Thanks. Good afternoon, everybody. My name's Mike Zaremski, I'm excited to have Bill and Rob Berkley of W. R. Berkley joining us today. There's a good amount of buzz around innovation and change within the property and casualty insurance industry, which some within the industry term InsurTech related companies. I'd be remiss if I didn't point out that one of W. R. Berkley's core competencies is its ability to capitalize on changing market opportunities, both within the company's insurance operations and alternative investment portfolio. Bill Berkley founded the company with a few thousand dollars back in 1967. Many of W. R. Berkley's 50-plus operating subsidiaries were formed over the past decades in order to take advantage of changing market dynamics. The format of today's conversation will be a fireside chat. In the second half of our discussion, I'll poll the audience for potential Q&A.
With that, I'll kick off our conversation with a question for Bill and Rob. I feel even though your stock price has done very well over the last couple of years, I still feel like there's a lot of investors that might not fully appreciate some of your, let's call them competitive dynamics or core competencies or why you're structured differently than the average P&C company. Maybe you can just talk at a high level if you feel there's one or two competitive advantages or distinctions between W. R. Berkley and some of the other insurance companies you're compared to.
Do you want to? Okay. I think that there is a big difference between us and certainly many of our peers, or at least how our peer group has been defined by others. It starts with the idea of specialization. We believe that the insurance industry, while there are aspects of it that are easily defined as a commodity, the parts of the market that we choose to participate in are easily de-commoditized through knowledge, expertise, intellectual capital. It is this understanding, this focus, this recognition, which is really what's led us to a decentralized model. It's our decentralized structure and the empowering of people and leveraging their expertise in certain subject matters is ultimately the great differentiator for us in bringing value to customers and for us bringing value to shareholders.
I would tell you that the specialization and our structure allows us to specialize in a way that others don't. Ultimately, that allows us to achieve better outcomes. It's worked well for some period of time. We are quite committed to it.
That's great. Maybe we can move to kind of P&C market dynamics. Let's just start with interest rates, given everyone's kind of staring at their screens the last, especially couple days. Do you feel the curve being flattish, combined with, I know there's a number of insurers that have wrongfully over the last decade felt that interest rates would increase. Do you feel like this leads to a dynamic whereby insurers are more disciplined, and you feel that the industry will kind of be able to push pricing to get the kind of extra rate they need given the loss of investment income?
Well, certainly from my perspective, and you'll have some thoughts, too, I would imagine, but my view is that there are a few different pressures that are creating a level of discipline for the commercial P&C space in particular. It is the reality of a low interest rate environment and what does that mean for investment income? There's the other reality that we would all define as the tax arbitrage that existed for an extended period of time has gone away. Clearly, frequency of severity on the property front has brought pressure to the situation. Then finally, and perhaps we'll get onto this a little bit later, but you're seeing just a tick up in loss cost trend, particularly in some of the liability lines that's stemming from something that's been labeled social inflation.
All of those things, investment income, not to be glossed over at all because it is a huge component of the industry's economic model, that is putting a lot of pressure and forcing people to think about rates and how they are going to generate earnings in a different way than they did not that long ago.
I think that there's also the issue of how do you invest your money? If you look at our portfolio 10, 12 years ago, we were effectively a fixed income investor. As you started to see the demand for fixed income securities increasing and returns going down, we started to invest in other ways. We're investors in real estate, private equity, and a number of things to give us a better return, and we think risk-adjusted, a substantially better return. While it's not as smooth and predictable quarter by quarter, we think we found other ways to get that return that we need. One, we do need better underwriting results, which we're getting through price increases. We also have changed our portfolio mix, still very conservative, but a little bit more lumpy to give us better returns.
Can you continue to push in terms of moving towards non-plain vanilla fixed income, or is there kind of a regulatory governor in terms of how much you can push the limit?
