Is It Time To Buy The Insurance Sector?

I just came across a survey from the Council of Insurance Agents and Brokers that gives confirming evidence that the soft market in insurance may be over.

The survey concludes that "Commercial property/casualty market premiums showed definite signs of leveling off in the fourth quarter of 2008 across small, medium and large accounts and for most major lines of commercial business."

Rates still declined in the fourth quarter of 2008, but at a slower rate than the last few quarters, according to the survey.

“We see evidence in the fourth quarter that premium rates eased as insurers tried to hold the line on pricing. It’s still a competitive market, but we think this may signal the bottom of the soft market, following six years of steady decline. We will see if this trend continues in the first quarter of 2009 as price increases in the reinsurance market begin to trickle down and as the full impact of the economy and market conditions comes home to roost on insurers’ bottom line,” Council President Ken A. Crerar said.

Most insurers are trading below book value due to investor concern about the investments they hold, so is it possible that a return of the hard market along with decade low valuations might be a buying opportunity for investors?

The survey is here.

White Mountains Insurance (WTM) Analyst Day - Review of OneBeacon

White Mountains Insurance (WTM) held its annual analyst meeting on June 17, and I finally got around to listening to the webcast. The URL is here if you want to listen yourself. I have written two previous posts on the meeting:

Reserve Issue and Barrette Speaks.

OneBeacon Presentation

OneBeacon (OB) is a publicly traded company that is 75.1% owned by WTM. Mike Miller, the President and Chief Executive Officer of OneBeacon, said that since the partial IPO in November 2004, book value for the company has grown by 22%. The book value in the first quarter of 2008 was down 1% due to a flat investment return. The combined ratio in the quarter was 100%, which was good considering that the first quarter is typically its most challenging.

Book value growth in 2008 will not reach the 17% growth achieved in 2007, due to a “softening insurance marketplace…well as a choppy investment climate.”

Miller showed a chart of net written premiums and the combined ratio for OneBeacon for the last five years, showing a decline in net written premiums from $2.4 billion to $1.8 billion from 2004 to 2007. The combined ratio also declined from 99% to 93% over the same time period.



Miller says this was the result of a repositioning of the company and the book to one that was more specialized in focus, and “a significant amount of effort went into making sure that our $2 billion book of business roughly that we have is a book of business that we believe in that we understand general line dynamics and results in.”

OneBeacon, which focuses on specialty commercial lines, started seven new business segments since 2005, and has a personal lines business in eight Northeastern states. “We don’t have a nationwide personal lines business; we are focused in New England region. It’s a book of business that we’ve had since the inception of OneBeacon in 2001. It’s a book of business we know, we understand, the agents know who we are.”

Miller indicated that any expansion from this region was unlikely. “To consider going nationwide with a personal lines business we would bring little to distinguish ourselves and would not be a good use of your capital.”

Miller also said that the personal lines business has become more “challenged” and competitive the last year and a half, but that OneBeacon has been “holding our own in the Northeast and more importantly we have a consistent level of profitability in that Northeastern book of business.”

OneBeacon has tried to manage capital well and paid a special dividend of $190 million in the first quarter of 2008, and has repurchased 4% of the outstanding shares of the company over the last year.

My Comments:

It’s always been amazing to me how every insurance company proclaims as loudly as possible that they won’t write unprofitable business during a soft market, yet somehow the industry collectively does write it. Also, OneBeacon is performing a review of its reserves and balance sheet in the third quarter, and let’s hope that they don’t find any reserve skeletons in its closet like White Mountains Re did.

White Mountains Insurance (WTM) Analyst Day - Introductory Comments

White Mountains Insurance (WTM) held its annual analyst meeting on June 17, and I finally got around to listening to the webcast. The URL is here if you want to listen yourself.

I wrote a post on the Reserve Issue at WTM, and this is a summary of the balance of Ray Barrette's introductory comments.

Introductory Remarks

After discussing the reserve issue at WTM Re, Barrette talked about undeployed capital at WTM and the plans for its use. He then used that as a vehicle to launch into a defense of the Berkshire transaction (buying Berkshire’s share of WTM). WTM is buying back 1/6 of the outstanding shares of WTM from Berkshire Hathaway. They believe that this is a prudent use of its capital.

Barrette said, “so $485 was the price and we hit the bid and I think when you look back five years from now or ten years from now, whether it was $485 or $450 it will have been a good deal for the company...We think the deal will close in the third quarter and we are happy with it.”

