This article was originally published on June 23, as part of a Friday File for the Stock Gumshoe Irregulars. It has not been updated or revised, but the ad is circulating again and we’re opening this article up for everyone to read. We don’t have precise teaser stock solutions that I can guarantee are correct for this one, but we do have an in-depth look at the industry and a lot of the relatively attractive companies who Porter might be recommending.

Porter Stansberry knows that controversial and religious and political stuff draws eyeballs, and that if you’re trying to sell something, being controversial is way better than being boring.

So his latest big “documentary” video sales pitch, which is an ad for The Big Secret on Wall Street ($1,000/yr, 30-day refund period with 10% charge), is called “God’s Investment” … and it touches on the religious theme a bit more than I would like, promising “An investment so perfect and with returns so endless, only God could have created it.”

But the basic argument makes sense, and I generally like the sector he’s touting. Can we ID any of the stocks he might be teasing in this “documentary?” Let’s see… I’m going to blather on a bit today, and touch on a bunch of different companies, so strap in.

Throughout today’s note, I’ll quote a few of the things Porter says in the piece… though, sadly, he doesn’t include a transcript, and I wasn’t willing to listen to it a second time (we’ve all got our limits), so I may be paraphrasing a bit… here’s one bit to tantalize you…

“If most people invested only in these firms, and no other sector, they would significantly increase their annual returns.”

He includes a chart of a stock that almost 10X’d the market’s returns from 1985 to 2023, with, as he puts it, “almost no downside” — though really what that means is the stock recovered within a few years from every big downward move. If you owned the stock during those drops that look small in the historical chart,  they probably felt like big “downside” events to you, in the moment. Here’s what it looks like, in a screen grab from his “documentary”…

But sure, it never had the “down 90%” downside of some of the most volatile big-time winners — like Amazon (AMZN), for example, which has fallen 70-90% a few times over the past 25-30 years.

And I’ve been following Porter’s pitches for 20 years now… so I actually recognized that chart immediately, it’s the chart of a company that 40 years ago was called Replacement Lens, Inc., and is now known as the fantastic specialty insurance company RLI (RLI). So yes, as he has done many times in the past, Porter is talking up the insurance industry with this “documentary.”

And I don’t blame him, frankly, he has very publicly been enthralled with insurance stocks for more than a decade, and often says that this is the only industry he wants to teach his children about. It’s a great business, providing a service that society needs and that is usually priced to give the company that aggregates and manages everyone’s risk exposure a decent profit, without tying up any of the company’s own capital. And while the prices fluctuate along with the rest of the market, the best insurance companies have provided very good long-term returns, with very little risk of severe losses…. that’s a pretty good recipe for success, as long as you can wait for things to compound over decades, and avoid selling good insurance companies during the inevitable bad quarters and years.

An insurance stock will rarely be in the top ten stocks in the market when the market is going up… but they also very rarely lose 50% of their value on a short-seller report or a bad quarter or a big change in market sentiment. Most people find them pretty boring, and the quarterly earnings numbers don’t really mean anything (it’s the balance sheet and operational data you generally have to watch, not the quarterly income), so they don’t get the kind of attention that hot growth stocks do… but I agree, it’s a good sector for seeking out strong long-term investments that give you a good chance of sleeping well at night.

Most insurance companies will never approach the returns of an RLI, which started out very small (and is still not terribly huge), because most insurance is more commoditized, even within the property & casualty insurance space that most of us think of when we think “insurance stocks” (there are other kinds of insurance, of course, with the biggies being life insurance and health insurance, and companies in those businesses are very different than the companies who primarily insure against property losses and commercial or personal liability). Your homeowner’s policy or your standard car insurance policy is usually sold to you in an extremely competitive market, with more distinction driven by marketing than by real differences in service or pricing (which is why we all know the ads for GEICO and Progressive and State Farm).

RLI is in what are called specialty areas of insurance, starting out with that crazy business of insuring contact lenses (back when they were much more expensive than they are today), which is really more of an “extended warranty” kind of insurance, and finding those niches where there’s less competition is generally where the best underwriting profits have been made in insurance… but they can also be harder to find and keep as you get larger.  Prudential, for example, was never going to pop in and be able to write a billion dollars worth of contact lens insurance, so they never got into the business.  RLI has expanded into lots of other kinds of specialty insurance over the years, both organically and through acquisitions, so they’ll underwrite lots of special warranties, insure business specialists like architects or contractors, cover marinas and boat dealers and marine cargo, provide special add-on insurance so you can take your sports car on the racetrack for a day, etc. The more specialized you get, the more you learn about a business and the risks it carries, and then you can have a pricing edge because you’ll write coverage that other companies don’t really want to deal with, or can’t price as well as you can.

And yes, as Porter goes on to tease, RLI corp also pays special dividends that don’t necessarily get recognized by investors — most financial websites will indicate that RLI has a dividend yield of a little less than 1%, paying a quarterly dividend of 27 cents now… but most years, in November or December, they pay a special dividend from their excess earnings, and last year’s was HUGE, at $7 per share, so the trailing 12-month yield today is actually about 6%. Now, the special dividend a year before that was $2, and it has often been $1 per share in the past, it goes up and down, so there’s certainly no guarantee that we’ll see another $7 windfall like that… but they did pay it last year.

