Sunday, December 30, 2007

Is Kingsway Financial a "cigar butt" stock despite its reserving problems?

In my previous article on the Canadian non-standard auto insurer Kingsway Financial(KFS-TO ; KFS NYSE)I discussed that there may have been potential warning signs at Kingsway's subsidiary, Lincoln General, prior to its announcing big reserve increases both recently and during the last year.

Furthermore management's strategy with Lincoln of employing external claims assessors likely contributed to these reserving problems.

Despite the reservations I have expressed over management's stewardship of Lincoln, as investors we have to ask the Kingsway's stock now priced for a worst case scenario and does it have a "cigar butt" quality.

Lets run over the numbers (in US $s)

KFS's current market cap is $690 million or $12.30 per share, $1.90 or $125 million is the high end estimate for reserve increases at Lincoln so my current book value estimate for December 2007 is $17.40 ($18.80 less $1.90 reserve increase plus $0.50 in earnings). Kingsway's debt to equity ratio also looks reasonble at 50%.

Kingsway's current share price is around 2/3 of book value or net assets. This appears cheap and fears of future reserve problems are beng priced into the stock.

Lets look at Kingsway's 5 year performance from 2002 - 2006. Looking at the 2006 Annual report, its combined ratio was 99% , return on equiy 15% and growth in book value 18%(note this includes Canadian dollar appreciation).

So Kingsway has a history of growing book value and achieving decent returns on equity. Furthermore, Kingsway's other US operations are operating at break even. So if we can view Lincoln's problems as isolated and its future reserve increases as manageable then a buy thesis could be made for Kingsway's stock.

If Kingsway can break even on their underwriting in 2008 and do a conservative 4% after tax return on their $63 a share in cash and invested assets, then thats around $2.50 a share. So at $12.30 a share the shares are priced at 5x 2008 earnings or a 20% return. If Kingsway is successful in restoring investor confidence in management and fixing the bleeding at Lincoln General, then Kingsway should at least trade for its book value, that would mean around 50% upside for the stock from its current price.

In conclusion, Kingsway's insurance business is not a high quality auto insurance franchise like Progressive or Geico, nevertheless Kingsway's stock at its current price of 2/3 book value looks like a "cigar butt" buy despite the problems of reserving at Lincoln. Concerns over management and reserving appear compensated in the current stock price.

Disclaimer: The opinions expressed in this article by the author represent the authors own point of view and are not intended as investment advice and should not be relied upon as such.

Disclosure: I have no position in the securities discussed.

Mark Twain on Accident insurance

Here is an extract from Mark Twain's amusing speech on the insurance business.

For the full speech please click link below....

"Ever since I have been a director in an accident-insurance company I have felt that I am a better man. Life has seemed more precious. Accidents have assumed a kindlier aspect. Distressing special providences have lost half their horror. I look upon a cripple now with affectionate interest - as an advertisement. I do not seem to care for poetry any more. I do not care for politics even agriculture does not excite me. But to me now there is a charm about a railway collision that is unspeakable. "


Saturday, December 29, 2007

Buffett moves into bond insurance

In my article on the 21st December I indicated that Berkshire Hathaway could take the opportunity, caused by the capital problems facing MBIA & Ambac, to make a move into insuring municipal bonds.

Well Buffet has decided the time is right to make that move. Please see link below for the story.

Insuring bonds raised by states and local governments to finance public works, schools, roads and the like is a good business. Unfortunately MBIA and Ambac didn't have the good sense to stick to this business , and instead they made an ill-fated move into CDOs and the like.

Berkshire Hathaway will no doubt be careful about the risks they take on but municipal bonds are generally safe and you can expect Berkshire will get good pricing on the premiums it charges. After all, Berkshire Hathaway has a solid "Rock of Gibraltar-like" balance sheet, unlike other competitors.

Berkshire's entrance will also provide stability to municipal bond pricing which is good for everyone from bond investors to states and municipalities and their residents.


Tuesday, December 25, 2007

Big Reserve hit at Canadian insurer . But were the warning signs there years earlier?

Its been a not so merry Christmas for shareholders of Toronto based non-standard auto and specialty insurer Kingsway Financial (KFS-TO,KFS-NYSE)

On Monday , 17th December, Kingsway’s founder & CEO, Bill Starr announced his sudden resignation. Starr said it was a difficult decision to retire but that the “time was right” to make the transition to a new leadership (Starr remains as Chairman while former CFO Sean Jackson takes up the role of CEO).

Then on Tuesday 18th December , Kingsway Financial(KFS) dropped a bombshell when it announced it needed to further increase its claims reserves in its long haul trucking & artisan contractors liability books of business at its Lincoln General subsidiary by between $95mil to $125mil. This is on top of $83 milion of unfavourable reserve development already reported by Lincoln in the nine months to September 30 2007.

Thats around $180-200 million in reserve development, a substantial hit for an insurer with shareholders equity of around $1 billion. The market was unimpressed, marking down its share price down by 22% to $11.82, a far cry from the $20 share price Kingsway enjoyed at the beginning of January. This amounts to Kingsway’s market cap being cut by around $400 million in value in just 12 months.

In the light of Tuesday’s announcement, Bill Starr’s departure as CEO was probably more than a coincidence. One could speculate the timing was quite deliberate, an acknowledgement of his responsibility for the ongoing failures at Lincoln General.

Certainly the management of Kingsway have lost credibility. Just over one month ago in November 2007, Bill Starr was reassuring investors on the third quarter conference call that Lincoln General had put the worst behind it and there was every reason to be optimistic about their results going forward.

Here are two excerpts from the conference call

BILL STAR: “Most of our people, particularly at Lincoln, feel that they've done a great job in reserving, bringing more claims in-house, reserving them much higher this year than they have in the past, so that should reduce the amount of development in the future years.”(Bill Starr 3Q 2007 conference call)

JOHN REUCASSEL:” I guess just the broader question, then, would be, what I'm trying to get at is -- maybe for Bill -- is it's been a struggle here with Lincoln this year. Can you give us some sense of when you expect this to turn around? I know you don't want to talk about next quarter, but it would just be interesting to get some insight into you as how long this should take or what the timeline is here? “
BILL STAR: “John, with all the corrections we have done in the past 12 months, there's every reason to believe that going forward we should have much better results from the Company. That is our expectation.” ( 3Q 2007 conference call)
Bill Starr then discussed measures being taken by Kingsway Financial to fix the problems at Lincoln General including making changes to management, discontinuing certain lines, removing agents where they had poor experience and using computer systems to monitor the majority of the underwriting activities of their MGA’s and wholesale brokers.

So what has gone wrong at Lincoln General & were the warning signs there years earlier?

Lincoln General was acquired by Kingsway Financial in 1998 as part of their push to grow their insurance business in North America. Lincoln has been specialist in providing insurance to the transportation industry since 1977.

The first point worth noting is that 33% of Kingsway’s US business is providing trucking insurance. This is one line where Lincoln has been forced to substantially raise its reserves. This has always been a very tough area to operate profitably in as an insurer. Tony Markel of Markel Corporation (MKL), a leading insurance industry veteran, has indicated that two insurance lines his company ,Markel Corporation, will always avoid because the profitability levels are unacceptable are long haul trucking insurance and workers compensation.

As well as operating in difficult waters of the insurance business, a number of aspects of Lincoln’s business were presented at the investor day conference in November 2007 and perhaps provide a series of clues to investors about what went wrong.

In one chart , Lincoln’s direct premium’s written is shown as having grown at a furious pace from $44 million in 2000, to $171 million in 2001,$690 mil in 2002 and $994 mil in 2003. It is the case that the insurance industry was enjoying a hard market existed in 2002 and insurance pricing had definitely improved , however, Lincoln grew premiums by over 300% between 2001 and 2002 , this suggest that Lincoln was not simply enjoying better pricing, but was pushing aggressively for business.

