Thanks, everyone. We've got W. R. Berkley here with us. We have Rob Berkley, the CEO, and we have Bill Berkley, the Executive Chairman. With that, we'll get started. Just to kick it off, can you provide us with an update on Hurricane Harvey and now Hurricane Irma and the potential impact that could have on your book of business?
Well, certainly both events are meaningful on multiple levels from our perspective. We do have exposure, though we think it's very manageable, both how we manage our gross as well as our net exposure through the use of reinsurance. I think the bigger question that we're grappling with is trying to understand, on the heels of Harvey and trying to figure out what Irma will be, what does this mean for the industry over time, what the reaction will be. It's been some time since we've seen a series of storms of this nature and this scale. Probably goes back to, give or take, about 10 years ago. We're expecting that there will be a reaction, certainly in parts of the marketplace.
Hurricane Harvey obviously caused a lot of flooding. The NFIP is already in a financially difficult position, and that'll obviously get worse with Hurricane Harvey. What are your thoughts on the privatization of flood, is that something that you'd be interested in potentially pursuing at your company?
Flood insurance and the National Flood Plan, from our perspective, is really just a subsidy, if you will, coming from the government. There are two issues. One is whether society and politicians are willing to allow the exposures to be appropriately priced. That's yet to be seen. Number two, whether the information is really there and available to underwrite the exposure. Obviously, flood maps are one of the primary tools, but when you look at flood maps, they are very dated. There is no real standard, from our perspective, to update them in a timely manner. Some of that data is more than a decade old. We see the changes in society where places where once upon a time it was just dirt and grass, now is asphalt, and that has a material impact on how flooding can occur and what can unfold.
When they started the National Flood Insurance Program, it was supposed to be a pay-its-own-way program. It's evolved until today, it's a huge subsidized program, $17 billion before Harvey of accumulated losses and more to come. The biggest objectors, in fact, historically, have been the people in Texas. It'll be interesting to see their view about the National Flood Insurance Program and disaster relief after Harvey. I think that we're going to see a new roadmap for flood insurance program. It's as Rob said, there's only one question. The market will do flood insurance. It just is, are we willing to say there's a real economic cost? First time, subsidy. Second time, you pay the economic value. It works.
If that makes sense. Rob, you've stated on one of your recent earnings calls that competition within the standard commercial market appears to be intensifying, that you're seeing standard market carriers compete for specialty risks. You've seen state risk plans depopulate to, I guess, satisfy the increased appetite from some of the standard market players. Can you talk about that level of competition and what you're seeing in the marketplace?
Generally speaking, in the insurance space, we certainly are seeing competition on the rise, and it's demonstrating or presenting itself in a variety of different ways, some of which you referenced a moment ago. Excuse me. The workers' comp would be an example. Certainly, as you suggested, in the specialty space, in particular the E&S space, some of the standard markets that had curbed or retrenched as far as their appetite goes, we're starting to see them reappear. It's incremental, it's gradual, but it certainly begs the question of what is around the corner. I think fundamentally, it is still a cyclical business.
While, yes, we have better data and we have better analytics, and perhaps the cycles will not be as severe as they once were, there is still that reality, and we are seeing people with a desire to grow, and that comes about in ways that don't always make sense.
Just on the topic of competition, can you talk about the pricing that you're seeing in the market, how new business pricing compares to renewal pricing, and how that then compares to the loss trend?
Well, I should distinguish between what we're doing versus what we see in the market. As far as our business goes, there are certain pockets where we see opportunities to grow, and we like the margin, and there are parts of the business, quite frankly, where we are concerned and the business is moving away from us. Overall, clearly, commercial auto would be a part of the market that seems to have the greatest momentum. Other parts that I think are increasingly challenging. As far as the new versus renewal business, our new business relativity metric, which is something that we've been using for years, trying to compare new business pricing to our renewal book, is give or take about flat or so. There's not quite the level of precision that the numbers would suggest, but I would say it's approximately flat, depending on the part of the business.
