Best Insurance investment right now? MFC, RE, CNA or RNR

[prevalou]

It is a question of degree. If you prefer, i can call them grey swans (recession in the construction industry, inflation of raw materials, irrationality of the players which is anavoidable). Insurance is more diversified and less correlated to a single event, altough extrem events (earthquake  in California, etc.) can occur. The probability of a big contraction in the commercial construction industry is not so remote after all...

[Myth465]

I would say we are / have been in a big contraction in Commercial realty construction for a while. I used to own URI and RRR, and they have been hit hard by the slow down in construction both commercial and housing. Projects were literally stopped over 2009 and 2010. You can google and see pictures of commercial properties mothballed right in the middle of construction. I sold RRR because they moved from repaying debt to refleeting because they saw a pick up in the market. The things you listed could destroy any business though. Severe slowdowns and the like. Even now we have been discussing what will likely be a very active hurricane season which could cripple insurers and turn on a hard market.

 

Either way I dont think there is a why to compensate for these risks. You either feel that the price overcomes them or you dont. Thanks for the devils advocate though, its always useful.

[Guest HarryLong]

It is a question of degree. If you prefer, i can call them grey swans (recession in the construction industry, inflation of raw materials, irrationality of the players which is anavoidable). Insurance is more diversified and less correlated to a single event, altough extrem events (earthquake  in California, etc.) can occur. The probability of a big contraction in the commercial construction industry is not so remote after all...

 

Prevalou, you're a funny guy. While you're not bothered at all by a combined ratio which is actually deteriorating in the latest quarter (when I went over your picks), you are bothered by one which could deteriorate, but hasn't deteriorated at all.

 

Like I said, all surprises in insurance are nasty surprises. Why not take a good look at RLI, NATL, and SUR. Why put all your eggs in the surety basket?

[Guest HarryLong]

Has anyone actually taken a hard look at RLI and NATL?  ;D

[prevalou]

SUR has about 100% equity invested in munis and states. I imagine it is for tax reasons. (their tax rate is 30%) and "conservative" policy (if the past is an indication of the future...)

I am wondering if these tax exemptions don't encourage bias in investments (especially if rating agencies give their approbation with AAA because these states and municipalities are too big to fail!)

It reminds me other bubbles!

[Packer16]

I think the reason CNA is cheap is it is post-arbitrage situation as described by Whitman in the Aggressive Conservative Investor.  Whitman observed many of the situations in the 1970s. 

 

As to the munis, I think CNS will be fine unless they are forced to sell these bonds to pay claims and I am would think that they have other fully priced bonds they could sell.  I also think on an after-tax basis, I think munis are probably still the best bond investment out there. 

 

As to RLI and NATL, they both are selling at or above book value and thus may not be as misspriced as CNA.  That at least explains my lack of interest at these price levels.  If they were trading at 70% of book my interest would be greater.

 

Packer

[Guest HarryLong]

I think the reason CNA is cheap is it is post-arbitrage situation as described by Whitman in the Aggressive Conservative Investor.  Whitman observed many of the situations in the 1970s. 

 

As to the munis, I think CNS will be fine unless they are forced to sell these bonds to pay claims and I am would think that they have other fully priced bonds they could sell.  I also think on an after-tax basis, I think munis are probably still the best bond investment out there. 

 

As to RLI and NATL, they both are selling at or above book value and thus may not be as misspriced as CNA.  That at least explains my lack of interest at these price levels.  If they were trading at 70% of book my interest would be greater.

 

Packer

 

What I've been trying to highlight, is that given the over-reserving, RLI and NATL may be, in reality, cheaper than many of the companies most people view as cheap on a pure P/B basis.

 

By the way, on another subject, has anyone been looking at Hellenic Telecom (OTE)? That's probably the cheapest company of its quality in the world right now.

[prevalou]

Actually, RLI combined ratio for surety insurance is  better than SUR (77.5% average for 2005/2009 and 79.5% respectively) although RLLI being 10 time smaller in written premiums. There seems to be no advantage in scale for SUR. Or if SUR management is outstanding, RLI management is still better!

