W.R. Berkley's (WRB) Management Presents at Keefe, Bruyette, & Woods Insurance Conference

| About: W.R. Berkley (WRB)

W.R. Berkley Corporation (NYSE:WRB)

Keefe, Bruyette, & Woods Insurance Conference

September 7, 2016 01:00 PM ET

Executives

Bill Berkley - Executive Chairman

Rob Berkley - President and CEO

Unidentified Company Representative

Thank you everyone. We have WR Berkley Corp with us here today. We have Executive Chairman Bill Berkley, and President and CEO, Rob Berkley. And with that said, let's get started.

So my first question across both of your segments, insurance, and reinsurance, what areas or product lines are you seeing opportunities for growth in? What areas are you shrinking in? And on top of that, can you also touch on worker's compensation given the strong growth you had there in the beginning of the year, but then the shrinkage you had in the second quarter, which followed the strong growth in the first quarter.

Rob Berkley

This is when I answer and corrects me with an audience. So I think there are a couple of questions in there. For starters, there is no doubt that at this stage, the insurance market is a bit more challenging or competitive today than it was call it 12 months ago. Having said that, we continue to be able to find opportunities out there, which has really been driving the growth. I think one of the things that has evolved once upon a time, if you back some number of cycles ago, the market tended to move much more in lockstep across product lines and as there's been greater specialization within the commercial P&C space, you see different product lines marching to the beat not of an independent drum, but not one in the same.

So certainly, the specialty lines we continue in the insurance space to find particularly attractive. Worker's compensation would be certainly an area where over the past several years, the margins have been outstanding and we've tried to continue to grow and develop the business. The professional space is a pretty broad arena. We have found certain pockets within the professional space to be attractive as well, and then just the general casualty market or the GL market is a good place to be. We have benefited quite frankly from the dislocation that has come about for a variety of reasons in the marketplace, much of it stemming from M&A activity or large organizations that continue to go through some type of reorganization and that creates confusion both for distribution and uncertainty as to who will be operating those businesses on a day-to-day basis going forward. So we've capitalized on that as well.

Maybe turning to the reinsurance marketplace, clearly a challenging market. Has been difficult from my words for some number of years. I think the lack of cat activity or the benign property cat environment has contributed to that. I think the entry of alternative capital participating in a more meaningful way has certainly contributed to that as well and that almost feeding frenzy that started in the property cat market space has spilled over to the general reinsurance market and even impacting some of the casualty lines within the reinsurance market space. So the areas that we've been able to grow in the reinsurance market space have tended to be more one off. There are some markets outside of the US, what I would define as some of the developing markets that have provided opportunity where you can still partner with [indiscernible] and it's not just where you're viewed as capacity but they actually value your expertise. And in addition to that, there have been certain one-off situations.

Some of you have perhaps heard us speak to it on our quarterly call where there have been structured transactions where it is a defined deal for a defined period of time and we think the return on capital tends to be attractive because of how the capital charge actually works. So long winded answer. I don't know if you have a -

Bill Berkley

I would just point out that investors form the outside look at the insurance business in a more homogenous way than it really is. So if XYZ company is very aggressive in their market position in a particular location, state, area, and they're too aggressive, their response from losing money is total withdrawal, which creates an opportunity. So one of the things that’s changed is as statistics and information becomes more widely available, is as long as you're paying attention, you can find those opportunities where people are overreacting to their own mistakes, which still creates smaller but more frequent opportunities. And as long as you're paying attention it gives constant opportunities for those who are aware.

Unidentified Company Representative

So you had mentioned, Rob, on the last earnings call that discipline is returning to the commercial auto market and that you're seeing a shift in supply and demand. Can you expand on that comment a bit and discuss, if given those dynamics, commercial auto is something that's increasingly attractive?

Rob Berkley

Well, I think commercial auto by and large for the industry has been a thorn in its side for what would be measured in years at this age. And it always takes longer than one would expect for the market to actually react to those realities. Part it is because it takes time for those realities to come into focus. Part of it's because people can't believe it, partly because people defer actually taking the medicine and having the potential consequence of the actions required. But yes, we are seeing an increasing amount of evidence that there is a degree of discipline that is finally returning to the commercial market, auto market space.