Having said that, when we look at the marketplace overall, we are seeing that there is a growing amount of competition for new business amongst many of our competitors, which is one of the reasons why we, as an organization, haven't been able to grow at the same pace we could a couple of years ago.
Moving on to your reinsurance business, obviously the growth there has slowed. I just wanted to get your thoughts on the value of that segment longer term. To some extent, the benign cat environment has provided some level of a subsidy to the industry. Now, with Hurricane Harvey and Hurricane Irma approaching, do you think it'll serve as somewhat of a wake-up call to the industry?
For us, property cat has never been a big part of our book of business, and that's by design. We will participate in somewhat of an opportunistic manner when we think that the rates are there, and you get paid for the risk included in that as volatility, then we are prepared to participate. I think it's unclear, as mentioned earlier, what the impact will be, what the result will be from Harvey and potentially Irma, and how the industry will respond from a pricing perspective, terms and conditions, et cetera. Once upon a time, I think we would have been more confident that there would be a severe reaction, and you would see a change in pricing in a dramatic way, as well as terms and conditions. Quite frankly, on the heels of Sandy, some number of years ago, we were surprised by the lack of reaction.
Part of that may stem from alternative capital. I think we still are curious to see whether alternative capital really has the stomach to participate in this marketplace over the long run.
Before I go on, are there any questions from the audience? One of the things you mentioned on your last earnings call was that by shrinking some of the lower margin reinsurance business, you could actually have somewhat of a margin tailwind for the business overall. By that, did you mean that margins should actually increase to some extent or that they should contract by less given current market conditions?
I think if you look at what we are writing on a policy-year basis today, the actions that we are taking will enhance our underwriting margin. Obviously, some of that business, it takes time for that to earn through and for those changes or realignment to come through. Overall, we think that the business is growing in areas where we find the margins particularly attractive, and there are parts of the business that are shrinking dramatically because we find the margins less than acceptable. That should be a positive from our perspective.
I wanted to shift gears a bit into your investment portfolio. Obviously you've benefited from a lot of gains in the last couple of years as you shifted more to a kind of capital gain strategy. We saw you had a large Washington, D.C. real estate sale earlier this year. Can you talk about some of the other opportunities that are currently in the portfolio?
I think it's your turn. I'm doing all the talking here.
Well, I think that we made a conscious shift a few years ago when we didn't think we could get adequate returns in fixed income securities to invest for capital gains. We have a number of other buildings in New York, in Washington, in Palm Beach, which we hope will still be there.
Well insured
to invest for capital gains. As well in London, right across the street from Lloyd's. We've been an investor in real estate. We've been a developer. We've bought buildings and built them. We would expect at least one, if not two more of those buildings will be sold within less than 12 months. We continue searching for opportunities, but honestly, these are longer time horizon opportunities, and at this point, new opportunities are more expensive than are likely to entice us.
We're having to step back and say, "What's next on the horizon?" While we have probably more than $500 million of gains that are there that aren't reflected on our balance sheet in our real estate portfolio, and probably increasing as we finish up developing the twins, I think that it's unlikely that we're going to certainly go into new development projects now given how competitive the marketplace is.
Just as a follow-up to that, to what extent would your investment strategy change if interest rates were to rise more significantly?
We would probably move back more towards fixed income securities.
Okay.
By the way, I might add, that would be our optimistic view that interest rates would move up significantly.
Exactly. Yeah. That's a fair point.
It's not what we see at the moment.
It's a fair point. Obviously, you have several new initiatives that you're working on at the company, one of which is Berkley One, the high net worth offering. Can you talk about what attracted you to that business and what your expectations for that business may be a bit longer term?
Would you like me to, [inaudible]?
Well, I just want everyone to know that we've arranged for these hurricanes to create more dissatisfied customers. Now Robert, we want a good story. Why don't you tell them about the good story?