[Guest HarryLong]

Actually, RLI combined ratio for surety insurance is  better than SUR (77.5% average for 2005/2009 and 79.5% respectively) although RLLI being 10 time smaller in written premiums. There seems to be no advantage in scale for SUR. Or if SUR management is outstanding, RLI management is still better!

 

Scale advantages, if any, would come out in the expense ratio, so one would have to compare the expense ratio for surety business at RLI to SUR's expense ratio. However, even though those comps are real, in reality, it is often a thorny problem, in practice, to allocate certain expenses directly to one line or another (but it can be done).

 

RLI and NATL are high quality, no doubt about it.

 

Has anyone looked at OTE?

[prevalou]

do you mean RLI underwriting is better if SUR has scale?

[Ballinvarosig Investors]

Actually, RLI combined ratio for surety insurance is  better than SUR (77.5% average for 2005/2009 and 79.5% respectively) although RLLI being 10 time smaller in written premiums. There seems to be no advantage in scale for SUR. Or if SUR management is outstanding, RLI management is still better!

 

Scale advantages, if any, would come out in the expense ratio, so one would have to compare the expense ratio for surety business at RLI to SUR's expense ratio. However, even though those comps are real, in reality, it is often a thorny problem, in practice, to allocate certain expenses directly to one line or another (but it can be done).

 

RLI and NATL are high quality, no doubt about it.

 

Has anyone looked at OTE?

http://www.ote.gr/investor/Uploads/synopsi_1st_sem_2010_gr_new.gif

Look at that pile of debt that falls due next year. Either they're going to have to try and refinance at much higher levels, or else raise equity.

[onyx1]

 

...over-reserving which equals, on average, approx. 14% a year for the last 10 years?

 

 

Harry,

 

  Please help me understand how you arrive at the figure.  My calculations are significantly different than 14% per year for SUR.  Specifically, here are the last 10 years of one-year later re-estimated net reserves as a percent of the initial reserve (all data from page 9, 2009 10-K) :

 

2000 -5.2%

2001  3.6%

2002  4.1%

2003 23.6%

2004 -0.2%

2005 -9.5%

2006 -1.9%

2007 -1.7%

2008 -14.1%

2009 -15.7%

 

where, for example 2009 is calculated as:

 

Net reserve  12/31/2008  345,033

Re-estimated 12/31/2009  290,751

Change                          -54,282

% change  -54,282/345,033 = -15.7%

 

and 2008 is calculated as,

 

Net reserve  12/31/2007  322,346

Re-estimated 12/31/2008  276,845

Change                          -45,601

% change  -45,601/322,346= -14.1%

 

The average for all 10-years is -1.7% per year.

 

Thanks for bringing this up as a point of discussion.

[nodnub]

By the way, on another subject, has anyone been looking at Hellenic Telecom (OTE)? That's probably the cheapest company of its quality in the world right now.

 

I'll read the annual report.  Off the top of my head--I wonder what happens if Greece figures out how to effectively tax its citizens?  I think it could result in reduced discretionary spending on mobile use.

 

 

[Guest HarryLong]

 

...over-reserving which equals, on average, approx. 14% a year for the last 10 years?

 

 

Harry,

 

   Please help me understand how you arrive at the figure.  My calculations are significantly different than 14% per year for SUR.  Specifically, here are the last 10 years of one-year later re-estimated net reserves as a percent of the initial reserve (all data from page 9, 2009 10-K) :

 

2000 -5.2%

2001  3.6%

2002  4.1%

2003 23.6%

2004 -0.2%

2005 -9.5%

2006 -1.9%

2007 -1.7%

2008 -14.1%

2009 -15.7%

 

where, for example 2009 is calculated as:

 

Net reserve   12/31/2008  345,033

Re-estimated 12/31/2009  290,751

Change                           -54,282

% change  -54,282/345,033 = -15.7%

 

and 2008 is calculated as,

 

Net reserve   12/31/2007  322,346

Re-estimated 12/31/2008  276,845

Change                           -45,601

% change  -45,601/322,346= -14.1%

 

The average for all 10-years is -1.7% per year.

