We're going to move on with our next presentation. It's a chock-full schedule, isn't it? Great quality people. Obviously our next presenters are no exception. We've got Bill Berkley, Chairman and CEO of W. R. Berkley, Rob Berkley, President and COO of the company. I've actually been either covering or helping to cover this company since I got into this business. I was a summer intern in 1990. What's amazing is not only, one, that the company has changed over the years, but it also has been quite consistent in how they approach the business, and that's driven the kind of results you've seen over the years. I want to start with really maybe just a bit of a reflection of the past five years, what you have been able to accomplish during that time, and where does it position you now going forward?
I think that fundamentally, we have continued over the past five years doing the same thing, but seizing opportunities. Five years is a little shorter than the change, because really when the financial world went to hell, you could look at it with a little perspective, sort of 2008, 2009, we started to say, "This is not a permanent change. There'll be opportunities." For the most part, the property casualty business wasn't hurt. What we did is we went out and looked for teams of people, and we brought capital to those teams where we could add to our specialty expertise, either domestically or overseas, and we grew our business substantially. We grew our business in everything from offshore oil to D&O to a whole array of specialty lines.
We expanded our business in Latin America, in Europe, in Asia, trying to find the best people and grow the business internally. Our experience has always been growing the business internally is a better strategy for the most part than acquiring things. That came from a long and painful experience when we first got in the business, and we learned about inadequate loss reserves were frequently a problem when you acquired companies. We figured out that that was a very expensive strategy, and the less expensive the company was, the worse the decision was. Why don't I let Rob talk a little bit about some of the companies we specifically got started in this most recent five or six years, and he can demonstrate how we built that specialty business up dramatically and how we added some of the internationals.
What we've tried to do for many years now is examine where we think there are opportunities in both the domestic as well as the global economy. When opportunities present themselves, position our organization to take advantage of parts of the economy where we think there's disproportionate growth. Certainly, we've benefited less so in the very recent past. Over a more extended period of time, we've benefited from the boom in energy. Certainly here in the United States, as our economy continued to shift more towards a service economy, our professional liability lines have benefited as well. We've also invested in platforms outside of the United States, where there have been economies that over the past few years have grown quite a bit.
We try and make sure that we marry the necessary fundamentals on a day-to-day operating basis of making sure that we have teams of people with true expertise in their specific discipline or space. At the same time, trying to take into account where do we think that there are more broader or macro opportunities.
I think one of the things that was a little different is as we started to add more units, we started to realize the economies of having some shared services became a real benefit. This way, a team of people could drop in and get started more quickly. We started to provide shared services to let teams of people with real expertise get started more quickly. I think that's the biggest change from how we were 15 years ago and how we are today. Today, a team of people can join us, and we're a lot more set up to get that team up and running more quickly.
Let's talk about the market a little bit, the commercial insurance market that you're operating in. I guess first question is, give us your outlook. Over the next one or two years, where do you think pricing and underwriting conditions are going? I know it's going to vary by line of business, and you can break it down a little bit, that's fine, but what's your outlook?
I think generally speaking, we're positive. We think that you have to look at pricing for insurance companies relative to inflation, and inflation clearly hasn't taken hold, and interest rates. I think the biggest help to pricing is virtually no inflation, and with declining rates, everyone knows they need to get profits on the underwriting side. We're optimistic about pricing. We don't think prices are going to go crazy. We don't think we're going to see double-digit price increases, but we think prices will continue very modest increases to flat, and some lines will be really substantially better than that.
Any other views on that, Rob?
I would just echo the comment that, generally speaking, I think when we look out at 2015, we see a modest addition to underwriting margin on a policy-year basis because of the rate that we think we can get. Things may plateau as we make our way through 2015 into early 2016. Generally speaking, at this stage, we are not seeing any signs that would lead us to believe that anything's going to fall off a cliff.
One of the things that's interesting, Jay, is most of the quick-look pricing reports are put together by brokers who would like to present declining price mechanisms.