Yeah, okay. I'll do that. A couple of things. First of all, I think it's important for people to recognize that the high net worth space is not something that for us was just sort of the flavor of the moment or the flavor of the day. This is a part of the marketplace that we've been looking at for more than a decade at this stage. We like the business because it is a part of the market where we believe you can differentiate yourself based on knowledge and expertise and service, and it is a customer base that is willing to pay for that as opposed to looking at more as a commodity, which is generally speaking, something that we choose to avoid. What ended up happening was we looked at some number of opportunities over a decade plus.
We visited with a variety of people, and we never could find the right fit. Due to a series of circumstances and consolidation in the industry, there was an opportunity for us to enter. The opportunity presented itself really twofold. One, the talent was available, and number two, the consolidation created a situation where, from our perspective, the distribution and ultimately the customer base was going to want to have more alternatives because some of those alternatives once again, were consolidated. It's a meaningful investment for us, but we think long term it is going to be a great contributor to the group, and it helps grow our footprint in a direction and in a manner that we think makes a lot of sense for our shareholders.
I just think that it really goes to our strength, which is the customers we deal with, the brokers, the agents, know us as someone who meets their commitments, fulfills their promise, and that's the kind of insurance enterprise they're looking for to put their most trusted clients with. It's a great opportunity.
Sticking to the topic of new initiatives, cyber risk is a business that you recently launched. We've heard some numbers out in the market about cyber going from about $3 billion in premiums today to about $30 billion by 2020. Sort of to get your thoughts, does that growth trajectory seem realistic for the industry? What type of demand do you expect within your book?
Look, cyber is clearly a growing part of the marketplace. Society is every day more and more recognizing the exposure and is grappling with how they're going to deal with it. Obviously, insurance is one mechanism or tool for them to do so. Will it be $30 billion? Will it be $18 billion? Will it be $45 billion? I don't know, but clearly it's growing, and it's growing rapidly. I think that metric tends to be more focused on cyber when it's standalone, and one of the things that is not fully contemplated is when cyber is just covered in a general policy that exists. It's one of the things that we as an organization are very sensitive to.
We think the industry is behind, and they need to catch up as far as many cases where people are not either charging for cyber, excluding cyber, recognizing that cyber is a material exposure, and if you are silent, you run the risk of providing the cover even when it's not intended. I think whether it's $30 billion or some larger number over time, clearly it is a meaningful part of the market in the future. I think that there's a little bit of a feeding frenzy of people trying to jump in from a monoline perspective. I think the bigger issue is for the industry to start to grapple with where they're accepting the exposure and aren't necessarily cognizant of it.
Commercial auto, that's obviously a line that's been a challenge for the industry. Pretty much everyone is raising rates within that line. You've said that you're not yet ready to grow more aggressively within that segment of the market. How much more rate do you think is necessary until that's an attractive line of growth from a growth perspective?
The commercial auto space is pretty broad in nature, and you're asking us to use a brush that is pretty broad. I think it really requires a finer brush. It depends on what part of the commercial auto space. Having said that, from our perspective, the rate that is needed is considerable from where it is. Certainly, things seem to be pointed in the right direction. The question is whether the momentum will build from here. It's one of the few parts of the commercial line space at this stage where you're getting meaningful rate increases still. Hopefully, that will continue, and if it does, then there will be perhaps an opportunity for us to expand that line of business significantly.
Shifting gears a bit to capital management. You've paid three special dividends in the last four quarters. In the first half of the year, you didn't repurchase any shares, but you did up your authorization. Can you talk a bit about your capital management strategy and if that's changed at all in the last 12 months or so?
I think that our capital management strategy hasn't changed.
It's value to our shareholders. We run the business as though we are the owners of the whole company. We own 22% of it as it is. We make decisions about how much capital we need, what are the opportunities we see, how much capital do we expect to generate, what's the price of our stock, and how do we maximize the benefits to our shareholders. That doesn't always help us in the category of how do we report maximum return on capital, because some of these calculations don't work that way. Every day we look at the price of the stock, we look at the alternative uses of our capital, and we make that decision. So far, we thought paying a special dividend was better. If we would have changed our strategy, we would have changed our regular dividend.
