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Published: September 22, 2009
I heard an interesting story last week from the
CFO of an insurance company I follow...
This company had insured a restaurant in Miami last year. It's a
modest restaurant with a property value of $1.5 million. It's
located six miles from the coast, which makes it "zone one" in
terms of hurricane risk.
The insurance company had written a $1.5 million property
insurance contract on this restaurant and a "companion" contract
for a further $1 million to cover additional liabilities. It
collected $46,000 in premiums for writing this insurance.
When it came to renewing the contract this year, the
underwriters reviewed the case and decided the property was
worth more than $1.5 million. They ran the new data through
their risk models and decided to raise the price of their
insurance to $54,000.
The increase prompted the restaurant to shop around for a better
deal. It found three other insurance companies willing to write
the insurance for less than $40,000.
The CFO used this story to explain to shareholders why his
company is losing business every quarter. "The appetite from a
lot of the competitors is much stronger than [ours] right now."
The key to banking is, you never lend money at an interest rate
that's too low, even if it means you lose business to a more
aggressive lender. It's the same in insurance. Never write
insurance when it's not profitable, even if it means you lose
the business. There's a saying in the insurance industry that
makes the point: "Volume is for vanity, but profit is for
sanity."
MarketScout tracks pricing trends
in the insurance industry. In June,
Richard Kerr, MarketScout's CEO,
announced three publicly traded
insurers were "clamoring for
premium, seemingly at any rate." He
called these insurers "the terrible
trio," and said they were
responsible for keeping insurance
prices low across the whole
industry.
(Kerr didn't identify the terrible
trio, but AIG is one of them. With
the company on government life
support, AIG's underwriters went on
a massive insurance binge,
collecting as many premiums as they
could, as quickly as possible.)
Here's the thing: These acts of
desperation by a few large players
almost always mark the bottom of the
insurance price cycle.
Towers Perrin's Commercial Lines
Insurance Pricing Survey (CLIPS) is
the most accurate pricing survey in
the insurance business. CLIPS shows
prices in property and casualty
insurance have fallen every quarter
for the last four years... and are
now down as much as 66% from their
peak after September 11, 2001.
The chart shows the year-over-year
change in insurance prices, as
measured by CLIPS. When the line is
above 0%, insurance prices are
rising. When the line is below 0%,
insurance prices are falling. Prices
were still falling in the first
quarter of 2009...
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But the most recent survey shows prices fell less than -1%
from the same time last year. "The smallest decline in four
years provides increasing evidence that the soft market is
reaching its end," says Insurance Services Network. The classic
insurance cycle takes a decade to go full circle. Once the cycle
turns, we should get three to five years of strong prices.
As an investment analyst, I've studied all kinds of income
products that can compound your wealth -- including bonds, real
estate investment trusts (REITs), blue-chip dividend growers,
and high-yield stocks. But I've never found a mature business
that compounds wealth better than a high-quality insurance
company.
One company I follow has compounded its stock price at +23% per
year over the last 23 years. This includes the last weak
insurance cycle, where shareholders made nothing for seven
straight years. Another company has generated +16% compound
annual growth in stock price over the past 25 years, but the CEO
expects his company to "comfortably" exceed these returns going
forward.
Of course, the classic example of an insurance company that'll
make excess returns in an insurance bull market is Berkshire
Hathaway (NYSE: BRK-B). It's the best insurance company in the world... and
Warren Buffett, Berkshire's CEO, expects shareholders to
compound their money by about +7% a year.
With the insurance cycle about to turn, it's the perfect time to
load up on top-quality insurance companies... Berkshire Hathaway
is a great place to start your research. -- Tom Dyson
Contributing Editor
Daily
Wealth |
