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Tickers in this Article: WRB, ALL, ACGL, NSYE:BRK-A, PGR, XL
Storms both real and figurative have been buffeting the insurance industry for some time now. Loose underwriting standards and a drive for market share have kept a lid on premium price increases, storms and natural disasters have been whacking the loss ratios and a low interest rate environment - combined with default worries at national and local levels - has hampered investment income.

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In times like these, W.R. Berkley (NYSE:WRB) is a relatively safe harbor.

A Mix of News For Q2
In one very big respect, the second quarter was a bad one, but in many other ways it was a confirmation of real progress. Operating income was down about one-third from last year and that's the big negative take-away for investors.

This decline in income was a direct result of storm and catastrophe, as Berkley had to pay much more in claims than normal. Berkley only rarely sees its combined ratio climb above 100 (basically meaning that it paid more in claims than it took in premiums), but this one of those quarters. While the company saw a slight increase in its expense ratio (up about 60 basis points), that was buried by a whopping six point increase in loss ratio (for a combined ratio of 101.1).

On a more positive note, written premiums were up 10% and earned premiums rose 7%. Berkley reported a 2% increase in average premiums, continuing a trend of price increases, while strong volume made up the difference. Premium growth was notably strong in the company's specialty (a core operating segment) and international.

Well-Positioned for a Bad Scenario?
Insurance is all about understand and pricing risk, and maybe that speaks as to why the company has a modest allocation to Treasury securities in its investment portfolio (around 8%). What's more, Berkley is seeing better performance from its portfolio, as investment income rose 15% this quarter. With that relative tolerable allocation to Treasuries, Berkley should do alright in the event of a default.

Cat Losses Nothing New
By no means is Berkley alone in a poor combined ratio for this quarter. Storms and natural disasters have affected virtually all insurers - including large P&C players like Allstate (NYSE:ALL) and Progressive (NYSE:PGR), reinsurers like XL Capital (NYSE:XL) and Arch Capital (Nasdaq:ACGL), and major international operators like Berkshire Hathaway (NYSE:BRK.A), Munich Re and Swiss Re.

What makes Berkley different, though, is the company's demonstrated record of excellence in operations and underwriting. Like Berkshire or Arch Capital, Berkley is prudent in pricing risk (and stepping back when pricing is not good enough), willing to devolve authority to managers down the chain of command, and led by very savvy senior management. What's more, unlike major P&C companies like Allstate and Progressive, Berkley is not beset to the same extent by unreasonable competitors and burdensome state-by-state regulation.

The Bottom Line
Even allowing for difficult operating conditions, Berkley does not seem to be getting the respect it deserves. Berkley routinely produced returns on equity in the high teens and 20s prior to the credit crisis, but the stock seems to be pricing in future ROEs below 15%. Granted, the environment of pre-2008 may never return (or at least not for a long, long time), and there is the inevitability of Mr. Berkley's retirement, but it still seems like the Street is unusually pessimistic regarding a proven player.

Of course, Berkley isn't alone in under-loved insurance; Berkshire Hathaway itself has a similar price-to-book valuation and expectations for Arch Capital aren't too strenuous either. If Berkley rebounds to a level of 13% ROEs, the shares are modestly undervalued, while a return to a sustained ROE of 15% or so would mean almost one-third undervaluation (on a returns-to-equity model). All in all, Berkley seems like a risk worth taking, but investors need to realize this won't be a fireball stock in their portfolio. (For additional reading, see How ROE Can Help You Find Profitable Stocks.)

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