We'll continue when we see an opportunity to buy back stock. We haven't changed. If we see the world's changing, where we think there'd be a great opportunity to invest, we would hoard our capital. We continue to look every day, and we talk every day, literally, about what are those opportunities? What should we do with this money? Because we think that ultimately what we do with the capital and the returns we generated, that's what shareholders pay us to do. That's one of the things that differentiates us from our competitors. We don't look how we can make the business bigger. We're the fiduciaries for that money. That's one of the things that really differentiates our business.
Just wanted to check again and see if we have any questions in the audience. Excuse me.
Yes, sir. Yes, sir. Yes.
I know you don't have much property and property casualty exposure, so your exposure to hurricanes is very low, especially relative to a lot of companies that are out there. My question to you is, [inaudible] if this a huge amount of losses, do you think that would be enough of impetus to actually have casualty pricing go enough that you can mitigate some of the costs? Because I'm not a big fan of just attaching prices for the most part of the results. You need some amount of rating.
Just to repeat the question, it was basically if an event like Hurricane Irma could have the potential to increase not only property prices, but casualty pricing as well.
The answer is it's a bit unclear at this stage, as you perhaps already recognize. If you go back and you look at 1992 and Hurricane Andrew, all that did was sort of give casualty pricing a bit of a pause and property pricing spiked. From our perspective, if Irma is all that the media would suggest it could be, that would be a very meaningful storm, and it's unclear what the reaction would be in the broader sense. There are parts of the casualty market that we think clearly need rate, and there are parts of the casualty market that we think are adequate, and there are parts that we think are attractive, and hence why we're growing in those parts. Generally speaking, our view is that you are likely to see some type of reaction on the property front and the casualty front.
To the extent there is, it will be muted compared to what you'll see on the property front. The one benefit of having an old person around is the remembering of what it used to be in the market for storms and hasn't been for more than 25 years. What that is a really bad catastrophe had an impact on the total capital of the industry. That's changed to some extent because we have external capital sitting on the edge waiting for opportunities. Then, as Rob mentioned before, the question is: Does that external capital have the stomach for the kinds of losses that Irma could bring about? We don't really know the answer. If Irma brings about losses at its worst, you might find a lot of things changing.
It's really not because it's going to be just a regular hurricane that causes $50 billion in losses. It's only going to come about because it's a monumental loss that truly makes people say, "Huh, PMLs, AMLs that our sophisticated modeling teaches us are so valuable may not be so certain." When external capital says we can't rely on PMLs, for those who might not know, probable maximum loss, we no longer want to bet our money, if external capital stops being a supplier to the industry, everything changes.
It's not only the amount of the loss, but it's whether you get at that core factor that causes all these external suppliers of capital to rely upon the statistical probabilities of forecasting losses. We won't know that till after the fact.
When the World Trade Center hit, I guess you wouldn't know what the loss ultimately, but they wanted to, I forget, $50 billion-$60 billion or something like that.
That was years later. It went all through the courts, it was a long time before they knew.
Before Berkley, casualty prices then actually rose.
I think you're right. Casualty prices did rise, then you saw that bounce that was 2003 through 2007. That was a great run, 2002. I think what is not widely recognized is that casualty pricing really bottomed out in 2000, the pain was being felt already into 2001, the industry was beginning to build some confidence to push for rate. 9/11 served as a further catalyst or shot in the arm. That ground swell of a need to push rate already was in existence. Not to suggest that 9/11 didn't have an impact, it certainly did, directionally, it was already moving that way. Back to the comment that was being made earlier, whether it's alternative capital or other forms of capital.
