Pleased to have W. R. Berkley with us. We got Rob and Bill Berkley. Rob took over as CEO in 2015 after serving as President and COO for six years before that. Bill, of course, is the company's Founder and served as CEO for 50 years. Has to be one of the longest tenures, probably the longest tenure in the insurance industry.
No, you have Hank.
Oh, fair point. Although you're still at your company. Rob and Bill have been presenting at our conference for years. The company has changed over that time, but the message typically stays the same. It's very consistent, and that's what's created value over many years. I wanted to start with kind of a bigger picture topic, Rob, an open question, if you will. When you think about 2018, your key top 3 priorities for your company, the stuff you really want to get done.
Well, obviously, we are always focused on a simple idea, which isn't always easy to execute, and that is risk-adjusted return and return on capital through that lens. Our primary goal is just to make sure that we are getting the returns that we need given the risks that we take on. From our perspective, there are a lot of moving pieces out there in the marketplace these days, ranging from just general market conditions to inflation in general to certainly questions about loss cost trend and where that is going. Priority number 1 for us always is to make sure that we are charging what we believe is an adequate rate to achieve the margins that we are looking to achieve. Number 2 is to obviously pay attention to what's going on in the market and look for dislocation in the market, opportunities to build the business.
If you look back over the history of the organization, the vast majority of the activities that have gotten us to where we are today have been activities that could be defined as organic, that has really been as a result of us seeing dislocation in the market, which leads to opportunity for us to grow the business. We've seen some of that over the past few years, and we expect that there will be more to come.
You have done deals historically, it's been a long time since you've done an acquisition of size. Question is why? Are they deals that you probably could have done over the past five or 10 years that you passed on that in retrospect might have worked? What's held you back so much from doing deals?
Ultimately, some would suggest that we are cautious and cheap. From our perspective, yes, we are cautious. The cheap piece I don't think applies because really we look at the earnings power of an opportunity, we look at the risk that would come with that. The fact is, when it comes to buying an insurance business, we've seen this time and time again in the industry, very often people will fall in love with an M&A opportunity, very rarely does it work out to be as rosy and wonderful as they had thought it would be during the honeymoon period. Buying an insurance business is a very complicated thing. The seller should know more than the buyer, just naturally. Getting one's head around someone's balance sheet, particularly their reserves, is a very slippery slope.
Since we take a long-term view, we have preferred to take what we would define as more of a de novo approach, we think that allows us to create value for shareholders. Yes, it may take more time, ultimately, we think that gives it a better return. We have looked at transactions. It's very rare for you to hear about a transaction that occurs that we were not aware of in advance of it hitting the media or the tape. Again, generally speaking, we are not always convinced that you really get rewarded for that risk of unknown.
He was wrong. We are cheap.
Frugal.
Frugal.
We view our company's money as our money, and we will have the same tests for spending it on acquisitions as we do on investing it in our company, except there's the added uncertainty, and that causes you to be cheap. You need the margin that's additional to what you get. It embarrasses for me to say we're cheap, but it's okay.
We're cheap.
You mentioned these kind of de novo startup opportunities. We know you guys are doing them. They're not very visible because they're still in their infancy. If you could shed a little light on that, if you could talk about one or two of these opportunities that you've already planted, which ones could be the biggest, and how long does that take?
Well, the timeline of development really depends on the operation and the part of the market it participates in. Platform that is required to participate in that space. Perhaps the piece that has gotten more attention recently would be Berkley One, which is our entry into the high net worth space. It is a robust platform that is required. It is clearly different from some of the things we've done when we've entered certain parts of the specialty commercial line space, where quite frankly, you get a team of people, they join you and in relatively short order, that being less than 90 days from when they join you, oftentimes you can be up and running and writing business. The platform that is required to participate in the high net worth personal line space is significant and robust.
Not only does it take the time as an admitted product where you need to get your rates filed, and certainly insurance departments pay a lot of attention to filings when it comes to the consumer space. There's also the internal platform to ensure that you have the people, the expertise, the knowledge, and the technical platform to support the customer's needs. That would be an example of something where there is more lead time, but over a few years, we think it is going to have a very dramatic impact on the organization from a top-line perspective as well as obviously a bottom-line perspective as well. Other examples of businesses that we have entered would be more in the specialty space, obviously, some admitted, some non-admitted. An example would be what we've done in the energy space where we had a team of people join us.
