This article is part of our Rising Star Portfolios series
Just last month, I opined that economics are not permanently out of fashion, but on vacation. As a matter of practicality and computer models, I believe insurance markets are bound to harden. With that as a backdrop, I've thought W.R. Berkley (NYSE: WRB ) and Aon (NYSE: AON ) compelling ways to pay this trend's likely emergence.
Insurance markets have languished for seven years running, characterized by soft pricing, overcapacity, and the industry's willingness to insure risks at bad prices. At some point, that becomes unsustainable. With Berkley's second-quarter earnings out, I'd wager that time is coming near.
For the unapprised, W.R. Berkley isn't a garden-variety insurance company: It writes insurance on unconventional, weird, or sometimes ugly risks. The company doesn't work in well-trafficked areas of the market, because the money isn't there. And most importantly, management will not grow for growth's sake. It waits for the market to serve a fat pitch.
That makes this quarter's results, a period wrought by catastrophe, particularly significant. The company actually grew: Net written premiums increased 10%, and pricing improved 2%. Book value at the insurer grew 4%, on solid investment returns and share repurchases. The company's combined ratio -- a metric used to measure underwriting profitability -- clocked in at 101%, as losses mounted on the Midwest tornadoes. All considered, this is a very good result, in light of the severity and frequency of catastrophic events last quarter.
These results tell two stories. One is Berkley-specific, and that's of continued, disciplined underwriting. The other is industrywide. In line with recent quarters' rhetoric, Chairman Bill Berkley expressed guarded optimism that rates are poised to turn. With pricing improving, are we really on the verge of a recovery?
Tentative indications are …
Yes. Well, yes with a caveat. A quarter doesn't make a trend, but if we're to give a nod to some of Berkley's larger peers, all signs point to yes. Their profitability was absolutely dreadful, and that just might be enough to compel pricing higher.
Travelers (NYSE: TRV ) , not known to stretch for underwriting results, posted a 136% combined ratio. Let's rephrase that for emphasis: For every dollar of premium it brought in, it lost $0.36. Chubb (NYSE: CB ) , among the industry's savviest underwriters, had its underwriting profits just halved from the year-ago period, as its combined ratio slipped to 94.9%. Both cited improving pricing and signaled firming markets.
A look at the reinsurers -- which assume the (sometimes large) risks ordinary insurers would rather not -- reveals much of the same. RenaissanceRe (NYSE: RNR ) , reported a 95.5% combined ratio, compared with 20.2% in the year earlier. Arch Capital's (Nasdaq: ACGL ) combined ratio slipped to 99.6% from 90%. Also note: These are two of the industry's savviest. In the context of a Berkley thesis, it's also quite important. If reinsurers and insurers are suffering, the industry can't write risks at bad prices anymore.
Unfortunate as it is, that may be just what the industry needed.
Oh, but wait …
That all comes with one caveat, as Bill Berkley was quick to note, and that's the state of the economy. If politicians continue their self-destruction dance over the debt ceiling, unemployment will continue to stagnate and businesses small and large will undoubtedly suffer, to put it mildly. That'd put a tentative recovery to an abrupt stop.
That said, at just 1.1 times its book value, Berkley shares aren't pricing an astounding recovery. In fact, they're not pricing much of anything, which affords more-than-adequate protection against the downside. And for my part, I think a recovery to underwriting markets is drawing close. That's why I'll continue to hold and, if conditions permit, buy more W.R. Berkley, in my Rising Stars Portfolio.