Warren Buffett’s success with Berkshire Hathaway Inc. (NYSE:BRK.B) has inspired countless investors to emulate the insurance and private equity model. Former Buffett lieutenant David Sokol left Berkshire to build his own mini-Berkshire, while David Einhorn started his own insurance business just a few years ago.
However, the only copycat to come anywhere close to matching Buffett’s success is Tom Gayner’s Markel Corporation (NYSE:MKL). Markel has compounded book value per share at a 20% annualized rate since its 1986 initial public offering — a feat only a handful of other companies can boast.
Moreover, Markel Corporation (NYSE:MKL) has only recently begun to acquire non-insurance businesses. As the company becomes more and more like Berkshire, expect shareholder returns to rapidly increase.
Not just any insurer
Most insurance businesses lose money underwriting policies and make up for it by investing the float. It is extremely difficult to make money underwriting insurance because policies are differentiated based on price.
Markel Corporation (NYSE:MKL) gets around the heavy competition by focusing on specialty insurance — insurance that requires highly specialized knowledge to gauge the risk associated with each policy. It turns out that not many actuaries can do the job, but Markel seems to have a monopoly on actuarial talent.
Markel Corporation (NYSE:MKL) has averaged a 96% combined ratio since its IPO — meaning that, on average, Markel earns a profit on policies it underwrites. Few other insurance operations are profitable underwriters, and those that are tend to be special cases.
For instance, The Progressive Corporation (NYSE:PGR) has a history of sub-100% combined ratios. The Progressive Corporation (NYSE:PGR) is a plain-vanilla P&C insurer, but it is extremely good at segmenting risks. That is, its actuaries are better than most at determining which customers are riskier and which are less risky. This allows it to offer lower prices to less risky customers.
The Progressive Corporation (NYSE:PGR)’s direct-to-consumer model, instead of relying on agents to sell policies, is also a key part of its success. Only GEICO has made a similar commitment to marketing directly to customers. Both of these companies figured out the same thing that Markel Corporation (NYSE:MKL) did — that you have to be special if you want to earn outsized profits.