As far as the insurance industry is concerned, now is not the best time for the industry. Referred to as a soft market, insurance premiums are not strong enough to coincide for the risks assumed. Some insurance companies overlook such conditions and choose to write premiums regardless of the underwriting quality and the rates charged. For other insurers who exercise more underwriting discipline, these aren't the best times to be in business. But ironically, this may be the best time to invest in them. (For more, see Introduction To Insurance.)
As Cycles Go
About the only predictable thing in the insurance business is that at some point the market must improve. Undisciplined insurers can only write unattractive premiums for so long. At some point, claims paid begin to overwhelm the premiums charged. Insurers who write such policies begin experiencing greater losses and are forced to write fewer policies. As the supply diminishes, rates begin to harden. Insurers who have then been waiting and watching are able to come in and write profitable policies. In the insurance business, it's all about discipline and risk assessment. (For a quick refresher, check out The History Of Insurance In America.)
One Of The Finest
In terms of quality, White Mountains Insurance (NYSE: WTM) is one of the more highly regarded names. This property and casualty insurer operates all over the world. It also provides reinsurance and various other specialty lines of insurance. One of the most important metrics in the insurance business is per share book value. Insurance, in its essence, is a simple business. An insurance company writes policies, takes the premiums and waits to pay out claims. The complexity is in the discipline and capital allocation. While waiting to pay out claims, insurance companies can invest the cash, otherwise known as float. No better example exists of how skilled capital allocation leverages the earnings of an insurance company than Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B), the conglomerate run by Warren Buffett.
When you read Berkshire's annual results, the first thing Buffett reveals is the growth in book value per share. It's that number, not the stock price, that defines a well-managed insurance company.
A Great Record
Since 2001, White Mountains has increased its book value per share from $151 to over $400 today. As of April 29, book value per share was $411. Today the shares trade for $333 or approximately 80% of adjusted per share book value. That's a very attractive valuation for such a quality business. During hard insurance markets such as 2004-2005, shares in many insurance companies, including White Mountains, traded for as much as twice book value.
Today other excellent insurance companies like Markel (NYSE: MKL) and Fairfax Financial (OTCBB: FRFHF) trade at premiums to book value. There's no reason for White Mountain to do the same. Don't expect such valuation to occur soon simply because other competitors are trading at premiums to book. However, as the insurance industry hardens, premiums will become more attractive, and the opportunity to deliver strong underwriting profits will improve. That, in addition to management's conservative approach to managing the float, should all lead to a continued increase in book value per share over the years to come.
For more, see How An Insurance Company Determines Your Premiums.