If you look at the industry going back to some number of decades at this stage, every time there's an event, we have seen capital coming into the industry more freely, more readily. Whether it's new businesses starting and more recently, whether it's what we refer to as alternative capital. The question is, will capital in the future have the desire and the ability to come into the industry in such a fluid manner when they perceive the opportunity?
A few questions brought up cyber before. It sounds like a no-brainer.
Here you go.
You talked about Thanks. We were talking about cyber a little bit earlier, and it sounds like obviously a kind of a no-brainer from a standpoint of potential for growth. Given that it's still relatively new, infancy stage, can you maybe just talk about a little bit right now what maybe a typical policy might look like, what exclusions you might put in there, what factors we need to have and everyone wants to have, how you price around that, how you think about losses around that. Just again, what a typical policy might include and what particularly it might exclude.
Well, you're welcome to come up to Greenwich, and we can walk through a policy if you'd like, but it's pretty painful. I think the answer is that it is a developing market, and as a result of that, there is no so to speak standard. Different types of clients are looking for different types of coverage. Different carriers have different appetites. It really hasn't evolved to the point where there is this standard. I'm reluctant to give you that there's this cookie cutter form, if you will. I think the bigger unknown, as I mentioned earlier is, I think that there is a fair amount of exposure that the industry is taking on as it relates to cyber that is not even being contemplated, and I think that's the scary part.
Generally speaking, the industry does okay when, to your point perhaps a moment ago, when you build the box and you define it, and it's clear as to what the exposure is that you're taking on, and then presumably you underwrite with select or price appropriately. That's one thing. I think the bigger question, the bigger issue, which quite frankly far outstrips the exposure that exists in the monoline cyber marketplace, is the amount of exposure that's being taken on inadvertently or unintentionally where people are offering just a GL cover or a package cover, and they are not excluding it. As a result of that, they are taking on that exposure. Specifically to your question, there is no standard at this stage. That's evolving over time. Certainly, people are going out of their way to control the exposure through limits.
People are doing their best to try and understand how the exposure can aggregate and what the exposure is from a sideways perspective for industries or beyond. Ultimately, I think the primary focus is on limit control. Certainly, there are some parts of the market where they are offering a very stripped-down amount of coverage. It might be where in the event that it is a systemic event, there is no coverage. It may be if it's an event that not only is systemic but affects more than one of your insured's clients. Again, it really is all over the place at this stage. Which from our perspective is a plus because that's when it really is a specialty product and our underwriters' knowledge and expertise can differentiate.
Any other questions? Moving on. Tax Reform is obviously a topic that you've been very vocal and passionate about. Given some of the challenges the new administration has had with healthcare reform, are you incrementally more concerned about Tax Reform passing? Has your expectation of the playing field with your offshore peers leveling, has that changed at all in the last few months?
Well, Rob has worked diligently in getting an increased participation in our consortium. We now have virtually all the domestic companies participating. We think we have a better chance than we ever have. Our Tax Reform issue is right at the heart of what the administration is complaining about, which is the government never would have had a tax law that favored non-U.S. insurers. It's a quirk. They changed how taxes are paid for property casualty companies in the '86 Tax Act. By doing that, they effectively gave a simple way, in spite of the excise tax, for companies to reinsure their business offshore. It means non-domestic insurers pay tax rates from as little as 1% to as much as 13% or 14%, versus domestic companies paying on average 27%.
The fact is, the vast majority of insurance business and reinsurance business has now moved from domestic to being offshore. If the country wants to maintain a domestic insurance presence, it needs to change the law, because a lower cost of capital will ultimately drive everyone to move offshore. It's not a function of if, it's a function of when. That continues to happen. Our leading partner in this effort for eight years was Chubb. Chubb is now offshore. The fact is that it's just a function of what the government wants to do. I might add that when the World Trade Center event occurred, a group of foreign reinsurers asked, "Well, maybe this is an act of war, and then there'd be an exclusion." Chubb stepped up and said, "No, it's not an act of war. We're paying." Domestic company versus foreign company, different interests.