In most industries, if a company achieves rapid sales growth is often associated with a healthy growing company. However in insurance, extremely rapid premium growth is more often than not associated with insurers that are prepared to forgo pricing discipline for the sake of premium growth. It is probable that Lincoln was able to rapidly grow its premiums because it was prepared to underprice its competitors, it was taking on the business that other insurers had viewed as unprofitable. Its recent announcement to significantly raise claims reserves certainly point to this conclusion.

It is stated in the 2002 Annual Report that Kingsway’s US operations including Lincoln had used thousands of independent agent agents and around 20 MGA’s to write business for their US subsidiaries.

“We market and distribute our automobile insurance products through a network of over 3,500 independent agents and approximately 20 MGAs in the United States , in 2002 approximately 58%
of our gross written premiums in the United States were sourced through MGAs and approximately 42% were sourced through independent agents “(Kingsway Financial - Annual Report 2002)

In the same 2002 Annual report, Kingsway states that it sets clear guidelines over what business its agents and MGAs have authority to bind on its behalf. However, whether its agents & MGAs were following these guidelines in practice is another question.

In the 3Q 2007 conference call, Bill Starr stated the following “… In the case of Lincoln, we have made management changes. We've also made several changes in respect to the programs and discontinued several lines, particularly the business that was written directly through agents. So now all of the business at Lincoln is written through MGAs or wholesalers, which we have found have a better experience on an overall basis.”

These comments suggest that independent agents appointed by Lincoln General were either writing business which did not meet Lincoln’s required guidelines or alternatively Lincoln had not set out the right guidelines in the first place ie. Lincoln had not correctly estimated the eventual loss experience it would have on specific business lines.

Bill Starr in the 3Q 2007 conference call also indicated that there were control deficiencies in Lincoln’s management of its independent agents and MGAs. Bill Starr’s comments were as follows

“…..We have also introduced a new computer system to Lincoln to more effectively handle the commercial business going forward. And one of the other important steps that we've taken is that we will have all of our MGAs or a majority of them using our system directly so that we know that all the business being written is property rated. That's a control we did not have in place before. The only control we'd have is going out and physically looking at the files.” (excerpt -3Q 2007 conference call)

This comment does suggest that Lincoln’s management may not have been fully aware at all times that business its independent agents and MGAs were writing was in fact business that met Lincoln’s underwriting requirements. Kingsway has said it had over 3,500 independent agents and 20 MGAs writing business for its US subsidiaries on its behalf in 2002. Keeping a careful watch and making regular house calls on all these entities on a regular basis would have been difficult. In the 2005 investor day presentation, John Clark of Lincoln General indicates that they performed 84 underwriting audits on their program partners in 2002 and this increased to 176 audits in 2005. Its unclear if this included both the audit of independent agents and MGAs nad whether or not they were auditing all of their third party representatives . Certainly what is clear is that Lincoln general was concerned enough about its underwriting to raise its level of scrutiny over its underwriting partners

Outsourcing Claims

Keeping a handle on claims is vital if an insurer is to accurately price its business. Most insurers don’t delegate the claims handling function because by keeping it inhouse management has more control over its pricing and reserves.

In 2002, Lincoln had 65% of its claims handled externally , in 2003 it was 40% and reduced in 2007 to 14%. So in 2002 and 2003 during a period Lincoln was rapidly increasing its premiums, it was using a substantial number of external assessors to value its claims and so it was really relying on third parties to provide the information required to set its reserve levels. Furthermore, the 2005 investor presentation indicates for the Kingsway group the level of pending claims in 2003 varied between 13,141 and 13860 compared to a lower level below 12,500 in the nine months ending September 2005. The fall in claims pending at the same time in-house claims processing at Kingsway was increasing would indicate that as claims were brought inhouse they were being closed faster. The higher level of pending claims in 2003 would have made it harder for Kingsway to accurately price these claims and set its reserves at that time.

In conclusion

In my opinion, Lincoln General’s reserving problems arose from a number of factors including its focus on providing long haul trucking insurance where it is hard to write profitable business , its decision to aggressively pursue premium growth over the 2001-2005 period while at the same time permitting third party agents and MGAs to write business on Lincoln’s behalf when it lacked critical controls needed to supervise their activities and its over-reliance on third party claims organizations to accurately price its claims which meant management of Lincoln effectively relied on third parties when pricing and setting reserves.

Given recent events, Kingsway Financial’s management have a big job to do now in rebuilding their trust with their shareholders. Investors will be hoping that further reserve increases at Lincoln will not be required and that the troubles at Lincoln have now been dealt with once and for all.

Disclosure: I owns shares in Markel Corporation (MKL) but have no interest in any other securities discussed.

Berkshire pays $4.5 billion for 60% of Marmon Holdings

Berkshire Hathaway has just announced a $4.5 billion purchase of a 60% stake in Marmon Holdings, with the remaining 40% to be purchased as a staged acquisition. Here's the link to the news story on the Marmon Group website. On their website you can also view their 3 year financials and CEO & Chairman's letters.


Here's the Berkshire press release


Disclosure: I own BRK-B shares

Sunday, December 23, 2007

Holiday reading

If you are looking for some excellent holiday reading this Christmas can I give you a suggestion, get your hands on "The Keynes Mutiny" by Justin Walsh. This has been one of the best books I have read this year.

It is the story of John Maynard Keynes. Keynes contributions to the field of economics are well known, however, what is less well known is that Keynes had a phenomenal investment record both as custodian of the Kings College Funds and as Chairman of National Mutual Life Assurance. He really was the "Warren Buffett" of his day and this book is packed full of pearls of his own investment wisdom.

Keynes always invested with a margin of safety. In one letter to a colleague, Keynes wrote" My purpose is to buy securities where I am satisfied as to assets and ultimate earning power and where the market price seems cheap in relation to these. If I succeed in this, I shall simultaneously have achieved safety-first and capital profits"(p134 The Keynes Mutiny).

He believed in a concentrated portfolio and saw the problems of diversifying too heavily..."to carry one's eggs in a great number of baskets,without having time or opportunity to discover how many have holes in the bottom, is the surest way to increasing risk or loss"(p184 The Keynes Mutiny)

In Chapter 10 "Leaning into the Wind" , Walsh describes how Keynes knew that the time to buy was at the "the sound of canons" ,literally. In 1918 the Germans forces launched a final offensive against France. Arriving on the outskirts of Paris, they began to unleash their new destructive weapon, "the Big Bertha" canons. The citizens in the French capital were terrified & many fled. In this moment of panic with the threat of a German occupation of Paris, John Keynes, on behalf of the British Treasury, seized the opportunity to acquire numerous priceless works of art by Gauguin, Manet & Delacroix from the National Gallery in Paris for knock-down prices.

On a final note, I think one of the most powerful messages to come out of my reading of John Keynes life and his ideas is that great investors are great thinkers. They are philosophers, historians and in the same vain businessmen and investors. Warren Buffett often says he is a keen reader of financial history. Keynes was a journalist, University Professor and economic advisor before he became a successful investor. I believe that Keynes was able to draw on all of these influences and experiences in developing his own powerful philosophy of value investing.

Merry Christmas and Happy New Years

Friday, December 21, 2007

Marty Whitman backs Bond insurers - says Ackman is wrong

I'm a big fan of Marty Whitman. He has one of the best track records of any investor and is an expert in insurance and company restructuring.

In this CNBC interview (link below) Whitman says quite bluntly that Ackman is a good salesman but doesn't know how insurance works. Marty says these bond insurers just need capital to survive & he is investing in their shares,he is confident that over the next 3-4 years they should be okay.

As much as I regard Martin Whitman highly, I believe Ackman is right on this one. Given the downgrade to junk of ACA capital recently which effectively prohibits them from writing new business , Ackman certainly looks to have taken first points. Of course there are many more rounds to go.

