W. R. Berkley. There's only a couple of companies at our conference this year where the CEO's name is also on the door of the company, and Bill Berkley is one of them. We have Bill, who is Chairman and CEO, and Rob Berkley, who is President and COO. With the name being on the door, what you've seen over the years is this is a company where the management acts like owners because they are owners. They plan for the long term. They manage the business in such a way as you would want them to manage as a shareholder. Again, because they are shareholders. I'm going to turn it over to Bill just for some opening comments, and then we'll jump into Q&A. Once again, we have mics out there. Please feel free to jump in with any questions. Bill?
Thanks. I think that one of the most interesting things about the insurance business is how on the external view, it changes so little and how on the internal basis, not only our company, but many companies change a lot. It's not always visible from the investor's perception. The change in mix of business, the change in profitability, the change in strategies all end up delivering varying investment results. An example would be how we moved from longer tail lines to somewhat shorter tail lines. In fact, we became from 85%-90% casualty business to where we're 80%-85% casualty business because investment returns weren't as attractive. How we changed our investment philosophy and invested somewhat for capital gains as opposed to investment income because returns were lower. How we try to balance the risks of inflation versus deflation.
Strategic things that make a big difference in the long run in a company's results, but in the short run aren't always as visible. We think we do a unique job about balancing those things and delivering long-term returns, but it only shows up when those changes take place. We try to tell people about some of them. Sometimes people understand the signals, and sometimes we don't do as good a job as we might. I think the best example is the capital gains that run through our portfolio, not from our bond portfolio, but from some of our unusual investments where we've been able to deliver more than $100 million a year of capital gains. We expect that'll continue at that rate or more, giving us really good returns on the capital we employ in those various strategies. We're excited.
We think our business is more conservatively managed than many of our competitors because we're concerned as owners with managing our capital account. We bought back stock long before it became something other people did. In the 1980s, we were buying back stock. We bought back stock in the '90s, and we've bought back stock now. We've consistently managed our capital as one of the tools to deliver shareholder value. We are different, and it's not just Rob and I and our family that own stock. All of our key officers own stock, and they own it for as long as they are key officers of the company and a year afterwards. Every RSU granted, when you get it, you own it until a year after you leave the employ of our company. There's no one who buys the stock, gets stock options, and trades out.
We really are vested in how well the company does. It's the old-fashioned model that used to make people who became partners in Wall Street firms wealthy. You owned a part of the business, and whether you liked it or not, you stayed in until you retired. We think that's been a great way of keeping talented people from leaving. Because of that, we have very low turnover at our highest levels. We're excited. We think that certainly 2014 and in all likelihood, 2015 will be great years, and we're very optimistic. Okay.
I guess I'll start with, I'm going to go back, I guess about five or six or seven years, when a lot of companies were a little concerned about the market. You seemed to be zigging when others were zagging, you were making investments in the business, hiring teams of people, starting up new businesses. You were really one of the first ones that was doing it back then. Fast-forward now a number of years, what's your opinion, what's your view of how the startups have performed? Was it the right decision to do it back then?
Well, first of all, you have to separate out accounting from reality. In reality, absolutely. We've built a great group of new companies, and I'm going to let Rob talk about that in a minute. Again, one of the differences in how we do things is when you study the business, you find that the greatest risk you take is loss reserves and inadequacy of loss reserves. When you buy a business, especially one that is for sale on purpose, it's on for sale on purpose frequently because loss reserves are inadequate. Expanding through acquisition is a dangerous thing, getting adequate reserves is difficult. For us, expansion by starting ventures was low risk. It didn't take into consideration, however, the accounting aspect.
If you paid 150% of book value to buy a really good business, it may look good on your balance sheet because you get an immediate return. The cash economics, if you own the business, of starting a business and taking two or three years of losing money, are still much better to start up than it is to have all that goodwill. On an accounting basis, because we all know accounting doesn't always reflect reality. I apologize to all those accountants in the room. It doesn't, because they have goodwill of, let's just say they spent $150 million buying a company that earned $10 million. At the end of three years, they have it on their books for $180 million, the accumulated net worth of the businesses. We may invest, at that point in time, $20 million of losses.