There was part of the energy market that we were underweighted or really didn't have a presence in. Five, six years later, that's a $300-plus million-dollar business for us that's making a 10% underwriting margin.
On the high net worth business, you guys have highlighted that you've obviously had to invest in the business. I'm surprised those investments are multiples of what you had to do given the infrastructure you need. Have you approached this business in sort of a unique way, differently than, say, Chubb would have historically?
I can't speak to the details of the Chubb approach or anyone else's approach. Certainly when you're starting something from scratch and you don't have the burden of a legacy system, it does give you an opportunity to take a step back and say, "Since we're starting from scratch, in a perfect world, how would we build this?" When we think about customer needs, when we think about distribution needs, and honestly, at this stage, given the shift in how people want to transact and how their definition of service and how that's evolving, it gives us the opportunity to build out a platform that can give the high touch, if you will, in the traditional manner. Also make sure that the platform is multidimensional so we can give the high touch experience in what some might define as a more digital manner.
My insurance agent is looking forward to that offering, by the way, so just to let you know. Let's talk about the commercial side. You talked a bit about it on the conference call, outlook on pricing. You weren't overly enthusiastic, but there was a hint of enthusiasm in your voice on the call.
I think once upon a time, Jay, and you'll remember this, and I'm sure many people who are here remember it, the insurance marketplace seemed to move somewhat in lockstep, particularly the commercial line space. At this stage, it seems as though that is no longer the case, and it really differs by product line, and you need to use a much finer brush. On one hand, you're seeing, for example, commercial auto pricing moving up. You're seeing incremental improvement in casualty pricing. You're seeing significant improvement in some parts of the property market. On the other hand, the largest component of the domestic commercial lines market being workers' compensation, you're seeing rates come down and come down at a pretty healthy clip.
I think that it's not a free-for-all that everything is wonderful, but I think it's when an organization like ours where we are able to look at the business in a very granular way, and there are parts of it where we see great opportunity and there are parts of it that we are going to be very cautious to make sure that we write the business when we think the margin is there.
Let me question on this topic for Bill. You've lived through a couple more cycles than Rob and I have.
Thank you.
It's just a fact.
It seems like I could hit somebody with this.
How does the market now it feels like it's more rational than it had been in the past. Is that accurate? How would you compare today's environment to what you might have seen historically?
I don't think the market is more rational. It is different in its irrationality. That is we can look at the cat business, and we look at horrendous cat losses, and people average this year's horrendous cat losses with a long period of minimal cat activity, and they think the minimal cat activity was the standard. It's just naivete that no one has been here long enough to understand that these are long-term trends. I think that would be a good example where prices probably haven't moved up appropriately because we're still waiting for another bad year to happen to give those results more currency.
I can try to understand.
Thank you, Siri. I think that as to large parts of the other business, I think there's tremendous expense pressure to write more business and therefore people are optimistic and don't have the experience of, again, those longer-term trends. We've gone through a long period with very benign inflation and people have benefited greatly from it. I think we're about to find that optimism tested and, yes, I think there is a level of naivete about how that inflation can affect people's levels of loss reserves. We're going to go through a time period where redundancies are not the standard, and when that happens, people are going to have to respond more quickly. Yes, I think it is naivete and the optimism of the current people.
I fortunately have a team of people and my son who are cautious, but it's a hard business to adjust to the enormous changes we're seeing, and clearly we're seeing more changes in Washington than we've ever seen.
You mentioned the word inflation. CPI came out this morning, a little hot. Question for you, Rob. Obviously, inflation could be a bad thing for insurance companies. What are some of the things that we, as investors and analysts, should be looking at relative to claims costs, inflation, that would give us an indication that things might be getting dangerous, if you will?