Jay, to your point earlier, I think it's worth mentioning that all lines are not equal. The market does not march in lockstep, there are parts of the market that are becoming increasingly competitive, and there are others where significant rate increase is still available. Obviously, the world of reinsurance is very different from insurance these days.
Bill, you mentioned claims being, or inflation being relatively modest. Outside of, I guess, commercial transportation, commercial auto trucking, that's been the case. I think it's been surprising to people. Two questions. Why do you think that is? Secondly, what could spark a change in the claims environment?
First of all, the economic climate is such that claimants would like to get things settled and get their money. It fosters a general view of getting claims settled and getting things resolved. I think second of all, with this low inflation environment and with a general public attitude that's evolved, at least up to now, that insurance isn't the way just to reward people. I think you've had a climate that has restrained outcomes on claim settlements and jury awards. There are changes that can happen in a minute. In fact, some courts have moved somewhat in the other direction. Right now, no change. There's still that general attitude. I think here and there you'll see a surprise, but not generally speaking. I don't see the claims direction changing yet.
Let's talk about the reinsurance market. You obviously have a position in the reinsurance market. You're a buyer of reinsurance. What's your outlook for this market?
From my perspective, I believe our perspective, we don't see a dramatic shift in macro direction at this stage. Some of the new entrants or some of the pools of capital that are looking for ways to participate in the space, we do not see them retreating. Do we think the approach and the technology will continue to be refined, do we think that there's a chance over time that their appetite will broaden beyond just some of the traditional short lines or property cat? Yeah, there are a lot of people who are working hard to try and figure out what are some new ways to utilize that capital and participate in some of the longer tail lines of business. I think from our perspective, the pressure will continue. I think it is a challenging time to be in the treaty reinsurance business.
I think to the extent that you are not bringing value beyond just capacity, it's a very difficult situation to find oneself in.
You have a different approach than many in reinsurance. It's a rough environment. Some might argue that it's permanently changed. Is this going to be a long-term business for you?
I think from my perspective, I don't see us stepping away from the reinsurance market. We do take a different approach than many. We do not feel as though that we are just offering pure capacity to the marketplace. We think ultimately the value that we bring goes well beyond capacity. It's the expertise that we bring to bear. If you look at, quite frankly, the nature of the client relationships we have, you can really put it into two buckets. There are some that, quite frankly, trade with us because they value our expertise, not just our capacity. There are others that, quite frankly, are looking for ways to arbitrage our capital. From our perspective, there are some relationships you own and there are others you rent.
I guess arbitraging reinsurance capital can work the other way if you're a big insurance company, which you are. How has your ceded strategy changed given the changes in the reinsurance market?
I think it would be fair to say that we are very aware of the market conditions. We try and make sure that we do what's in the best interest of our organization and get deals that make sense for our shareholders. At the same time, one needs to take somewhat of a longer-term view and not necessarily just get the very best deal one can today. There is still something to be said for a relationship, and with some of our traditional reinsurers that we've done business with for many years, we're not quick to turn our back on those relationships. Clearly it is a buyer's market, and we are conscious of that. At the same time, we recognize there needs to be a balance.
At the moment, many people who have capital that's employed in investments, pension funds, hedge funds, whatever, find the use of it in some way or another in the, what they perceive as the predictable part of the insurance business, seems very attractive. That will be something that continues until the unforeseen event takes place. When you've been in the business for a long enough time, you know the unforeseen event happens, you just don't know when, which is why it's the unforeseen event. I think that to say it's changing permanently may be presumptuous. I think that it certainly is going to change for a while as there's lots of capital around, and the returns on that capital are so crummy.
Those people would like to say, "Can we get our return with relatively little statistical risk higher?" In the insurance business, when you've been in it long enough, those sides of the bell curve actually count.
