Saving the best for last, I'm very pleased to introduce Bill Berkley, CEO of W. R. Berkley, a specialty insurance company, market cap about $5 billion. Bill is the Chairman and CEO of W. R. Berkley. Has a lot of experience kind of navigating market cycles. I thought it would be appropriate to have him close out our conference today. You can stop listening to me and listen to Bill. I'll sit down, and here's Bill Berkley.
Good afternoon. One of the things that you stand up and think about when you talked about a group is what's the mix of talking about the industry and about your company. You should all know that really the only thing I care about is when you leave here, you think you should buy our stock. I don't really care if you know more about the industry, more about any other company or whatever. The nature of informing you about why you should buy our stock requires me to talk somewhat about the industry. I should start by telling you that it's one of the real opportunities to buy property casualty company stocks. First of all, the industry is at a point in its cyclical nature where opportunities are at their best.
Number two, it's a point in the industry where, in all likelihood, we're going to see some peripheral benefits from the problems in Europe. Much of the industry's capital and reinsurance base is in Europe that we're likely to get some benefits from the investment portfolios of these companies suffering with all the malaise in Europe, and I'll talk about those things later. From our point of view, we think this is a great opportunity. We think value is created in this business by having real knowledge about the business and being immersed in the business, understanding about how every line of business works, managing exposure, understanding where you do business is important, and it varies, and knowing all the levers to pull within the industry and within your business.
You need to keep the very best people who are intellectually grounded, not just in theory, but in the underwriting, claim settlement, and management of this industry. You have to have a long-term culture that's based on the outcome, not based on, I have a lower loss ratio, or I settle this % of claims, but that's based on the outcome. That's risk-adjusted return. It's important that you grow at the right times in the business. Now, what does that mean? A key element in understanding the business is retention. How much of the business stays with you? Now, what that means is you need to grow when prices are increasing, and that way, you won't have to reduce your prices nearly so much as prices come down because people don't change where they buy insurance for small amounts of money.
Add business and grow dramatically when prices increase, gaining market share, and then you reluctantly follow markets down and business erodes. You might have 90%-95% retention rates as prices move up, moving down to 85% or 80% or even 70% retention as prices come down. We've been able to grow dramatically in times when prices have moved up, doubling and tripling the size of our company in expanding markets and contracting somewhat when markets go down by being willing to lose business when it's priced unprofitably. Our growth has been driven, in fact, in this recent period by new businesses. We've started more than 20 new operating businesses in the past six years. Our old businesses have shrunk by about 25%, but we've more than offset that by the premium volume of our new businesses.
Now our new businesses are growing, and our older businesses are regaining the amount of business they lost. It will give us great leverage on the upside. We'll not only regain our old size as our other businesses replace the business that's gone away, but we have twice as many operating units that will give us more business overall. Our units grow at varying pace. It was interesting, at the end of last quarter, we grew in that quarter at 11.5%, which was down from the previous quarter. Most of our competitors grew at 3%, 4%, 5%, or 6%. No one complained about their growth, and everyone complained about ours. It was a little frustrating. First of all, 6.5% of our growth came from price increases.
More importantly, some of our growth was derived from a few units, some of which grew 150% or 200% over the previous year. Some actually shrank. Shrinking is always okay in the property casualty business. You have to remember, you can always grow in this business. You can grow as fast as you want to. There's always business available at a price. What you need to have is the discipline not to grow or to grow when the price is right. We've been able to do that. If you look at each of our operating units, some, in fact, as I said, even in this time of modestly rising prices, still elected to shrink. The growth rate of our various units has been wide. As I said, some shrinking, some growing.
At the same time, some have grown only through price increases out of a substantial amount, and others have grown because of exposure changes. Overall, what that means is you have to understand, it's not a simple business to examine. We build platforms to allow us to take advantage of the opportunities available to us. To position ourselves to seize the opportunity. You can't go into the marketplace today and expect to write business today. It just doesn't work that way. You have to talk to the agents, you have to talk to the brokers. You have to reinvigorate relationships that you may have had other places. You have to let them know you're there to do business. You have to create those relationships. We have a history of well-timed growth, building on new areas consistently. We build on long-standing relationships.