 

Thanks for bringing this up as a point of discussion.

 

My language should be more precise. For instance, in 1999 SUR created reserves. Reserves re-estimated as of 10 years later showed a redundancy (over-reserve) of $28,612,000 (the 20.8% redundancy is just below this number on the table).

 

For instance, in 2000, SUR set aside reserves. Reserves re-estimated as of 9 years later showed a total redundancy (over-reserving) of $16,637, re-estimated as of 9 years later as 12.4% of the original estimate in 2000.

 

We only get more and more accurate re-estimates as time goes by and claims are paid out. As it turned out, their initial estimates in those years, for instance, were wildly pessimistic vs. later reserve re-estimates which took into account actual claims paid out, among other factors, in later years.

[onyx1]

 

My language should be more precise. For instance, in 1999 SUR created reserves. Reserves re-estimated as of 10 years later showed a redundancy (over-reserve) of $28,612,000 (the 20.8% redundancy is just below this number on the table).

 

For instance, in 2000, SUR set aside reserves. Reserves re-estimated as of 9 years later showed a total redundancy (over-reserving) of $16,637, re-estimated as of 9 years later as 12.4% of the original estimate in 2000.

 

We only get more and more accurate re-estimates as time goes by and claims are paid out. As it turned out, their initial estimates in those years, for instance, were wildly pessimistic vs. later reserve re-estimates which took into account actual claims paid out, among other factors, in later years.

 

OK.  And since the triangle is cumulative all those subsequent years are incorporated into the yearly percentages shown above. The 10 year average is -1.7% per year.  (Mix in a little CPU and you get a Std Dev of +11.2%).  What this means to me is that historically, SUR has on average set reserves slightly conservative.  This is a respectable number relative to other long-tail insurers (ex. similar averages for MKL= -0.4%, BRK= -.5%, CNA parent = +2.7%).  However, I don't see the reserve conservatism as consistent enough to give it much weight in valuation.  Concerning to me is the fact that the CEO has been in place since 2003, got $2mm last year, but doesn't own any stock.  Total management ownership is only 0.3%!

[Myth465]

I never really hold it against a CEO for not owning stock. They have enough risk being in charge. The worst thing is to have a black swan event effect both your Job and your Net Worth. He should own a bit though, but thats how I look at it.

[Guest HarryLong]

I'm not sure why you wouldn't give it a huge weight. In 1999 (the earliest year on the table), the reserve, as it was re-estimated 10 years later, turned out to be too conservative to the tune of 20.8%.

 

[onyx1]

I'm not sure why you wouldn't give it a huge weight. In 1999 (the earliest year on the table), the reserve, as it was re-estimated 10 years later, turned out to be too conservative to the tune of 20.8%.

 

 

Well if I knew SUR was underreserved by 21% hell yes I'd give it a huge weight!!  :o  But unfortunately, that development cannot be projected upon today's reserves (any more than one can project the required addition to 2002 reserves of 14.7% so far).  If historical reserve performance is what you are after then the best to way get it is a year-by-year % calculation of development from the prior year.  The cumulative nature of the calander year triangle makes this very straightforward and all prior years get incorporated as you move forward in time.

[Guest HarryLong]

I almost find it hard to believe that you would say/think/believe such a thing. The reason you have a reserving table is precisely because 1 year does not tell you the story about a company's reserving.

 

Let us be clear--in 1999 SUR was over-reserved by 20.8%. With each year that goes by, that number becomes more and more certain as claims are paid (ie, claims have been paid for 10 years subsequent to the initial estimate, so the number becomes more "solid" as each year goes on).

 

Therefore by definition, you are wrong to state: "If historical reserve performance is what you are after then the best to way get it is a year-by-year % calculation of development from the prior year."