We're a long way from the regulatory governor. We have lots of space. The question is, do we have lots of opportunity? We talk about measuring our results by risk-adjusted return. Notice we don't say return adjusted by risk. We say risk-adjusted return because we look at risk first. A lot of the kinds of investments that we make have implicitly a certain level of risk. In order to get those returns, we don't want to increase our risk beyond what would be acceptable. It's harder to find those kinds of things. We'll continue to look. We'll realize some of the gains, and we'll continue to look. It's the market that's going to tell us whether we can find those opportunities.
Your non fixed income investment returns have been superior than those of most of your peers. Are most of those investments sourced internally or a mix of internal and external? Is there a team inside Berkley that works on that?
Yes. The gains have predominantly been from a couple of different parts of the investment team that is within the organization. By and large, the gains that you're referring to, that we've seen over the past several years that we would expect we will be seeing going forward as well when we look at the pipeline, they are primarily driven, again, by teams of people that are operating in the alternative asset space that are employees of the company, for the organization.
Maybe, Rob, we'll move back to a topic you brought up earlier in terms of, you mentioned a pickup in casualty inflation. I feel for some companies, some of the results have depicted more than just a pickup. It's been a little lumpy in terms of some charges. Maybe more broadly, do you feel like social inflation is something that's here to stay? Is it something that insurers can truly measure? Maybe if you want to remind, do you feel like there's a definition of social inflation, or is it just kind of a number of factors in terms of more jury awards and more?
The way we think of social inflation or internally would define it, is anything that's driving loss cost trend as a result of what you see going on in the social environment, the legal environment, or a shift in society. Clearly, we have been seeing a trend over the past couple of years, and we've been talking about it for a few years. While it first started to sort of percolate a little bit, it's very visible at this stage in a lot of the liability exposure across the board. Is it going to go on forever? It's going to go on for some period of time. What will stop it? What will stop it is when all of a sudden society decides that they've had enough and that they look for some degree of tort reform.
History would suggest it needs to get pretty bad for that to happen. If you think back to, I don't know, give or take a decade and a half or 2 decades ago, we saw it. We've used this example in the past, but we saw it in the healthcare space with med mal, where jury awards got to the point where insurance companies were losing oodles of money. The rates went up dramatically for med mal cover. Doctors couldn't afford to pay for it, and lo and behold, you find yourself in certain parts of the country where you couldn't find a doctor to deliver a baby, amongst other things. We haven't gotten to that point where the pain is so overwhelming it's affecting society in that way. Is it pointed in that direction? Yes. How bad will it get, and how quickly will we get to that inflection point?
I don't know. There have been some people that have suggested that they don't think it's real. There are some people who have said that it's just a blip. From our perspective, it is a meaningful trend that is clearly driving loss costs, and it is likely to be impacting the industry's loss costs for some period of time.
Would you say there's any attributes an insurer may have that would make them more or less susceptible to inflation? Has Berkley tried to remix its portfolio at all, maybe de-emphasizing certain industries? Just thinking more broadly.
Certainly from our perspective, this is something that will affect societies across the board. I don't think anyone is completely insulated from it. Clearly, there are certain industries and certain profiles of accounts that are more susceptible to this type of exposure than others. I think there's been some discussion comparing large accounts versus small accounts. We think everyone is exposed. Generally speaking, again, using a very broad brush, larger accounts are going to probably draw more attention than smaller accounts when it comes to some of the challenges around this topic.
Okay. Limits, remind us, Berkley's limit size tends to be $1 million or less.
What we've shared with people is that if you look at our limits profile as an organization in our insurance business, for the policies where you're legally allowed to have a limit for not workers' compensation, but other types of policies, approximately 90% of our policy count has a limit of $2 million or less. I think that speaks to the idea that by and large, we are not a large account organization. While we do write some of that's not the primary focus.