Commercial auto is a pretty broad arena. It ranges from business auto to long-haul trucking and lots of things between those two bookends. So again, I don't think that all opportunities within that space are equal but we are encouraged by again a marketplace that for the moment seems to be pointed in the right direction. I would caution folks though that again, it is not a free-for-all where it's a marketplace full of opportunities. It's that directionally things have improved and we think over time that if things continue on the course that they are, there will be opportunities in the broader sense to make reasonable risk-adjusted returns.

Unidentified Company Representative

Moving onto pricing a bit. Obviously, that's been somewhat weak recently. Can you talk about the pricing in your book for new versus renewal business and how that would stack up against [indiscernible]?

Rob Berkley

Well, I think generally speaking, the pricing power that exists for the commercial lines markets based particularly in the US is - there's not as much leverage, if you will, today as there was yesterday. Having said that, we think there still is pricing power. We think that the margins are adequate. We have 52 different operating units. So it's difficult to get into the details of new versus renewal pricing for each one of the operating units in each one of the various product lines that they offer.

Having said that, we do certainly monitor our new business pricing compared to our renewal pricing at quite a granular level. It's an imperfect measurement. Sometimes we carry things out to decimal points and it gives a sense of confidence as to the precision, which can be misplaced at times. But again, it's an important benchmark. Generally speaking, certainly we look to price new business in a manner where we take into account the fact that we don't understand that business or that account as well as we would our renewal book. Our renewal business, obviously, we've had on the books for at least a year, oftentimes much more so we're more familiar with the account. So we try and make sure we take that into consideration.

Having said all of that, one needs to start from a point thinking about where are your margins in various different lines of business? To what extent do you want to try and grow your book because the margins are healthy enough, robust enough that in fact you are willing to perhaps for a new business be a bit more competitive, and again in a controlled measured way because the margins are so outstanding you're prepared to do that?

So there are certainly today are parts of our business where we find the margins are such that allows us to exceed our targeted return and in some cases we are prepared to be a bit more competitive on new business. But again it's only where we think the margins and by extension, their available returns are outstanding and would justify that type of action.

Unidentified Company Representative

I guess staying on a similar topic, your core loss ratio excluding cats and prior period development improved in the first and second quarters of this year. How were you able to achieve that given again that pricing isn't stellar today? And is that type of performance sustainable?

Rob Berkley

There are a fair number of moving pieces and you touched on a couple of them, but we are looking at our reserves. We are looking at our numbers not just on a quarterly basis, but on a monthly basis. We are looking at the assumptions that we make that go into supporting effectively our loss picks amongst other things. And ultimately we try and start from a place where we will more likely than not err on the side of caution with the assumptions in how we make our initial loss picks. And then as the business seasons out and as there's more information available, we are then prepared to revisit those numbers.

So when we see certain trends, particularly around frequencies, suggestions that a certain outcome over time we're willing to take that into more account. And then ultimately, as there is more visibility from the past results, then we learn from that. We'll extrapolate and then apply that to our current picture as well. So we thought the loss ratio, we thought was acceptable in the quarter and we'll have to see how the story unfolds from here.

Unidentified Company Representative

You've had obviously a considerable amount of M&A and dislocation in the P&C industry. Can you talk about some of the opportunities that's provided your Company to add underwriting talent and what other benefits you think that the dislocation has for Berkley?

Rob Berkley

I'll touch on that. I do have a few thoughts but I'm going to yield to my boss to start off.

Bill Berkley

I think that change always creates opportunity. Uncertainty always creates opportunity. It's difficult to differentiate opportunity and risk sometimes. So we have concluded frequently that the acquisition of companies, from a risk point of view, is generally lost reserves or unforeseen events. And therefore our strategy has been to find great teams of people and build businesses where we start with them adapting to our culture.

So we're generally not searching for companies to buy. But we think that accounting wise, it often looks better from running and building a business for the long run, building a culture that fits with what we think, it's a little better to find great teams of people and starting. And Rob has spent a huge amount of this time searching out those teams and talking to people, and he's done a great job doing it.