We have it on the books for, let's just say, $70 million, the capital that we require plus $20 million of premium. We have it on the books for $70 million, and it earns the same thing as their $170 million investment. We earn the same thing, we have the same business, but they have $80 million more book value. Which would you rather own, all things considered? We run our business in a different mentality, and we don't focus enough on the accounting because of that. Rob, do you want to talk a little bit about the results?
Yeah. I would just add, as far as the specifics of the younger operations, by and large, they have met or exceeded our expectations. Probably of the businesses that we have started over the past few years, there's two that have come up a bit shy of what we had hoped for. Those issues that we face there are as a result of market conditions, where the people running these businesses, they're disciplined underwriters, and they're not going to do foolish things. The market has remained competitive. Consequently, we haven't gotten the scale, and we have a bit of an expense ratio situation there. We are very supportive and believe underwriting discipline has to come first and foremost.
I think the only other comment, if I may add to what was mentioned earlier, in addition to the accounting, is when you start a business from scratch, it's a much more controlled scenario as opposed to when you make an acquisition. Obviously, managing risk is something that we are sensitive to, and there's a good deal of risk, as we have all seen in the number of acquisitions in this industry that have not gone particularly well. When you start a business from scratch, it's like if you're there building the house yourself. You know what's going into it. You know how it's being put together. On the other hand, when you acquire a house, well, you never know for sure what's behind the wall.
From our perspective, it may take a little bit more time to get to scale, but the value of that additional control and our ability to manage risk around the unknown, that value is quite meaningful.
Shift towards pricing. We'd like to get your view on where you think the commercial pricing environment is going. I know it's going to vary by line of business, you look out 2014 into 2015, based on what you see now, what's your view on commercial pricing?
First of all, loss costs have been lower, as far as increase, than anyone expected. That's fundamentally, you see a $4 trillion balance sheet with the Federal Reserve. We would have all expected greater inflation than we've seen. We haven't seen social inflation of consequence yet. People have forecasted loss costs of 2%, 3%, 4%, and it hasn't happened. That's why we've seen substantial redundancies. Some companies, such as ours, have been more reluctant to release those redundancies because we're concerned about that inflation being around the corner. It doesn't mean the redundancies aren't there. It's really a function of when do you make the judgment that says, "Okay, we're comfortable it's not going to happen tomorrow." I think that I was more optimistic a year ago about pricing increases this year than I probably should have been.
I think that loss costs, I would guess, are going to increase at 3% this year, and I would guess that pricing will certainly increase significantly more than that. I would guess the high-end number would be 6%, and the low-end number would be 4% for price increases. One of the things you have to be careful of is some of these people who talk about price increases, like IIABA, they call their agents up and ask them to tell them what are price changes and MarketScout. That's not the statistical basis. They have their own biases. We think the public data that a few of these firms have thrown out are on the low side of reality. We would guess the market as a whole price increases are probably between 3% and 4%.
One area where you are seeing price decreases is in the reinsurance business, which is not great for your own reinsurance segment, but good for you as a buyer of reinsurance. Can you talk about your ceded reinsurance strategy, given what appears to be a somewhat softer reinsurance market?
Jay, obviously, we're quite conscious of the reinsurance environment and as it relates to how we operate and work with our partners. We are conscious that it needs to be a long-term relationship. At the same time, we realize it's a very competitive reinsurance market. There is opportunity to improve one's margins by using someone else's capital. Typically, really the benefit that we're seeing is we are able to buy reinsurance and get a better ceding commission, which will enhance our margins or just better terms in general. You're not seeing, at least we are not going out and buying dramatically more reinsurance because quite frankly, at this stage, we have a lot of confidence in what the underwriting results are going to be on a policy year basis of the business that we're writing.
Even though the reinsurance is attractive, we're very happy with keeping the business that we do keep, if not more. Having said that, the improved economics, we are certainly benefiting from those as well as a ceding company.
I think we will also say that while we might see $650 million-$750 million of premium last year, and we might only reduce that modestly. How we reduce it might also not just increase our profitability, but also take off the tops of exposures should the unforeseen event happen. You pick up some exposure also coverage.
That could free up capital as well.
Yes.
I guess shifting to the investment side for a second, you talked before about realized gains being $100 million, should be another good year. Where are those coming from? You obviously have some visibility into that. What asset classes are producing these gains?