I think it is possible for one or more of these bond insurers will end up in bankruptcy, either way it is likely given the large amount of subprime exposed business they have written & which is multiples of their shareholder surplus, that they will be forced into heavily diluting their stock. MBIA recently revealed a $8 billion dollar exposure to highly risky CDOs backed by CDOs when it only has $6.4 billion in shareholder equity. How heavy will the dilution be, that is an open question but one can predict its probably going to be considerable and raises the issue of whether an insurer such as MBIA actually has negative book value, if its liaiblities were marked properly.

Marty Whitman does have an advantage over individual investors in that he coud end up brokering deals with these bond insurers to provide convertible debt which would dilutive to other shareholders but would be great for Third Avenue Funds.

One question I keep on asking myself in relation to MBIA & Ambac is this. If the business they were doing, insuring complicated derivatives like CDOs was so compelling and so profitable (as MBIA at one stage declared they were the most profitable company in the S&P 500) why were the smart players such as Buffett & Berkshire Hathaway not there as well? Why was Berkshire not playing the game. Were the economics really that good ? Also you have to ask about the margin of safety of investing in a business that requires a AAA credit rating otherwise its business would be materially damaged. Property and casualty insurers can can suffer downgrades & still operate, bond insurers don't have that luxury.

One area that I believe Berkshire Hathaway could end up getting involved is in providing insurance to municipal bonds that are mostly AAA and have very low risk. If MBIA or Ambac are forced to cut back on this business due their own capital issues, I'm prepared to bet that Buffett will take a good look this municipal bond business. Buffet may even buy municipal bonds for his insurance companies as munis have represented really good value recently given the subprime credit crunch.

Heres the link to Marty Whitman's interview...


Disclosure: I have have no position in securities discussed except Berkshire Hathaway (BRK-B)

Thursday, December 20, 2007

Bond insurers - CDO nightmare continues

I'm not sure whats harder to believe, this announcement by MBIA or the fact the credit rating agencies just reaffirmed their AAA rated standing, albeit with a negative outlook.

heres the link


Bill Ackman has spent enormous time researching the bond guarantors MBIA and Ambac. His research is excellent & below is the link to three of his presentations , including his presentation "Who's holding the bag" from the Ira Sohn conference given in May'07.

Ackman has put his money where his mouth is and is shorting both MBIA & Ambac.

To access the presentations you are required to fill in some brief info which just takes a few moments.


Wednesday, December 19, 2007

Gurufocus have published my article "AIG - a valuable franchise on sale"

If you haven't done so already, gurufocus is a really great site to check out. They track the investment portfolios of the top Investment managers and have plenty of interesting articles.

Hank Greenberg CNBC interview

interesting interview.....Hank Greenberg says he is seeing a lot of investment opportunities in Russia,China,Vietnam & Brazil. He also says he remains confident about the outcome of the ongoing lawsuits with AIG.

here's the link


Monday, December 17, 2007

AIG - A valuable franchise on sale

With the global credit crunch and housing slowdown, many financials have suffered falls in their share prices. I believe that some financials represent good value but you must pick carefully. Some of the investment banks and mortgage and financial guaranty insurers in my view have very questionable balance sheets and some may only survive through large dilutive capital raisings. I believe the housing downturn in the US will be hard and last for several years, so picking financials with international exposure where economic growth remains favourable, which are not simply focused on housing and have excellent businesses is really the key to riding out this credit storm.

My favourite financial stock at the moment is American International Group (AIG).

Why do I like AIG? To put it simply…AIG possesses the best global insurance franchise in the world and it is trading at its cheapest valuation in over a decade.

Very few companies have attracted so much scandal over the last couple of years as AIG, yet this has not affected the underlying business performance which continues to be excellent.

AIG is a global financial powerhouse. It’s most important business is insurance . Around 80% of AIG’s earnings are split evenly between property and casualty insurance and life insurance and the remaining 20% of earnings come from funds management, leasing and other businesses. AIG’s international operations account for more than half of AIG’s profits.

General Insurance operations

AIG’s strength in insurance comes from its diverse product offerings by product line as well as its geographic reach. In its US general insurance P&C operations, AIG has over 300 products under each product category. This is an advantage because it allows AIG to focus on only those products which are the most profitable and use its capital most effectively. AIG is constantly innovating, introducing dozens of new products each year. Of note, AIG owns Lexington, one of the best excess and surplus lines businesses and its Private Client Group serves over one third of the Forbes 400 rich list. To demonstrate AIG’s competitive advantage over competitors, AIG’s large capital size allows it to offer wealthier individuals high policy limits for example with kid-nap & ransom insurance, also AIG offers its own fire emergency service to Clients.

AIG’s foreign operations are extensive and cover 11 regions and 130 countries. AIG’s presence in fast developing countries in Latin America and South and North east Asia will continue to provide big growth opportunities. Its foreign premiums grew at a decent 13.7% pace in 2006.

Whilst the insurance market is softening with rates falling by 10% generally across most non-catastrophe lines and 20% for catastrophe exposed lines, this is likely to be offset by continuing favourable loss exposure trends and higher invested assets leading higher investment income.

Life Insurance

AIG’s life insurance earnings grew 10% in 2006.

Overseas AIG has strong life insurance operations particularly in Asia. It is the largest foreign owned life insurance business in Japan and has a strong brand recognition with American International Assurance(AIA) throughout south east Asia.
In the US , AIG American General , is a leading life insurer and AIG Sun America is a big provider of retirement products and services as America’s baby boomers move to retirement.

Other businesses

Through International Lease finance corporation , AIG owns one of the largest lessors of aircraft in the world.

AIG Global Investment Group manages over $75 billion in non-afflilated client assets, making it the sixth largest asset manager in the world. It increased AUM at 21% during 2006 so this is a promising growth business for AIG.

AIG owns other financial service businesses including AIG Financial Products (customized finance and risk), Imperial A I Credit(finance insurance premiums) and American General Finance(consumer lending).

Great brand

AIG’s brand was nominated as the 47th best brand in the world and valued at over $8 billion. AIG’s logo can be seen on the famous red shirts of the Manchester United football team. I believe this is an excellent piece of marketing given the popularity of soccer particularly in many Asian countries where it is the number 1 sport.


Martin Sullivan has done a solid job as CEO since taking the reigns from Maurice (Hank) Greenberg. Greenberg was the driving force behind much of AIG’s growth over the last few decades and is widely regarded as an insurance visionary, filling his shoes is a big ask not to mention his political contacts and networks. But Sullivan’s pedigree is good. He has worked with AIG for over three decades so he knows the performance driven culture. Greenberg had previously ear marked him as a replacement even before the scandal that enveloped Greenberg. Importantly many of Greenberg’s key lieutenants stayed even after Greenberg left AIG.

Hank Greenberg has recently indicated he is not happy with AIG’s management and believes new changes need to be made. While I have no doubt Hank Greenberg could do a better job managing AIG (his record speaks for itself) I would tend to believe Hank as well as wanting more from management is also playing politics with his comments, after all AIG & Greenberg are in the midst of a big legal fight.


I believe that AIG’s foreign operations with strong economic growth continuing in Asia and Latin America and AIG’s non-insurance related businesses will continue to do well and help offset domestic weakness due to softening in insurance premiums and losses from AIG’s housing exposed businesses and mortgage investments. AIG’s non-reliance on the commercial paper markets to fund its operations is a key strength given the unsettled credit environment ikn their ability to hold their mortgage bonds to maturity. AIG could be expected to face claims from subprime lawsuits, these may be substantial but these are unlikely to be material to AIG , on the positive side they could also result in hardening of premiums in D&O & E&O lines.

Why investors currently don’t like AIG

AIG’s exposure to subprime debt and the housing market has resulted in AIG recording large unrealized losses in its mortgage guarantee business and mortgage investment portfolio. This has resulted in investors questioning AIG’s balance sheet.