So is RLI actually one of the top three picks he suggests?  He doesn’t specifically say so, and it’s pretty far above what he has considered a fair valuation for insurance companies in the past (more on that in a moment), so I’d guess he’s not recommending a buy today — but maybe he values this one differently, it is a different beast.  And it’s been a fantastic investment for a long time, for sure.

He mentions several other folks in the “documentary” who created vast fortunes from this “God’s Investment” industry, including Leo Goodwin (who founded GEICO insurance), and goes pretty deep into the history of insurance, which is basically the history of mutual aid societies turning into institutions, and eventually corporations. There are still mutual insurance companies that are owned by their policyholders, without anyone taking a profit off the top, including some big ones like State Farm (a company that Warren Buffett sometimes jokes about as proof that capitalism has failed, since the largest and fastest-growing consumer-facing insurance company was never really incentivized by a profit motive at the top), but most insurance is now commercial — it’s sold by insurance corporations who manage and price the risk, and effectively spread the risk around among all their policyholders while also taking a little risk themselves, and if they price the insurance well and make a profit, they can reward their shareholders or invest in growth.

So… why is it the best business? Here’s a bit from Porter….

“Insurance is essential — without it, people wouldn’t take any risks. Health, property, travel, etc, you can’t get a mortgage or drive a car or run a business without it. “

And he includes a quote from Peter Hancock, who was once CEO of insurance giant AIG (which, if you recall, was also part of causing the great financial crisis in 2008):

“Insurance is the backbone of modern economies, providing individuals and businesses with the protection they ned to take risks and invest in the future.”

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So part of it is that insurance is necessary, it provides confidence in transactions and loans (if you have a mortgage, you don’t get to choose whether or not to get home insurance), and most people want it even when they don’t need it.

But part of it is the unique way that insurance works… here’s how Porter puts it:

“The ‘unique financial advantage’ is that insurance is the only business in the world that enjoys a positive cost of capital. Insurance companies get paid to use other peoples’ money for their own benefit.

“Everywhere else you look, the cost of capital is one of the key considerations… but for insurance companies, the best ones will be paid to accept other peoples’ money. It’s like taking out a loan, and having the bank pay you interest.”

That’s a reference to the “float”, which is essentially the money that all policyholders pay in, to buy their insurance coverage… but it doesn’t have to be paid back out right away. If 10,000 people are insured, a few of them will have car accidents (or whatever), and that estimate is worked into the average price for those customers, but not many will have them that first day, or even that first year. Insurance companies calculate the risk they think they’re taking, and they aim to have an underwriting profit, but even if they just break even on the underwriting, which means that their operating costs and the insurance claims end up eating all of the premiums they bring in, they still get to hold those premiums until the claim hits, and keep any profit they earn from investing them.

Some insurance is “short tail,” like car insurance, where claims are generally processed quickly and you probably won’t hold the float for even a full year (though most policies are renewed, which keeps that float a “perpetual” free loan for the insurer)… but some also has a long tail of risk that extends out for decades, with liabilities for worker’s compensation that may not even be known for years, or construction errors that can be fought over in court for what seems like a lifetime.

Porter says it this way…

“The float is an unfair, unique advantage for insurers. A free pile of cash they can invest.

“A permanent and ever-growing interest-free loan that they can invest however they like.”

That’s not entirely true, most kinds of insurance are regulated to make sure the underwriters follow rules with the money they hold, and keep it safe enough to make sure that they can fulfill all their obligations even in a pretty extreme scenario… those regulators won’t let an insurance company invest all the float in the S&P 500 unless they have lots of other assets that they can use to guarantee they’ll be solvent to fulfill all their liabilities if they face a big wave of insurance claims (like from a few big hurricanes in one year, or something like the 9/11 attacks).

But they don’t have to keep all the float in T-bills, they can certainly invest some of it in riskier stuff (corporate bonds, equities, alternatives investments, real estate, etc.)… and most insurance companies also reinvest at least some of their own capital in their investment portfolio, whatever excess earnings they don’t pay out as dividends or use to repurchase shares, so they earn profits on their retained earnings and compound that value over time, too.

The basic way to assess a property & casualty insurance company is to first look for their combined ratio, which unfortunately isn’t in basic charting software on financial websites. That will tell you whether or not the company can underwrite consistently and profitably… almost all insurance companies will have a bad year from time to time, losing money on a lot of claims, whether that’s because of something new and unexpected like asbestos litigation (or now PFAS), or just because a few hurricanes hit Tampa and Miami, but you generally want your property & casualty insurance company to have an underwriting profit in almost every year, and the bigger the profit the better.

The combined ratio just takes the premiums coming in, and divides it by the insurance operating expenses and the claims paid — so if it’s under 100, then you’ve got an underwriting profit… if it’s over 100, you’ve got an underwriting loss. Over a very long period of time most insurance companies have posted underwriting losses most of the time, but in recent decades they’ve generally gotten smarter and better at pricing… partly because they had to, since their investment returns were not consistently good enough to make up for underwriting losses (there have been long periods of time in the US when insurance companies were happy to underwrite at break-even, or even lose a few percent, because they knew they could invest the float in corporate bonds at 12% yields and still make plenty of money… but that’s not been true in recent decades, and insurance companies, like most companies, have used data and computers to get smarter and more efficient).