First, common stock. We have relatively small common stock portfolio, but it's been very profitable. It's really what my background was. We've had significant gains in our common stock portfolio. Number two, our real estate portfolio, real estate owned. We've sold some of that real estate, and that has generated some gains, and we expect that that will generate gains in the next 12- 18 months of a significant amount. Simultaneously, we've got new real estate ventures that are moving ahead. We have private equity investment. All those ventures have given us compound returns of 10, 12, 15, 18, 20, as much as 25%. You don't book them, you don't mark unmarketable securities, unmarketable investments to market. They carry the cost until the gain becomes realized.
Because of that, we may own some of these things for three, four, five years, and they're still at our cost. They'll appear as though a miraculous event happened yesterday, whereas in fact, the miraculous event was a five-year accumulation of value.
Any questions from the audience? There's one thing on reinsurance that I wanted to ask, I should have asked it before, and that is your own reinsurance business. What you do hear from some players in the market is that the larger reinsurers are getting a bigger piece of the pie. They're seeing and keeping more of the business. You have a relatively small reinsurance business. Where does that leave you strategically? If in fact that is the case.
Jay, I think we're quite comfortable with our reinsurance businesses. Certainly, the facultative business has had its challenges over the past few years with the soft market. Also, you're really seeing ceding companies looking to increase their top line by just buying less facultative. On the treaty front, certainly scale makes a difference, but scale tends to make more of a difference as to the size of your balance sheet and your financial security to the extent that it also makes a difference that there are some larger ceding companies that are looking for ways to buy many of their programs, less on a regional basis, more on a global basis.
Certainly, we have seen some of that, and amongst our various treaty operations that are divided by region, they are joined up so they're able to address those needs of those clients when we think it makes sense. Oftentimes, we do not necessarily always choose to participate in those opportunities because when people try and pool up their reinsurance buying, oftentimes they are looking for terms and conditions or pricing that would be difficult for us to meet. For the most part, we're very comfortable with our business. We don't think the reinsurance business is going to go away. The lion's share of what we do is casualty-based, which has had some pressure, but certainly not the same level of headwind that you've seen in the property cat market. Question over here.
I wonder if you can give us your thoughts on the ILS market. We've seen a lot of money come into the ILS market last year. Returns were pretty good. As long as interest rates stay low, I would guess more institutional money will come chasing in. How significant a factor will that be in the reinsurance side in the years to come? Do you see it as a short-term phenomenon due to low rates? Do you think that, as we have some events in the downside of the ILS securities, some of the institutional investors are seeing whether they will withdraw or whether this is a long-term structural element to the reinsurance capital supply?
Why don't I let Rob answer first specifically, then I'd answer the philosophic piece of the second part of your question. Could you go and talk with the market? He has me answer first, so then he can tell you why I'm wrong. I don't think it's just the ILS market. I would suggest it's this space that has been developed for alternative capacity or capital to come into and erode to a certain extent what's been the traditional reinsurance marketplace. The capital has come in from some different sources, ranging from hedge funds on one end of the spectrum to funds that just manage money in this space, to the other end of the spectrum, pension funds that are looking to now not just indirectly through a third party, but directly participate.
Certainly, low interest rates that the world has been coping with played a role in driving them into this market. It is unclear as to what their long-term intentions are at this stage, but we do not see them as a group overall exiting altogether. When you think about a pension fund with tens of billions or hundreds of billions of dollars in some cases, they can take a very small percentage of their assets under management and post them effectively as collateral. To the extent that they can get a reasonable return, I think they're pretty happy to do that all day long. As it relates to the world of property cat, while it may ebb and flow a little bit, and if you have a series of natural catastrophes, it may get people to pause, but I don't think we see them exiting altogether.
As far as it spilling over into outside of cat reinsurance, certainly there are many smart people that are trying to develop the technology, if you will, to find ways for these pools of capital to participate in other lines of business. At this stage, while they may expand into certain lines, perhaps in the personal line space, they tend to like the lines of business that are easily modeled and relatively short tail in nature. Consequently, we think much of what we do, while it's possible they will participate over some period of time, much of what we do is not really space that they want to participate in. As mentioned earlier, we are very much a casualty-focused shop. Let me now answer my piece of that and then we'll answer your question.