AIG has been very open about its exposures and has provided a continuing dialogue. On December 7 , AIG indicated that since September 30, its credit default swaps sold through AIG Financial Products which provide insurance against defaults had unrealized losses of $1.1 billion. AIGFP insures super senior rated debt in which the likelihood of non-payment is very remote even under severe recessionary conditions. AIG maintains it is unlikely these unrealized losses will actually result in actual loss. Also AIG stated its mortgage bonds have lost $2.6 billion. This is a total of $3.7 billion in unrealized losses although AIG says its unlikely that all these losses will be actually realised. The exposure is large in my view but still manageable given AIG’s $100 billion in shareholder equity. Also it is worth bearing in mind that during the fourth quarter AIG’s foreign owned bonds and investments would have increased with the fall in the US dollar while its US treasuries would have likely increased in value.

United Guaranty (mortgage insurer) and American Financial Guaranty(mortgage provider) are two AIG businesses which will continue to post losses as the housing market worsens, my back of the envelope calculations put a worst case result for the two companies to post further losses of around $1.2 billion, depending on housing price depreciation. Again a hit that AIG is big enough to withstand.

So if you throw in the issue of subprime and housing correction, more headline scandals in the form of AIG/Greenberg lawsuits, a softening insurance market and a share price that hasn’t gone anywhere over 10 years and its no wonder investors aren’t buying AIG stock.

My valuation of AIG

Over the last 10 years since 1997, AIG’s book value has increased from $12 to around $40 today. That’s compounded return of around 13% p.a (Please note that this does not include reinvested dividends which would make the return higher, the current dividend yield is 1.3%. Over 10 years AIG’s net income has also compounded at around 13% annualised from $1.68 to $5.72 today.

But since 1997, AIG’s stock price has increased from $36 to just $56 today. That’s a compounded return of only 6% a year.

The reason why the stock price has not grown at the same pace as AIG’s intrinsic value is because AIG was overvalued in 1997. In 1997 the price to book value was 3.2 and PE was 23 whereas today in 2007, the price to book value is a much lower 1.4 and the PE is 9.7.

Management believe that AIG can continue to grow earnings at 10-12% over the next few years. That seems fair and even conservative, given AIG has managed 13% over the last 10 years. So I’m going to assume 12% growth.

If AIG grows earnings at 12% then in 2010 they should earn $8.43. If we apply a 13 PE multiple you would expect the share price would be $109, that would give a share price return of around 26% per year + 3 years of dividends would take it closer to 28%.

Using a price to book analysis. Given the high quality nature of AIG’s insurance business, considerable value in its non-insurance businesses that could potentially be spun off and its real estate holdings which would be stated at cost, a price to book value of 2 seems reasonable. If they grow book value at 12% over 3 years that’s $56, at 2x book value you would expect share price of $112 in 2010, double today’s price.

I believe the fair value of AIG today is $80-$85. Based on the current share price of $56 , the shares have close to 50% of upside in my opinion.

Maurice (Hank) Greenberg recently filed a 13D urging management change and a review of strategic alternatives for AIG. No-one knows AIG from the ground up better than Hank Greenberg. So for Greenberg to say the shares are undervalued is far more telling than some analyst from a brokerage house!


There are several

1. Value is its own catalyst. AIG is cheap at 9x earnings & 1.4x book, AIG’s insurance businesses & funds management operations continue to perform well and earnings continue to rise at a good clip. Looked at another way, if you put a value of 15x earnings on AIG’s large non-insurance businesses , then AIG’s insurance businesses are valued at just 7-8x earnings which is really cheap, as Chris Davis pointed out in Value Investor Insight May’07.

2. As investors become more comfortable that AIG’s subprime exposure and mortgage security writedowns are manageable, doubts about AIG’s balance sheet risk will dissipate. Even if AIG takes a $10 billion hit, that’s really just a few quarters of earnings and once the storm passes, those unrealized losses could reverse as valuations of mortgage securities are re-appraised.

On a recent conference call, CEO Sullivan said that AIG will be okay provided house prices do not fall 30% or more such that the Loan to value on mortgage securities drops. While I am not an economist or soothsayer, this kind of “depression” like outcome is very unlikely in my view.

Warren Buffett on a recent CNBC interview when asked is this like 1974? and he gave the short answer of “no”. So the Oracle of Omaha doesn’t believe a depression is likely but he does believe a recession is possible, I’m happy to bet that Warren’s right.

3. Another catalyst would be higher revenues from overseas operations with growth in emerging markets such as China & foreign exchange effects leading to higher revenues and earnings driving the bottom line even while US operations slow.

4. A final catalyst could be from activist shareholder Hank Greenberg who with his recent 13D filing is putting pressure on management for a splitting of AIG. There are two things here, the spin off or sale of AIG’s immensely valuable funds management, real estate and leasing operations could unlock considerable value for shareholders. Also there is a slight chance , Hank Greenberg could become a lot more involved in the running of AIG. The re-emergence at AIG of Greenberg ,who is such a shrewd operator in the insurance business, could result in AIG’s shares taking on more of a “Greenberg” premium.

But even if this possibility does not emerge I think AIG represents a good investment anyway at its current price.

Please note: The opinions expressed above reflect authors own point of view and are not intended as investment advice and should not be relied upon as such.

Disclosure: I own AIG stock

Thursday, December 13, 2007

NY regulator says Greenberg's AIG fight violates rules

Disclosure: I own AIG shares

Subprime lawsuits - insurers to face billions in claims

Insurance companies which are big writers of E&O & D&O insurance, such as AIG & Chubb as well as others, could face up to $19 billion in claims according to some analysts as a result of the subprime credit storm.

As an aside..professional liability loss reserve redundancies have been commonly reported by insurers over the last few years in what has been until now a very favourable claims environment. I wonder if some insurers have been a bit too hasty in releasing these reserves, it may come back to bite...I guess time will tell!

Anyway here's the link

Wednesday, December 12, 2007

Tuesday, December 11, 2007

AIG & Hank Greenberg - new round in legal battle

In my November column, I discussed Hank Greenberg's filing of a 13D may signal his desire to return to a more active or "operational" role at AIG.

AIG 's directors & management are now well & truely on the defense and wanting to turn up the heat. They have asked for an early trial on the issue of C V Starr's ownership of AIG stock

Here's the article

I've had trouble with the link its under Breaking News , December 7 - "AIG asks for speedy trial in Starr dispute"

Berkshire Hathaway is back!!

With subprime wreaking havic on the balance sheets of financials throughout the world, standing like a colossus it seems is Warren Buffett and his insurance focused investment company Berkshire Hathaway(BRKA & B).

Berkshire's shares after being largely neglected over the last few years ,despite wonderful underlying business fundamentals, have been on a tear since mid-June rising around 38% from around $3,600 per B share to close to $5000 over last 6 months.

Suddenly conservative and high quality is the mantra on Wall Street and Berkshire fits the bill perfectly. Sitting on $40 billion in cash, Buffett is likely to have plenty of opportunities to put that cash to work as the credit crisis unfolds over the next 12-18 months.

I believe Warren Buffett is the greatest investor of our generation and the credit derivative turmoil further reinforces his claim to this title.

Disclosure: I own (not enough unfortunately) BRK-B shares

Carlos Slim - world's richest person

Below is a link to an interesting article about Carlos Slim, a Mexican based industrialist, who has made a fortune as an investor.

One of his coupe's was to buy an insurance company Seguros de Mexico for $13 million in 1984 which is now worth more than $1.5 billion today after 4 spin offs.

Sunday, December 9, 2007

Alleghany Corporation - analysis and valuation

Alleghany Corporation (Y)

Alleghany is an insurance holding company based in New York City. Alleghany has a rich and colourful history dating back to 1929. While the composition of Alleghany’s businesses have changed over the years, Alleghany’s modus operandi as an opportunistic yet conservative investment company remains the same. Over recent years the Company has developed a core focus in property and casualty insurance.