Especially when your money is tied up in a company as well, it makes a difference to some. Your international business, I want to start. I think not everyone fully understands what you're doing outside the U.S. Bill and Rob, if you could walk through sort of the evolution of your international business and how it's structured today.
Why don't I take the history part, and Rob will talk about where we are. History part was in 1996. I went to Argentina. Everything was wonderful in Argentina. The peso was pegged to the dollar. A classmate of mine from Harvard Business School ran the biggest bank in Argentina. It was a good opportunity, and that was our first consequential step outside the U.S. We did all right. Subsequently, we did very well because we had terrific people. Then we continued to expand slowly into Europe, basically the U.K., and then into Australia, Asia, and Spain, all with the idea that the global insurance marketplace was going to become one. The U.S., which at one point represented 70% of the insurance market, was going to decline, and it has. It's today less than 50% of the property casualty insurance market, and it's going down.
That if you wanted to be a significant player, you at least needed to know what was going on in the rest of the world, and you had to choose spots to play in. With that, in fact, one of Rob's early jobs in the company was in the international segment. Do you want to take them through where we are?
Yeah. Today, we have operations in Latin America, which are focused primarily on Argentina, Uruguay, and Brazil. We've been in all those countries for many years, well before Latin America became the flavor of the day. We've been in Canada for more than a handful of years. As it was suggested earlier, we have a presence in Australia, a very modest presence in select parts of Asia, and then a presence in the U.K./Europe.
The con-
Sorry.
No, go ahead, Rob.
I was just going to add, the idea or the fundamental approach is no different than the approach we take in the United States, which is based on an idea of trying to achieve good risk-adjusted returns, a decentralized structure where you're able to find people who have excellent expertise that are specialized in a certain niche. By and large, we've been reasonably successful in doing that outside of the U.S. Certainly comes with some additional challenges, whether it be country risk or just the complication of getting one's head around a different culture and getting to know a local market. Excuse me, Jay.
No, I was going to say, main products, are they going to vary by region?
Yeah, they vary by region or territory, quite frankly, the market and how developed the market is. Some of the less developed markets, the products tend to be shorter tail in nature. The U.S. hasn't managed to export their attorneys all over the world yet, as opposed to parts of Europe or Australia, where the product offering is more akin to what we would see here in the U.S.
In 2014, the international business, I guess, hit a bit of a speed bump maybe. What exactly happened? Why were the results somewhat below what you had hoped for?
I think we had a couple of issues that all came to a head at the same time. We had a bit of cat activity, as we had talked about in our fourth quarter call, coming out of Australia as well as Mexico. Then we had some development coming out specifically of the professional liability book that we have in Europe, primarily the U.K., but a little bit in some other parts of the market as well. That was really, by and large, the noise, if you will, or the obstacles that we faced. We think we've gotten our arms around it. We think we've actually pinpointed the issues with a great deal of precision, given the process that we've gone through. We think that the issues are being remedied. It just takes a little bit of time for that to come through in the numbers.
Are there any questions out in the audience? We've got microphones circling about. If you have any questions, just raise your hand. Let's talk about the investment portfolio. Maybe talk about the alternative portfolio, what exactly is in there, and talk about some of the returns you've been able to generate in that portfolio.
We have a wide array of things in the portfolio, ranging from development real estate, where we're building buildings and renting them up, to we've bought railroad cars and airplanes that we've leased, in some cases we've sold. We have a private equity fund internally, all of which have delivered excellent returns. We have a couple of hundred million dollars in a series of partnerships in the oil business. That really accounted for a substantial part of the decline in the fourth quarter. We still, in spite of that, our funds had a 12.7% return for last year. Overall, the alternative investments, which includes the few other things that aren't in the funds, had a return that was even better than that. We have an in-house investment group.
