When people think of exciting industries, insurance rarely makes the list. Maybe it's all the mathematics involved, or maybe it's the image of the flannel suit-clad door-to-door insurance salesman of yore that leads to yawns.
Whatever the case, insurance is actually a dynamic, not to mention profitable, business. As such, companies that remain nimble and flexible enough to exploit opportunities can do very well for themselves. With a mix of management that is both aggressive and prudent, Arch Capital (NASDAQ:ACGL) is one such nimble player.
For the fourth quarter, its gross premiums written grew to just over $900 million and EPS came in at $1.45, versus $1.22 a year ago. Also, the company's combined ratio (a measurement of expenses and losses on policies) also improved by about 1.5%. Book value growth, one of the most important metrics for insurers, was up 21.6% for the year and 5.1% from the third quarter.
Dividing its business almost 50/50 between insurance and reinsurance, Arch Capital is involved in numerous markets like casualty, professional liability, and property insurance. While management likes to maintain a toehold in almost all of its markets, the company is very aggressive about focusing on specific niches when the pricing appears favorable.
During the strong pricing environment of the early 2000s, Arch Capital was extremely aggressive in writing business, and that's generally a good thing. By writing a lot of profitable business when prices were strong, Arch Capital salted away some profitability and does not have to be nearly so aggressive in chasing business now that the market has turned weaker.
Arch Capital's management applies that same philosophy of opportunism and flexibility to its capital structure. Specifically, the company looks to increase its capital base in times of strong pricing so that it can write more business, while reducing the base in weaker environments.
While management did not commit itself to any particular moves such as a dividend, a special dividend, or a share buyback, there was a clear suggestion that the company's board would soon be talking about ways of returning capital to shareholders.
Fools also need to be aware of potential regulatory risk. While the company believes it has nothing to worry about from the bid-rigging investigation that hit Marsh & McLennan (NYSE:MMC ) and other insurers, it has been subpoenaed regarding some activities in underwriting insurance for (ironically) lawyers and law firms.
As many insurers are choosing to follow a "growth for growth's sake" approach to writing new policies, rates are coming down. Concurrently, valuations for insurance companies have come down in anticipation of lower growth and lower profitability.
While it is probably true that Arch Capital won't be able to maintain its current level of growth or return on equity, it appears as though current valuations are overdiscounting the coming slowdown. With a solid (albeit aggressive) underwriting philosophy and a broad exposure to numerous markets, Arch Capital will almost certainly be one of the survivors of any industry downturn.
Fool contributor Stephen Simpson, a chartered financial analyst, has no ownership interest in any stocks mentioned.