We talk to the same brokers who did one type of business with us yesterday and can do another type of business with us today. We've built the infrastructure, so when a team joins us, we can be up and ready to run in a relatively short period of time. I might add, a relatively short period of time is never quick enough for the new team, but in the scheme of the insurance business, probably 90 days, we can be up and running. Growth, though, in and of itself, is not our objective. It depends on the pricing environment. Our objective is always the same: optimizing risk-adjusted return in the aggregate. That means we want to make as much money as we can, as long as the risk-adjusted return meets our criteria. We've been able to do that for a long period of time.
You can go back to the start of our company. We have had a loss ratio that has always exceeded. Excuse me. Has always been less than, has performed better than the industry's. In fact, recently, our loss ratio has been going lower while the industry's has been going higher. Underwriting, while the cornerstone of a great property casualty company, is only a bit. It's the key bit, but not the whole thing. Investing, which is the side of the business I started in, is a cornerstone. Our portfolio is primarily fixed income securities. We've shortened the duration because we're worried about inflation. It's interesting to note that 18 months ago, our duration of our portfolio was 37 months, 3.7 years. That matched up with a number of our competitors.
Today, our portfolio duration is 3.5 years. A number of those same competitors have moved their duration upwards of five years. They've solved their yield problem in part by taking greater risk and greater exposure to inflation. We think that's a just tremendous problem and a great mistake. We think inflation is out there. We don't know when or how long it'll be out there for, sitting on the sideline. We found opportunities to invest in the mezzanine mortgage market with low loan-to-value, sort of under 60%, and getting yields in the 5%-6% area. Without moving our duration, we've been able to keep our yield virtually unchanged. We continue to find opportunities to invest which don't give anything on the quality of our portfolio, although they do reduce liquidity. We have more than enough liquidity. We're not at all concerned about that fact.
Cash flow continues to be outstanding. Our greatest concern is when cash flow starts to really accelerate, as we think it will at some point, the end of this year or early next year, will we continue to be able to find places to invest? Today, our portfolio is 86% fixed maturity and cash. Duration as of the end of last month was 3.4 years, an average AA- quality. The rest of the portfolio are loans receivable, real estate that we own in an unleveraged fashion for the most part, our arbitrage trading account, and straight equities. We continue to buy equities, although it's unlikely that'll represent a significant portion of our portfolio, nor is it likely anything else will really offset the focus on fixed income securities. Our reserving process, which is the cornerstone risk in understanding a property casualty company, is robust.
It's robust because we make decisions in a series of ways that, in the aggregate, give us real comfort that our reserves are adequate. Initially, the reserves are set by the head of claims and the actuary at each company. They're then reviewed by the chief financial officer and the president of each company. The corporate actuary who's assigned to that company then reviews them. They then get reviewed by our chief actuary, our chief financial officer, and our chief operating officer. Each one is targeted at the 60% comfort level. After that, we aggregate them. When you aggregate everyone at that level, you moved up to sort of the 70th% level of probability. It's simply a mathematical calculation. Everyone at the 60th% brings you to the 70th% in the aggregate. We have full quarterly reviews. Each level is done in a conservative manner.
We think that our reserves are exceptionally conservative, and we're more than comfortable with what they are. We manage our business towards that focused return. First of all, if you look at our results, 16.7% compound return over 35 years. Over the past five years, our average return on equity, 13%. Over the past 10, it's 19%. 15, 13. The 10-year measure, we think, is the best measure. It's when we got out of the personal lines business and consolidated our regional business. For 10 years, the nature of our business has basically remained what it is. During that period, five-year Treasuries returned 5.7%, and the S&P 500, 2.9%. We comfortably met every one of our targets. We think there's a lot of leverage in owning our stock.