Maybe moving to margins on the P&C side. Last year, on the podium up here, I believe you, Rob, spoke to being optimistic that Berkley could show some margin improvement, given the rate environment seemed to be conducive, increasing, and you felt there was some mix shift benefits that would come to fruition. Fast-forward a year, and for the most part, your outlook came to be. What are you thinking now in terms of the coming year? It feels like you're getting more rate than you have in the past. Loss inflation is still increasing. Maybe you could kind of talk to how you see the next year playing out.
I think for the industry overall, there is a broad recognition that there's a bit of catch-up that needs to go on. Loss costs have proven to be above and beyond what many people had anticipated, and I think there's also a general recognition that that trend continues to move up and forward. It is a game of catch-up. I think the industry, depending on who you're talking about and what corner of the marketplace we're referring to, is in a different position as far as hardening goes. Ex workers' compensation within the commercial line space, I don't think there is a meaningful pocket that you're not going to see at least a continuation of what we saw in 2019, and in many cases, likely an acceleration as far as rate goes.
I think for those organizations that along the way have not let things get away from them very much and have kept an eye on their loss costs, this is going to prove to be a great opportunity because they're able to use this as a way to sprint forward. I think there will be some market participants that are scurrying around trying to figure out how to bail the water out of the boat as quickly as possible. When we looked at the fourth quarter, we were pleased with what was accomplished for us as an organization and what we were able to achieve in the marketplace. We continue to, by and large, choose rate over policy count growth, and you could see that in our fourth quarter numbers where we grew at approximately 9% and we got 8.9 points of rate.
Again, as we see those margins start to become more attractive, I think you are going to start to see our top-line growth even more, not just due to rate, but policy count growth will be there as well. Our sense is that's coming in 2020.
Given loss costs are increasing, even though pricing seems like it's outpacing it as you're describing, does it make sense for a P&C insurer to reserve more conservatively, given there might be some additional uncertainty around loss inflation?
From our perspective, we think it makes sense when it comes to reserving to early on err on the side of caution, with the idea as those reserves season out, then you can recognize that caution. When we think about the environment that we're looking at today, with the type of pricing that was achieved in the fourth quarter and our expectations going forward, clearly in spite of trend being up, we think when you're getting about nine points of rate, we're comfortably outpacing trend. As that premium earns through at those higher rates, it's hard to imagine that that is not going to prove to be accretive or enhance our margins.
You've improved your expense ratio over the past couple of years, fairly measurably. I think you have a long-term goal of bringing it down another couple of points. Let's say the rate environment moves to the double digits next year. Will that kind of get you closer to your 30% long-term target faster than the base case?
I think there are three opportunities for us as an organization over time to continue to push that expense ratio down and seek greater efficiency on behalf of not just our shareholders, but all stakeholders. Number one, clearly we'll benefit from more scale in the organization, higher rates, and ultimately greater policy count. There are many of our operating units where there is a lot of runway, a lot of leverage to be had as they can scale in a market which is more conducive to growth, which seems to be coming our way. That's what I would define in the short run.
In the short to intermediate term, I think you're going to see opportunities that we're able to capitalize on in finding efficiencies in how we operate internally. We have found some of those, which is one of the reasons why you've seen our expense ratio coming down over the past couple of years. There's more opportunity there, but that will take time. Then I think sort of intermediate to longer term, perhaps the question for the industry is how does one think about acquisition cost? When you think about the expense ratio and how much of that is associated with acquisition costs, from our perspective, it's not clear that long term is going to be sustainable.
Ultimately, it's likely, in our opinion, at some point the customer, the insured, if you will, is going to be scratching their head saying, "How many pennies on every dollar of premium am I paying for access? Beyond access, what is the value proposition?" I don't think that's here. I don't think that's today. I don't think that's solely a distribution issue or a carrier issue. I think that's a shared issue for carriers and distribution to work together to figure out how are we going to be bringing more value to customers.