Rob Berkley

So I would just add that, in some ways going back to the comment that was made earlier, there has been a fair amount of upheaval in the marketplace amongst very large carriers, probably as much or perhaps arguably more than we saw during or on the heels of the financial crisis some time ago. And we tried to capitalize on that opportunity and I think we are perceived by many within the industry, certainly as an entrepreneurial organization that is an attractive platform for people with great skills and a particular niche to come and build a business on behalf of our shareholders. And that's why 43 - forty something - 47 out of the 52, thank you, Karen, of the 52 operating units are businesses that we started from scratch. And it's opportunities like referenced a few moments ago that create the chance for us to do so and it's all the reasons that were suggested also a few moments ago, why we find that model or that approach attractive.

Question-and-Answer Session

A - Unidentified Analyst

What do you look for when you see a new understanding team?

Rob Berkley

I think that we look at a couple things. First of all, we need to - did everyone hear the question? The question was what do we look for when we see a new understanding team. First of all, we need to believe in the fundamentals of that part of the market, that there is an opportunity to bring value to customers beyond just who has the most efficient factory floor, who has the cheapest cost of capital. Is there an opportunity through intellectual capital and expertise to truly bring value to customers both distribution and insured, where they will recognize the value you bring and not just view you as a commodity, if you like.

I think once you get beyond that, that you believe in that niche within the overall marketplace, then it turns into do you think there's an opportunity to build a franchise? Do you think these people have the expertise to really bring that opportunity to life, not just today but to really build a franchise that has the ability to grow, develop, and flourish over an extended period of time, and can survive and prosper throughout a cycle. Sometimes that means the business will grow. Sometimes that means it will shrink, but it has the staying power to navigate its way through a cycle. And ultimately if you believe in the niche and you believe in the people with the expertise, you're fundamentally a long way down being the path of being able to demonstrate that there is a business case here for a use of capital

Bill Berkley

When we find a group, though, it's really something in addition, which is they don't just meet Rob, they don't just meet me. They meet a group of people in the Company. We want them to buy into our long run, risk-adjusted return culture. People need to understand that it's okay if they don't write a lot of business in the first year or the second year. We want to write business that meets what we believe is the appropriate risk-adjusted return. So we need people who buy into our long run culture at the same time. Sometimes finding people with discipline is not so easy.

Unidentified Analyst

Can I follow-up on that? Have you contemplated [indiscernible] lines of business?

Rob Berkley

Well, it's fundamentally based on profitability. And perhaps to your point, when it' a longer tail line, how do you know the outcome. There are components of our compensation structure that are targeted and are quite frankly matched up with the duration of our reserves, if you will. So we're able to align to a great extent with a meaningful piece of their compensation, the timing of when you really know the outcome and when compensation is there. And that's been a key to how we've structured compensation.

In addition to that, you know, for us, we don't just sort of dole out capital and ask them to send us a postcard once a year. that they're still in business. In spite of our decentralized structure, we have very much an infrastructure in place to make sure that both the people operating the individual business as well as colleagues at the holding company, if you will, are joined up as to loss picks and how we see things developing. It's not that we always agree, but we certainly are having the dialogue and if we disagree we need to make sure we understand how we reconcile between the two.

Bill Berkley

I think Rob and I also believe that our full restricted stock unit plan is a cornerstone for our compensation system. We give restricted stock units now every year, but that's not really very relevant because for all the senior people that means the top hundred plus, they can't sell the stock that they get under the restricted stock unit until they leave the Company. So these people, and by the way, our average tenure is more than ten years. So our people stay a long time. And in fact, for that group, if we weren't growing, it would be substantially more than ten years. So people own stock for a long time, which gives you a pretty good incentive to be sure your reserves are right.

Unidentified Analyst

Switching to the concept of understanding team additions, you've recently announced the formation of a high net worth personal lines team. Can you just talk a bit about what attracted you to persona lines and what the timeline in your eyes is to get that business to scale?

Rob Berkley

Sure. Do you want to lay it out and I can -

Bill Berkley

Go ahead.

Rob Berkley

Okay. So personal lines is a big arena, I think as we can all agree, and one needs to recognize it's not advisable to paint with too broad of a brush. The niche within the personal lines space, or the high net worth space, if you like, is a space that we've been looking at for many, many years. We've looked at a variety of different opportunities and explored those in some level of detail and granularity. And what we found more recently is we were presented with a unique opportunity because of circumstances that existed in the marketplace.