One, we think our earnings are going to do exceptionally well because as a hard market comes, the leverage in increasing pricing is dramatic. Number two, we think our premium volume will increase substantially. Number three, we think people will pay a higher price as we demonstrate that leverage. Our return on equity during the last hard market exceeded 25%. Our stock traded over two and a half times book value during that period. We think there's a lot of opportunity. We think we're barely starting that process. From our point of view, if you look at our correlation between tangible book value and growth and total return, we are number one on the list of companies. We continue to believe that the opportunities are enormous.
One of the things that's interesting is 13 out of 39 companies, public companies, who have reported their earnings have shown adverse development in their loss reserves. We don't think most people are focused on it because most of them have been smaller companies, although a few of them, AIG and Liberty, one can't say are smaller companies. We think that when you start to look at that development, you're going to see more and more companies showing adverse development, and the benefits we've seen are going to go the other way. It's going to put substantial additional pressure on management to raise prices. Prices never can get raised quickly enough because of the lag. We expect that price increases will accelerate, not decelerate, in the next 24 months. We expect price increases will continue or increase the balance of this year.
In the first quarter, we were up 6.5%. We would expect by the end of the year, prices will be up at least 8% on average, year-over-year. We would expect it would be 8%-12% next year-over-year. That can easily change if any one of the big companies in Europe has some kind of difficulty with their balance sheet due to challenges with the euro. We're pretty excited that that's the most likely surprise that will come and approach the industry. When you look ahead to understand what's going on, you have to look back a little bit. The last turn in the market came in October of 2000. Prices started to turn around. You saw price increases of 5% or 6% in September. In October, Reliance Insurance Company and Frontier Insurance Company went out of business.
About four or five lines of business prices were up 30% in a month. More and more prices were up as you went through the rest of 2000 and into 2001. The events of the World Trade Center dramatically drove the market. Not so much because of the loss of capital, as people said, because if you measure the capitalization of the industry at that time, there was plenty of capital, but because fear. Fear and greed drive the business. People were afraid of the uncertainty. There's certainly plenty of things going on in the world that can create lots of fear. We think the combination of those events is more likely to impact this industry, the one that's supposed to provide stability, and that we think will drive prices substantially higher. We've rarely been more optimistic than now.
We had expected this to happen two years ago. In fact, last year prices were up but probably half of what we expected. We had expected it to actually start in 2010. The government stepped in and decided that American International Group needed to be saved. The consequential result was that American International Group being saved effectively kept the cycle from turning. I think all that's beyond now. The change is upon us. I'd be happy to answer any questions.
I'll start if I could. Bill, can you talk about the rate trends that you saw at the end of the first quarter and what progress you've seen since the end of the first quarter? Has the momentum that you saw in the first quarter continued?
One of the things that was surprising in the first quarter is, and really surprising for the whole past 18 months, is price increases have not been even. They've been somewhat erratic, up and down. We were really optimistic in January. We were less optimistic in March. We weren't sure how April was going to be. April ended up being fine. I think all the signs of this change happening, and price increases continue as they were, a bit more erratic. I think people are focusing in on what to do, how to react, how to decide what areas of the market to deal with. I think still the biggest problem in the industry is workers' compensation. It's also the part of the industry that you have a lot of smaller players who are busy trying to explain why it's okay that they're growing fast in that line of business.
They write small artisan contractors, and it's okay to charge half of what everybody else charges. This is a business where there's such a wide array of customers, people can justify what they do. It's unusual to have that in such a large industry. In fact, lots of people pay lip service to the reality of underwriting profits, and it takes a few years to pay those prices. That's why I think not many people recognize that a third of the market had adverse development, and my guess is you'll see half the market before the end of the year having adverse development. Yes, sir. Question in the back.
You got a mic coming right there, Porter. Thanks.
Given the fact that a lot of these European insurers have somewhere between two and seven times their equity base in sovereign PIIGS exposures, why do you think we haven't seen more change from these players yet?