Alleghany’s largest shareholders are the Kirby Family and Alleghany continues to operate very much like a private company. Management don’t provide conference calls and rarely give media interviews. This makes scuttlebug on the company difficult and explains why Alleghany receives no analyst coverage. They have recently received some favourable press in Barrons.

Alleghany’s philosophy

This is stated on the front page from their website. It can be summed up into the following key aspects.

1. “Objective is to create stockholder value” over the long term ie. By growing book value per share at a double digit pace.

2. “ownership and management of a small group of operating businesses and investments, anchored by a core position in property and casualty insurance.”

3. “operating businesses function in an entrepreneurial climate as quasi-autonomous

4. “Conservatism dominates management philosophy.”

5. “relatively few interests in basic financial and industrial enterprises” ie. concentration of investment resources.

Current Management & Insider ownership

Alleghany’s current CEO is Weston Hicks. Weston has done a solid job in his brief time as CEO although it is hard to properly assess his performance in a period of just under 3 years. Prior to joining Alleghany Weston was CFO of Chubb and prior to this a top-ranked insurance industry analyst and former managing director at J P Morgan securities. John Burns is Chairman (Allan Kirby former Chairman retired in 2006)and was extremely successful as Alleghany’s former CEO. John Burn’s continued involvement on the strategic and investment front is positive.

The Kirby remain the largest shareholders. Management are rewarded appropriately with stock incentives to achieve long term growth in book value and returns on equity. So the interests of shareholders and management appear properly aligned although the closed nature of management is not ideal from a corporate governance perspective.

Alleghany’s subsidiaries

Insurance subsidiaries

The core focus of Alleghany is property and casualty insurance. Its subsidiaries include:-

RSUI Group led by CEO James Dixon is the largest and most important insurance subsidiary , it underwrites specialty insurance in the property, umbrella/excess, general liability, directors and officers liability, or “D&O,” and professional liability lines of business .

RSUI was severely tested during the severe Hurricane season of 2005 by storms Katrina and Wilma , suffering US $303 million in pre-tax catastrophe losses . RSUI has since taken actions to reduce its loss exposures on a risk by risk basis and reviewed its overall book of business.

RSUI is Alleghany’s largest subsidiary writing $560 million in net written premiums for the first nine months to September 30 2007. The underwriting profit reported is $164 million with a 69% combined ratio. For 2006, the numbers were $503 million premium, $149 million profit and 70% combined ratio.
With over $900 million in surplus, RSUI is achieving in excess of a 15% return on equity.

Darwin Professional Underwriters (55% majority ownership, listed ticker “DR”) – specialist insurer focused on professional liability insurance and related lines

Stephen Sills is the CEO and he had a great track record. He was founder and former CEO of Executive Risk which was eventually sold to Chubb Corp. He has brought a number of his colleagues into Darwin from Executive Risk. Darwin’s growth and performance to date has been excellent, Weston Hicks CEO commented in the Annual report 2006 “Darwin Professional Underwriters has grown from a start-up managing agency to a publicly-listed insurance underwriting company in less than four years, producing almost $250 million of gross written premium in 2006 …The company is emerging as an innovative force in the specialty insurance marketplace, and we believe it has excellent long-term prospects.”

Darwin Professional is facing considerable headwinds in the form of softer pricing in the professional liability area with declines of over 10% in most lines. However, Darwin has been able to successfully increase its written premium by 6% in the most recent third quarter of 2007.

Darwin and insurance industry continues to benefit from a more favourable claims environment which will continue to place downward pressure on their loss expenses. Darwin has been conservative with reserving, recording much higher IBNR than its actual loss claims experience , this is likely to result in continuing favourable loss reserve releases as recent quarters have demonstrated. Its most recent combined ratio for the quarter end 30 September 2007 was 85% versus 96% for the year earlier.

Alleghany spun-off Darwin Professional in 2005 but retains 55% ownership. In August it did register an 8K which gives Alleghany the opportunity to sell down this stake but as of 30th September 2007, no stock had been sold. At 7th December 2007, Alleghany’s stake was valued at $235 million versus $202 million at 30th September 2007. Darwin has from the very beginning been an excellent investment for Alleghany with great prospects.

Capitol Transamerica Corporation or “CATA” (consisting of Capitol Indemnity, Platte River and Capitol Specialty)

CATA is a specialty insurer based in Madison, Wisconsin and led by David Pauly CEO who has done an excellent job since his appointment in 2003 at growing CATA’s profitability. CATA wrote a combined ratio of under 90% in 2006 and CATA’s statutory surplus was around $250 million as at 30th December 2006. Around 72% of their gross written premium was property and casualty and the remainder commercial surety.

They wrote $189 million in gross written premium in 2006 recording an underwriting profit of $19.1 million versus $173 million and $15.6 million in 2005. The difference was primarily due to favourable reserve releases pre-tax of $13.6 million in 2006 and $5.1 million in 2005. It is worth noting that in 2004 CATA reported a $8.9 million underwriting loss due to reserve strengthening of $10.6 million related primaril to construction defect claims. CATA exited the construction lines of its commercial surety business in 2004.

CATA continues to benefit from favourable reserve releases in 2007. For the first nine months ended 30th September 2007 it has written $162 million in GWP with $19.5 million in underwriting profit recording a combined ratio of 86%. This is due largely to $14million pre tax reserve releases in 2007 compared to $11million for same period 2006.

Employers Direct Corporation - EDC & Homesite Group (minority ownership – 33%)

Employers Direct Corporation was acquired by Alleghany in July for $192 million and EDC writes workers compensation insurance on a direct basis in California. It appears to have grown rapidly since 2002 and continues to be managed by founder and CEO Jim Little.

Alleghany took a 33% ownership stake in Homesite, a monoline home insurance provider, for $120 million in December 2006. For further discussion of Homesite I can recommend readers review pages 8-9 of the Plymouth Rock Assurance Annual shareholders letter for 2005 (as an aside I recommend reading Chairman Jim Stone’s letters as they are full of insightful wisdom on the insurance business).
Alleghany’s acquisition of Homesite and EDC signals their intention to build a diversified group of insurance holdings including strategic stakes such as Homesite.

Alleghany Properties

During 1994, Alleghany sold Sacramento Savings Bank which it had acquired in 1989. As part of the deal Alleghany purchased the real estate and related real estate assets of Sacramento Bank. The total book value of these properties in the Sacramento region of California was $22.6 million at December 2006 and consisted of 345 acres of land classed for multi-family residential and commercial use. During 2006 Alleghany sold 59 acres having a book value of approximately $5million for a net gain on sale of $23 million.

It is fair to conclude Alleghany’s real estate is probably worth over $120 million or $13 in excess of its book value. However, given the housing downturn particularly in the Sacramento housing market, Alleghany may not seek to fully realize this value in the short term and will likely wait patiently for the housing market to improve.

Investment Portfolio

Alleghany’s investment approach can be summed up by the following quote from Weston Hicks & F M Kirby 2005 annual report… “While we continue to pursue suitable acquisitions, we are working to grow Alleghany’s capital by investing in public equity securities when we see the opportunity to earn at least a 10 percent after-tax return…. Our investment approach, however, is first and foremost downside risk in orientation; we seek a non-diversified equity portfolio in which the core investments have measurable and limited downside, with significant potential upside to be realized over a three- to- five year investment horizon.”

Alleghany’s $1.2 billion equity portfolio is a concentrated one, dominated by a $400 million stake in railways through Burlington Northern , a $205 million shareholding in insurance via Darwin Professional and another $300 million or so invested in an assortment of energy oil and gas producers. Weston described in his 2006 annual report that they were pleased by the hedged nature of their investment portfolio as energy and railway holdings are cyclical and work as a hedge against their bond portfolio which will tend to perform better during an economic downturn.

Based on Alleghany's annual report for 2006, Alleghany's $3 billion bond portfolio is conservative consisting mostly of highly rated or liquid debt securities. Over 73% of bonds hold a AAA rating with just 1% having no rating or below investment grade.