There was a fair amount of consolidation [indiscernible], if you like, were two significant players in the marketplace. They were consolidated and as a result of that, combined with another large market participant going through a time of - a time when they're very inwardly focused, how about that, we believe created a real need in the market. In addition, as a result of some of that consolidation, they were groups of people or individuals that we were able to engage in discussions with to build a team, again back to the question or the discussion earlier around expertise, where there were individuals that had great expertise within the space and were looking for a new opportunity. And were able to attract them.

So this was not something that we just woke up one morning and said, hey, wouldn't it be neat if we were in that part of the personal lines space. It's something that we've been looking at for more than ten years and the opportunity presented itself. The planets and the stars lined up and we were able to take advantage of it. As far as the rollout goes, this is certainly a different process than when we started a specialty company writing on not admitted basis. This does require infrastructure, both from a systems perspective, a service perspective, a whole host of things and it's important to us to get it right because we want to make sure that we are not just meeting but we are exceeding the expectations of both the distribution and ultimately the insured. So long story short, we expect that this business will be up and running and beginning to roll out its product offering between the second and the third quarter of next year.

Unidentified Analyst

Follow onto that.

Rob Berkley

Yes, please.

Unidentified Analyst

Could you describe you’re your strategy and high net worth will differ from your competitors, whether it's distribution, geographic focus, or the type of products and services that you'll be offering.

Rob Berkley

I think it's probably premature to get too much into the weeds on that front, but what I would tell you is that we are actively looking - this is not just a me too. And I think it's one of the attractive things that we have had in common with the people that are running the business that the idea just to come and do a me too like everyone else does it, it's not that we won't do some things in a similar way. The same customer base that has expectations but this isn't just let's do the same thing.

This is an opportunity, when you start a business from scratch, to take a step back, use that clean slate and say are there better ways to serve the customer. Are there different things that we can be doing to meet their needs because we are not encumbered, if you will, by legacy systems. We are not encumbered by an existing process. We have again the ability to ask the questions in an unencumbered way and think about are there ways to use technology or other things to more effectively meet the needs of the customer. As far as getting into the details and the granularity, and laying out for you a bit of a blueprint, I think it's probably a bit premature to do so.

Unidentified Analyst

Shifting gears to investments, you've basically shifted your portfolio towards more of a capital gains focused portfolio. Can you just take some time to talk about the investments that you are focusing on now and how you're able to investment in those without impacting the quality or liquidity of your portfolio?

Bill Berkley

Well, I think, first of all, liquidity has never been an issue for our portfolio. We've had lots and lots of liquidity and our cash flow has been positive in every quarter that I remember for the business, including the worst catastrophe quarters. So liquidity has not been a problem. Finding investments that have the right level of risk and return is always complicated. So I'll give you some kinds of things we do to differentiate. For instance, we're active investors in the real estate business, but we don't invest broadly in commercial real estate every place in the United States. We invest in Washington, DC. We invest in New York. That's basically where we invest, a little bit here or there, but our core investments are places where the market has done substantially better over a longer period of time. And big markets with liquidity.

We've invested in residential real estate, i.e., multifamily and other markets, but again in markets that have been growing markets and the results have been excellent. We don't just say, okay, we're going to buy it, and hold it, and own it forever. We're active participants. We have a partner. We're their exclusive partner. We do some buying of real estate. We develop some real estate and it's been extremely rewarding to date. But we measure our aggregate returns both by market, by type of building, and by where we are. And it's, at the moment, unleveraged, although fully leased long-term buildings we'll consider putting leverage onto those in one of commercial buildings has some leverage on it now.

So that's been a very rewarding process for us and we continue to do that. We have a private equity business. It started out with me doing the private equity investing. We now have a team of people that’s consistently delivered mid to high teen returns. We have a few areas we invest in. We're very disciplined. Again, we don't use any consequential leverage. That lowers our return again to the low teens, mid-teen returns. Again, liquidity is an issue that if you don't use a lot of leverage, it's not particularly high-risk kinds of businesses we buy. We basically by pretty good businesses where if for some reason or another, they become available.

And then when we find teams of people just as we do in the insurance business who have expertise in particular areas. So in the pharmaceutical business, we're the deck portion of pharma royalties. We're not willing to get the higher return you get from being an equity participant, but we get great returns from being the debt portion of pharmaceutical royalties. And we continue searching for things like that.