I think that ultimately we are the most expensive insurance overall, life insurance, along with profitability, distributor of financial services. We have to drive the cost down. There's two pieces to the cost. One is the distribution cost, the other is the claim settlement cost. artificial intelligence is going to do wonders to claim settlement cost. It's going to drive down the cost. We're going to have a lot more data. People have barely started to use that. If you look at claim settlement cost, huge number, a very substantial part of that goes to attorneys who represent plaintiffs. It's going to really have an impact at some point in time. The distribution cost, again, it's going to end up being a service fee, and it'll depend on how much advice you get. It all has to change because it's going to come down to this data-focused age.
Everything is transparent. People will see how much they pay. People won't like what they pay for lots of these services, and it's going to become visible, and visibility ends up changing how business is done. Lots of changes, which will create opportunities to lower the cost to the customer. Net will improve our margins.
What is Berkley doing in that InsurTech world? Are you guys partnering with any interesting companies, investing in companies? How do you guys view-- it seems like there's a lot of exciting things taking place. How are you guys involved in that world?
The answers to the questions, Mike, are yes and yes. We are partnering. We are investing. The InsurTech space is an interesting one, where clearly there are going to be some fabulous grand slam home runs, and there will probably also be some horrific failures along the way as well. We do think that it's a great opportunity. We look at it in a two-pronged way. One, an opportunity for us to explore tools to run our business more effectively and to bring more value. Two, obviously, as a component of the investment portfolio. In many of the things that we've done around this topic, we've been able to employ both prongs of that fork, where we're able to, as a potential user of a product, be part of the due diligence and assess the applicability. We have done a few things.
I expect we'll do a few more, it's not because we're just trying to do it because everyone else is. We're very selective. I think one of the other things is because of our structure, it lends itself to experimentation. We have 52 different laboratories that are very specialized, and we're able to play with different tools in a very focused way. That's proven to be very helpful in exploring opportunities within the InsurTech space. Quite frankly, it's helpful to us in general because it allows us also to consider new ventures without necessarily tinkering with what we already have.
Is there any examples or areas you're tinkering with maybe looking at trying to go direct to the business, so disintermediate the broker?
We do have an operation, not where we are necessarily trying to disintermediate the traditional distribution, but we do have a business that is part of the group that does deal directly with certain types of customers.
Okay. Maybe we could talk about excess capital, and maybe you can remind us. I know usually over the last year or so, or maybe more, or you can tell us, you use special dividends as the main means of returning excess capital to shareholders. Is there a valuation kind of level that you feel buybacks make more sense? People are looking at their screens today and this past week and seeing stocks come in a little bit. Maybe you can remind us when it flips to buybacks making more sense.
Every day, our stock is a bargain. The only question is how and what we allocate our resources to. We bought some stock back at the end of last year. We'll buy stock back opportunistically, and we'll pay a special dividend. It's a judgment at any one point in time. One of the problems, as we go over the new accounting rules and whatever, the financial statements, while the accountants are desperate to try to make them easier to understand, they really make them less easy to understand. Unrealized gains on securities now come through your income statement. You haven't sold them, but they still come through your income statement. We have real estate where we realize gains, but that doesn't come through until you sell it. You have different kinds of assets that only get recognized when there's a transaction.
We try and look at what we think the intrinsic value of the company is and look at the value of the stock and make that decision. We're, I think, always interested in buying stock back, and if somebody offered us a big enough block at a reasonable price, we're very likely to buy it. I don't think we have one rule that said today, this is what we would do. It's a judgment, just as we manage our business at any point in time slightly differently, depending on how we see the future and where we think. The optimal thing for us is we would never buy a share back, and we would never pay a special dividend because that means the business opportunities are so great we can use all the money.
We do not believe in accumulating excess capital for the potential for what the future will be. We're confident in our ability to earn money, to generate capital, to be able to grow. The long and short of it is it's an opportunist decision that's constantly under review.
