September 20, 2008I'm Back, Sort Of
For almost 20 years I wrote a newsletter about the insurance business, Schiff's Insurance Observer. In early 2006, however, I realized I was growing weary of following the industry so closely. Concurrently, I discovered a renewed interest in pastimes I'd long forgotten — hanging out with friends over long lunches, reading books, traveling (for fun), and getting a good night's sleep. So I stopped writing the newsletter and did other important things: sitting on the deck in Marin and having a glass of wine in the midafternoon, for example, cycling in Sonoma, and exploring the towns on Lake Atitlan in the Guatemalan highlands.
Although I still paid some attention to the oscillations of the insurance industry, I eschewed the minutia of it all. I was bearish on insurance stocks — had been for a while — and had the feeling that if I looked too hard I'd end up frustrated, or even worse, getting seduced into untimely, or even bad, investments. The markets, I'd often opined, were filled with risk, and insurance-stock valuations in particular, were rich.
As an investor, I'd characterize myself as an old-fashioned Graham and Dodd type. I'm looking for good businesses with clean balance sheets that are cheap — generally selling at a discount to tangible book value. (These have been rare in recent years, so I've confined the majority of my investments to a security that has served me well in such times: short-term Treasurys.) In fact, during my three decades as an investor in insurance businesses, I'd say that about 90% of the time there were no insurance stocks I wanted to buy. But, every now and then, the industry (or particular stocks), got particularly out of favor. On those rare occasions, good businesses with strong balance sheets and fairly easy-to-understand financial statements could be bought for bargain prices.
Over the years in Schiff's Insurance Observer, I have pointed out many of these opportunities — while they were available, of course! (I've also pointed out when the risks were high and the reward low.) And I've commented on, at great length, the avarice, deceit and foolishness that is commonplace in the great business of transferring risk for a fee. (The complete archive of Schiff's Insurance Observer is now available for free at www.insuranceobserver.com. If you click on the section of the home page titled "Insurance Investing," you'll find 21 articles on that subject.)
Insurance companies are in the business of managing risk and yet, from time to time, they manage to take on risks that are far too large. Perhaps no better example of this is the sad case of American International Group. (I've also written extensively — and critically — about AIG for the past 15 years. Those articles can also be found on the home page of my Web site.)
There are several simple reasons why companies take on too much risk. The folks running most companies aren't nearly as smart as they would have you believe. And most companies are seeking to do something that most cannot possibly do: namely, grow earnings by 15% and earn a 15% return of equity. This stretch for growth and for yield has historically injured or impaired many an otherwise good company.
Risk, of course, isn't always easy to measure. In 2007, AIG, which historically had not been a significant purchaser of its own stock, decided that it was a clever thing to repurchase $6 billion of its shares in the $70s. AIG was obviously of the belief that not only did it have plenty of capital, but that it had excess capital. As it would turn out, they had, perhaps, a $60 billion shortage of capital. I don't bring this up to show what a colossal error or stupid speculation the wise men at AIG made, but rather to emphasize and show that the august members of AIG's board that approved the repurchase didn't have the foggiest idea what the company was worth, what risks it was exposed to, or what the hell they should have been doing. And, sadly, they still don't.
Anyway, my two-year sabbatical from the insurance field seems to be winding down somewhat. The financial panic that began over the summer has provided a few good opportunities for insurance investors, and perhaps the unwinding of the insurance cycle and the dislocations that are a reaction to the rampant speculative excesses of recent years will provide some more opportunities going forward.
I will be commenting on this, and providing some suggestions, over the coming months.