Porter is being a bit disingenuous in his claim that he’s “never told this story” before — I guess he hasn’t made a “documentary” about his view of the history of insurance before, but he has been talking up the industry as the “world’s best business” for a decade or so. While he was still working at his eponymous Stansberry Research, back in 2019, he had a pitch we covered called the “World’s Best Business” and “The One Business I’ll Teach My Children,” for example, that touched on some of his favorite ideas in the space (including RLI).

One way that Porter used to like to look at insurance companies, and I bet this hasn’t changed, is by assessing them relative to the size of their float — essentially, calculating the float + book value of each insurance company, analyzing them to see if they routinely post underwriting profits, and buying the insurers he believes are high-quality, with underwriting profits and a growing business, that are also trading at a good discount to that “float + book value” number.

And he still says this today, in this documentary…

“When buying insurers that trade at discount to the float + book value, you can significantly increase your returns.”

Plenty of insurance companies trade at steep discounts to their book value, let alone their book value + float, because investors don’t trust them to underwrite profitably or grow. As with most areas of investing, you have to do some work to find the sweet spot — great companies that aren’t priced like great companies.

And he lays out the ways in which you need Porter and his analysts to cover the industry for you… which mostly revolves around the fact that insurance accounting is complicated, the data can be tricky and subjective and isn’t reported in  a standard way by everyone, and it requires you to have quite a bit of faith in the management team and the company’s history of managing risk. This is mostly paraphrased:

The float is not disclosed anywhere in SEC filings, and isn’t necessarily easy to calculate without doing a little work.

Earnings are based largely on estimates — you want insurance companies whose managers routinely overestimate the future losses, not those who are aggressive in underestimating their loss exposure and playing tricks to inflate current earnings.

But they’re often mis-valued by the market — in part because the float is treated as a liability, but in the hands of a good and consistent insurance company it is better thought of as a corporate asset.

Some insurance companies do talk about float, since they know investors have been taught (mostly by Warren Buffett) to care about that concept… but it’s true that it’s not a line in the financial statements, you do have to figure it yourself. I have some quick ways that I calculate an approximation of “float,” but it’s not really a standard measure that everyone agrees on. More on that in a minute.

Why buy now?

Porter says he’s doing this now because “today is the ideal time to invest in the insurance industry. Not only are several of these firms trading at large discounts, but today’s heightened interest rates boost their potential”

What happens with rising rates? Well, first they depress earnings and cut into the book value of the insurance companies who hold big portfolios of bonds, since they owned a lot of bonds last year when rates were at 2%, and the value of those bonds dropped considerably when rates rose to 5%. That provides some accounting pressure, and it helped reduce the book value of some insurance stocks over the past nine months or so, as bond prices dropped (rates going up means existing bonds fall in value). It makes the portfolio look worse, but it’s not really a big impediment in the long run — insurance companies mostly hold bonds to balance out their expected liabilities, so they only hold long-term bonds when they need to match long-term liabilities, and they generally hold those bonds to maturity and get their original investment back, they aren’t trading them or selling them at a loss just because rates spiked higher. They may under-earn because they hold a low-yield bond, perhaps, but they don’t lose money as dramatically as the income statement might imply (for a couple quarters last year, insurance companies posted big accounting losses on their income statement, too, because their investments fell in value, both stocks and bonds, and a change in the value of their investment portfolio counts as “earnings” or “losses” under GAAP accounting… but they mostly didn’t sell those investments, and they’re gradually recovering much of that value).

But in general, rising rates are very good for insurers, eventually — because they have to keep a big chunk of their float in bonds to assure their ability to meet expected liabilities, and they write new business every day, they earn more and more on that “safe” part of their float as interest rates rise.

Porter includes a quote from Charlie Munger, Warren Buffett’s most trusted business partner and the 99-year-old Vice Chairman of Berkshire Hathaway, a guy who has certainly seen a variety of markets in his lifetime:

“In the long run, higher interest rates are good for the insurance business. It’s been true for 300 years, and it’s not going to change now.”

In the short run, particularly when rates rise quickly, it’s not necessarily great… but over time, rising rates make insurance a much easier business.

The risk, I would point out, is that companies generally figure this out, which leads them to invest more in growing their insurance business so they can earn more “float” to invest in higher-yielding bonds, which historically has sometimes led to a “soft” market for insurance… meaning insurance companies, knowing they can earn good and safe returns on their investment portfolios, become willing to take more risks and underwrite more aggressively in order to grow those portfolios and buy more bonds.

When that gets extreme, you end up with a lot of insurance companies who are losing money on their underwriting even in non-disaster years, and that puts competitive pressure on pricing for everyone. We’ve been through long “soft markets” of flat or falling insurance premiums before, it’s not like that’s a crisis, but when the insurers get stuck in a soft market for several years, it sometimes takes a few ugly natural disasters to scare some of that excess underwriting capacity out of the market and create a “hard market” again, with rising costs for risk and better underwriting profitability.