You don't have instant liquidity. That's what we give up. There's no question that we give up that instant liquidity. On the other hand, very, very high quality assets. Very predictable outcomes. Low to no leverage and it gets us returns let's just say low teens on the average and that's been very rewarding. We obviously have to be concerned with the aggregate exposures there and we do keep that down. And that's so far been taken care of as we've found opportunities to sell things. And with some of them where we have more than a 20% interest, those unrealized gains are reflected on our balance sheet. So the companies both help equity where we own over 20%, we equity account. So there's over $400 million of unrealized gains that is not reflected any place on our balance sheet because we equity account for it. And there are a few other things that are like that. And again, obviously, all the real estate is carried at cost.

Unidentified Analyst

So you've obviously been very vocal in terms of your views on your tax rate versus some of your peers. Can you talk about some of your efforts on that front and something like an inversion, something that's being considered?

Bill Berkley

The answer is every year for eight years, almost nine, I've gone to Congress and said, how can you have tax laws that favor non-domestic property casualty insurance companies. Until just recently, my partner in going down to Congress was Chub. Surprisingly, Chub is no longer my partner. The fact is that it all has to do with the structure of the tax law and transfer pricing, partly because when you pay - when you're a property-casualty company, you pay tax on the discounted value of the loss reserves. So there's no issue of transfer pricing. It's prepaid interest on your reserves, pre-earned estimated interest and you pay tax on that in advance. So we pay the tax. If you move the reserves off [indiscernible], you have no tax to pay. It's a smart thing to do. They're not doing anything illegal.

Some of them are - some of the foreign companies are very aggressive and don't really adequately reflect appropriate transfer pricing, but not most. It's taking advantage of what the laws are. They're not breaking the laws. They're not doing anything wrong and at some point, everyone in the US will be at such a disadvantage, you can't afford to be a domestic property-casualty company. That is a reality, whether you like it or not. That's where the world is going to go and at some point, everyone will have to address that issue whether or not they like it because Congress, as on many things, is just not addressing the core issue.

Unidentified Analyst

Do we have any questions in the audience before I continue with mine? Brexit is a topic that's gotten a lot of attention this year. Is that something that you think could have an impact or is it just over hyped in your opinion?

Rob Berkley

When you say an impact, an impact on?

Unidentified Analyst

On your business.

Rob Berkley

On our business. You want to start?

Bill Berkley

Well, I'll start with one thing and then you can pick it up. And that is a year and a half ago, we established a company in Lichtenstein. So we were equipped for some of these potential changes. So in fact the change in Brexit and the ability to do business in the EU would not have an adverse impact on us and we have a broadly licensed EU company based in Lichtenstein. So the literal Brexit change won't have an impact on our being able to do business because we were concerned about these issues and Rob went out and said, look, we need to protect ourselves from it. I think we're a long way from Brexit being implemented. It'll be hard to say what's happening and where it's happening, and how everything holds together. There's more uncertainty than ever in the EU. So I think we'd have to wait and see. Clearly, it's having an impact at the moment.

It's hard to imagine London falling apart, however. Not many people were around in 1974 in New York when New York was going to fall apart and disappear, and everybody was going to leave, and son of a gun, it didn't happen. London is a place people with talent and intellectual capacity and capital are, and we'd be surprised, we couldn't imagine going to Frankfurt. We couldn't imagine the companies going to Paris, or Milan. So there are not many places that offer alternatives. So there will be a lot of bumps in the road, but we don't think it's going to change a lot at the moment.

Unidentified Analyst

Rob, you recently talked about the tension between insurance distribution and carriers. Can you expand on that comment a bit and the implications you think that has on your business?

Rob Berkley

I think that you start from a place where everyone is trying to maintain or improve their margins, everyone being carriers and distribution. And ultimately, as the market becomes ever increasingly more competitive, and history would suggest that means rates over time go down, then that means that there is a smaller pie to be split between carriers and distribution.

And I think that that tension is on the rise-this. I think that there's also a question around whether both carriers and distribution are in touch with how consumer, both individual, small and midsize business, want to be serviced in the future, want to transact, and what they value and what their priorities are. There is no doubt that the way these products were distributed a couple of decades ago, that doesn't make sense to younger generations. They are not interested in many cases, in having that traditional experience where an independent agent or broker would come and see them, and walk them through. These people, small business, medium-sized business owners, they want to be able to transact at night, sitting at their kitchen table after they put their kids to be.

