I’d like to thank Bill and Rob for their time today.
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