It's very important for the biggest insurance market in the world, the U.S. represents over 40% of the world's insurance marketplace, to step forward. By the way, just as an aside, in spite of all the growth everyone thinks, the United States is not only the biggest insurance market, it will become a larger part of the insurance market because self-driving cars are going to cause a decline in automobile insurance pricing. Automobile insurance is the vast majority of global insurance. Not in the U.S., it's a substantial part, but it's going to increase the U.S. share of the marketplace. It's really an essential thing. Otherwise, this market will all move overseas. We do get traction, but as we all have seen, traction and getting things done in Washington are not the same thing.
This is a very fair point. Rob, you mentioned on the last earnings call that you've seen somewhat of a shift in the marketplace from one in which the insurance carriers define the product to one in which customers are starting to define the product. Can you elaborate on that comment and what it means for the broader insurance marketplace and what it means for your company?
I think it's clearly an evolution that is being driven by the consumer. You can see it in other industries, and you're beginning to see it in the insurance industry, where the consumer is looking to have more of a voice in the decision-making process. Where the consumer, younger generations, their definition of service and transaction and what they want that experience to be is clearly evolving. If you look at the insurance industry historically, we've been an industry where we tell society, this is what we're going to sell you, and we tell them, this is how we're going to sell it to you. I think as we've seen in other industries, and more so in the consumer space in this industry, the decision makers, the consumers are, again, looking for a different experience.
We are going to, over time, see that evolve and have an impact on the commercial line space.
Insurtech is a topic that's been getting a lot of attention, a lot of hype lately. Can you talk about your involvement in that space and to what extent you view Insurtech as something that will benefit carriers versus challenge them?
Insurtech, we're involved in two ways. One, as an investor, and two, obviously as a user of new technologies and new tools. I think whether it's going to prove to be an asset or a liability completely depends on the company. To what extent the company is willing to embrace the realities of a changing environment and find tools that will allow them to bring more value to the customer. From our perspective, we as an organization are working hard to try and pay attention to the new tools and the changes in the environment, and trying to assess how we are going to evolve and adapt to meet the needs, not just of the customers of today, but of those customers tomorrow. One of the nice things about our organization is that we have 54, soon to be 55, operating units.
That allows us to run very, what I would define as, specialized and focused experiments with each one of those operating units. Also allows us, when we find something that gets traction, to cross-pollinate those ideas and those learnings amongst the other companies. We are certainly acutely aware of some of the changing technologies, and that certainly goes hand in hand with the changing behavior of consumers and how, again, they want to transact. We think that there are going to be great opportunities for all of our companies in the group to take advantage of that. Again, we think because of our structure, it allows us to explore those in very constructive ways.
Any other questions in the audience? One other question that I had is just on favorable developments, both at your company and in the industry as a whole. Obviously, we've continued to see favorable development at Berkley. We've continued to see favorable development across the broader industry. You've made some comments in the recent past about seeing increasing signs of loss trends, higher jury awards. With that said, are you surprised by the level of favorable reserve releases we're seeing in the industry?
Honestly, it's hard for us to opine or offer a view on someone else's reserves. Having said that, there are certainly data points that make us pause and scratch our head when we see some of the information around reserves that other companies have released. An example would be what came out of the U.K., the Ogden tables, which was an adjustment to the discount rate that they use for bodily injury over there. When the third-party actuaries do the math, it was pretty clear that they came up with a $ or in that case, GBP amount, as to what this impact meant for the industry. When you look at what people's announcements have been, the parts don't add up to the whole.
From our perspective, that would be an example that makes us pause and scratch our head as to, are people being honest with themselves? Are people cheating? I don't know the answer to that. Again, there are examples that make us wonder whether people are being as honest and frank with themselves as perhaps they should be.
I think we're just about out of time, before we wrap up, are there any audience questions? All right, well, thank you very much.
Thank you.