We do some arbitrage, we do bond arbitrage, we have the vast amount of our portfolios in what I would call plain vanilla fixed income securities. That probably represents 85% of our total portfolio. That's pretty plain vanilla, double A minus, double A, fixed income securities with about a three-year duration. It's been hard not to get tempted to extend the duration or lower the quality. Mistakenly or not, we decided that inflation needs to happen at some point. For now, we're willing to sort of sit aside and keep several billion dollars of relatively short, one year or less money, and wait for the opportunities. We invested several hundred million dollars in rental housing. Opportunities do come along, but there aren't huge dollar values that we can put to work right away at high returns.
The opportunities we see all mean we'll give up short-term liquidity, we can have relatively low risk, medium to high single-digit returns, in some cases, low double-digit returns.
During the third quarter call, you were talking about the portfolio, you suggested that there may be unrecognized value in that portfolio, I think you said north of $5 a share. I assume that's still the case after the fourth quarter. Discuss the major contributors to that unrecognized value.
There's a couple of pieces that are big pieces. The biggest single piece is a company called HealthEquity, where we were an original investor, we own probably around 30% of the company. It went public, but we still carry it at our underlying equity. We carry it for probably $300 million under the fair market value of the stock. Those are the accounting rules. We might have addressed how we owned it in a different way if I realized when it went public, we'd continue to carry it at our cost. That would be one example. Another simple example is our building. Our building's on the books for $13 million and worth $100 million. There's a whole series of things like that
It's because we act as owners. We make decisions on asset purchases based on real intrinsic values, not based on the accounting values, the reported values. In the short run, that can result in underreporting or understating as opposed to fair market value. In the long run, it all washes through.
Got it. Questions from the audience. Just to bring up the topic of M&A again, you obviously were pretty clear before about what could scare you with M&A, but you certainly feel pressure building in the industry, and you've seen some deals getting done. I assume you get shown any deal that's out there. Question I have is, are you seeing more of those deals, and is the quality of those deals getting any better?
Why don't you comment on that?
Jay, I think your comment is accurate. By and large, we're aware of most transactions before they're announced, or at least to a certain extent. I think our view is that there has been a spike in the number of transactions more recently because there is a fair amount of pressure for people to take a step back and think about their business and how do they grow, where do they go from here. Having said that, I don't think that we have any particular concern about the position that we're in or our ability to continue to grow and develop the business from here. We think our business excuse me, by and large, is very well-positioned, and quite frankly, a lot of the things that we've done over the past several years have positioned us so we are where many others are trying to get to.
We just did it organically through internal growth and starting new businesses while others are trying to address their positioning through an acquisition. We think scale is relevant. Having said that, we believe that we, as an organization, have more than adequate scale to participate in the marketplace as we see fit.
The fact is, internally, we're adding $500, $600, $700 million of business a year. Most of the people who are finding it necessary to make acquisitions are people who are in businesses where they're not able to grow, where their margins are under pressure, where they don't see opportunities. We see lots of opportunities. We see teams of people. We're not worried about our growth or expansion.
Got it. Last question from me. Bill, you've been a visible and vocal opponent to offshore companies that have a U.S. sub and reinsure back to themselves offshore, and made a big effort to try to have some of those laws changed. So far, nothing has happened. Are you continuing with the efforts? Is there any hope you can get a change in that regard?
There is always hope. I am persistent. I was in Washington yesterday. We hope that Congress recognizes they never intended the tax laws to give a benefit to companies based outside the United States, and that's what the tax law does. On the other hand, we have been in an environment where nothing gets done. When the president in his State of the Union message said, "This is the Obama economy," what he must have meant is the economy where the government didn't do anything. In fact, what's happened is no one wants to do anything. I do believe that will change. This is an easy probably between $7 billion and $10 billion a year of tax revenue. It is in the president's budget. It will not have an adverse impact on any U.S. taxpayers. Will they do that? I have no idea.
Yes, we continue to urge Congress to decide that business should be even. I think the one difference is there are a lot of other places around the world that are looking at the same issue and addressing it. I think there's a better chance than there's been so far.
Got it. That brings us right to the end of the session. Bill, Rob, thanks for spending some time with us.
Thank you.