Barrette then hinted that share buybacks would restart if the price continued to stay down in the mid $400 range. “We also bought back some shares at $500 average last year, 291,00 we still have 700,000 shares as a buyback program, its not a program it is an allowance from the board, we still have excess capital but we are entering Cat (catastrophe) season so we have to be a little bit more careful about being too thin during the Cat season but as our businesses shrinks in the soft market as we produce I believe good underwriting results, good investment results we will generate more undeployed capital as we go forward here so at this price I can tell you we are buyers of our shares.”

Barrette next talked about the purchase of Answer Financial (AF), an online insurance agency. WTM spent $30 million to buy 69% of AF, and it will be used to help Esurance convert more of its incoming rate inquiries into business. The current conversion rate is 8% and WTM's goal is to double that rate. AF also has large net operating losses (NOL’s) that can be used.

Barrette said, "“It’s a good financial deal. We paid a discount to what we think is the real solid value of the company but that value is not a book value it is not an insurance company, it is an agency. We are buying intangibles so for the first time in a long time you will see us put up some intangibles and some goodwill to our balance sheet but we tell you we have a very good deal but the numbers are not huge.”

My Comments

Barrette made a spirited defense of the purchase of Berkshire Hathaway's stake in WTM. The price on the day of the analyst meeting was $442, which was 10% below the $485 paid to Berkshire, so maybe he was getting some heat from shareholders. Later during the analyst meeting, management went into further detail on the transaction. WTM also bought the balance of Answer Financial in July, and now owns 100%.

Symetra Financial IPO - White Mountains Insurance

The long awaited initial public offering of Symetra Financial Corp. has finally arrived. An S-1 filed by the company this morning has put a price range of $18-20 per share on the 39.5 million shares being offered in the IPO. Symetra was created in 2004 by an investment group led by Berkshire Hathaway and White Mountains Insurance. Both entities own 26,887,872 shares of Symetra. WTM will be selling from 9,870,306 to 11,350,852 shares.

If we assume a pricing of $19 per share then WTM will receive from $187 to $215 million in the IPO. Its remaining stake in Symetra Financial, which will trade under the symbol SYA, will be worth $295 to $323 million.

Book value per diluted share for Symetra as of 9/30/2007 is $15.10, so the IPO is being priced at 1.25 times book value assuming a final price of $19 per share. In my blog post from June I used 1.5 times book value so the value comes in a little less than I thought.

This was still a good deal for White Mountains Insurance as the investment group purchased these assets from Safeco at less than book value in 2004, and they have also withdrawn capital since the original purchase. Here is the lead paragraph from the WTM press release in 2004:

"HAMILTON, Bermuda, Mar 15, 2004 /PRNewswire-FirstCall via COMTEX/ -- White Mountains Insurance Group, Ltd. (NYSE: WTM) announced today that it and Berkshire Hathaway Inc. are leading an investor group that will acquire the life and investments business of Safeco Corporation for $1.35 billion, subject to adjustment based on June 30, 2004 adjusted statutory book value.

Safeco Life and Investments, with headquarters in Redmond, Washington, focuses mainly on group insurance, individual life insurance, structured settlements, retirement services and mutual funds. As of December 31, 2003, the business had approximately $22.5 billion of total assets and $2.57 billion in GAAP book value ($1.74 billion excluding FAS 115). President Randy Talbot and his management team will continue to run the business following the acquisition."

The S-1 is here at the Edgar web site.

White Mountains Earnings Release

I just saw this a few minutes ago but here are some quick observations:

1) Company grew book value 2% sequentially.

2) GAAP combined ratio for Esurance was up sequentially but at the analyst day in June, WTM said that this reflects requirement to amortize policy acquisition costs over 6 months rather than the economic life of 30 months.

3) Comments on Esurance business very different than comments given on analyst day. In June, management said

"Underwriting comes first in all businesses excepting Esurance – where premiums come first. This exception because it is a good business and can grow profitably."

"Combined ratio if WTM stops writing new business – 82% combined ratio. It is incredible that you can write new business at a combined ratio at that level. 2/3rds of Esurance is new business. It’s so good we are going to grow."

Compare this to the press release from this morning:

Gary Tolman, CEO of Esurance, stated, "In the second quarter, Esurance faced an increasingly challenging environment. Competition for new business increased as many of our competitors, along with Esurance, have reduced rates and continue to spend heavily on advertising. While our rate of growth remains strong, it will not be as strong as previous years. Additionally, we increased our reserves by $6 million during the quarter, primarily for bodily injury claims for prior accident years. Overall, we remain very excited about our position in the market and our performance. The current accident year loss results look good, and we have grown our policyholder base by more than 50% in the last 12 months."