Can you comment on the coronavirus and its potential impact on P&C insurers? More broadly, most insurers have said that there's exclusions within the policies, and they don't feel that many policies would be triggered. Maybe you could comment on Berkley's view.
Why don't I give a broad-based and then I can talk specifically.
Yeah.
Broad-based, in general, there's nothing about the coronavirus that would cause particular claims or considerations. Business interruption generally is not covered by these things. Workers' compensation generally would not be covered by these things. I think that the likely issues are adverse consequences because businesses take decisions in order to prevent adverse consequences, none of which would be covered by insurance. You close a plant for a week or a month, not an insured loss. Those are the kinds of things that are likely to happen. A hotel in the Canary Islands got quarantined by the Spanish government. It's not an insured event. I'm not sure what the people who were inside the hotel think, and most of them wouldn't have insurance that would cover. For the most part, the coronavirus is a non-insurance event. Not 100%, because you never know specific exclusions. Jim?
That's very good. Any questions from the audience?
I have just a comment on the market. We've had a big, long decline in prices and now we've got the automatic that will be more expensive than. Specifically, how do you decide when to stocks versus exactly? Obviously, for buyers, one of the biggest concerns is to get still insurance or reinsurance itself from the various types, not any much from small buyers. Is this something that we're missing it by various sizes of data that we haven't seen yet? Or is it that there's other metrics that we know from CNN and different types of things that tell you that there was all this stuff going on reflected in prices? Two things going through my head. Complex right now is just drawing prices into that CNN that's really expanding.
If you want to.
From my perspective, while recently there have been two, if you look back over maybe a slightly more extended period of time, there's been a bit more noise than that. I think there's likely to be more noise.
I think that we may not see the calamities that we saw in sort of, call it 1999, 2000, on a policy year, or 2001 into 2002 on a calendar year. You have this thing called workers' compensation, and that is helping a lot of folks cover up a lot of wounds. I think that for the liability lines, it is likely that it is going to get more challenging from here. I don't think all the pain has come to the surface yet, and I think that there is a reasonable chance, per the comments earlier, that you could see things for some of the liability lines accelerate from here. We don't, I don't, and my colleagues don't think that this is going to be anything like perhaps what you may be aware of, that occurred in 1986.
From our perspective, it will be more akin to, in some cases, what you saw in 2001, 2002, 2003. The workers' comp component, that is a big difference between now and 2001, 2002, 2003. That being the largest component of the commercial lines market has given people a little bit of breathing room. Again, that is not solving the problems. It's just allowing them to be able to address the problems in not such a short period of time. Again, from our perspective, the rate increases are going to keep coming. You're going to keep seeing terms and conditions tightening. You're going to keep seeing the standard market contracting its appetite, creating those opportunities for specialty players, in particular the E&S market, but specialty in general.
I think we can touch on that as our potential last question, unless there's another question in the audience. The contraction of the appetites of the, in the traditional market to the E&S marketplace, where are we in that cycle? Historically, has there been cycles where there's been a lot more contraction? Just kind of curious if there's a way to size up kind of what the dynamics are taking place right now.
As far as the shift in the appetite of the standard market, I think oftentimes when we reflect on what happened in the past, it feels like it sort of happened overnight. The reality is that it starts out as, or typically starts out as a bit of a groundswell that builds. Because people will take certain underwriting action and contract the appetite a little bit and with the hope that that's going to remedy the situation. As things continue to develop, it becomes apparent that actually that wasn't enough, and it builds from there. To answer your question, Mike, from my perspective, we are still in the relatively early stages of the correction for the liability business. For the property business, we're probably farther along. Again, that's just a reflection of the tail. Property, those realities come into focus more quickly.
On the liability line, that takes longer for it to come into focus, as a result, it has more time to drift off course, quite frankly, oftentimes that's why the reaction is longer lasting and more meaningful.
Okay.
Early stages on the liability front.
Thank you very much. Bill, Rob, always great to speak to you guys.
Thanks for the invite. Thank you.