WRB: W R Berkley (2)
Highlights for 2024
WRB achieved many great things in 2024:
ROE of 23.6% remained strong and elevated compared to historical average.
Record high underwriting results of $1.1b. Combined ratio 90.3%.
Record high net earned premiums, YOY growth +9.3%.
Record high net investment income, YOY growth +27%.
Total capital returned to shareholders of $836m, of which special dividends $412m, regular dividends $120m, share repurchases $304m.
Industry Comments
Overall Growth
The US P&C insurance industry is on track for higher profits this year, reflecting better underwriting and investment results:
Four consecutive years of ~10% premium growth have helped insurers repair underwriting results after a rise in claims costs starting in 2021. As more insurers reach rate adequacy, especially in personal lines, we see industry growth slowing toward longer-term averages.
Profitability
Industry profitability measured by combined ratio has improved to 97.9%. The last 2 years, the industry was making underwriting losses due to unexpected inflation claim costs. Premium rates have increased since then.
However, we expect the improvement in underwriting performance to slow due to:
1. Increased competition in private auto insurance. By Q3, growth started to decelerate noticeably, with premiums in auto +11% YOY, down from +15% in Q2.
2. Risk from social inflation, reserve adequacy and economic policies remain and could pressure claims costs.
3. Gradual narrowing of portfolio yields and market interest rates weakens investment income.
Catastrophic Events
2024 was another busy year for natural catastrophes. There had been 27 weather events in the US that caused economic losses of at least $1b each. Hurricanes Helene and Milton resulted in combined estimated insured losses of $50b.
Most catastrophic losses are in homeowners, and insurers have been increasing premium rates or entirely pulling out of certain geographies.
In reference to the ongoing California fires, WRB underwrites a small proportion of homeowners insurance but has no exposure in California.
Investment Income
The rate hikes came in 2023 and remained elevated in 2024, we expect recurring investment income to continue rising into 2025 as maturing securities are reinvested at higher rates. However, this tailwind will recede as the gap between new money and portfolio yields shrinks.
In Q4 earnings call, WRB mentioned the yield for Q4 was ~4.6%, and new money rate is ~5.25%. Investment income should continue to increase in 2025 driven by both higher invested assets and yield, unless there is a sudden drop in interest rates:
Valuation
The US P&C insurance hard market started around 2018, since then WRB market value has grown at 17% CAGR while our estimates of intrinsic value grew at 12%.
The market continues to reward WRB with a high price to book ratio. However, in terms of earning power measured by insurance operating results, it actually matched the market value CAGR of 17%. Currently, this earning power multiple is not expensive despite the higher investment yields WRB enjoys today.
We are buying WRB for its underwriting capabilities, not for its book value. WRB invests more than 75% of float in fixed income, but what it does very well is producing a negative 5% average cost of float over 25 years; this is like getting paid to hold other people’s money. Given that current borrowing costs are higher than recent years, the ability generate negative cost float is a huge advantage.
On expense ratio, WRB achieved 28.5% in 2024 (2023: 28.4%), and management expects it to be comfortably below 30% in 2025.
Therefore, in the valuation model we don’t expect underwriting profits or investment income to decline in the near future.
Details below:
Even with the float estimated at Q3 2024, we are getting a 12% discount to intrinsic value. For the past few years, WRB has been taking advantage of the hard market to expand top line growth. The green bars indicate years of hard market, and yellow bars for soft market:
The P&C insurance industry cycle is characterized by periods of:
Soft market: premium rates are stable or falling and insurance is readily available.
Hard market: premium rates rise, coverage may be more difficult to find and insurers profits increase.
A dominant factor in the insurance cycle is intense competition. Premium rates drop as insurance companies compete vigorously to increase market share. As the market softens to the point that profits diminish or vanish completely, the capital needed to underwrite new business is depleted.
In the up phase of the cycle, competition is less intense, underwriting standards become more stringent, the supply of insurance is limited and premiums rise as a result. The prospect of higher profits draws more capital leading to more competition and the inevitable down phase of the cycle.
For disciplined and intelligent underwriters, they aggressively expand during hard markets, because the competition is weak and they can charge higher premiums ensuring that the policies on aggregate will not result in underwriting losses.
Observe that in recent years WRB has been writing about 1.4x premium-to-equity and ROE naturally increases due to the leveraged nature of the business.
Implied PE Normalized Earnings
Another way to check if we are paying a good price is to derive the ROE by breaking up the business earning power into its components. WRB generates earnings from invested assets and core insurance underwriting.
We assume the normalized yield on investments is 3.5% and combined ratio is 95%. Using 2024 results, we get the ROE of 19%, then using the PB ratio of 2.7x, the implied PE ratio is 13.8x. This is quite a good price to pay for a business that can generate 19% ROE. There are 3 factors that can cause this conclusion to be wrong going forward:
Invested assets shrink.
NEP decreases.
Combined ratio worsens.
Conclusion
WRB is still our third largest position, we think the stock is undervalued. We will continue to add shares at current market cap of $22.6b.
Other Notes
1. Insider ownership continues to be significant with William Berkley (founder, chairman) owning 21.3% and Robert Berkley (CEO) 1.4% (2024 proxy statement, pg. 81). Their salaries were $1.1m each, a fraction of their net worth in the company.
2. William Berkley has not sold a single share since 1969 other than in connection with cashless exercises of stock options or to cover taxes on vested restricted stock units from time to time.
3. William Berkley has significantly reduced the number of shares pledged by ~86% (35 million shares) since 2011. His pledged shares represent 2.2% of total shares outstanding, down from 13% in 2011. He has significantly more unpledged shares at 51 million, worth ~$3b now.
4. Capital allocation for shares repurchase is rational.
Blue cells: when market value change was higher than our intrinsic value growth, management spends little for shares repurchase.
Green cells: when market value falls but intrinsic value grew, management aggressively repurchased shares.