I think that that's what I was referring. You've got a lot of very large players. You probably have 7 or 8 companies bigger than Travelers. The biggest reinsurers in the world, not in terms of capital, but in terms of premium, are in Europe. They're highly leveraged compared to U.S. companies in a similar position. My guess, they have substantial exposure. One of the reasons you saw no crisis at a property casualty company, even AIG's crisis was not really within the property casualty business, was that you have cash flow all the time. The crisis will come based on what a regulator elects to do.
Sovereign regulators of sovereign nations that have problems are less than likely to decide to say, "You own our debt, therefore you have a problem." I can't imagine the Italian regulators going into Generali and saying, "Oh, it's terrible that you own all this Italian debt. We're going to close you up." It's just not going to happen, and I don't mean to pick on Generali. I think that that's the reality. I think that it's going to have to be something that no one can hide from. Certainly, all the big companies are sitting here saying, "What are we going to do?" The insurance companies, I'm sure, in Portugal and Spain and Italy are all trying to sit and say, "What are we going to do right now? What's our position? What can we change?
What can we move?" I'm sure their banks and their national governments are saying, "No, you can't do this. You have to look at the big picture." I think it's a while. I think that that's the real wild card that's sitting out there. Will one of those companies face the public cry, and which one, if one, will that be? I think that is the big wild card, because those are big companies. We shouldn't either forget about the giant companies in Japan who are huge, and the Japanese economy has many problems. Yes, sir. In the front, right over here.
There's a mic.
Yep, there we go.
With respect to the companies that are suffering adverse development, is it a function of simply too low pricing in the business that they wrote, or is it lax terms and conditions, or is it something else within their customers themselves that are causing frequency and severity to be too high? What do you think is the dynamic there?
I always like to tell people, if you have a complicated problem, it's unlikely a simple answer will be a correct answer. I'm not able to give you such a simple answer as that. My guess is it starts with the issue that people underpriced their business to start with. They didn't charge enough. Given they didn't charge enough, they set reserves that are too low. I give people this example, and every one of you should understand how it works because then you'll understand how we are such an incredibly stupid industry, and it's important to understand it. If I charge $100, and my industry loss ratio for that line of business is 70%, and I say, "Oh, I don't really know how different I am. I'm going to establish raw loss reserves of $70." I put up $70.
Obviously, it's $100 million, it's $70 million, it's $1 billion, it's $700 million. If I then go and charge half that price, so for business that should have been priced at $100 million, I charge $50 million. I'm a conservative guy, so I'm going to put up 70% loss ratio. I put up $35 million. That's how it happens. That's exactly how it happens because the people who wrote it at $35 million don't really think they mispriced it when they wrote it. They think they charged the right price and everybody else didn't understand. Let's just say that $70 million took five years to pay out. You paid out, for simplistic sake, $14 million a year, starting in year two. You paid nothing out in year one. By the end of year three, you've paid out $42 million.
The guy who wrote the $70 million worth of business for $35 million, or put up $35 million of reserves, rather, his reserves don't change based on the price. His reserves are based on what the right price should have been. He pays out $14 million in year one, and he has $21 million left in reserves. The end of year two, he pays out $14 million more, left with $7 million. Now he knows he's in deep shit. That is the moment where he says, "I have a problem, and I got to do something about it." If he's smart, he may have done something about it earlier. I think that's what's about to happen. The other thing you have to remember is if you look at loss reserves, all loss reserves aren't the same.
Loss reserves from 2004 or 2005 or 2006 were really good reserves because you probably charged the right price. Loss reserves from 2009, 2010, and 2011 are less likely to be good. If you look at the loss reserves and say, what accident years did they come from, you can assess the likelihood of their redundancy. If a company has the vast majority of their reserves from 2008 and 2009 and 2010, you probably shouldn't assume they're going to be likely to have such great redundancies. Now, every company that continues existence will have that, but you'll have to make an assessment of that likelihood and look in the past and see where they are. The reason we haven't made very many acquisitions is because there are very few companies that have adequate loss reserves. There are some, but not many.
I think you'll see those deficiencies coming out more and more, and my guess is people will be shocked at the magnitude of the deficiencies, especially from what I call the small to mid-size companies.
