The Best Defense at ProAssurance?

Since its IPO in 1991, ProAssurance (PRA) has identified itself as a "reputation defender" for doctors, trying lawsuits where other medical malpractice companies would typically settle. In 2005, PRA settled about 10% of its cases, whereas the industry norm had been around 20%. This approach has been rewarding. In 2005, PRA delivered a loss ratio of 81.5% in an industry that rarely breaks a ratio of 100%. (For the insurance illiterate, less than 100% is profitable while more than 100% is money-losing.) More telling, PRA spends 70% of its expenses on legal fees and only 30% on loss payments whereas the industry standard is exactly the opposite - about 30% on legal fees and 70% on loss payments. But all that may start changing.

On October 4, 2006, a Florida jury tagged a group of physicians insured by a subsidiary of PRA for $217 million. ($100 million is punitive.) This monster verdict came as a result of poor care that may have allowed a stroke to become severely debilitating. Rather than having doctors attend to the patient, the doctor group allowed an unlicensed physician assistant (PA) to diagnose and treat sinusitus. This PA was unlicensed because he had failed the exam four times. That's the case against the doctors.

In theory, PRA should only be liable to the policy limits of $1 million. However, the plaintiff's attorney claimed that they tried to settle with the insurance company for the policy limits, but were rebuffed by a settlement offer of $300 - $100 for the disabled man, $100 for his wife and $100 for the 10 year-old son. If that is true, PRA may be liable for the entire amount for negotiating in "bad faith." In such a situation, PRA would also be sued by the doctors it had defended. It appears that PRA will have a chance to defend a new reputation - its own.

The General at Mercury General (MCY)

Mercury General Corporation (MCY) is a wonderful example of "making a stepping stone out of a stumbling block." Rather than view the independent agent as excess cost in the Internet age, MCY puts the independent agents to work as part of the underwriting team. The result: lower total cost ratios (MCY 58% vs. ALL 70%) with higher independent agent commissions (16% MCY vs. 8% PGR).

The founder and long term leader (since 1961) of the company is George Joseph. He and his former wife control 52% of the company's stock. During the same period it took for my parents to get me to age 45, George and his former wife built a net worth well over $1.5 billion. (I guess I should be mindful of how much I might have cost my parents!)

But, now, at age 85, Mr. Joseph is passing the CEO job to Gabriel Tirador. When he was asked about his retirement on the third quarter earnings call, he emphatically stated, "I am not retiring! I am only passing part of my responsibilities on to Gabriel." It is encouraging when I think about already being 45 to realize that my last two posts focus on businessmen who are active in their late eighties.

MCY continues to face the challenge of expanding its model successfully outside California. Premiums had accelerated outside of California as planned. However, expense and loss ratios were higher than expected. As a result, MCY has been more restrictive about its underwriting outside of California, leading to a drop off in premium growth. Clearly, these are appropriate steps to take - few mistakes are more painful than creating a book of mispriced insurance. Mr. Buffett compared its creation to Hell - easy to enter, hard to exit. It appears that Mr. Joseph's leadership continues to keep shareholders from going to Hell, so to speak.

Kerkorian and GM (Greedy Management)

Today's WSJ announced that Kirk Kerkorian had sold the rest of his shares, completely closing out his 9.9% position of 56 million shares with a value of about $1.6 billion.

In an earlier post (1/25/06), I described Kerkorian's long history of successful, but unusual investments. I also described how difficult it was to replicate his decisions because they were made, in part, by his ability to directly affect the outcome.

True to form, Kerkorian studied the situation, purchased shares, got Jerome York to propose solutions and set about accomplishing them. Management seemed to listen, for a brief period. But when it really came to making changes, like cutting inefficient projects, such as Saab or Hummer, management balked. The more dramatic proposal of creating a global alliance with Nissan-Renault was rejected under the reasoning that GM was not getting enough. I believe that the real likelihood was that the management getting enough.