I think you need to start to if you can get your hands on people's paid loss ratios. Ultimately, the paid loss ratio is telling you where things are going in the short term and is a good leading indicator for the long term. From our perspective, we think inflation is something that a lot of people in this industry are not appropriately thinking about. When we think about our loss picks or our design ratios that we book our business to, we are making the assumption that the benign period that we have been to is not necessarily the reality for the future. Now, our business, obviously medical is a meaningful component of that. We've been living with pretty severe inflation on that front for a long time now. If anything, there are signs that that may be somewhat curtailed.
Again, I think the industry just loss cost trend in general and inflation is something that people have gotten more comfortable with than they should be. In addition to that, and we've commented on this in the past, we're focused on the change in the legal environment. From our perspective, there certainly are signs that the impact of an environment with a more aggressive plaintiff bar, an erosion of tort reform, and a White House that for an extended period of time that had appointed many judges, you get a trickle-down effect of a more liberal or, if you will, or more open to the plaintiff bar.
You mentioned your general lack of love for the catastrophe business. We've seen that over many years. Every time there's a big storm or big event, you guys generally or almost always do better. You saw that this year very obviously. Is it just a pricing issue? Is there something about the business you just don't like?
Going back to the comment earlier in the discussion, Jay, we're very focused on risk-adjusted return. We have no problem with property cat. In fact, there are moments in time when we're happy to write a good deal of it. Our issue is that we don't think that the marketplace, more often than not, prices appropriately for the risk. In particular, we don't think that they, when they think about risk-adjusted return, don't appropriately contemplate volatility. As a result of that, we have chosen to steer away from that business more often than not. To the extent you get paid for the volatility, we are happy to participate. It's an interesting part of the market. It was touched on a few moments ago.
When the earth doesn't shake and the wind doesn't blow, people who write property cat, well, all that premium tends to drop to the bottom line. They think they're brilliant. Oftentimes, when the earth shakes or the wind blows, there's horrible losses, everyone is so eager to get back in that they see because rates they expect are going to go up tremendously
People don't oftentimes seem to take a step back and say, "Well, what kind of return am I getting over an extended period of time? Am I getting paid enough for that volatility?
The best part is when people say, "Except for our catastrophe losses, this is what we would do." They also fail to take out in that except for the premiums they received for those catastrophe losses. They take out the losses, but they don't take out the premiums. I would do wonderfully in every line of business that way. It's just a ridiculous statement that people make, and they do it all the time. Even some analysts think it's okay.
Any questions from the audience? Scott?
Just out of curiosity, the #MeToo moment and what's happened with Steve Wynn, does that lead you to think there's anything going on with pricing that might have to happen in D&O or policy like that?
I think generally speaking, even before that activity in general and what we've seen going on in society, I think a lot of the professional liability world has been under pressure. I think it's been very competitive, and I think it has been ripe for a calamity. Things happen. It's just a matter of when. When the pricing is inadequate, it makes it glare very brightly. I think there was an issue with much of professional liability, D&O, EPLI in particular to begin with. I think this is just going to really put a spotlight on it and get people to start to think about, again, risk and return.
Have you guys changed your underwriting for the EPLI business? That's employment practices liability, by the way.
We are constantly, as you would expect, refining it. The recent activity that we've all been reading about in the media, it hasn't had a dramatic impact on us. We have been less aggressive, which is one of the reasons why parts of our professional liability book have been shrinking over the past few years. We just haven't liked the terms, the conditions, or the pricing. It does vary by territory within the country.
One topic with your company that I don't think we talked too much about, we probably should talk more about it, is distribution. If I ask you the question, what distinguishes W. R. Berkley from others relative to its distribution, what would you say?
Our approach to distribution, quite frankly, is we have 54 different approaches. Each one of the operating units in a group decides what makes sense for their business model, and that's what they do. We have everything from independent agents to large retailers to wholesalers, and more recently, we have a direct-to-consumer approach as well. Our goal is to bring value to customers, and we are very pleased to provide product to them in any way that makes sense. There is no point of distribution or type of distribution, if you like, that has an appointment with W. R. Berkley Corporation. Again, each one of the companies has their own approach.
