Like Berkshire Hathaway Inc. (NYSE:BRK.B), Markel Corporation (NYSE:MKL) capitalizes its financial strength and the float provided by its insurance operations to invest in high-quality companies and generate superior returns on its capital.
The insurance business is crucial for Berkshire Hathaway Inc. (NYSE:BRK.B), not only in terms of the profits it produces but, perhaps more importantly, as a source of low cost — or even free — money for the company to invest in all kind of businesses. In 2012, for example, Berkshire’s insurance segment delivered $1.6 billion in underwriting gains while at the same time giving Buffett $73 billion of free money to invest.
From Buffett’s 2004 letter to shareholders:
Float is wonderful — if it doesn’t come at a high price. Its cost is determined by underwriting results, meaning how the expenses and losses we will ultimately pay compare with the premiums we have received. When an underwriting profit is achieved — as has been the case at Berkshire in about half of the 38 years we have been in the insurance business — float is better than free. In such years, we are actually paid for holding other people’s money.
In a similar fashion, Markel Corporation (NYSE:MKL) invests its low-cost capital in a wide variety of high-quality businesses, both via the stock market and through private ownership of 13 companies in sectors like industrials, health care, and financial services, among others.
Markel has recently acquired reinsurance company Alterra for $3.1 billion, this is a big deal for a company like Markel and a considerable risk to watch. On the other hand, Alterra could play for Markel a similar role to the one General Reinsurance plays for Berkshire, diversifying risks and allowing for more flexibility in the investment portfolio.
Based on the proforma combined financial statements of Markel Corporation (NYSE:MKL) and Alterra, the company is trading at a moderate valuation with a price to book value ratio in the area of 1.15. This is a reasonable price tag for such a high-quality insurance company with plenty of opportunities to continue growing at a nice rate over years to come.
Bottom line
The insurance business is notoriously tough, but that doesn’t mean investors should stay away from the sector. On the contrary, buying well-run insurers at attractive valuations can be a very profitable approach to the sector, and companies like American International Group Inc (NYSE:AIG), AFLAC Incorporated (NYSE:AFL), and Markel are well positioned to outperform the market over the next few years.
The article 3 Insurance Companies Poised to Outperform originally appeared on Fool.com and is written by Andrés Cardenal.
Andrés Cardenal owns shares of AIG, Markel and Berkshire Hathaway. The Motley Fool recommends Aflac, American International Group, Berkshire Hathaway, and Markel. The Motley Fool owns shares of American International Group, Berkshire Hathaway, and Markel and has the following options: long January 2014 $25 calls on American International Group.
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