Valuation and Conclusion

Currently as of 7th December Alleghany trades for $420 a share. Alleghany’s stated book value is $294 per share. Alleghany’s real estate is probably worth another $12+ per share more than its book value. So at over $300 per share the price to book value is around 1.4x.

They should earn over $30 per share in 2007 which puts the PE at 14x earnings. Note the PE takes no account of their minority investment of $400 million in Burlington Northern or $120 million stake in Homesite. Therefore growth in book value is a better way to look at Alleghany, and insurers generally, given it includes increases in the market value of their equity securities.

Their book value has grown around 8.7% over 5 years ending 31st December 2006. However, in the last 5 years Alleghany’s business has transformed considerably, from having $1.3 billion in cash and invested assets and no insurance subsidiaries in 2001 to $4.1 billion and three insurance subsidiaries and another significant investment in another insurer as at December 2006. Cash and invested assets should reach $5billion or $546 per share by 31st December 2007 with no debt leverage and 25% invested in equity investments.

Alleghany’s insurance subsidiaries are capable of doing a 15% ROE. If they can do an underwriting profit of $15-20 per share and a 5% after tax return on $546, it would be reasonable to expect they can compound book value at a higher rate of 12-15% going forward. For 2006, Alleghany reported a 15% increase in book value and for the first nine months of 2007 a 12.2% increase in book value. It seems reasonable they can grow their book value at 12-15% for the next 2-4 years.

The main risks here are heightened hurricane activity over the next few years and softer insurance pricing. There is also the risk of lower interest income but this would be balanced by increase in the value of their bonds & equity securities.

If the current credit crunch continues through 2008 with a resulting economic slowdown, Alleghany is well positioned to opportunistically take advantage of distressed selling & its strong balance sheet with no debt leverage means it is well-insulated from the credit market problems.

In conclusion, fair value for Alleghany would be around 1.5x its book value of $300, or $450 per share. In terms of buying Alleghany shares I believe they represent good value below 1.2x book or below $365 per share.

Please note: The opinions expressed above reflect authors own opinions/point of view and are not intended as investment advice and should not be relied upon as such.

References: Alleghany annual and interim reports.

Disclosure: I have positions in Alleghany (Y) and Darwin Professional(DR)

Thursday, December 6, 2007

David Einhorn speech - Heilbrunn Center for Graham & Dodd Investing

17th Annual Graham & Dodd Breakfast
David Einhorn’s Prepared Remarks
October 19, 2007

This an excellent discussion by David Einhorn about why the current credit crisis goes beyond subprime and is really a reflection of poor lending standards ... in David's words "There has been a colossal undercharging for credit across the board."

Bond insurers and guarantors such as MBIA & Ambac have also played their part in contributing to this credit mess.

Here is the link..."

Credit Crunch – Issue of Funding - Insurance Companies & Banks

During AIG’s meeting with investors on 5th December 2007 , Martin Sullivan commented “AIG does not rely on asset-backed commercial paper or the securitization markets for its funding. We have the ability to hold devalued investments to recovery _ that's very important."

Martin’s comment really highlights a critical distinction between an property and casualty insurance company and a commercial bank or mortgage thrift and why I believe this credit crunch will have a lesser impact on the former rather than the later. Two qualifications here , firstly I am limiting my comments to property & casualty insurers not bond and mortgage insurers and secondly some property and casualty insurers have weaker balance sheets than others and will be impacted to a greater extent by current credit conditions.

Insurance companies mostly fund their debt purchases from the pool of policyholder premiums they collect, known as the float. They are not dependent on the commercial paper or securitization market, like Capital One that securitizes its credit-card receivables, nor do they depend on GSEs like Fannie or Freddie to raise more funding for the business, like Countrywide.

An insurer can’t suffer a “run on the bank”. E-trade and Countrywide have both faced this potential scenario recently. Both companies have been forced to publicly defend their liquidity in the press and to shore up their balance sheets with dilutive capital raisings.

For insurers generally, funding using insurance premiums is all fine and good provided you are underwriting with the strictest discipline. Float is a wonderful thing provided it comes with a zero cost!

Disclosure: I own AIG shares

Wednesday, December 5, 2007

An attack on free speech in China

It is the goal of my blog to provide financial opinions strongly supported by factual evidence, however controversial or opinionated my articles may be.

I can only do this in a democratic society that supports free speech. I believe that free speech is one of the most fundamental rights that we have.

So it was very disappointing to recently to read an article on the WorldHealth Care blog that discussed the closure of the China Development Brief, a newsletter reporting NGO issues, by the Chinese government authorities. Furthermore, Nick Young the author of this newsletter has been banned from re-entering the country.

According to the Australian publication "The Age", Nick Young reported that a senior official had told him "You can be the Government of China's friend or our enemy; there is no other way."

China appears focused on only presenting the State of their Country in a positive way to the outside world. Of course many countries even "democratic" ones have & will attempt to engage in media manipulation, but the closure of an independent media news is an extreme form of censorship which no citizen no matter what their political beliefs are should accept or tolerate.

In talking about his goal with the China Development Brief, Nick Young recently wrote...

"I have always argued that it is important to get coherent, informed and independent Chinese voices into international debates about China—rather than those debates being dominated by Western voices that are often ill-informed and unsympathetic to the real difficulties of governing this huge and complicated country—and I hoped that China Development Brief could come to offer the world at large “the best in Chinese thinking on social development, in plain English.”

China's Government needs to realise that free speech promotes openness and transparency. It is also key to China's own economic development. Given that most of China's largest companies are majority owned by the Chinese Government it does create concern in my view that this same organisation and majority shareholder is supporting the censorship of independent news services in China.

Lets us hope that this manipulation of the media is not also extending into the corporate arena and that reported financials produced by large Chinese corporates is accurate and complete and is not being presented in a way to support a positive view of China's corporate health by the global investment community.

Ratefinancials is a highly respected New York-based forensic research firm. Recently they issued a report (September 2007) entitled 'Government Controlled Entities Masquerading as Independent Public Companies’ which was critical of the ten largest NYSE-listed Chinese companies by market capitalization. They received “Poor,” or “Very Poor,” ratings for their accounting, quality of earnings, and governance.

Victor Germack, the founder and president of RateFinancials was quoted as saying

"Investing in publicly traded Chinese companies at the end of the day is a crapshoot that requires blind and unfounded faith that the PRC will ultimately put the best interests ofshareholders ahead of political and other considerations,” said Victor Germack, founder andpresident of RateFinancials. “These companies are government-controlled enterprises masquerading as independent public companies and it is virtually impossible to adequately assess their financial condition given their poor level of disclosures. Given the inherent risks of these companies, it’s both surprising and disappointing that they are allowed to trade on the NYSE.”

The fast pace of economic growth that China is experiencing potentially offers exciting opportunities for investors I genuinely believe that. There are Chinese companies with wonderful businesses. But there needs to be good corporate governance. In most countries, political bodies that majority own public companies tend to let politics interfere with decisions about the business.

Given, the censorship tendencies shown by the Chinese government it is in investors interests for the Chinese Government to sell its majority ownership in these various Chinese public companies as soon as possible. It is also imperative that the Chinese Authorities embrace the notions of transparency and openness in all aspects of government as this is critical to China's future and economic development.

Tuesday, December 4, 2007

Valuing an Insurance Company – using Cash & Investments per share

Bruce Berkowitz & the Fairholme Fund have a great track record & I thought it would be worth discussing Bruce’s approach to valuing insurance companies.

Here is an excerpt from an interview with Businessweek in (October 2000), Bruce talked about his approach to valuing Markel Corporation(MKL).

