This has been a year many investors would like to forget. The S&P 500 index is down 17% since the start of the year, while the tech-heavy Nasdaq Composite is down more than 29%.
Although no one knows when the market will rebound, every bear market has eventually given way to a bull market. One way you can capitalize on the rebound in stocks is by investing in specialty insurer Markel (MKL 0.80%).
Markel writes insurance policies, but what I find most intriguing is its sizable investment portfolio. While most insurers invest conservatively in bonds, Markel takes a more aggressive approach by investing in stocks and private businesses to boost returns, earning it the nickname Baby Berkshire. Here's why the insurer deserves a spot in your portfolio.
Markel writes insurance policies on things others won't touch
Markel writes insurance policies for individuals and businesses, covering things traditional insurers won't touch. These policies are known as excess and surplus (E&S) because they are above and beyond standard insurance policies.
It offers policies covering small businesses, such as health and fitness centers, cattle farms and ranches, and medical services. Its policies for individuals range from bicycles, classic cars, and watercraft to wedding insurance.
Competition in E&S insurance is less about competing on price and more about using built-up knowledge to manage these unique risks. Markel has done a solid job of managing its risks and writing profitable insurance policies.
One measure of an insurer's profitability is its combined ratio, which is the ratio of claims and expenses divided by premiums collected. A ratio of less than 100% is good because it means a company is writing profitable policies. Over the last decade, Markel's combined ratio has averaged 95.5%.
It takes a more aggressive investment approach compared to peers
Markel does a fine job of writing policies on hard-to-place risk. However, its investment portfolio makes it stand out from other insurers.
Insurers collect premiums up front and don't need to pay out until customers make claims. In the meantime, insurers can put this cash (called the "float") to work in investments. When the policy period ends, the company keeps any funds not used to pay claims and is free to invest them as it sees fit.
Markel invests in high-quality government, municipal, and corporate bonds. And unlike most other insurers, Markel also invests significantly in equities and private companies -- 33% of its $21 billion investment portfolio is in equities. Some of Markel's largest investments include Berkshire Hathaway, Brookfield Asset Management, Alphabet, Home Depot, Deere & Co., Diageo, and Amazon.
The insurer also operates a Markel Venture segment, through which it owns a controlling interest in businesses outside of insurance. Some of its investments include luxury handbags, heavy construction machinery, homebuilders, and building supplies.
Its approach to investing in stocks and private companies is similar to that of Warren Buffett and Berkshire Hathaway: It seeks out high-quality, honest management teams, good capital discipline, and a reasonable acquisition price and intends to hold these investments for a long time.
Warren Buffett is already a huge fan of insurers because of the cash flow they generate. This, combined with Markel's similar investment principles, is likely why Berkshire Hathaway bought a stake in the specialty insurer for the first time this year, adding over 467,000 shares worth more than $600 million as of this writing.
Stellar cash flows from its insurance business will help grow its investment portfolio
Markel has done a stellar job of directing its investments in publicly and privately traded companies, but this year, those investments have struggled along with the rest of the market. Its investment losses through three-quarters of this year total $2.2 billion after posting gains of $1.1 billion in the same period last year.
Despite this, the stock is still up more than 4% this year as its insurance business keeps humming along. Its earned premiums are up 18% from the year before, driven by higher volumes, a favorable pricing environment, and expanded product offerings.
The company's free cash flow, or cash left over after paying for operations and capital expenditures, was $860 million in the third quarter. Markel can put this cash to work in more investments and take advantage of higher interest rates and discounted stock prices -- so when the market rebounds, this company will be in an excellent position to reap the rewards.