None of this is universal, every kind of insurance is a little different, but in most areas of insurance it seems like we’ve been in a “hard market” for six or seven years, interrupted by the major uncertainty of COVID, for sure, but with pricing mostly going up. Prices are still rising, as capital is more scarce now in general, and as inflation means rising costs for claims (replacement values go up), but that probably won’t last forever.  In the most basic kinds of insurance, you can see the “hard market” yourself as your car and auto rates rise.

We’re pretty clearly not “softening” yet, at least for most kinds of insurance — money is not flooding into the insurance industry, you don’t hear about hedge fund guys starting up new insurance companies willy-nilly, and in some areas you’re lucky to be able to find anyone who will underwrite insurance at all, with some property and casualty insurers running away from Florida, for example, and California (because of the combination of harsh regulations or regulatory incompetence, especially in Florida, and high rates of expensive disasters, like hurricanes in Florida and wildfires in California).

Porter does also mention everyone’s favorite insurance conglomerate, Berkshire Hathaway (BRK-B), which has been a pretty consistently profitable underwriter for decades, and trades at a rational valuation, but is also much more complex because of all of its non-insurance businesses… and is probably also too big to have extraordinary returns for the next couple decades…

Berkshire won’t average 20% annual returns in the future like it did in the past, because it’s so large, but it’s still a “forever” stock, even if the best returns are more likely to come from smaller insurers.

And he also says he’ll recommend three insurance companies that you’ve probably never heard of, that are among the best companies in the world, ideal buys right now, and that he also has a watchlist of about three dozens others that he monitors… I assume these are insurance stocks which are high quality and consistently profitable, but are not “buys” until they are valued at an appropriate discount to the book value plus the float.

He does not, however, drop any hints about the three stocks he says are buys right now. Might we hazard some guesses?

Well, I’ve mentioned W.R. Berkley (WRB) several times over the years, I know that’s a high quality specialty insurance company that Porter has liked and recommended in the past… and I just did the calculations recently, so the way I figure it, WRB’s float is about $16 billion, and book value is about $6.75 billion, that would mean the “intrinsic value”, the way Porter is simplifying that number, is about $23 billion. The market capitalization of the company today is about $15 billion, so by that metric it’s about 35% undervalued. We shouldn’t necessarily expect that to change quickly, the stock was similarly undervalued on those same metrics about five years ago, too… but it does sometimes get more richly valued, it got very close to that “book + float” value at the highs last year, both in May and in October-November.  My recollection of past commentary from Porter and other Stansberry folks over the years was that they like to look for insurance companies with consistent profitability that trade at at least a 25% discount to the “float plus book value” metric… so WRB fits on that front.

WRB has been one of the most consistently profitable underwriters around, and on that front it has lately been better than my favorite specialty insurance company, Markel (MKL), so it’s hard to argue with that as a pick today. It’s been on my watchlist, though it’s also not an easy buy at 2X book value, that is historically far above where it has traded, so there’s some risk if other investors are overly focused on book value in the future, instead of on that “book + float” measure Porter prefers… but the float has really grown nicely, their underwriting has been genuinely excellent in their specialty areas, it’s still run by the founding family and hasn’t really changed culture or style in any way that I can identify, and that consistent excellence should power future returns. And they should be a pretty clear beneficiary of higher prevailing interest rates, over time.   This is a stock that looks more appealing each time I look at it, so even though it’s not at a perfect valuation in my mind, I’d like to see it trade at a much lower multiple of book value, I can see the logic in really incorporating the value of their float, which makes me a little more willing to buy today.  More on that in a minute.

The appealing part of the float at any good insurance company is the consistency of it — which is why we can think of it as a valuable asset, not just a liability. Yes, they’re going to have to pay out most of that float in claims… but because they’ll also be selling a similar amount of insurance next year, and the year after that (maybe a little less, maybe a little more), the float can be seen as an almost perpetual loan. The word “almost” is important there, but that’s why you focus on quality — management teams who have done this for a long time, corporate cultures you can trust, and a clear ability to maintain the business, maintain your market share, and hopefully grow it over time.

So I’d guess that WRB makes his list of three “buy now” insurance companies, but that’s absolutely a guess.

Without clues, I can’t tell you with any certainty which insurance companies are the best buys for Porter right now, but I assume that he’s using the same criteria he used when he started up the Insurance Value Monitor for Stansberry Research a decade or so ago.   These are the insurance stocks that come to mind from my past coverage of Stansberry, along with some basic valuation metrics (book value growth, and price to book):

American Financial Group (AFG), trades at 2.5X book, book value per share shrunk 20% in past five years.
Chubb (CB), trades at 1.5X book, book value grew 16% in five years
W.R. Berkley (WRB), trades at 2.2X book, book value grew 33% in five years
Arch Capital (ACGL), trades at 2X book, book value per share grew 71% in five years
Axis Capital (AXS), trades at 1X book, book value per share roughly flat over five years.
Travelers (TRV) 1.75X book, book value per share grew 18% in five years
Markel (MKL), 1.3X book, book value per share grew 44% in five years

And there’s also the resurrected American International Group (AIG), which is a shadow of the company it was in 2006 but is still a big player that many people bring up when talking about insurance stocks — their book value has also fallen in the past five years, about 13%, and the stock trades at about 0.9X book value… the total return for AIG investors has been about 61% over the past decade, about the same as the disappointing Axis Capital.