"Look, the key concept for insurance companies is to take a look at the investments per share. And you can find companies where the investments per share are significantly higher than the stock price. Markel has roughly $400 per share of investments. If they can break even on their underwriting and only make a 5% after-tax investment return, that's $20 per share. Not bad for a company at $140 per share (in market price).
So the trick is to have that investment leverage and at the same time break even or make an underwriting profit. And it's hard for people to see it. These are not easy companies to understand."

Calculating the cash and investments a company has per share and determining what return they are likely to achieve is an excellent way to value an insurance company.
At the time Markel Corp had shareholders equity of around $94 per share, the price to book value was around 1.5x. With cash and invested assets of over $400 they had a 4:1 leverage. So using a 5% return after tax would be equivalent to a 20% return on equity & growth in book value.

Bruce Berkowitz also discussed a number of important issues that really go beyond the financials. He described Markel’s approach to underwriting as very disciplined & he knew Markel had honest and capable managers and had a great track record of growing their book value at 20% + compounded since the mid-80s.

Lets see how the investment thesis panned out?

By December, 2006 book value had grown to $230 per share which was a 15% compounded growth return from $94. Nevertheless, by December 2006 investors re-rated Markel’s price to book value to 2x and shares rose to $480 from $140. That’s a shareholder return of over 20%. So investors put a quality premium on Markel for its consistency and long term record of 20% +book value growth.


Bruce Berkowitz used a big margin of safety and even though his investment thesis was not exact (no thesis ever is!) it still gave a very favourable outcome. Hurricane Katrina & reserving issues with various acquisitions did conspire to limit the book value growth rate. However, Markel’s book value growth over 20 years remains at an excellent 23% so it is worth being wary looking at 5 year time frames as book value growth is lumpy in the insurance business.

Disclosure: I own shares of Markel (MKL) & Fairholme Fund (FAIRX)

Monday, December 3, 2007

Disclosure note

In my haste to publish my last article "Life Insurance in China" I omitted in the disclosure note that I do hold shares of AIG.

I have amended this disclosure but for completeness I am also posting this notice.

I have disclosed this AIG position in a prior article also.

apologies & cheers

Sunday, December 2, 2007

Life Insurance in China - Investment opportunity?

Significant growth opportunity

The insurance business is one of the fastest growing industries in China. According to the CIRC (China Insurance Regulatory Commission), insurance premiums grew from from RMB 160 billion in 2000 to RMB 492 billion (US$64.7 billion) in 2005.

With nearly 1.3 billion people, a rapid increase in incomes and prosperity resulting from China’s economic boom and the curtailment of government welfare with the removal of the iron rice bowl (State welfare for life) , many Chinese citizens are rapidly seeking financial protection in the form of life and health insurance for themselves and their families and have the financial means to do so.

There is significant scope for growth in life insurance in China. When measured as a percentage of GDP, penetration rates for life insurance are only 1.7% in China compared to 4% in the US based on CIRC statistics. And premiums are small relative to world averages, the per capita premium in 2006 was around US$30 compared to the international average of US $219 . These premiums could be expected to increase at a faster rate in China as disposable incomes and economic GDP in China grows at a faster rate than the rest of the World.

As well as the opportunity to grow premiums , life insurers are increasingly being given greater scope on the investment front to boost returns. Recently, the Chinese Government has been liberalising investment mandates to permit greater overseas investments by insurers. From July, Chinese insurers are now permitted to invest 15% of their portfolio assets in overseas stocks and bonds, whereas previously they were limited to 5% .

The players & investment opportunities

The life insurance and annuities industry in China is dominated by China Life Insurance Company(LFC NYSE) with 47% market share & Ping An Insurance(2318.HK Hong Kong) with 16% and the remaining 37% shared among other insurers. American International Group (AIG) also has a life insurance presence in China through its subsidiary AIA along with other strategic Chinese investments.

The huge potential for Chinese insurance growth is more than captured by current stock prices for all listed Chinese Life Insurers. Which unfortunately makes it difficult to take advantage of this Chinese growth story if you are an investor.

Lets look at the largest life insurer in China which is also NYSE listed. China Life insurance Group has seen considerable business growth over recent years. Its total revenues including premiums and investment earnings grew from RMB 78 billion in 2003 to RMB 147 billion in 2006 and shareholders equity rose from RMB 62 billion to RMB 139 billion. At June 30 2007 , shareholders equity had increased to RMB 167 billion (US$22 billion).

China Life Insurance Group had a market cap of US$155 billion as of 3rd December 2007, based on 2006 results its PE is 54 and it trades for 7.3x sales & 8.2 x book value. This kind of valuation is too expensive for my frugal tastes even with the rapid growth in business they are experiencing. Nevertheless, due to its market leading position and franchise, China Life is a company worth keeping an eye on, particularly if there is a substantial correction in the Chinese market allowing for a more attractive and reasonable price on these shares.

I do at this stage want to express a certain caution with China Life Insurance and it comes about through a quirk in their accounting which allows Chinese Life to book unrealized gains on a portion of their equity portfolio that they classify as held for short term trading. For the June 2007 half year, US$1.45 billion pre tax of China Life’s earnings came from “net fair value gains” in equity securities out of a US$3.3bil pre tax profit. For the same period in 2006 similarly around 50% of earnings reported came from these “net fair value gains” in equity securities. I should qualify that these net fair value gains include realized & unrealized gains but I was unable to determine looking at China Life’s interim filings exactly what the percentage breakdown was.

Unlike China Life, US insurers mark to market all of their equity securities and they only report realized gains on the Income Statement when equities are sold. So US insurer reported earnings won’t be an apples to apples comparison with an insurer like China Life. I think the best way to get this comparison is probably to look at the comparative growth rates in book value per share and dividend growth.

In conclusion, I find the growth story in China very exciting, however, at this time I am unable to recommend attractively priced insurance opportunities amongst Chinese Life insurers at the present time, hopefully that will change at some point in the future.

Disclosure: I have no position in any securities mentioned except for AIG.

Thursday, November 29, 2007

Enstar Group’s inflated premium - ESGR

Enstar Group (ESGR) was created in 2001 and is in the business of acquiring and managing insurance and reinsurance companies in run-off. This has been very profitable for Enstar as Enstar has been successful in re-negotiating insurance claims at a point below their reserve level. This has increased Enstar’s book value or net worth at a decent clip.

Since 2001 Enstar has grown its book value per share/ net asset value (generally the best way of valuing an insurance company) from around $17 per share in 2001 to $34 as of September 2007.

Sometimes even good businesses get too expensive and Enstar is too expensive. Its shares trade for $114 which is over 3.3x its book value. Interestingly its price to book value has expanded from 0.9 in 2000 to 3.3 today. During this time its book value has doubled.

Whilst famous investors like Warren Buffett made their fortunes investing in insurance holding companies , no-one has ever made their fortune buying insurance companies for over 3x book (more likely smart investors would only be interested in paying around book value or modest premium to book value depending on the quality of the business).

In fact Enstar trades at a significant premium to all of its peers. Even if you take the view, well Enstar is a far superior company, you could respond by saying the same was said about AIG back in 2000 before reality set in and the rule of numbers took their toll.

By my calculation it will take Enstar over 8 years of consistently growing its net book value (currently $416 billion) at 15% (its historical average) to reach its current market valuation of over $1.3 billion and this means also making consistently profitable acquisitions. That’s a high threshold for any company to meet without a hiccup. Its also a long time to wait for the price you pay to match the underlying net asset value of the insurance business.

Furthermore Enstar has only been tested over a 6 year time frame, that’s not very long. Other insurance companies with excellent track records and stronger paper trails over 20 years such as Markel Corp trade for a more modest price to book ratio of 1.8.

It could be argued Enstar is more of a private equity vehicle than an insurer and part of the premium on Enstar’s stock is no doubt attached to Christopher Flowers involvement.

Flowers is a billionaire and has proven himself as a successful investor. I’m not disputing that fact. I am simply making a point that when you risk your capital you expect to be compensated for that risk and at its current price , even with the potential for private equity deals, Enstar is priced for perfection!

