W. R. Berkley Corporation (WRB) Earnings Call Transcript & Summary

Good afternoon, everybody. My name's Mike Zaremski, and I'm excited to have Bill and Rob Berkley of W. R. Berkley, joining us today. So, there is a good amount of buzz around innovation and change within the property and casualty insurance industry, which some within the industry term insurtech companies. So I'd be remised if I didn't point out that one of the W. R. Berkley's core competencies is its ability to capitalize on changing market opportunities, both within the company's insurance operations and alternative investment portfolio. Bill Berkley founded the company with a few thousand dollars back in 1967 and many of W. R. Berkley's 50-plus operating subsidiaries reformed over the past decades in order to take advantage of changing market dynamics. The format of today's conversation will be a fireside chat. In the second half of our discussion, I'll poll the audience for potential Q&A.

So with that, I'll kick off our conversation with a question for Bill and Rob. I guess, I feel -- even though your stock price has done very well over the last couple of years, I still feel like there's a lot of investors that might not fully appreciate some of your, let's call it, competitive dynamics or core competencies or why you're structured differently than the average P&C company. So maybe you can just talk at a high level, if you feel there's 1 or 2 competitive advantages or distinctions between W. R. Berkley and some of the other insurance companies you're compared to.

Okay. So I think there is a big difference between us and certainly, many of our peers or at least how our peer group that has been defined by others. And it starts with the idea of specialization. We believe that the insurance industry, while there are aspects of it that are easily defined as a commodity. The parts of the market that we choose to participate in are easily decommoditized through knowledge, expertise, intellectual capital. It is this understanding, this focus, this recognition, which is really what's led us to a decentralized model. And it's our decentralized structure and the empowering of people and leveraging their expertise in certain subject matters, is ultimately the great differentiator for us in bringing value to customers and for us bringing value to shareholders. So I would tell you that the specialization and our structure allows us to specialize in a way that others don't. And ultimately, that allows us to achieve better outcomes. And it's worked well for some period of time, and we are quite committed to it.

Okay, great. Maybe we can move to kind of P&C market dynamics and let's just start with interest rates, given everyone's kind of staring at their screens the last, especially, couple of days. Do you feel the curve being flattish, combined with -- I know there's a number of insurers that have long, for over the last decade, felt that interest rates would increase. Do you feel like it's leading to a dynamic whereby insurers are more disciplined? And you feel that the industry will kind of be able to push pricing to get the kind of extra rate they need given the loss of investment income?

Well, certainly, from my perspective, and you'll have some thoughts, too, I would imagine. But my view is that there are a few different pressures that are creating a level of discipline for the commercial P&C space, in particular. And it is the reality of the low interest rate environment and does that mean for investment income. There's the other reality that the -- what I'll define as the tax arbitrage that existed for an extended period of time has gone away. Clearly, frequency of severity on the property front has brought pressure to the situation. And then finally, and perhaps we'll get on to this a little bit later, but you're seeing just a tick up in loss cost trend, particularly in some of the reliability lines that's stemming from something that's been labeled social inflation. And all of those things, investment income, not to be glossed over at all because it is a huge component of the industry's economic model that is putting a lot of pressure and forcing people to think about rates and how they are going to generate earnings in a different way than they did not that long ago.

I think that there's also the issue of how do you invest your money. If you look at our portfolio, 10, 12 years ago, we were effectively a fixed income investor. As you start to see the demand for fixed income securities increasing and new terms going down, we started to invest in other ways. So we're investors in real estate, private equity and a number of things to give us a better return, and we think risk adjusted is substantially better return. So while it's not a smooth and predictable quarter-by-quarter even if we found other ways to get that return that we need. So one, we do need better underwriting results, which we're getting through price increases, but we also have changed our portfolio mix, still very conservative, but a little bit more lumpy to give us better returns.

So you've continued to push in terms of moving towards nonplain vanilla fixed income? Or is there kind of a regulatory governor in terms of how much you can push the one there?

We're a long way from the regulatory governor. We have lots of space. The question is, do we have lots of opportunity? We talked about measuring our results by risk-adjusted return, and notice, we don't say return adjusted by risk, we say risk-adjusted return because we look at risk first. A lot of the time with investments that we make, have implicitly a certain level of risk. And in order to get those returns, we don't want to increase our risk beyond what would be acceptable. So it's harder to find those kinds of things. We'll continue to look, we'll realize some of the gains, and we'll continue to -- it's the market that's going to tell us whether we can find those opportunities.

And your nonfixed income investment returns have been superior than those of most of your peers. Are most of those investments sourced internally? Or a mix of internal and external? Is there a team inside Berkley that works on that?

I mean the gains have predominantly been from a couple of different parts of the investment team that is within the organization. So by and large, the gains that you're referring to that we've seen over the past several years that we would expect, we'll be seeing long forward as well. When we look at the pipeline, they are primarily driven, again by teams of people that are operating in the alternative asset space that our kind of employees are in constant kind of communication.

And maybe, Rob, we'll move back to a topic you brought up earlier in terms of -- you mentioned a tick up in casualty inflation. I feel for some companies, some of the results that have depicted more than just a tick up, it's been a -- it's a little lumpy in terms of some charges. Maybe more broadly, do you feel like social inflation is something that's here to stay? Is it something that insurers can truly measure? And maybe if you want to remind -- do you feel -- the definition of social inflation, or is it just kind of a number of factors in terms of more jury awards and more...