 

It is precisely the opposite: It is by seeing how claims actually were paid out subsequent to the initial estimate 10 years later, 9 years later, 8 years later, etc, that one can get a clear quantitative/contextual picture of reserving.

 

Any given year's development from the prior year can be highly volatile. It is many years put together where a clear pattern emerges.

 

 

[Guest HarryLong]

 

...over-reserving which equals, on average, approx. 14% a year for the last 10 years?

 

 

Harry,

 

  Please help me understand how you arrive at the figure.  My calculations are significantly different than 14% per year for SUR.  Specifically, here are the last 10 years of one-year later re-estimated net reserves as a percent of the initial reserve (all data from page 9, 2009 10-K) :

 

2000 -5.2%

2001  3.6%

2002  4.1%

2003 23.6%

2004 -0.2%

2005 -9.5%

2006 -1.9%

2007 -1.7%

2008 -14.1%

2009 -15.7%

 

where, for example 2009 is calculated as:

 

Net reserve   12/31/2008  345,033

Re-estimated 12/31/2009  290,751

Change                           -54,282

% change  -54,282/345,033 = -15.7%

 

and 2008 is calculated as,

 

Net reserve   12/31/2007  322,346

Re-estimated 12/31/2008  276,845

Change                           -45,601

% change  -45,601/322,346= -14.1%

 

The average for all 10-years is -1.7% per year.

 

Thanks for bringing this up as a point of discussion.

 

I think the other point of your confusion is the conflation between the year(s) in which reserves are released and the total cumulative effects of changes in estimates from the initial estimate. Just because a high/lower % (in the case of over-reserving) of the reserves are released in any given year has little bearing (except for the cumulative effect) on the actual total amount of over-reserving that occurred in the initial estimate (as measured by subsequent re-estimates).

[Guest HarryLong]

do you mean RLI underwriting is better if SUR has scale?

 

Scale can, but not necessarily, should give a company a better expense ratio, everything else being equal.

 

Scale, however, will not help with the loss ratio, since theoretically, a smaller book of business, while more volatile, would let one cherry-pick the very best risk/reward/priced risks. In other words, it would make sense that a smaller book of business could have a lower loss ratio, but should, everything else being equal, give a company a higher expense ratio.

[vinod1]

Has anyone actually taken a hard look at RLI and NATL?  ;D

 

I only took a quick look to see if it was interesting and definitely like what I see. Disciplined underwriting, consistent/conservative reserving, and a rational asset allocation policy. However, they could be better on the investing front (higher allocation to equities when market is overvalued and lower allocation to equities when market is undervalued).

 

Based on an expected return of about 5.8% for the portfolio as a whole (based on their seemingly preferred allocation of 80/20 bond/stock mix and assuming a return of about 5% on fixed income and 9% on equities) and about an 88% CR (their last 11 year avg), their pre-tax earning power is about $150 million after a $6 million reduction for interest expense. With a 30% tax rate (past three year average) I get about $5 per share in normalized earning power or about a 12%-13% ROE. This would justify about a 1.5 book value multiple which at the current book value of about $40 translates into an IV of about $60. If you assume that their reserves are overstated by 12-15% then book value increases to about $45-$46 which translates to an IV of about $70.

 

At a current market price of about $54 it is trading at about 80% of IV. This does not seem to offer sufficient enough margin of safety for investment at this time. I like what I see so far, so I am going to dig much more and hopefully Mr Market might give an opportunity may be in the next decade or two.

 

Thanks again for doing this research and sharing it with the group.

 

Thanks

 

Vinod

 

[prevalou]

If I follow your reasonning Harrylong, because sou seem to know well your subject, I have to conclude SUR has a competitive dis-advantage because it is one of the biggest players in a fragmented industry: small players probably get the best business with companies like SUR getting what remains. We don't see it now because the sea lifts all boats but could discover it when the next tsunami happens(the surety industry like credit industry is prone to tsunamis). I add a second competitive dis-advantage: main competitors are multiline that can underprice SUR, if they earn money elsewhere. Moreover, SUR portfolio is heavily invested in munis, which Buffett call the next financial hurricane. The price seems fine but CNA group can take-under the business if it finds it undervalued, knowing  the business better than outsiders. Thank you anyway for sharing your idea, I found it very interesting.