Bill, just to play maybe devil's advocate a little bit, what do you think would have to happen in order for us to not see this kind of grind higher in terms of rate improvement? Let's say instead of going from five to 10 to 15 to 20, to kind of stay in this mid to high single digit range, what would have to happen for that to be the outcome you would expect?
I think that what I've said is our plan and our expectation are based on prices going up modestly. We're happy if prices go up by the end of this year at an average of 8% over last year, and next year, 8%-12%, we're okay with that. We'll get great returns. I think the status quo is where you're going to get with that. I think the question is what's going to change that and make things be better, Mike? I think what's going to make it be better is a couple of these billion-dollar size companies getting into financial difficulty and effectively closing down. It'll make brokers and agents more cautious with who they do business. One of these European companies having severe difficulties and having to pull back on their capacity.
I'd be shocked if any of them really went out of business, but it's not impossible, but they could easily decide they're capital constrained, and they would get more cautious. I also think that a consequential difficulty in the Eurozone would have a real chilling effect on many of these European companies that do business throughout that area and use that as their currency. It would have a real chilling effect on that global marketplace. My answer is, I think our expectations are modest, and it'll be a good cycle change. However, I think there are probably a better than 50/50 chance that some of the things will happen will make the change harder than our expectation.
What about the impact of this discussion about Europe to Lloyd's? Obviously it's not in a currency denominated area, that's kind of where you're talking about, but what do you think the impact could be in a stress scenario like you're talking about to Lloyd's?
We're big believers in Lloyd's. We think Lloyd's has done a terrific job. We think Lord Levene really grabbed hold of it and has done an excellent job. I think that the real question that Lloyd's faces is can they maintain the discipline and keep out marginal players who don't have the financial wherewithal? Because while we have a good Central Fund at Lloyd's, once it starts to be called upon, it's never such a good Central Fund. Guarantee funds are great until someone calls on them, and then they're always suspect. I think that the discipline that Lloyd's has operated within has to be maintained, and hopefully, that'll continue. I think at this point, Lloyd's has been 98% maintaining that discipline here and there. They've been tempted on a few things, but I think Lloyd's continues to be pretty disciplined and pretty cautious.
Thanks. A question here in front.
Turn on the mic again.
There it comes.
Can you talk about more specifically, aside from Size of the insurance company, but maybe the specific lines of business where you think folks are most under-reserved or maybe give us a little bit of a roadmap to try to figure out.
No, I'm not going to tell you who I think is going to go broke. I used to do that when I was my son's age, and I would get in such trouble about that. The answer is it's really workers' comp, malpractice, some of those longer lines where people have misassessed tremendously the levels of reserve. We've seen people do it all the time. When a billion-dollar capitalized company, they think that they have a lot of capital. They don't realize how much losses they can take at writing $100 or $200 million of malpractice business, especially outside the U.S., but in the U.S. too. I think that there's no business that's quite as notable for the grass being greener on the other side of the street. When you're having problems with your business in the insurance business, the other guy's business always is great.
You drop the line you know something about, and you go do something you know nothing about, and then you can't help but make money. I think workers' comp is a great area for that because there's tail. I think there have been a few people who wrote excess workers' comp, who found that out also.
Hey, Bill, by that theory, maybe Michael should ask Rob that same question. Is that right?
Sure. Rob? You over there, Rob? I think I see you back in that corner. Could you give him the microphone back in the corner? I know where you are. I've been watching you.
Sorry.
He tries to hide. No, you go ahead.
I think I'm not going to make the same mistake my father did at my age.
Hey, Bill, maybe I could ask a question. In terms of the areas where, if you can talk about your different segments and which areas are providing you with the best rate opportunity compared to the areas where you've seen growth, and just talk about those offsetting dynamics as we've seen play out over the last few quarters.
I think that, obviously, even non-catastrophe-exposed property business has been more attractive than many other areas. It's been a place where there's not enough capacity. We found it to be interesting. I think in addition to that, we sit and look at areas that people have perceived risk in such things. Suddenly, anything other than professional liability is more attractive. Professional liability is one of the most competitive lines still. I think workers' compensation, again, people are raising prices aggressively, but probably not enough. I think it's across the board and in spots it's a lot, in other spots, it's not. I think every place prices are up, with the exception probably of professional liability prices are not really up enough.