4) I am still looking at the 10-Q filed this morning but WTM seemed to avoid stepping into the sub prime mess in its investment portfolio. I think if there were any impairments here it would have been mentioned in the press release.

5) I didn't see any update on the Symetra IPO.

6) Net written premiums were down in all businesses except Esurance, but this was expected due to the combination of declines in pricing and the WTM devotion to underwriting discipline.

Symetra Financial IPO

Symetra Financial announced today that they have filed with the Securities and Exchange Commission (SEC) to do an initial public offering of its stock. The shares will trade under the symbol SYA. Symetra is owned by White Mountains Insurance (WTM), Berkshire Hathaway, Inc. (BKRA) and a host of other private investors and hedge funds. The investor group purchased the company in August 2004, when it was known as Safeco Life and Investments, for $1.35 billion.

It's hard to tell what type of return WTM made on its investment in the three years it held it. The issue has not been priced yet, and although we know what the total purchase price was back in 2004, WTM and others had to put capital in at the closing of the deal. They also may have withdrawn capital over the preceding three years.

If you assume that the offer is priced at a 1.5 times multiple of Symetras book value of $124.6 per fully diluted shares and shares owned by WTM of 3,090,560 then that will value its stake at $577.8 million.

I don't remember WTM saying much about Symetra at the recent analyst meeting - a quick look at my notes shows the following:

"Private equity buyout of Safeco Life and Investments in 2004. 14% after tax rate of return – paid $100 mm dividend to shareholders."

There was a question at the end about the tendency of WTM to exercise excellent cycle management when it comes to exiting and entering different businesses so maybe this is an example of that. I looked up an old story from 2004 and it appears that WTM paid less than book value for the Safeco assets at the time.

White Mountains Insurance (WTM)

Here are my notes from the WTM analyst day. Please forgive the misspellings and abbreviations.

White Mountains Investor Day June 8, 2007

Ray Barrette - Introduction

2006 was a good year for WTM. A complex year with reserve developments at WTM Re and Olympus Re but grew BV by 21% in 2006. One Beacon IPO in June 2006 helped but would be 16% growth without One Beacon. Track record is 17-18% range.

One Beacon had a good year with a 96% combined ratio – 1Q is typically a bad quarter for a New England based insurer with lots of claims. Still had a 98% ratio anyhow

White Mountains Re – 102% combined ratio very much impacted by reserve developments - pricing going down – had $45 mm Catastrophe hit in 1Q-07 in WTM Re - Some competitors did better with lower ratios – sometimes you get big claims in reinsurance.

Esurance at annualized premium rate of $701 mm through May. Will be $900 million by end of year in premiums here.

Underwriting comes first in all businesses excepting Esurance – where premiums come first. This is the exception because it is a good business and can grow profitably.

To understand Esurance you have to look through the GAAP combined ratio since the marketing expenses are up front. These are very large but are expensed in first 6 months despite life of policy being much higher.

2% return in Q1-07 on investments. Investment people have done a great job – they just have to keep doing it.

Track record is 17% annualized growth in TBV since 1985 - 20% since 1999 – it will get tougher to grow this book value as business getting tougher and less profitable going forward.

Bermuda and hard market has helped over last few years on TBV growth. Overall we have ramped up business well.

He has come back after two years of turmoil in reinsurance business to assess what has been going on. We found an IRR of 15% in WTM Re from 1996-2006. This is a decent result – wish it was 20% but this is acceptable. We sold Montpelier Re giving us an 18% IRR – all these returns are after tax. One Beacon has had a 20% IRR –

We can deliver value because of our structure and because of our management teams – we have a good board and can focus on what matters. We are merchant bankers – we make money buying well – fixing broken businesses and exiting well. We do our own due diligence rather than outsource - won’t buy business unless we feel that we can run it.

One Beacon - $2.0 billion capital
White Mountains Re – $2.6 billion capital
Esurance - $0.4 billion capital

One Beacon

Bought for $2.1 billion in 2001 – took combined ratio from 120% to 96%.

Restructured it from top to bottom and now a specialty company – IPO’d it at 1.5 times book value.

Took $1.8 billion in capital distributions out over last five years. IPO very successful since WTM was able to maintain Bermuda structure for Beacon – effective tax rate is 23%.

20% IRR will be a challenge to maintain as markets become more competitive – but some people feel that insurance companies are worth 2 times book.