[onyx1]

I almost find it hard to believe that you would say/think/believe such a thing. The reason you have a reserving table is precisely because 1 year does not tell you the story about a company's reserving.

 

Let us be clear--in 1999 SUR was over-reserved by 20.8%. With each year that goes by, that number becomes more and more certain as claims are paid (ie, claims have been paid for 10 years subsequent to the initial estimate, so the number becomes more "solid" as each year goes on).

 

Therefore by definition, you are wrong to state: "If historical reserve performance is what you are after then the best to way get it is a year-by-year % calculation of development from the prior year."

 

It is precisely the opposite: It is by seeing how claims actually were paid out subsequent to the initial estimate 10 years later, 9 years later, 8 years later, etc, that one can get a clear quantitative/contextual picture of reserving.

 

Any given year's development from the prior year can be highly volatile. It is many years put together where a clear pattern emerges.

 

 

 

Each one year re-estimate reflects the most recent development from all prior years, nothing is left out or missing. The most recent one year re-estimate includes 1999's 10th year change, 2000's 9th year change, 2001's 8th year change, etc..  All ten years of 1999's 20.8% over reserving are incorporated as they developed one year at a time. All nine years of 2000's...same...and on and on.  The set of annual changes will give a good idea about trends, and whether the firm is chronically under/over reserved.

 

That SUR was conservative by 20% for reserve estimates set in 1999 is a good thing (for investors of course).  But aside from association, it tells me nothing about what transpired with new policies written in the next decade.  It is a dangerous leap of faith to assume because the management team in place in 1999 under reserved by 20%, that the current management has systematically done the same thing in 2009 and therefore current reserves are also 20% too high.  Anyone making this assumption is fooling themselves.

 

[StubbleJumper]

I almost find it hard to believe that you would say/think/believe such a thing. The reason you have a reserving table is precisely because 1 year does not tell you the story about a company's reserving.

 

Let us be clear--in 1999 SUR was over-reserved by 20.8%. With each year that goes by, that number becomes more and more certain as claims are paid (ie, claims have been paid for 10 years subsequent to the initial estimate, so the number becomes more "solid" as each year goes on).

 

Therefore by definition, you are wrong to state: "If historical reserve performance is what you are after then the best to way get it is a year-by-year % calculation of development from the prior year."

 

It is precisely the opposite: It is by seeing how claims actually were paid out subsequent to the initial estimate 10 years later, 9 years later, 8 years later, etc, that one can get a clear quantitative/contextual picture of reserving.

 

Any given year's development from the prior year can be highly volatile. It is many years put together where a clear pattern emerges.

 

 

 

Each one year re-estimate reflects the most recent development from all prior years, nothing is left out or missing. The most recent one year re-estimate includes 1999's 10th year change, 2000's 9th year change, 2001's 8th year change, etc..  All ten years of 1999's 20.8% over reserving are incorporated as they developed one year at a time. All nine years of 2000's...same...and on and on.  The set of annual changes will give a good idea about trends, and whether the firm is chronically under/over reserved.

 

That SUR was conservative by 20% for reserve estimates set in 1999 is a good thing (for investors of course).  But aside from association, it tells me nothing about what transpired with new policies written in the next decade.  It is a dangerous leap of faith to assume because the management team in place in 1999 under reserved by 20%, that the current management has systematically done the same thing in 2009 and therefore current reserves are also 20% too high.  Anyone making this assumption is fooling themselves.

 

 

That's why I like the accident year triangles that FFH added to their AR this year (or was it last year?).  You can actually follow how specific accident years develop over time.  People should really look at what FFH has done for the last five or so accident years...

 

SJ