He gives a more balanced view than I do, but when you've been in the business long enough, you have an opinion about everything. First of all, the insurance industry really needs no capital in theory because if you price your risks properly, there's always a margin. The reason you need capital is for the unforeseen event that's out of sequence. If you look at well-run insurance companies, if you take any extended period of time, they never lose money. There are exceptions. What has come about with increased computing power, more statistical analysis, is people have now deceived themselves into thinking that they have great precision and accuracy. As an aside, I would suggest that those same people forecast the Katrina losses at $15 billion. You need to ask yourself how good and how accurate are all these models?
As they get more and more data, they get more and more confident, and as they have more and more confidence, more and more people participate in all of these alternatives, and they will grow and expand until the unforeseen event happens and their models fall apart. Those people who have lots of resources will understand and will continue to play and make money. The peripheral players will fall out because the losses will be well beyond three standard deviations of expectation.
That having been said, if you have a lot of capital, it's a great way to get a second return, since you're pledging a security, your investment portfolio that's giving you the return you always expected. We're already seeing great investors choosing shitty underwriters to manage their portfolios of insurance, not realizing that just as there are great stock pickers or investment managers, there also are a wide difference in underwriters. Yesterday on the phone, a friend of mine who invests called me and said, "Hey, we're thinking about putting money in this particular fund.
What do you know?" I said, "Why don't you look up where this fellow worked and the results?" He called back and said, "I guess he didn't do so well." I think that right now, there's not enough really good underwriters to go to all the people who want to invest their money at the moment. All that having been said, you also don't have a lot of people who want the extended tail on the business. Yes, for catastrophe, property business, and other short tail business, highly uncertain for casualty business. I think it's going to be a while before people get enough knowledge to understand what they're doing.
Question right here.
Hey, Bill. Given you've got a lot of things going on, you've got these new business lines ramping up. You're leveraging expenses, and you've got some interesting things going on in the investment portfolio. You said you're optimistic about 2014 and 2015. What kind of returns in this environment can a good insurance company expect? What kind of returns would you be happy with? Is a mid-teens return good, or is a 10% return good? In a low interest rate environment, should returns systemically be lower?
As we've moved our portfolio to achieve capital gains, we consider those capital gains as alternatives to investment income and keeping those returns. Our targeted return is still, if I had a range, it would be 12.5%-17.5%. I think our target of 15% hasn't changed. Clearly, if interest rates stay where they are, that's actually more attainable, because if interest rates stay where they are, that really means loss costs are going to continue to grow at a much lower rate than we are currently thinking. It means that our redundancies will be increasing, not decreasing. At what point do you get comfortable that being the case, and you stop worrying about that inflation that's around the corner? I can't answer that. Our targeted 15% return hasn't changed.
Truly, at the moment, where we're getting a lower investment return and we're cautious as to our inflation assumptions with our investment in our loss reserving, it doesn't appear like that's where we're going, but I think that's our own caution as to those results. We're a tax-paying company, so it costs us not to be aggressive in that area.
Can you give us a little color on how you do your internal discussions, debates, speculations, analysis about that very topic that you mentioned twice, which is inflation around the corner, or are we living in a world of disinflation? Elsewhere in the world, there is plenty of disinflation, not just in the U.S. There's a view that there could be a disinflation contagion going on locally. How do you think about it internally, and how do you come up with your projections?
First of all, we're a risk-focused company. When we talk about people and our returns, we always talk in terms of a risk-adjusted return as our goal. We focus on risk first and foremost. We look at what the risk of inflation versus deflation is, and that puts a definite bias on our fears of inflation versus deflation. The reason for that is if there's deflation, we're going to make a lot of money on our loss reserves, because our loss reserves are going to be substantially redundant if there's deflation. The risk of deflation, while it's a long-term concern, we're going to make money on our loss reserves because they're going to be more redundant than we ever thought. We're going to make money in our bond portfolio. We have two really big pluses already in our business.
If there's inflation, on the other hand, we have risks in our loss reserves, and we have risks in our bond portfolio. Because of that, we worry more about inflation. I don't think it's quite a balance that says which way do we think is more likely? We say, which is a riskier decision for us in managing the company. It's much riskier for our enterprise to bet on deflation than to bet on inflation. We always try and let's assume for the moment that we're going to be faced with the risk of inflation, because if there's deflation, we've got it made. This is probably, I can't remember how long ago, but a long time ago.
