Part of the Fool's mission is to continue to update investors on the companies they're interested in. As part of that mission to educate, we bring you this series of "Revisited," where we go back to recent SEC filings to dig in deep so you don't have to.

Although competing insurers such as Progressive (NYSE:PGR), Markel (NYSE:MKL), White Mountains (NYSE:WTM), and Berkshire Hathaway (NYSE:BRK-A) get most of the "props" (or, in SAT language, "accolades") when it comes to running a great insurance operation, I strongly believe that WR Berkley (NYSE:BER) belongs on that first-tier list. I recently went over WR Berkley's latest 10-K to see what 2007 might hold.

Company snapshot
WR Berkley is a property casualty insurer with five insurance lines: specialty (including professional liability and commercial auto), regional commercial property casualty, alternative markets (including workers compensation), reinsurance, and international operations.

Bullish on Berkley
In 2002, WR Berkley wrote $2.7 billion in net premiums. By 2006, that number had jumped to $4.8 billion, a 15% annualized growth rate.

As you can see, WR Berkley's best attribute is its ability to internally grow its business at a fast pace, with the key caveat being that the company grows profitably. Any fool (with a lower-case f) can write an insurance policy; however, as Mr. Buffett says, it's when the tide goes out that you see who's swimming naked.

But much more important than the premium growth rate is WR Berkley's underwriting discipline. After all, if you're underwriting at a large loss, the more premiums you write, the tighter the noose gets around your neck. From 2002 to 2006, WR Berkley's combined ratio dropped (the lower the better) from a high of 95.4% in 2002 to 88% in 2006.

Another important note is that WR Berkley isn't simply overleveraging its balance sheet and taking wild risks to achieve great returns. All of WR Berkley's subsidiaries are rated by insurance rating agency A.M. Best at either A+ or A -- the second- and third-highest ratings.

Year in review
Fiscal 2006 was a banner year for WR Berkley. Although net premiums earned only grew 5% to $4.7 billion, investment income grew 45%, thanks to higher interest rates and a higher average level of invested assets. This, combined with a 130-basis-point drop in the combined ratio, led to a whopping 28% increase in net income, to $700 million.

Things to watch out for
On a historical basis, WR Berkley's 88% combined ratio is an outlier. In a nutshell, an insurer makes money by investing float (policyholder premiums). A very simplified equation for estimating the float's cost of funds is (100% - combined ratio). Thus, for any combined ratio below 100%, WR Berkley has a 0% or less cost of funds. As you can see, in the long run it'd be tough for WR Berkley or any competitor to sustain a positive 12% cost of funds -- in other words, an 88% combined ratio is almost too good to be true in the long run.

In fact, the P&C industry has seen a rising tide lift all boats. Many consider 2006, which was immensely helped by hard pricing thanks to the 2005 hurricanes, to be the best year ever for the U.S. P&C industry's profitability. According to a chart by A.M. Best and the Insurance Information Institute, there were only four years since 1975 when the P&C industry in totality posted an underwriting gain (implying a sub-100% combined ratio). The first two were in 1977 and 1978, and the second two were 2004 and 2006.

In other words, I expect WR Berkley to continue outperforming the industry; I just think (and I'm not exactly going out on a limb here) that the industry will be getting more competitive. In its 10-K, WR Berkley remarked that it saw significant price increases in 2002 and 2003; however, pricing pressures started to creep up in 2004, and pricing on WR Berkley's renewal business declined 2% in 2005 and 2006. In its latest conference call, WR Berkley management remarked that business has held up well, and pricing has been tough, albeit not yet irrational.

How to play it
I believe WR Berkley is the type of company where one smart purchase can result in a decade of outperformance. I consider very few companies worthy of holding for more than five years. The criteria I look for are great management, a competitive advantage, and a high return on equity (ROE) -- because in the long run, a stock's performance will generally mimic its ROE. WR Berkley has achieved 17 consecutive quarters of ROE in excess of 20%.

I calculate WR Berkley's $700 million 2006 net income as a 24% return on average equity. In terms of management, listening to WR Berkley's conference calls has given me extreme confidence in management's honesty and shareholder oversight -- not to mention the fact that founder William Berkley owns about 14% of the company.

Despite my belief that WR Berkley's stock is undervalued at less than 10 times trailing earnings, I'm not in a rush to buy the stock. This is a company I plan on owning for the long haul, so I also plan on picking my entry very carefully. Because I believe the P&C industry is near a cyclical peak in profitability, I am also willing to patiently wait for a severe industry downturn -- where the babies will be thrown out with the bathwater.

Because WR Berkley is such a stellar performer, the crisis will have to be very severe for its stock to sell off, so I will have to be very patient. Most value investors refer to this as waiting for a fat pitch before taking a swing. Although I think WR Berkley's current share price represents a fat pitch, if an industry downturn occurs within the next couple of years, I think I might have an opportunity to knock the cover off the ball.

Related Foolishness:

Berkshire Hathaway is a Motley Fool Inside Value recommendation. Try any one of our investing services free for 30 days.

Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.