Ultimately, the question is not just how will a dollar of premium get split between distribution and carrier. I think the question is how will the industry both carrier and distribution be bringing value to customers, and what will the customers' definition of value be, how will we together, both distribution and carrier, make sure that we are addressing those needs. And we've as an industry done at best a mediocre job at that historically. We have been an industry that has taken more of an approach of this is what we want to sell your customer and this is how we will sell it to you, as opposed to what does the customer want and how do they want to transact.

And as we've seen in other industries and we've seen spill over to the personal line space, younger generations, they are not going to tolerate that. They want to be served in a different way and they will demand that. And those that adjust will get their business and those that don't will have a problem. As it relates to us, we try and be conscious of some of the realities that I touched on. We are trying to collaborate with distribution to find ways to make sure we understand what ultimately the customer wants, what they value, and how we will deliver that. And we recognize that some of the things that got us to where we are today are not necessarily all the same things that will help us succeed tomorrow.

Unidentified Analyst

Just moving onto your uses of excess capital, can you talk a bit about how you prioritize the uses, whether it's repurchases, or dividends, internal investment backing for the company?

Bill Berkley

I think it's a constant question about where, what, how, buying back stock, dividends, expanding the capital base of the company. We try and look at what we think the real capital is in the company, which means we try and value some of the assets that aren't shown on the balance sheet and that in fact determines what we think is the real tangible book value and that helps us make a judgment of what price we're willing to pay to buy the stock back.

We're not aggressive in buying the stock back because there always are opportunities. But if we have more capital and it accumulates faster than we think we can use it, we'll pay special dividends as we're going to pay a special dividend in October of $0.50 a share and we considered what that number should be and we'll sit and look, and be prepared for whatever may happen. There's lots and lots of opportunities and we're always looking for how to deliver value to our shareholders. And it's not complicated. It's every day you look at your capital position, you look at what you see your business is doing and you say, okay, what's going to be best for our shareholders.

When we talk about doing what's best for the shareholder, we don't say as though we were shareholders. We don't need to say as though we were shareholders. We are shareholders. I own 22% of the Company with my family and every single one of the top 100 people has well over 100% of their salary, multiples, on average seven times their salary, in stock in the Company. So we don't have to say as though we were shareholders. We are all shareholders and that amount of vested interest is increasing every year.

So we're constantly trying to figure out what we think is the best thing to do with the capital that belongs to the shareholders because that's what we are and that's what our goal is. And it's not what the best stock price will be. It's what's best for the economic value created for our shareholders in the long run.

Unidentified Analyst

We have about a minute left. Is there any questions from the audience?

Unidentified Analyst

How would you assess the level of competition from [indiscernible]? There are a lot of companies that try to hire understanding teams in Bermuda that didn't work. And now, one of your comments was that there are a lot of understanding teams on the market because of the acquisitions that are taking place. So how would you assess the level of competition to hire understanding teams on a profitable basis?

Rob Berkley

I think that we have fortunately a good reputation in the market and we have a track record of a high degree of success in starting businesses. As I suggested earlier, we literally started dozens and dozens, not one situation exactly like another but we understand our way down the path or how the process works and I think people value that and they take comfort.

As far as attracting talent goes, is it competitive? Yes, I guess it's competitive but ultimately, we don't participate in auctions for talent. People want to join us and we're going to pay them what we think is reasonable, so to speak, given what we think the value is that we, for shareholders, over some period of time [indiscernible]. But if somebody wants to auction themselves off, I can assure you forget about us even - we won't even show up to the auction. We have absolutely no interest in participating in that something akin to free agency. You want to be part of our organization, you believe in our macro values, wonderful. If it makes sense for our shareholders, perhaps there's a place for you at the table.

If it's solely about who can pay you the most money at any given moment in time, it's a sure sign that we will not be [indiscernible]. So long story short, when we found opportunities, it would be very unusual that we haven't been able to find a way to bring it to a head in a positive way. But ultimately, again, that's perhaps in part, people who are solely driven by how much money they're going to make. It's a pretty obvious sign that we will not be a fit and we will not invest time.

Unidentified Company Representative

Thank you very much.

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