Brit Insurance Share Discussion Threads

[effortless cool] 11/6/2010 16:50

JTC,

You stated (post 245): "Underwriting should wash it's face and maybe provide a small return over time".

You now claim that that is a quote from Buffett and then go on to support that with an actual quote from Buffett that says something quite different.

In fact, it is you that seem to be implying things from your posts that were not implied.

And I still say you are naive in your understanding of insurance.

If Brit target an additional 1.5% return on investments per annum, that means taking on more investment risk; more investment risk means a higher solvency capital requirement; a higher solvency capital requirement means less underwriting; less underwriting means a smaller float; a smaller float means a lower investment return. Simplistic but broadly true.

Buffett had the advantage of operating for a great many years in an environment where investment risk was given a free ride from a solvency perspective. That's not the case any more, and even the great man is now getting his pips squeezed on his derivative exposures.

Effortless Cod

[jtcod] 11/6/2010 16:35

EC
"I would say your belief that "underwriting should wash its face and maybe provide a small return over time" is naive."

I was quoting Buffett actually.

I'll quote him again here:

"Every Insurance company will have you believe that their underwriting makes money but very few do in the long term".

You seem to be implying from my posts things that I have not implied. I refer to the risks of driving a float. I merely said the float is a means of valuation because from their the returns on investment are made. If one doesn't trust the underwriting one wouldn't look at the company in the first place. Moreover if a company buying BRE could achieve just 1.5% greater return on investment over the long haul then this would have a fairly profound affect on the value of the business imo.

[effortless cool] 11/6/2010 16:20

I wasn't meaning that it doesn't work, I just couldn't think of anyone else that has made it work in an insurance context.

Two things I would point out.
- The underwriting business is always a ticking timebomb, especially when it is used as a means to add to the float, rather than to generate a profit in itself. I would say your belief that "underwriting should wash its face and maybe provide a small return over time" is naive.
- The float is a debt to your policyholders (borrowed as premiums, paid back later as claims). Taking risk on your borrowed funds is dangerous, no matter how much alpha you add, and even a small setback can have a signficant impact on your capital and, hence, on your ability to borrow in future. You describe yourself as "an investor who has beaten the market and institutions for 15yrs by a significant margin". Why aren't you gearing up and doubling or trebling that return? Answer: because the volatility risk is too great and could easily wipe out the benefit of your positive alpha.

[molatovkid] 11/6/2010 16:17

JT, I have had some hits using the value investing formula, but I am a swine for making a quick, rash decision from time to time and maybe getting into things I shouldnt. How do you stop yourself from doing that? Or do you?

[effortless cool] 11/6/2010 15:54

JTC,

You've set out the principle upon which Buffett runs his insurance companies, but it is not relevant to the way that the vast majority of insurance companies are curently run, and certainly not compaies of Brit's very small scale.

Basically, for most it is the other way around - it is the underwriting that drives returns, with the float providing a small additional return over time.

The main reason for this is that the people running insurance companies tend to know a lot more about underwriting than they do about investing - hence they contribute (or believe they contribute) positive alpha on underwriting and zero alpha (actually probably negative alpha if they try to get actively involved) on investments. Also, insurance (meaning large scale commercial insurance of the type that Brit is mainly involved in) is a high risk, high return, i.e. high beta, enterprise.

Certainly, if you can add some alpha on the investment side, the insurance investment proposition becomes compelling. Many have tried to replicate the Buffett model, e.g. hedge funds setting up reinsurers in Bermuda and Europe, Phoenix rather comically with Goshawk) but I struggle to think of any that have succeeded. Indeed, its failed attempts to boost returns through targetting investment alpha and incresing investment risk to add investment beta have substantially driven Swiss Re into Buffett's hands.

[jtcod] 11/6/2010 15:33

I also suspect that whilst the world and it's brother has been expecting high inflation to come through in Europe following high central bank liquidity intervention post crises, the bidder has been quick to act on a reverse assumption following moves by EU nations to reduce Government employment and spending significantly going forward. This could have a strong deflationary influence long term once the initial inflationary influence has burned out. The bond markets may perform better than people had expected.

The whole sector is due a re-rating imo.

[jtcod] 11/6/2010 15:15

Jonwig
If we accept that none of us would buy an insurance company that we didn't believe had a good record for underwriting prudence and also a combined ratio that was not negative over time, then what you pay is Market Cap plus the bid premium and what you get is an interest free investment float from which to drive profits. The float is essentially the earning potential of the business. That's where the profits come from. Underwriting should wash it's face and maybe provide a small return over time.

So essentially what you pay for the company in relation to the float is what draws a buyer if that price is cheaper than the rest of the market and cheap against potential investment returns over the long haul.