In conclusion, if investing is like playing cards you bet heavily when you have a strong hand not when you have a weak or ordinary hand. Buying Enstar at the current price is the same as betting heavily when you have a weak hand. The probability or odds of being very successful are low and odds of a poor outcome are high.

Disclosure: No position in Enstar ESGR, shares held in Markel MKL

Tuesday, November 27, 2007

Really strange insured risks

Specialty insurers will insure all kinds of risks even exploding baseballs and underwater hotels. Here is a link to the article, please refer to page 23

Monday, November 26, 2007

Top fastest growing US insurers

Top fastest growing US insurers - growth book value from Dec 1997 - Dec 2006
(not including reinvested dividends)
min $1 bil mkt cap

31-Dec-06 B/V, 31-Dec-97 B/V,Book value growth, Div yield, Current Price/Book

PHLY Philadelphia Consol 16.48 3.03 444% 1.60% 1.93
HCC HCC Insurance 18.28 5.1 258% 1.60% 1.44
MKL Markel 230.48 65.18 254% nil 1.83
WTM White Mountains 413.19 117.53 252% 1.60% 1.17
AIG AIG 39.09 12.2 220% 1.60% 1.30
RE Everest Re 78.58 25.89 204% 2.00% 1.09
STFC State Auto Financial 20.35 7.11 186% 2.10% 1.31
MLAN Midland Co. 29.9 10.55 183% 0.60% 1.93 (subject to takeover)
BRK-A Berkshire Hathaway 70274 25487 176% nil% 1.73
BER W R Berkley 17.3 6.33 173% 0.70% 1.51
RLI RLI 31.17 12.35 152% 1.60% 1.67
CGI Commerce Group 22.53 9.01 150% 3.40% 1.62
all numbers taken from msn money / investing stocks analysis charts

Just a few comments on the above

1. I haven't included reinvested dividends. I have shown current dividend yields.
2. book value doesn't consider real growth in intrinsic value & earnings power
for example Berkshire Hathaway's non-insurance earnings have grown at a much faster rate than book value over the last 10 years
3. Some of the companies above like W R Berkley and AIG have substantial real estate shown at cost on the balance sheet which will not show in book value
4.Fairfax Financial results whose results have been disappointing for the last 5 years and so I have not included , nevertheless has a stellar 20 year record of 20% + compounded book value growth along with Markel Corp & Berkshire Hathaway.

Sunday, November 25, 2007

Prem Watsa on the credit crunch. Its just beginning...

According to an article in the Globe and Mail, published November 23 2007, Prem Watsa famed investor and CEO of Canadian insurer Fairfax Financial Holdings (FFH) says losses from the credit cruch are only just beginning and it will take a long time for the US economy and housing sector to recover from a spate of poor lending decisions by mortgage brokers.

Here is the link


Prem Watsa has strategically prepared Fairfax Financial's investment portfolio by concentrating his fixed income portfolio almost exclusively in government bonds "for the first time ever" according to Prem and and using credit default swaps to bet on a widening of credit spreads in a growing aversion to risk of corporate defaults. According to the International Herald Tribune , the Markit CDX North American index of credit-default swaps on over 100 investment grade companies tripled since February, to 90 basis points from 33.

Since the end of September the index has doubled. Many of the companies Fairfax Financial holds in its CDS book are mortgage or banking stocks such as Countrywide Financial, Freddie Mac, Radian have seen their spreads more than double since September 30. As a result Fairfax Financial's investment portfolio of CDSs would now be valued between 1 to $1.5 billion up from around $500 million at the end of September 2007.

Nick Nejad has a great write up on the changes in the value of Fairfax Financial's CDS's at

No doubt as corporate debt spreads widen (and corporate bonds become cheaper) more opportunities will present themselves to insurance companies and other investors over the next few years. However, with the housing recession intensifying in the US, the potential for corporate failure amongst weaker public companies in the mortgage and banking industry is high.

Sources: International Herald Tribune, The Globe (,, Fairfax Financial annual/quarterly reports
Disclosure: I own shares in FFH

Hank Greenberg - A return to AIG?

On the 2nd November 2007, Hank Greenberg, former AIG CEO & insurance industry icon, filed a 13D with American International Group (AIG) indicating that he and other interested parties are considering strategic alternatives for AIG. Here is an extract from the 13D lodged...

"....The Reporting Persons believe that there are opportunities to significantly improve the Issuer's performance and strategic direction, as well as the value of their investment. In this connection, the Reporting Persons anticipate holding discussions with stockholders and third parties that may address a number of issues, including without limitation, their respective views on the Issuer's business and prospects, the suggested disposition of certain of its operations, investment opportunities and concerns over the direction and management of the Issuer generally, and other opportunities to improve or realize on the value of their investment in the Issuer.... "

Clearly Hank Greenberg believes AIG shares are undervalued and the company is performing below expectations. Hank controls through CV Starr & other companies over 12% of AIG and has the ability to exert considerable pressure on management, particularly if he can win the support of other shareholders.

AIG shareholders have experienced disappointing returns over the last 5 years and and may still hold a certain fondness for the tough talking Hank Greenberg who as CEO of AIG achieved 20% plus shareholder returns before his controversial exit in 2005.

AIG's financial results have been recently plagued by subprime writedowns and a softer insurance pricing business environment, AIG shares have suffered and are now trading at the cheapest levels in over 10 years trading on a PE multiple of 9 & a Price to Book ratio of 1.3. Typically AIG shares have traded above a price to book ratio of 2.

So is Hank making a play for AIG? Does he want the CEO job back or is it simply a case a revenge against a Board who turned their back on their CEO in the face of the New York A-G Spitzer's allegations against Hank Greenberg.

With a large part of his wealth invested in AIG shares Hank Greenberg obviously wants to improve the returns from his shares. Hank has recently accused the AIG board of being a bunch of lawyers and also that AIG lacked real leadership. Hank Greenberg has publicly said he does not want to return as CEO but there is no doubt with this recent 13D filing that he wants to to exert some control on the key leadership & board positions in AIG.

Personally as an AIG stakeholder, I would like to see Hank Greenberg return to AIG, whether you like or loathe Hank there is no doubt he knows AIG better than any other person and is more qualified than anyone to run AIG , even if he acts in simply a advisor role. Of course court proceedings are possibly pending & the outcome is unclear this may impact on his ability to work as director.

I will make further posts on this blog as the issue develops.

On a final note I do recommend Ron Shelp's book "Fallen Giant; The Amazing Story of Hank Greenberg and the History of AIG" for a great and well balanced account on Hank Greenberg and the extraordinary success he achieved with AIG. As David Schiff put it in a WSJ article (march 05) Hank Greenberg has "been the most important figure in the insurance business over the past 40 years."

Sources: Forbes,SEC database,Wall Street Journal
Disclosure: I own AIG shares


Welcome to my first blog.

My goal is to post at least once a week and I hope I can entertain you as well as provide you with a few alternative investment ideas and views.

This blog is about the global insurance industry which I find totally fascinating and enjoyable. With by far the largest share of the insurance industry, North America will hold much of my focus . However, I will also be exploring the fast growing insurance business in the Far East in particular China and India as well as other parts of the world.

Many investors find the insurance business dull and boring and would much rather read about fast growing semiconductor stocks or the latest high-flying IT company. If you are one of these people you're in the wrong place!

Nevertheless when it comes to investment returns the insurance business can be very sexy (consider this, only two value investors , Warren E Buffett & Shelby Cullom Davis, have made the US Fortune 500 list through investing & they achieved this mostly through insurance company investments)

Of course the same discipline of investing should apply when investing in insurance businesses just like any other form of stock investing.

As well as posting blogs , I will be providing my favourite links and highlighting other worthwhile publications. Also please give me your feedback, I don't mind if its positive or negative , I'd love to hear from you.

So grab a coffee , sit back & relax and enjoy ....