A lot of other stocks that the Stansberry Insurance folks have liked over the years, using similar criteria to what Porter is talking about now, have been gobbled up by other firms or gone private — that includes past favorites like Allied World Assurance, bought by Fairfax Financial (… HCC Insurance, bought by Tokio Marine… Ace, bought by Chubb… AmTrust Financial, taken private by management… and PartnerRe, bought by Exor and then sold again, but still private.

And there are plenty of others who have been favorably covered by the Stansberry folks over the years, too, including RLI (RLI) and Progressive (PGR), as well as some reinsurance specialists like RenaissanceRe (RNR) and Everest Re (RE) (reinsurance is basically “wholesale insurance” — companies who provide insurance to other insurance companies to cap their losses — it’s cheaper to offer, since you don’t need the big sales force and you have a much smaller number of customers, but the profits are generally lower, and sometimes the big catastrophic events hit the reinsurers harder).

I don’t have access to any big insurance datasets, and haven’t built any such data collections like Porter has, so I don’t know exactly where those firms stand at the moment, but I can do some quick and dirty calculating. The easiest shorthand way to calculate “float,” in my book, is just to take the unearned premiums and unpaid loss reserves, both of which are typically lines in the balance sheet report, add them together and subtract the accounts receivable, including any reinsurance receivables, since that’s money they claim the right to but haven’t collected yet (so aren’t investing, they’re not “using” the cash). That’s over-simplifying and we can get more granular, but you can’t do it in a basic financial data site, you have to actually look at the 10Ks.  Let’s look at a few examples…

For Chubb (CB), using first quarter numbers, we would have $76.25 billion in unpaid loss reserve plus $20.26 billion in unearned premiums, minus $30.76 billion in receivables. That gets you $60.75 billion as one estimate of “float.” That’s not a perfect measure, by any means, we could go deeper and figure out where to put prepaid expenses and whether they’ve historically under-reserved or over-reserved for future losses (if you’re under-reserved, then as that readjusts because claims don’t come in, that excess becomes “income”), but it’s a basic number to start with, and it’s likely to get us in the ballpark. Add that to the reported book value of $53 billion, and you get $113.75 billion. The market cap of Chubb today is $80 billion, so it’s one of the larger insurance companies in the world, and one of the most respected ones, and it’s trading at about a 30% discount to its “book value plus float” if you calculate that way.  They haven’t been the best grower in recent years, their book value per share is up only about 15% in the past five years… but they should certainly become more profitable with interest rates higher now, and investors have been willing to pay for that (the total return for the shares, as the price/book multiple grew over the past five years, has been 71%).

(I actually did a somewhat deeper dive into Chubb’s balance sheet, and I think the actual float is more like $75 billion, making the discount a big bigger, but I’m not doing that with every insurance company so we should make sure to compare apples to apples when skimming through data.)

And since Porter mentioned RLI (RLI), which has been a great performer for a long time, what does a similar valuation look like for them? They’ve got an unpaid loss reserve of $2.29 billion and unearned premium of $800 mllion, so that’s about $3.1 billion, minus $906 million in receivables, which gets us $2.19 billion of float. Add that to the book value of $1.3 billion, and you get $3.49 billion. RLI still trades at a valuation way above that level, at almost $6 billion, and that rich valuation tracks — over the past decade it has almost always traded at a lot more than 2X book value, but these days it’s pretty elevated at 4.5X book. Still, over the past five years the price has mostly been driven by book value growth — as of January, book value was up about 49% in five years, and the stock price was up about 50% at the highs around then, but it has fallen back a bit, so RLI now is up only about 28% over the past five years. And they do pay those special dividends — so if you add the past five years of special dividends to RLI’s current book value, just to give some perspective, that would be another $12 per share, bringing current book value up another $500 million or so.

Great company, but it has also been slowly increasing its share count over the years, which I don’t love to see, and I can’t gather up enough math to argue that it trades at a discount.

Can we get at some ideas by choosing the best performers? Or the worst ones?

Of those companies that I know Porter and his gents have liked in the past, the ones who have beaten the S&P 500 over the past ten years are Progressive (PRG), W.R. Berkley (WRB), American Financial Group (AFG), Arch Capital (ACGL), Everest Re (RE) and RLI. The ones who have trailed the S&P but beaten the average insurance company (as measured by the iShares US Insurance ETF (IAK) are Travelers (TRV), Chubb and Markel. That’s probably a reasonable place to start when seeking out “quality”, though it doesn’t necessarily mean you’re getting bargains.

Axis (AXS) has been a serious disappointment over the past decade, despite being founded by an insurance rock star (I owned that one for a brief while, long ago), and RenaissanceRe (RNR) has been much worse than Everest (RE), the other reinsurer that pops up from time to time… but most of those companies have been at least above average for insurance companies, even if they haven’t kept up with the huge moves in the broader market over the past few years.