When we look at distribution over time, I think as we've seen in parts of the market and other industries, clearly things are going to change and evolve as younger generations that are comfortable transacting in different ways become more of the decision-makers. When you look at the way insurance is bought, for example, in the consumer space, it's not a big leap to go to the small commercial space. How that bar will continue to rise, we'll have to see over time. I don't think people are going to be buying insurance for a multi-billion-dollar offshore oil rig by clicking and binding. I do think there's parts of the commercial space that are ripe for disruption, potentially.
The direct-to-consumer distribution you mentioned, what products are we talking about there?
It's small commercial.
Just small commercial. Is that something you'll need to invest more heavily in in the next couple of years?
We've invested a reasonable sum of money to date, we'll have to see how it goes from here. Again, one of the benefits of our organization is we're able to run a lot of small experiments in each one of the businesses, as opposed to a more traditional model where people are running a big experiment from the mothership. Jay, do I think that there's meaningful opportunity there? Yes. As we are convinced that the opportunity is there, are we prepared to invest? Absolutely, no different than any other part of our business.
Bill, I wanted to ask about the investment portfolio. Given the market that we've seen, the volatility, are you making notable changes to your portfolio to react to that?
We have not ever been a big equity investor. We've invested in the equities market to the tune of a few billion dollars, we have a few billion dollars in real estate and various. Our core portfolio is fixed income securities, where we've reduced the duration to give or take three years, which is less by more than a year of the duration of our liability. From that point of view, we have anticipated and expect inflation, we've tried to hedge in a reasonable way. Our equity portfolio has been decreasing somewhat, we've sold some real estate as we're continuing to expand in others. We think real estate's a good hedge for inflation and the values concomitant with that.
Overall, we're trying to position ourselves with a little less volatility and a little more protection from what we expect would be the certainty of inflation at the moment.
Thank you. This is really helpful and interesting. I have a high-level, big-picture question. When you guys think about the essence of franchise value in a property casualty insurer, if maybe in the banking business, it's kind of a low-cost sticky deposit base, how would you classify the essence of franchise value in a property casualty insurer and what creates that? You guys have probably the best track record and understand that maybe better than anyone else.
Sure. I think it depends on the company. It depends on what you're trying to be, what you want to be. I think there are some companies out there that they are focused on being the low-cost provider. That is the competitive advantage that they are trying to leverage. That is how they are trying to bring value to customers. I think, again, there are a variety of different models. Our model is not about trying to be the cheapest. Our model is about trying to bring the most value. We focus on bringing value through knowledge, expertise, intellectual capital. We want to do business with distribution and ultimately customers that value that. I understand that it's a competitive market. We have no interest in being the cheapest. We want people who want to do business with us because they understand the value proposition.
We work very hard to find ways to, if you will, de-commoditize the business. In a world that is more inclined to view things more and more as a commodity, that comes with its challenges. It also does create great opportunity. While the world looks for ways to commoditize things more, at the same time, if you can demonstrate your value proposition and show how you are not a commodity, the world is very much willing to pay for that. If you look at the parts of the marketplace that we elect to participate in, it tends to be places where it is, again, people and their expertise that allow you to differentiate.
If you talked to the people we do business with, our biggest producers of business, they would tell you that we do what we say. When claims occur, we don't try to avoid the claim, we try to deal with the claim. I think that our reputation is what creates value. Historically in this business, that is one of the cornerstones. Creating value for all the things Rob talked about. When you convert that, it means building a reputation that your distribution and ultimately your customer believes.
Any other questions? Right here.
Hi. When I look at your book value per share growth over a very long time horizon, and you can let me know if you think that's not a good measure to value a business over a longer time. It's usually mid-teens. It was in mid-teens for the last maybe one or two decades, but the last five years has been a bit slower. Would you say that's because of maybe size is a bit bigger, or would you say that the market doesn't allow you to grow at that rate and it's more of competition?