Rather than fight it out, Kerkorian was slightly above breakeven and simply sold his shares. I think GM has lost its best asset. When Wagoner was asked about the move, he replied that management was focused on eventually posting positive cash flow and earnings, saying "that's what shareholders, all of them, really care about." It makes me wonder who bought Kerkorian's shares so as to become one of those caring shareholders?

Marshing Onward

Marsh McLennan (MMC) has endured two long ordeals and appears to be surviving both of them. First, an after-hours trading scandal and inferior investment performance combined to cause MMC's investment arm, Putnam Investments, to decline more than $200 billion in assets, starting 2000 with more than $390 billion under management and finishing 2005 with less than $190 billion. Second, Eliot Spitzer accused MMC of unethical practices, forcing new commission structures in its insurance brokerage division. As a result, MMC saw its brokerage margins move from 30% to less than 10%.

With these ordeals basically behind MMC, what lies ahead? Putnam Investments is still sizeable with $190 billion under management, arguably valued at nearly $6 billion by applying the multiples accorded other public traded mutual funds. This translates to about $11 per share, assuming the bleeding continues to be stanched.

The brokerage division is still powerful, sharing the title of largest in the world with AON. With the loss of contingent commissions, MMC's brokerage appears to be at reduced 14% operating margins, still giving an operating income of about $800 million. By applying a multiple of 10 times operating income, the brokerage area is arguably worth about $8 billion or $15 per share.

The two remaining divisions have been unhampered by controversy. The Mercer consulting division has been growing and should contribute about $500 million of operating income. Again, by applying a multiple of 10 times operating income, Mercer may be worth about $9 per share. The Kroll risk management division has done well and is probably worth another $4 per share, bring the entire value of MMC to about $39 per share, significantly higher than the current $31 per share. However, the long term debt level has risen and when subtracted, the intrinsic value seems close to current market levels.

Wells Fargo: Wild At Heart

In reviewing the 2005 annual report of Wells Fargo (WFC), some surprising facts emerge. While WFC is the only bank in the U.S. rated Triple A by Moody's, risk-taking behaviors do lurk under the surface. The first surprise was that WFC made more money as a venture capitalist last year ($500 million) than it did through its 1200+ stores in consumer finance ($400 million). The second surprise was that junior lien mortgages stood at nearly $60 billion or 20% of the loan book. This seems a departure from Triple A behavior. It will be interesting to see how these perform over this tightening cycle.

Coastal Insurance

An article in the NYT today describes the rising cost of insurance for homeowners on the coast. Insurance premiums are rising between 100 and 1000% for homeowners, depending on the materials used in construction and whether the home is single-family or condominium.

Such high premiums are required. Despite the appearance of gouging, insurance companies are aware that historical loss models have not protected them. Coastal insurance premiums have been dramatically underpriced, given recent experience. This may finally bring people back to the reason that coasts were not populated in the first place - no one wanted the high risk of loss. Thus, the coasts were populated with disposable structures by people who could afford to lose them. Mortgages were rare on the coast.

Of course there is a wild card. The Federal Government may just tax the rest of the country to cover the risks taken by coastal dwellers. Already, flood insurance is subsidized by those who don't use it. FEMA has flood policies that are much cheaper than what private insurance would charge. A fair approach is for the government to move these risks and their management to the private sector so that coastal dwellers bear the true costs of ownership. However, the article suggests that perhaps costs may move the other way - all coastal insurance may be transferred to the government.

Small Cap "Sure" Seems High

Signs of factors driving up the valuation of smaller companies continue to appear. The WSJ announced that a private equity company named Innovative Brands LLC is expected to purchase the deodorant Sure from Proctor and Gamble (PG) for $100 million.

As stated in an earlier post, I am seeing large companies and private equity concerns bid up the prices of smaller companies. The result has been a dramatic premium for lower quality companies over their larger and more powerful competitors.

The sales of Sure last year, ex-Wal-Mart, were $35 million. Assuming about a 12% number for Wal-Mart, I estimate the total sales were $40 million, putting the total sales price at 2.5 times sales. This is roughly the same multiple that PG is selling at. Given the dramatically superior characteristics of PG as a company to the single product line of Sure, it would seem that either PG is cheap or Sure is too high. Or both.