Where in international, that's been an area where you've grown through acquisition and grown through the development of new platforms. What is the pricing or rate environment in your international segment, and where are you allocating resources there?
By and large, our business is growing almost every place internationally. It's especially Brazil, Canada, all of the Asian countries. We offer stability, and stability is one of the things that's attractive. We represent a local environment. All of our people are local people running the businesses. They're there. They're on the spot. We have offices in Hong Kong, Singapore, as well as Australia. We have people there. We have offices in Germany and Norway, and we are in place, part of a culture, in almost all those places, we're finding opportunities. Obviously, in places like Spain, where the economy is not as strong, there are opportunities, but far fewer. We don't run away. From our point of view, we're part of the country. We're cautious. We invest very cautiously.
We keep the exposures we need to the local currencies, our capital accounts are pretty hedged, we don't have more exposure than we need. I'd say to all of Europe, but especially all the Asian countries from Korea, China. I'm trying to think, is there any place it's not? Most every place has offered us pretty good opportunities, we've avoided most of the catastrophe exposures because we don't write catastrophe business for the most part.
Time for about one more. Any questions from the audience? Seth? Anybody else? All right, I have time for one more. What about, we've seen some players lift out energy platforms, marine platforms here recently, citing better conditions there. A&H is also an area that we've seen companies grow. I believe you have an effort that you're growing as well. Can you talk about opportunities in those segments and those areas and how you view them and if you see them that way, and how you're approaching those?
We started probably eight years ago, our A&H business, maybe nine, and it's taken hold. It's starting to do well. There are lots of opportunities. It's an area that's very uncertain because the whole health business in the U.S. is uncertain. In addition to that, we see lots of opportunities in the oil and gas business, the whole energy business, but particularly onshore and offshore oil and gas. It's probably one of our fastest-growing segments within our company. We have a team that's onshore and a team that's offshore, and we're really excited about it. They're growing. It's probably one of our four or five fastest-growing segments, and the energy business, we think, is going to continue to grow. Fortunately, whether natural gas is expensive or inexpensive, it still costs to drill the wells.
We don't think that the prices are so low that at this point they're going to stop drilling much. It's a section that's doing very well. The ocean marine area is an area that's a quandary for us. We participate in the business through our syndicate at Lloyd's. It's been amazing because it's as though losses don't count. People talk about pricing business except for Concordia. It's not seeming to reflect the realities of the marketplace yet. We think that's going to happen, but we're not sure when. It's a business that should be more attractive, and we think that the entire marine segment is currently underpriced and will regain some thoughtful pricing, but it's not here at the moment. We're looking forward to that improving.
Oil and gas business and everything related to energy is one of the real opportunities that we see in the business.
Okay. Maybe one more. One of the charts here in your presentation, one of the early slides here, you talked about the components of growing premiums. It would be slide five. You highlight net new business, the purple bar. Should we interpret that to mean, so basically you're seeing less growth here in the first quarter than you saw in the trailing quarters, but more of the growth is now being attributable to rate. Is that because those startups, if you will, have reached scale, or?
No, in this particular case, there was a quirk, and there was some return premium and a few other things. One of the problems you always have is when you give very defined information, people can reach their own conclusions, and this conclusion, you shouldn't think that that's what it means.
Oh, okay.
Although that's what it says.
My mistake.
No, it's a problem. We debated it, but I think we have used it before, so we didn't want to take it away. That is, we think that there'll be more net new business shown that's going to come up next quarter. We just think that's an aberration for the quarter for a whole lot of things that went on in that quarter.
I see.
We expect our net new business will go back up and be a more significant part. If not, we probably won't show the chart.
Perfect. Okay. Well, I'm good then. Anyone else have questions? Great.
All right. Well.
Thank you so much for your time.
Thank you all very much.