One beacon has many opportunities to grow – now in specialty Lines, commercial lines and personal lines – about 1/3 each premium volume. 20% growth in specialty lines.

Commercial lines are niche lines not general. (General commercial is 1/3) – will continue to add niche lines.

Personal lines – NY marketplace is declining so net written premiums are shrinking. Forty percent decline year over year in market.

Had underwriting profitably last 4 years and growth in book value per share – 4-½% in the first quarter.

Focus is on growing specialty business. Just entered four new specialty segments, and lowering expense ratio overall is goal.

Premiums have gone down last 5 years but combined ratio going down.

One Beacon has always expensed stock options fully so expense ratio higher relative to others. Not an apples to apples comparison to peers.

White Mountains RE

Bought Folksamerica in 1996 – and have done 12 transactions since then. One bad one – Risk Capital Re.

Market has been going sideways or down and will be a real challenge to maintain margins going forward.

FolksAmerica – have established many long-term stable relationships (A & H and agricultural)

Sirius Intl – run by same guy for 17 years – rock solid relationships across Europe. Long term track record of truly conservative reserving – just had a $22 million release in Q1. A short tail writer mostly property but great A & H business and aviation. They also have a tax advantage – net earnings added to statutory reserve so no Swedish tax added.

Just issued a hybrid capital for this business so $2.6 billion capital to go up.

FolksAmerica ReSolutions – specialize in buying from motivated sellers who want out of reinsurance business – they get great deals – will buy net assets of business below economic value.

Overall in WTM Re net written premiums grew strongly and then peaked and declined in 2006, and Q1-07 due to moderating soft market and UW discipline. KRW havoc in 2005 leaked into 2006 and took 84% combined ratio to 102%,

Combined ratio not the entire story – company earns fee income also.

Numbers are much better than ratings indicate.

Reinsurance business becoming more competitive and will be a challenge to keep it a better business.

Esurance

Bought it for $9 mm in 2000 and put in $53 million to get it breakeven.

Business is profitable but there are GAAP losses due to required expensing of policy costs over 6 months vs. 30-month term of policy.

Low cost operating model – expense ratio of 8.6% - as this business gains scale it will have an even lower expense ratio. Will have 30% of claims reported without human intervention.

Writes personal auto in 27 states – spending a lot of money for advt to increase business – avg cost for policy acquisition was down 22% however.

Fastest growing auto insurer

GAAP combined ratio reflects requirement to amortize policy acquisition costs over 6 months. – economic combined ratio expenses it over 30 months.

Goals – Loss + LAE – to be at 75%.

Company pays a lot of attention to reserving – more confident about reserving in this sector.


Barrette comments:

Combined ratio if WTM stops writing new business – 82% combined ratio. It is incredible that you can write new business at a combined ratio at that level. 2/3rds of Esurance is new business. It’s so good we are going to grow.

Spend well under $500 to acquire each policy at Esurance.

Value of auto policy in marketplace – look at what PGR and other public companies trade at - look at premium over book for companies buying that type of business and convert that to a pct of premium volume. AIG buy of 21st century stub – buying 81% of premium volume. If you apply that to Esurance then you have a value of well over $1000 per policy. That is the economics of what we are doing. WTM is paying well below $500 per policy for something worth in the marketplace well over $1000 per policy. Grow as fast as you can without breaking the machine.

Co is also in merchant banking – looking for all kinds of opportunities. Looked at 60 or 70 last year but didn’t find any interesting. We did create two new businesses from scratch and one more built up

Galileo Weather Risk Mgt - start up – help utilities and others mgt risk. Chemical companies in Europe ship materials on Rhine River – but if not enough rain then Rhine isn’t deep enough for barge traffic – companies bought river depth cover. Business broke even in first year.

WTM life re – second new business – reinsures life (variable annuities) in Japan. Focused on Japan not US because it is easier to hedge because the way Japanese invest.
Very specialized.

Pentalia – invest in remote insurance risks - WTM is a seed investor and part minority owner of Mgt Company. Good potential returns for WTM’s.

Capital Position

WTM in excellent shape – total tangible capital at $6.5 billion – leverage ratios at 18% of total tangible capital.

Capital raising – IP of One Beacon at 1.5 times book value.

Symetra

Private equity buyout of Safeco Life and Investments in 2004. 14% after tax rate of return – paid $100 mm dividend to shareholders.

Investments

2.0% total return in 1Q-07 – 6.8% cumulative over time.

Internal benchmark is 10-year treasury plus 150 bp’s points. WTM has done better than that. WTM has done well in all asset classes.

