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WTM is slowly selling off its insurance businesses. The insurance industry is not what it once was. The WTM management team is one of the few who are awake to the risks. The CEO of White Mountains Insurance Group (NYSE: WTM ), Ray Barrette, has voiced concerns about the insurance industry and the general economic environment in his management reports over the last several years. Barrette’s comments are often times indirect by referring to the insurance market as highly competitive. Other times his statements are blatant, claiming that low interest rates and highly competitive insurance pricing do not offer insurance companies an adequate return for their risk exposure. He has voiced concerns with government debt, inflation and rising interest rates, which of course could bankrupt an insurance company if these scenarios happened sharply and unexpectedly. The investment management of WTM coincides with Barrette’s viewpoint. WTM has kept its bond portfolio very short term, far more conservative than the industry average. Large cash holdings are always on the books. WTM has also favored insurance lines that are short tail, as long tail lines can take many years for the claims to settle and are exposed to inflation risks. In my opinion, WTM is one of the most conservative and cautious insurance holding companies operating in the insurance space. There are other cautious holding companies, such as Fairfax Financial Holdings (OTCPK: FRFHF ) and Alleghany Corporation (NYSE: Y ), but WTM has them beat in its paranoia. Not only does WTM have shorter term bonds than these other companies, but WTM has been selling its insurance companies off whereas other insurance holding companies have been buying them and trying to consolidate. On July 27th WTM announced its sale of Sirius Group for 127% of its book value in cash. I found this surprising, as this company accounted for nearly half of WTM’s consolidated premiums and was by far its most profitable underwriter, having combined ratios in the 70-80% range. Selling a core asset such as this implies a bleak outlook for the insurance industry. The sale of Sirius Group is not the whole story. WTM is also selling its portion of Symetra Financial Corporation (NYSE: SYA ), of which it owned 17% of the outstanding shares alongside other partners such as Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ). After selling Sirius Group and Symetra Financial, only one of its three major insurance companies are still on WTM’s books, and that is OneBeacon Insurance Group (NYSE: OB ). WTM also has several other insurance holdings such as HG Global/BAM, but they’re small compared to what has been sold off. I believe these actions taken by WTM are very wise. The insurance industry has come under a lot of pressure in recent years. The macro environment has interest rates near zero percent interest. In normal times during the last several decades, low interest rates would push insurance companies to charge higher premiums to balance lower investment returns. However, the current state of the world comes with pathetically low rates, high debt both public and private, and irresponsible governments that simply will not operate within a balanced budget. Low interest rates and overpriced bond and stock markets are forcing other investment managers to seek returns elsewhere by invading the insurance space. Because of the new entrants, existing insurance companies cannot raise their prices during low interest rate environments. This is squeezing the profit margins out of the industry in an unprecedented manner. Warren Buffett has recently commented on the poor state of the insurance industry. Buffett stated that insurance has become “fashionable” for investment managers. I can understand his frustration, but I don’t think fashionable is the right explanation. Other investment managers are going into insurance because there are few other places to go with their money. The investment environment is dismal right now, and additional profits from insurance float are seen as a relatively safe way to enhance returns with few other options. WTM is cashing out of the insurance business, and at a premium to book value. This is truly contrarian when the rest of the insurance industry is trying to consolidate through mergers and acquisitions to become more competitive in a crowded industry. WTM is playing it smarter. WTM is accumulating large cash holdings and investing in startup companies, mostly services, that require minimal capital upfront. WTM’s portfolio is slowly being transitioned into a barbell, with a highly defensive cash component, and a small but highly aggressive component composed of start up companies. A barbell such as WTM’s is the best way to play the current macro environment, in my opinion. If deflation sets in, their large cash position will rise in purchasing power and provide many opportunities in an ensuing market correction. If inflation sets in, WTM’s cash will devalue to some extent but at least their insurance exposure will be reduced. Insurance companies could drop substantially in value under a scenario of high inflation and/or rapid interest rate increases. WTM is a very well managed company. I have been a fan for many years. However, I do not own shares of WTM right now because I perceive them to be fairly valued. The premium over book value that WTM is receiving in its sales of Sirius and Symetra is already reflected in the current share price. The share price has risen substantially since the sales have been announced at the end of July. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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