Before any of you, most of you invested in the insurance sector, we looked at that issue and we said that if there was 10% deflation over a three-year period, our net worth would double. We'd have a hell of a time earning money after that, but our net worth would double because deflation was such a positive on bond portfolio and reserves. That's why we worry about inflation right now.
I want to shift gears and talk about management transition. Both of you are up here. Is there a game plan? Can you share it with us?
There's a game plan. We're happy to share it. My expectation is between the end of this year and May of next year, Rob will become chief executive. I will become executive chairman. The board has been given a wider time horizon. Next week, we have a board meeting where we'll be talking about the time horizon narrowing till the end of this year and May of next year. Before, it had extended till the end of next year, from May of this year to the end of next year. Now it's narrowing to the end of this year and May of next year. I'll be spending my time primarily on investments, and I'll be involved in legal and accounting and some strategy, but lots of the other things will now be moving over to Rob 100%. He's been involved in all of it.
As I said, he's been exclusively involved in the operations up to now. He's worked with me on all of the other pieces. The other pieces we work together, other than accounting and legal, will move 100% to him, and accounting and legal will migrate more and more to him.
We have time for one more question. I want to just quickly, in about less than two minutes. Loss reserves. It has been, I think, a point of contention amongst some observers of your stock. Can you talk about kind of year-end 2013, how you feel about your reserves, you expressed some confidence, but why would that be?
Since I want the last word of this, maybe I'll let Rob talk first.
I think, first of all, analyzing someone else's loss reserves is a complicated exercise to begin with. There are some folks that think that you can just take Schedule P and an abacus and figure it all out. Actually, there are some subtleties that are quite meaningful. They can be quite leveraged as a result of how important they are. When we look at our loss reserves at a very granular level, that being by operating unit, so each one of the 49 by line of business, we are very comfortable. We are equally comfortable when we look at it in the aggregate. We do take, as it was suggested earlier, what would seem to be a more cautious approach than some of our peers.
As we've communicated in the past, our view is that when it comes to setting loss costs initially and also how you recognize positive development, we tend to err on the side of caution. We do not want to get ahead of ourselves, and as those loss reserves season, we will tighten up that tick. We do not want to declare victory prematurely, particularly given the potential exposure to trend and what that could mean. One of the issues, as we've explained to some, is that our business is not so easily analyzed, but it is about to become much more easily analyzed because we are going to have a consolidated Schedule P.
It is our expectation that when people look at the consolidated Schedule P and also take advantage of the additional information that we will be providing, particularly around excess workers' compensation and helping people to break out excess workers' compensation from regular comp, they will come up with an answer that is different than what has been suggested by certain individuals that you were referencing, Jay. Again, as it relates to reserves, we're very comfortable with where things are. We think we have a very robust process with a lot of check and balance in it, both at the operating unit level as well as at the holding company level.
That process is done every 90 days on a ground-up basis, and we do believe that we have our arms around it and the reality of the situation should become more visible with this new Schedule P that will be made available in relatively short order. Again, I would caution you, when you look at the Schedule P that we will be putting out, make sure you also look for the exhibits that we will be putting on our website that assist you in breaking out things such as excess workers' comp, that if you look at it like primary comp, it will lead you to the wrong answer. I think it's important to understand our goal is to have adequate reserves. To have adequate reserves, assuming a actually higher rate of inflation than currently exists.
People seem to imply on occasion, at least certain people, that that's not the case. We had a trucking accident in California. We put up what we thought was the right reserve. We didn't not pay any attention to it. We didn't ignore it. Yes, the case got thrown out and it's going to go up for another trial. It doesn't change what we put up. We put up what we thought was the right number, and that's going to go on just like this case is going to go on for a long time. I'll have already turned over the CEO job to him. I might not even be Executive Chairman by that time because it could easily be 10 years. That's the nature of reserves. Every day we have decisions to make.
Every day we make those decisions as owners of the business to pick what we think is the right number as cautiously as we can. It doesn't mean that we're always going to be right. It does mean that we go through a very lengthy process, having made mistakes, to be sure that that's not the case. It does mean that our reserves have been, for 28 quarters in a row, substantially redundant, and we would expect, given loss costs increasing at the current rate, that'll continue for as far ahead as we can continue and until those trends in loss costs change. We think that with good reason, we're optimistic that our reserves are more than adequate