Value oriented approach in Equity portfolio beat S & P 500 by 500 bps in Q1-07.

Two primary rules of investing – rule #1 is don’t lose money and don’t forget rule number 1.

WTM uses bottom up view of what securities to own – MBS as pct of fixed has increased to 40% from 6%. Totally avoided sub prime and other sub classes that imploded because thought that risk reward wasn’t good enough.

Equities

Total portfolio above $2.5 billion – top ten is 2/3rds of portfolio – much more use of converts to protect portfolio – much more diversified use of large cap names. WTM has been harvesting gains in Energy and Utilities.

What to expect from WTM

Growth in BV per share – how we do it is unknown or how lumpy or smooth we don’t know.

UW comes first – disciplined balance sheet.

Market is more competitive and assets very expensive so will deploy capital prudently. Have a loaded gun but will be prudent in deploying capital.

Q and A

Stock repurchase plan announced? What is status?

Has to make sense for remaining shareholders – follow Buffett rule - compute intrinsic business value and then pay 80% of that value – so far have not felt that we are right place do not use it for share support but as an investment – we compare it to other investments – 17% rate of return on investments is goal. We have excess capital but do not see using that now to buyback shares.

What is book value for Esurance on your books?

$360 million or $30 per share but much of book value on books of WTM Re.

If sold it sale would be tax-free since it is in Bermuda.

Common investments have even better if you take out Montpelier re investment so why not add money to this asset class it since you can go to 100% of stockholders equity?

This is totally up to investment team. We are putting money in market as fast as we can – we are putting it in at fastest clip we can but are selling also. Also, has been a long time since we have had a market correction so we would add to equity market faster if there was a correction.

Put some numbers behind right sizing CAT exposure? How much willing to lose over season?

At WTM RE have introduced concept of limiting exposure to maximum loss not probable loss – 1 in 10,000 year event – counting operating earnings of year – and accumulation of 1, 2,3,4 or 5 events - limit loss to 15% of total equity. ($2 billon of equity.)

Type of business that you would prefer to have in Bermuda? Long tail that would build up tax-free investment income maybe?

Long-tail profitable business – CAT business belongs in Bermuda, but when events happen there you lose heck of a tax deduction. Real advantage in Bermuda is having capital there. Your book of business turns over but capital is permanent.

What is One Beacon exposure to Cat 98? (Event in Northeast)

Haven’t announced anything but comfortable saying that it will not be over $15 million.

Question regarding claims in Esurance? What are actual benefits in seeing car being repaired? Is that good for customer?

Think that it is good for customer – customer want to know what is going on - want to see process and chose auto body shop. Can go online and see what is going on. Introduced this in January – 13% of insured are following this on line. It is good for customer and good for WTM so they don’t call. This is better service and maybe better retention. Two ways to lose customer - poor claim service or rates too high. It will help retention definitely.

Tax status of Bermuda discussions in Congress?

Legislation being rumored is same that has been introduced every year since 2001. It is not likely to be passed and many would be hurt as Bermuda brings a lot of money in so has some strong opposition. Great value in an efficient reinsurance market. Doesn’t think it will pass and won’t hurt WTM too much.

Question on reinsurance – compared to One Beacon – bought it at great time – great cycle management – are there market conditions where you would consider exiting reinsurance as a cycle management play?

Bought in reinsurance very well – did a fine job at underwriting – difference between one beacon – is that in One Beacon just can’t stop underwriting because whole infrastructure being fed by premium volume. In reinsurance business – no agents so you can reduce underwriting very easily – don’t have to sell WTM re but will just stop underwriting.

Jack Byrne made comment at last meeting about multi decade prospects of returns of reciprocal business – do you share that excitement and why?

We do but wish others would get excited - has to be multiple partners helping us. Farmers is very successful model for reciprocals with $2 billion in fees in 2006 with 50% margins. Travelers makes a lot of money but $20 billion in capital at risk – didn’t make much more than farmers – so which model would you pick.

One Beacon question – talked about reducing expense ratio – since we are entering soft market and top line will shrink- how will you reduce this ratio?

A good question – will have to through overall expense side – opportunities to cut expenses as infrastructure for $4 billion company can reduce since it is a $2 billion company. Looking for 300 bp reduction in expenses – half that coming from expense management initiatives and the other half coming from mid single digit growth. Opportunities on IT side as well.

What is next step on One Beacon in terms of spin out?

Looking at all opportunities but spinout would be taxable so does not add value. But our ownership will depend on market going forward – will WTM have better opportunities elsewhere for capital?