And really, that historical performance and the growth in book value per share are usually pretty good indicators of both how well they’re underwriting and how well they’re investing that float — W.R. Berkley has usually been a little better than Markel at underwriting, for example, partly because they don’t write reinsurance and stick to commercial lines, but it doesn’t usually grow its book value as well as Markel has, because it’s not as aggressive an investor. Markel is unusual in investing a larger chunk of its float and retained earnings in stocks, and also buying non-insurance businesses with its own capital, retaining all the profit to let it compound instead of paying dividends. Most insurers are more conservative on that front, they might put 90% of their float in bonds and maybe invest little bits in hedge funds or commercial real estate, and many of them pay dividends instead of retaining all the capital for internal compounding like Markel (and Berkshire Hathaway) do.

What are the valuations like?  Any insurance stocks pop that we might not have seen before?

Well, the ones who have the highest returns on equity (which is earnings relative to shareholder equity value)… generally also trade at the highest multiple of book value. AFG’s ROE is most recently a blistering 20%, WRB and ACGL are in the 16-17% range… TRV is down at 12%, CB at 10%, and many of the ones that are historically more volatile, including Markel, are much lower right now (2% for MKL, 6% for AXS, negative for RNR). That does smooth out over time, usually (MKL’s exposure to the stock market means their ROE has been both negative and 25% in the past three years, the more “boring” investors like CB and WRB are usually more consistent).

And there are some outliers among other companies that have historically been seen as “hiqh quality” using this kind of measure — Assured Guaranty (AGO) has grown its book value per share by 260% in a decade and 45% in five years, beating most of those companies, and yet the return on equity has been on a steady decline and is now just 2.5% or so. The total return has been good, partly juiced by big share buybacks, but it’s also a different kind of insurance company, they provide mostly financial insurance — like managing collateralized loan obligations. I would guess that investors are a bit worried about what that business will look like if defaults will pick up, but I don’t really understand the books at AGO very well at this point, so that’s just a guess.

I’ll leave you with a chart that will let you some of these calculations if you like — this is the result of a screen I ran to estimate “trading at a discount to book value + float”, and I also included the five-year growth in book value and the latest return on equity measure. I sorted the stocks by five-year growth in book value, which is why Markel and W.R. Berkley show up pretty close to the top.

Some of these I’ve never looked at or heard of, but some familiar names do pop up. The one I don’t understand is Arch Capital (ACGL), which has had a rocket of a share price of late but still ought to have popped up in this screen, and didn’t — by that assessment of “float” and book value, it’s still trading at about a 10% discount and has grown book value dramatically, and has an average ROE of about 12%.

Markel also has a growing non-insurance business under their Markel Ventures wing, owning a variety of businesses and trying to become a junior Berkshire Hathaway, so that makes their balance sheet less clean, and less important when thinking about valuation (I went into a deeper dive on Markel’s earnings and valuation last month), but their “float + book value,” using my oversimplified calculation would mean that today it’s trading at only about a 12% discount.

W.R. Berkley, however, stands out for a high average ROE and high current ROE and at least some longer-term book value growth, as do White Mountains (WTM), Safety Insurance (SAFT) and Kemper (KMPR), which are pretty small… and among the big players, I like the long-term profitability of Chubb (CB) and Travelers (TRV) and their high average returns, though I’m a little more worried about the companies whose book value has shrunk more than 1-2% in the past five years, and I’d want to understand why — some of those no doubt have good reasons, including rising interest rates and their non-property & casualty insurance businesses, and some of the ones at the bottom are probably little runoff insurance operations (just holding policies or buying old policies from other firms, not writing new insurance), but I haven’t researched them all.

Don’t use that chart as gospel. This is NOT the way insurance companies would calculate their own float, for that you have to dig into the 10K and get into the reinsurance recoverables and ceding and deferred acquisition costs and other stuff, and for the conglomerates like Markel and Berkshire and Loews you’d have to do some work to distinguish the assets of the non-insurance subsidiaries from the whole, and it’s both an art and a pain in the neck. There is no GAAP float calculation, there is no standard, but I find that screen represented above does a decent job of indicating how companies are valued relative to the excess capital they have access to — even though, once we dig into some individual companies, we’ll find that the numbers will be pretty far off.

Likewise, the long term combined ratio is a key factor for these companies… the only reason float is valuable is that it’s free (or better), so companies that don’t consistently underwrite at a profit shouldn’t consider the float to be a particularly valuable “asset,” it’s more like a loan that costs them money. And the combined ratio is also not reported in a standardized way in financial databases.

Many companies do boast about their combined ratio, and almost all of them report it in their earnings calls and annual reports, if not their press releases, so we can pretty quickly learn, for example, that Markel has had one underwriting loss in the last decade, and three in the last 20 years, and their 10-year combined ratio averages out to 95. And we know that Chubb is even more impressive, with an average combined ratio over the past decade of 90, and that W.R. Berkley’s combined ratio over the past five years has been about 93%. That makes Chubb look more compelling as the share price dips this year, and their discount to their book value + float grows (I think my number in the chart underestimates float in the case of both Chubb and W.R.Berkley, the only ones I’ve looked at in more detail, their float is more like $75 billion and $16 billion, respectively, as I skim through their 10Ks). But each of those has to be researched individually.

If I had to make some wild guesses, I’d guess Porter’s top three picks this time are among W.R. Berkley (WRB), White Mountains (WTM), Chubb (CB), Travelers (TRV) and Hanover (THG).

