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WIKI ANALYSIS
W.R. Berkley Corporation (WRB) is an insurance holding company. Through its subsidiaries, Berkley operates in five segments of the property and casualty (P&C) insurance business: specialty, alternative markets, reinsurance, regional, and international. Specialty includes excess and surplus (E&S) lines and commercial transportation. The alternative markets segment develops, insures, and administers self-insurance programs and other alternative risk transfer mechanisms with a primary focus on the workmen's compensation business. The reinsurance segment provides P&C and surety reinsurance. The regional segment provides commercial P&C coverage to small and mid-sized businesses, as well as to governments in 32 states. The international segment includes operations in Argentina and the Philippines. In 2006, the proportion of Berkley's net premiums written by business segment was specialty (37.7%), regional (25.6%), alternative markets (13.5%), reinsurance (18.5%), and international (4.7%).
Strong double-digit premium growth continues at W.R Berkley. Premium is expected to continue growing at double-digit pace and should benefit from W.R. Berkley's acquisition of a book of business from The Travelers Company Inc. (TRV). This book of business is expected to add to top-line growth over the next year and represented roughly $100 million in premiums (more than 25% of the company's annual premiums prior to the acquisition). The company has started several new units, which should be expected to meaningfully impact on its business by 2007.
Underwriting profitability remains strong. After improving substantially in 2004, the combined ratio remained at 88.5% in 3Q07. It was just 99.7% in the 4Q05, despite the string of hurricanes, which for the overall industry were the most severe insured losses on record. We think that the company will continue generating an underwriting profit in the coming quarters, despite the softening market. Management indicated that pricing, although moderating, is "rationally competitive and satisfactory returns are available" in most of its business lines. Management has indicated that it is focusing on a product mix that will give a consistent return on equity of 15% over the long-term. For 2007, management expects to achieve an ROE above 22%, though the company expects a modestly lower return in part next year in part due to its increasing equity base. Operating ROE was 21.6% for the reported quarter as compared to 26.9% in the prior year period.
Although underwriting profitability remains strong, we are moderately concerned with the company's recent string of prior-period reserve increases. During the last few years Berkley has added to reserves for losses incurred in prior periods. Clearly, this long string of reserve additions lessens our confidence in the company's current reserves and, therefore, in the quality of its underwriting profits and earnings. However, despite these prior-period reserve additions, Berkley's combined ratios remain almost flat. Moreover, our 2007 and 2008 earnings forecasts incorporate a slight increase in the loss ratio and, therefore, any modest reserve additions in 2006 will not likely affect our earnings forecasts. We also note that this string of reserve additions follows seven consecutive years of modest reserve releases.
Investment income is poised to continue growing vigorously. Cash flow remained strong in 2005 and 2006, rising to an all-time high, greatly benefiting from investment income additions. Investment income grew by 45.1% to $586.2 million for FY06, following the 39% increase for FY05. On a per share basis, investment income is a significant donor to the company's EPS. We expect it to continue growing at a hefty double-digit pace in the coming quarters, fueled by strong underwriting cash flow and lower interest credited on funds held for reinsurers. Management continues to maintain a short duration approach (i.e. weighted average time to maturity) on the investment portfolio, which should benefit the portfolio as interest rates rise, as it can reinvest proceeds from its rapidly maturing bonds at higher rates and will not need to sell bonds at a loss to pay claims. Though the company has a significant portfolio of mortgage backed securities, it contains no sub-prime element.
The company enjoys a strong balance sheet and lack of material exposure by legacy issues, such as asbestos and environmental liabilities, which we believe adds more visibility to Berkley's future earnings stream.
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