There are other smaller considerations but essentially this is what it all boils down to.

[essentialinvestor] 11/6/2010 15:01

JT

Many thanks for highlighting the attractions of BRE last year.
I put my Dad into these as a result, knowing your long term investment record.


Very Much appreciated,


Gavin.

[jtcod] 11/6/2010 14:58

EC
Perhaps that explains why Buffett is so successful and now such an influential player in world insurance and re-insurance markets. His job is made easier by the fact that there are still fools out there who think they know better.

[simon gordon] 11/6/2010 13:40

There is plenty of BRE chatter on Markets Live at Alphaville this morning:

[makingheaps] 11/6/2010 12:22

In the case of Amlin I was quoting NTA from the highlight bullets in the latest results statement. For RSA you are correct guys I failed to appreciate the subtlty of NAV/NTA. Quicj look at the actual balance sheet and they have £969m intangibles or about 28p a share so NTA is in the order of 76p and the rating is 1.6x. My turn to apologise. Doesn't change my view of what constitutes a fair price. I hold AML, BRE and RSA by the way.

[effortless cool] 11/6/2010 11:52

Buffett may use cost of the float, but the rest of the market aren't Buffett and, flawed or not, NTA is the principle valuation metric used by the market.

[jtcod] 11/6/2010 11:45

I have to say guys that I think the notion of assessing value of a GI company via NTA is flawed. It's the 'cost of the float' that values the company. Buffett has always used the cost of float measure. That's why this Private Equity company arrived at BRE's doorstep rather than the other choices and why I invested in BRE in the first place.

[effortless cool] 11/6/2010 11:30

I took mine from ADVFN, which perhaps has equal or greater potential to be misleading. I think MakingHeaps is looking at NAV per share, rather than NTA per share.

[hieronymous1] 11/6/2010 11:25

The Deepwater Horizon Disaster: Insurance Market Impacts
June 10th, 2010

The Deepwater Horizon Disaster: Insurance Market Impacts
Source: Insurance Information Institute


This PowerPoint report by Robert Hartwig, president of the Insurance Information Institute, reviews the insurance issues relating to the Deepwater Horizon Oil Rig Loss. Slides show the types of coverage that might apply and the number of parties that might be involved. The liability factor and legal ramifications are discussed and slides explain the Oil Pollution Act and the Oil Spill Liability Trust Fund. A section deals with risk management and regulatory fallout, noting that increased federal oversight is a certainty. Another section provides information on global energy insurance markets, with a focus on key trends, capacity, insured exposure and profitability. The presentation concludes with a review of past oil spills.

Available as PowerPoint or PDF.

[makingheaps] 11/6/2010 11:23

JT, I agree the rating of RSA has always been anomolous, but the last published net asset figure was £1.04 so they are rated more like 1.2x rather than 2x. AML which is arguably best in class last published NAV of £2.89 so currently rated approximately 1.34. If these ratings are anything to go by I agree £12 - £13 is fair.

[effortless cool] 11/6/2010 11:23

JTC,

I was benchmarking against peer group, e.g. Amlin, which has the best record in the sector by far, is only currently valued at about 1.5xNTA. (RSA is actually about 1.65x NTA, which seems mystifyingly high to me, though I suppose they have brand value which the commercial lines insurers do not).

I don't disagree with your view regarding the float, but increased expected returns on a fund of that size inevitably come with increased risk. An investment loss hits underwriting capital and can, especially given the gearing involved, fatally damage the underwrting business. Also, I believe that Solvency II is likely to increase the capital that must be held against riskier assets.

[crawford] 11/6/2010 10:54

My dividend is automatically reinvested here - I hope the share price stays on an even projectory or rises after payment date!

[jtcod] 11/6/2010 10:43

EC
Firstly RSA which is far from one of 'the very best insurers' is valued at 2x NTA. Yes it's far bigger but it has been a basket case for years.

Also, I agree that the institutions will decide but that figure will not necessarilly be what it is worth. I was stating what I believe it is worth because people were saying that £10 was fair. Institutions are on balance lousy investors btw. That's why 86% of them cannot even match the market.

Insurance is a long term game for the insurer and can only be judged/valued on the same basis rather than one years earnings or worries about a current market. BRE have a very big float when compared to their market cap. As an investor who has beaten the market and institutions for 15yrs by a significant margin, I believe a top investment team could gain significantly higher return (whilst still keeping within rules) from that float, should that be their strategy. And yes, even over the next 6 years.

I didn't say an Equity firm should pay £16 per share. They never pay fair value for a business but a reasonable take-out price should be nearer £13 imo. So we are not that far apart in our calculations.