Worse Than Ours

“At least 95% of the insurance business in the world are worse than ours.”
Charlie Munger, Wesco Annual 2008

That is a remarkable statement coming from a person with an even more remarkable reputation. Whether it is or isn’t true, the statement stands on it’s own for the sheer reason of bluntness. Not to suggest it isn’t true, in fact it may very well be an accurate assessment.

Sure would be great to be invested alongside the top 5%, or even the top 10%.

If you haven’t had the time or chance to read the Fairholme annual letters, you should. They are short and to the point. You could read all within a 2-hour time period and in the end, you will feel smarter. Mr. Berkowitz’ record is astounding in relative and absolute terms. Further, their intimate knowledge of the insurance business allows the ambitious Intelligent Investor to understand in layman terms what to look for.

For example: “Property and Casualty companies have three ways to make money: 1) Underwriting Profit, 2) Investment income (Equities and Bonds-but mostly bonds), and 3) Investment Appreciation (Mostly Equities).” (Parenthesis mine)

Because with “The right management, these streams can generate a torrent of free cash flow.”

Part of a great investment thesis is not the stream of information from one direction, but from multiple sources. Relying on what makes sense (to you!), and making a purchase at prices you feel comfortable based on your appraised value of the business. In the value investment world, relying on different models is attributed to Mr. Munger.

In 2000, 50% of Fairholme fund was in Property and Casualty businesses. Why? Because “Such company have earned 20% returns on Book, and we paid near book.” (Emphasis mine)

During Fairholme funds existence, they have purchased Markel, Alleghany, Berkshire, and a couple of others. With insurance, the triple waterfall that comes from: “1) Improving underwriting results, 2) Growing Float, and 3) the Redeployment of capital from low to high return investments” makes for a great investment model.

Putting 2 and 2 together, and searching for the 5% of insurance businesses that have the same model as Berkshire, the focus on underwriting profit, investment income and capital appreciation is pretty hard. This insurance industry and the three factors mentioned by the folks at Fairholme doesn’t happen in syllogism fashion in the insurance industry. You can find an insurance company that underwrites profitably, but doesn’t have the investment acumen to find solace in the latter two. In which case, you are with the other 95% of insurance business worse than Berkshire.

So be careful. Be strict with these guidelines. They are only qualitative factors and with the right checklist, you can easily scratch off a potential insurance investment in less than 24 hours.

Comment on Comment

I devoting a new section to comments posted on specific posts for two reasons:

1. Sometimes very good points are made that other readers may be interested to know, and
2. If a reader dedicates a portion of his time to read something of interest to me, the least I could do is make note of it.

Last week, a reader asked if I have made any recent purchases in ORH. I have not, most recently I’ve been a consistent Fairfax buyer. All in all, about three months ago ORH was 3X more than FFH, within the last 2 months, FFH is now 1.5X ORH position. At the same time, not one share of ORH has been sold. The decision to sell other positions to raise cash to subsequently purchase FFH was all too simple.

I’ve already penned next weeks post and with lower market appraisals, it may be perfectly timed.

Until then, take care.