That’s just a guess, based on the combination of growth, historical underwriting profitability and reputation (a judgement call on my part, for sure), and the book value/float valuation… plus a guess that Porter isn’t dipping down into the smaller players. Chubb, W.R. Berkley and Travelers, as relatively conservative investors, are probably going to benefit meaningfully from the rise in interest rates even though their investment income hasn’t been fantastic in recent years (most insurance companies will, though I don’t know as much about the others I mentioned).

If you don’t follow the industry much but would like to get some indication of which companies screen as “consistent quality” within property & casualty insurance, the Ward’s 50 List is a decent place to get some context — those are companies which routinely, on average, have higher ROE, lower combined ratio, and higher premium growth than the rest of the industry (and pass Ward’s proprietary screens for “safety and consistency”). Of the stocks I’ve mentioned so far today, CB, CINF, NDK, PGR, RLI, SAFT, TRV and WRB are on the latest Ward’s 50 list (and they call out RLI for being on the list for 32 years in a row). I don’t imagine NOT being on the list is necessarily a reason to throw a yellow caution flag, (I don’t think any of the Berkshire companies are currently on the list, for example), and haven’t seen the underlying data, but it’s still somewhat reassuring to see a company on the list.

So where does that leave us?

There are at least a dozen or so companies that are worth researching, if you want to put together a portfolio of insurance stocks as a long-term, relatively safe investment. I think it’s very important to assess the reliability and trustworthiness of management, and the consistency of their operations, and for me, reaching that level of comfort often takes time.

But I know I should be getting more diversified in this space, even though I’m also “overweight” insurance thanks to my large allocations to both Markel and Berkshire Hathaway, so I’ll start trying to move in that direction with small stakes in two of the companies that I routinely see as high quality and have watched for a long time, and which, when you incorporate the value of the float, are trading at reasonable discounts today in the ~30% range, and have persistently high profitability.

So I’ll add small positions (a little less than 0.75%) in both Chubb and W.R. Berkley to the Real Money Portfolio today, setting their “max buy” prices at about a 25% discount to what I think their current “float + book value” is today — so that would be a max buy for WRB of $66, and $231 for CB. I don’t know if I’ll ever get as comfortable with these companies as I am with Markel, but they are consistently great insurance companies, we can easily justify the valuation today and expect their earnings to begin to improve as their bond portfolios generate more income, and they’ll help me to widen my circle a bit.

The portfolio risk I’m sitting on now is that I’m substantially over-exposed to insurance… though all of my insurance companies operate in different ways, and have different risk exposures, so I’m not particularly worried, given the historical stability of these companies and the generally low-volatility nature of insurance. They’re not all going to be exposed in the same way to the next man-made or natural disasters, and they also all calculate those risks differently and choose to be exposed to different kinds of risks, and they have all generally been consistent at avoiding the “grow at any cost” temptation that has plagued some insurance companies who cut their pricing too low in an effort to grab market share. It’s a risk, but I’m less worried about being over-exposed to the property and casualty insurance sector than I would be with pretty much any other sector of the market.

As of today, the property & casualty insurance sector, if you include Berkshire Hathaway, is a little over 20% of my equity portfolio. Throw in the brokers and agencies, Brown & Brown (BRO) and Goosehead (GSHD), and you get to a little over 23%. There’s other insurance exposure, too, since Brookfield (BN) is getting more heavily into insurance and I’ve got a couple insurance companies in the Lock Box, and even companies like U-Haul (UHAL) have some small insurance operations… but that doesn’t rise to the level of being worrisome for me. I’ll let you know if my opinion changes.

The other insurance company I own today in meaningful size is Kinsale (KNSL), which is very much an outlier — they trade at a wild premium to their “book value + float,” rely almost not at all on investment income, and write coverage on the pretty extreme end of ‘specialty’ insurance and are dramatically more profitable and faster-growing than most insurers, with ~40%+ annual premium growth and a combined ratio last year of 78%, so in many ways that’s more like a technology stock, with high earnings growth, it just happens to be in the insurance business.   I went into much more detail on Kinsale three weeks ago, in case you missed that Friday File.

And Porter actually had a second teaser pitch built into his “documentary”, too, any interest in that one?

Here’s how he describes it…

“What’s the ‘investment opportunity engineered better than the insurance industry?’

He describes an “almost miraculous” origin story for this other asset, which is Bitcoin….

“… near-perfect attributes, and ‘divine’ origin, appearing from nowhere, with no one person as the founder.”

Is Bitcoin really a “divine cultural sacrament,” like gold as a currency, or the tradition of marriage? I’d call that a stretch, but you can form your own opinion there. Porter says…

“Bitcoin is a financial blessing, it has evolved to serve us, the safest and most reliable form of money ever created.

“Every two years, it gets about 100% more difficult and expensive to mine Bitcoin, and that rising cost of work underlies the value of Bitcoin. Similar to gold, which has naturally become more expensive to find and mine over time.

“Everyone should have bitcoin as part of their savings. Buying below the cost to mine is a sensible thing to do with your long-term savings. But it’s a long way from being a widely accepted financial asset. “

So if you’re nervous about Bitcoin, or maybe don’t think it’s as clearly “divine” as Porter does, how can you get exposure in a less risky way? Porter says this…

“Capture the upside potential of bitcoin, while minimizing the downside risk.