I'd answer that in two ways. First of all, numbers can be deceiving. We bought a lot of stock back at prices above book value, which lowers the growth of book value, but we think creates long-term value. That's one of the issues. The other issue is, I'm not sure what numbers you look at, special dividends distort that also, potentially, although maybe you're adding that back in. Buying stock back in big quantities at prices above book value distort that. I would say that the second piece of that is lower interest rates have clearly had an impact on our ability to grow book value. I surely don't believe it's size. We're not nearly as big as we would need to be before I would-
Concerned about our scale interfering with that. I would say maybe buying book value, which was, well, at cheap prices, relatively. If you buy stock back in big quantities, even at 120% or 125% of book value, it dilutes book value. The other thing, lower interest rates did do that as well as we went from a four-and-a-half-year duration to a less than three-year duration, which cost us yield. I haven't changed our target, nor have I changed my view about what we ought to do, and I think that we'll do just fine. I haven't sold any stock.
I wonder if you guys could talk a little bit about the international business. It's not broken out anymore, so we don't see it, but obviously, there is a growth potential there. Maybe just highlight some of the key parts of that business.
The international business is a business that, generally speaking, we're quite pleased with. We're happy with the progress that we continue to make in Latin America, with Mexico being our newest venture. We think there's a lot of potential. The business has grown. It's been profitable for many, many years, and again, we're pleased with those operations overall. We think there are some good fundamentals for Mexico. We have a different view on that country than our president. As far as Canada, Australia, those businesses, we're pleased with the progress, and the people who joined us recently to build out a business for us in Southeast Asia and Greater China on the insurance side. They're making progress as well. The area that has been a concern for us, quite frankly, has been both London as well as continental Europe.
I think there are two things that occurred there, and we are well on our way to getting those issues rectified. One, in some cases, we didn't have the right people, particularly in continental Europe. We think we do have the right people now. The London market, that business has just been shrinking. If you wanted to talk about a part of the market that doesn't seem to really, in our opinion, generally speaking, focus on risk-adjusted return, it would be the London market. We think there are real pluses, but we think there are real minuses. That business, again, has been shrinking, and we'll have to see whether market opportunities really return. If they do, we'll see that business grow.
International in the aggregate is a relatively modest part of our business today, and the lion's share of our business is U.S. or domestic specialty business. We expect that to continue to be the case.
I see we just passed the two-minute warning. I wanted to get one last question in on taxes. Maybe this is a 10-minute question. I know. Just give us your. Were you guys celebrating when this tax bill passed?
As much as you ever celebrate for the right thing finally happening. It was my old statement that a broken clock is right twice a day. Finally, the legislature caught up with the realities, and that is when you write business in the U.S., everyone should be on a level playing field and pay the same tax.
For whatever reason, we were unable to have that reflected in our tax law, and now it is reflected much better in our tax law. It's thanks to people like American Financial, Travelers, Hartford, EMC, a long list of other people who all helped and got behind this effort to see to it that we got people who said it's a good idea to change, it's a good idea to voting in favor of it. It's a really important thing to have that as a domestic policy. When the World Trade Center events happened, as we explained, a number of foreign insurers wanted to call that an act of war and exclude coverage. Chubb stood up, the old Chubb, and said, "No, this is not an act of war." Coverage was provided. I think it's really important.
We represent the biggest part of the insurance industry, it's important that everyone compete on a level basis. Jay, just to add to that. Obviously, we, along with many other domestic-based companies, will benefit from a lower tax rate. I think everyone's focused on the 21% and how much better an organization like ours will do. Well, the Revenue Service is still coming out, and Treasury is still coming out with a degree of guidance, you got to figure out how you optimize that. I think the other big piece for us isn't just the benefit of a 21% or lower tax rate. I think the other benefit is that many of the people that we have been competing with for an extended period of time, their tax rate is moving up.
Undoubtedly, we are going to get the benefit of the lower tax rate, many of our competitors whose tax rate is moving up, they're going to have to be examining their economic model. One of a few things is going to happen, in our opinion. A, they're either going to have to change their selection process to maintain their margin. B, they're going to have to raise their rates. C, they'll have to accept lower returns, potentially. In order to compete, they're going to, from our perspective, have to deal with the reality that their economic model, in order to achieve the returns they've had, they're going to have to be tweaking that. Good stuff. That is all the time we have. Join me in thanking Rob and Bill.