The way we think of social inflation or internally would define it as anything that's driving loss cost trend as a result of what you see going on in the social environment, the legal environment or a shift in society. And clearly, we have been seeing a trend over the past couple of years, and we've been talking about it for a few years. Well, it first started to sort of percolate a little bit. It's very visible at this stage in a lot of the liability exposure across the board. Is it going to go on forever? It's going to go on for some period of time. What will stop it? What will stop it is when all of a sudden society decides that they've had enough. And that they look for some degree of tort reform. History would suggest it needs to get pretty bad for that to happen. If you think back to, I don't know, give or take, 1.5 or 2 decades ago, we saw the -- we've used this example in the past, that we saw in the health care space with med mal where jury awards got to the point where insurance companies were losing a little bit of money. The rates went up dramatically for med mal covered. Doctors couldn't afford to pay for it. And lo and behold, we found ourselves in certain parts of the country where you couldn't find a doctor to deliver a baby, amongst other things. We haven't gotten to that point where the pain is so overwhelming, it's affecting society in that way. Is it pointed in that direction? Yes. How bad will it get? And how quickly will it take or how quickly will we get to that inflection point? I don't know. But there have been some people that have suggested that they don't think it's real. There are some people who said that it's just a blip. From our perspective, it is a meaningful trend that is clearly driving loss costs, and it is likely to be impacting the industry's loss costs for some period of time.

And would you say there's any attributes an insurer may have to -- that would make them more or less susceptible to inflation? Or has Berkley tried to remix its portfolio at all, maybe deemphasizing certain industries? Just thinking [ more growth ]...

Certainly from our perspective, this is something that will affect society across the board. So I don't think anyone is completely insulated from it. But clearly, there are certain industries and certain profiles of accounts that are more susceptible to this type of exposure than others. So I think there's been some discussion comparing large accounts versus small accounts. We think everyone is exposed, but generally speaking, again using a very broad brush, larger accounts are going to probably draw more attention than smaller accounts when it comes to some of the challenges around this topic.

Okay. And so limits, could you remind us? Berkley's limit size tends to be $1 million or less, if you can...

So what we've shared with people is that if you look at our limits profile as an organization in our Insurance business for the policies where you're legally allowed to have a limit, not workers' compensation, but other types of policies. Approximately 90% of our policy count has a limit of $2 million or less. And I think that speaks to the idea that, by and large, we are not a large account organization. While we do write some of that, that's not the primary focus.

Okay. So maybe sticking -- moving to margins on the P&C side. This year -- last year, on the podium up here, I believe you, Rob, spoke to being optimistic that Berkley could show some margin improvement, given the rate environment seemed to be conducive, increasing, and you felt there was some mix shift to benefits that would come to fruition. And fast forward a year, and for the most part, your outlook came to be. What are you thinking now in terms of the coming year? It feels like there's -- you're getting more rate than you have in the past, loss inflation is still increasing. Maybe you could kind of talk to -- how you see the next year playing out.

I think for the industry overall, there's a broad recognition that this is a -- there's a bit of catchup that needs to go on. Loss costs have proven to be above and beyond what many people had anticipated. And I think there's also a general recognition that, that trend continues to move up and forward. So it is a game of catchup. I think the industry, depending on who you're talking about and what corner of the marketplace we're referring to, is in a different position as far as hardening goes. But ex workers' compensation within the commercial line space, I don't think there is a meaningful pocket that you're not going to see at least a continuation of what we saw in '19 and in many cases, likely an acceleration as far as rate goes. I think for those organizations that along the way have not let things get away from them very much and have kept an eye on their loss costs, this is going to prove to be a great opportunity because they're able to use this as a way to spend forward. But I think there will be some market participants that are screwing around, trying to figure out how to bail the water out of the boat as quickly as possible. When we looked at the fourth quarter, we were pleased with what was accomplished for us as an organization and what we were able to achieve in the marketplace. We continue to, by and large, chose rate over policy count growth. And you could see that in our fourth quarter numbers where we grew at approximately 9%, and we got 8 points, 9 points of rate. And again, as we see those margins start to become more attractive, I think you're going to start to see our top line grow even more, not just due to rate, but count policy, count growth will be there as well. And our sense is that's coming in 2020.

But given loss costs are increased, and even though pricing seems like it's outpacing as you're describing, does it make sense for a P&C insurer to reserve more conservatively, given there might be some additional uncertainty around loss inflation?

From our perspective, we think it makes sense, when it comes to reserving, to early on err on the side of caution with the idea as those reserves season out, then you can recognize that caution. When we think about the environment that we're looking at today, with the type of pricing that was achieved in the fourth quarter and our expectations going forward, clearly, in spite of trend being up, we think when you're getting about 9 points of rate, we're comfortably outpacing trend. And as that premium earns through at those higher rates, it's hard to imagine that, that is not going to prove to be accretive or enhance our margins.

To the -- you've improved your expense ratio over the past couple of years, fairly measurably. I think you have a long-term goal of bringing it down another couple of points. What are the -- let's say, the rate environment gets immensely, let's say the rate environment grows double digits next year, will that kind of get you closer to your 30% long-term target faster than the base case?