“If Bitcoin prices continue to rally, you’re looking at the potential for returns as high as 243%…

“And even if Bitcoin prices fall by half, you could still be looking at returns as high as 17%, without ever investing in Bitcoin directly.”

“Purchase a ‘Bitcoin Bond’ to reap a huge profit while strictly limiting your risk.”

I’m pretty sure that what Porter calls a “Bitcoin Bond” is “buy the convertible bonds of Microstrategy (MSTR), the publicly traded company that has been most aggressive about borrowing money to build up a big bitcoin stake. I think Michael Saylor at Microstrategy has been irresponsible in borrowing money to buy bitcoin, and in effectively betting the company on this cryptocurrency, but it certainly might work out… and there is some protection from another collapse in Bitcoin, since Microstrategy does also have a real business (whether their founder is paying attention to that business in recent years is an open question, but it’s still chugging along).

He made that recommendation back on October 14, this is a little excerpt from his free preview of that issue of The Big Secret on Wall Street:

“The bottom line: in a world where overly-indebted governments around the globe issue endless new supply of fiat currency to inflate away their obligations, more and more of those currency units will flow into alternative stores of value, like Bitcoin. And if the global investment community begins diversifying even a small portion of their wealth away from traditional investments into Bitcoin, there’s simply not enough supply to meet demand at today’s prices

“Given Bitcoin’s hard supply cap at 21 million coins, a scenario where trillions of dollars flow into the asset class, the conclusion is clear — much, much higher prices. As global central banks, including the Fed, return to their familiar playbook of cutting interest rates and expanding the money supply to deal with unsustainable global debt burdens, we see Bitcoin reaching new all-time highs and hitting $100,000… and that could be just the beginning of the next leg higher.

“With Bitcoin prices recently falling from a high of $65,000 to around $20,000 today, we believe now is the time to get ahead of this trend. But instead of simply buying Bitcoin, we’ve identified a unique investment vehicle that will offer exposure to higher prices, while also providing protection against a downside scenario where Bitcoin prices fall in half from here.

“There are a number of Bitcoin ETFs and funds that allow you to ‘buy Bitcoin’ via your brokerage account, but you are always faced with potential losses if the underlying takes a hit. The opportunity we’ve identified here is the only way to profit iff Bitcoin no matter whether it goes up or down.”

Well, you can certainly see that Microstrategy stock has become a pretty pure bet on bitcoin — this is the three year chart of MSTR (purple) vs. Bitcoin (blue) (and I threw the S&P 500 in there, in orange, just for some context). Looks pretty impressive.

Of course, you can make any chart look impressive — it all depends on where you start and stop. This is the same chart, but starting in early November of 2021, the most recent Bitcoin “peak”…

That’s just the stock price, though — the convertible bond is a different beast. What does that look like? Microstrategy has a couple different tranches of convertible bonds outstanding, but they’re fairly similar.

The first is maturing on December 15, 2025, and I can’t find a recent trade price for this note, which is a little odd. That’s CUSIP 594972AB7, and this convertible actually has a coupon, too — it’s only 0.75%, but that’s still something. Those have a conversion rate of 2.5126 MSTR shares per $1,000 in principal, so the most likely outcome is that your convertible note gets exchanged for 2.5126 shares of Microstrategy at maturity, in December of 2025. Right now, 2.5126 shares of MSTR would be worth about $829. If you can buy the note at par ($1,000), then that’s a reasonable levered bet on Microstrategy, and therefore on Bitcoin… if it’s less than $800, maybe it’s a bargain (they’re usually quoted per $100 of principal, even though the minimum trade is generally $1,000 of principal, so the quote might be $80 for an $800 purchase).

Porter could also be recommending the 0% convertibles that mature on February 15, 2027, at CUSIP 594972AE1. Depending on the price, those are more speculative but also give you more time for the price to rise. Those notes have a conversion rate of 0.6981, which means that each $1,000 principal becomes 0.6981 shares of MSTR at maturity (or can be converted during some windows before that). 0.6981 shares of MSTR would be worth about $232 right now, and $1,000 worth of principal in this bond would cost you about $640, per the last trade I saw recorded. So you would need the stock to rise quite a bit before that becomes profitable. It was meaningfully cheaper back when Porter first recommended the bonds, those 2027 convertibles were around $400 at the time… though MSTR shares were lower, too, so the convertible value of the bonds back then was about $145.

So we’ll leave that dangling out there as a decent guess, though I can’t say I’m particularly interested in either of these “Bitcoin Bonds” — they’re not liquid, and they might be a little tough to find, depending on how good your broker is at locating corporate bonds for you on the secondary market. I don’t dabble in this area much, so you’re on your own — if any of you get into trading these kinds of convertible notes, or have an opinion on Microstrategy or Bitcoin, do let us know with a comment below.

Disclosure: Of the stocks mentioned above, I own shares of Amazon, Berkshire Hathaway, Brookfield Corp., Chubb, Markel, W.R. Berkley, Kinsale, U-Haul, Goosehead Insurance, and Brown & Brown, and I own some Bitcoin. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.