INSURANCE

Markel CEO Alan Kirshner: Insuring unusual risks is no summer camp.

Hopkins is executive director of the Jewish Community Center of Richmond, which runs a popular Goochland County summer camp. In addition to making sure little Sara has fun, he's got to send her back intact, both physically and emotionally. That, he says, is a full-time job.

"Every [summer camp] activity carries with it the opportunity for injury," he says.

So inevitably, despite the camp's high-quality staff and well-planned procedures, a few campers are bumped or bruised each year.Which leads us to the real prerequisite for a successful summer camp: liability insurance.

Without a buffer between entrepreneur and trial lawyer, summer camps couldn't exist. Nor could martial arts studios, day-care centers or motorcycle clubs. In fact, much of the diversity that Americans take for granted wouldn't exist without some way of handing risks off to a willing third party.

But how, in a litigious society like ours, do you insure such things? Very profitably, if you're Markel Corp. For the past decade, the Richmond-based "specialty" insurance company has done extraordinarily well by going where other insurance companies fear to tread, picking up precisely the kinds of risks that the competition either doesn't understand or can't stomach.

Specialization, however, is a recent chapter in a long story. Markel traces its lineage to the insurance brokerage business set up by Sam Markel in the 1930s and subsequently run by his two sets of twin sons. By the early 1980s another generation was in charge, and Markel had added a small claims-processing operation and a tiny insurance underwriting business. But it remained unfocused, and, by the standards of the business, small potatoes. Insiders were aware of the drift, says CEO Alan Kirshner, a Markel-by-marriage who now runs the firm in concert with co-chairmen Tony and Steve Markel. "I've been with the company 37 years, Tony about 30 and Steve 23. Once Steve joined us, we started searching for that thing that was right for our company. It just took us a while to figure out what that was." Kirshner and the two Markels looked at their strengths. "[We] found that in Steve we had investment expertise, and in Tony strength in underwriting." In other words, they had the nucleus of a pure insurance company. So beginning in the mid-'80s, they jettisoned everything not directly related to writing insurance and adopted a radical strategy: Tony's underwriting division would seek out a wide variety of "non-standard" risks like race horses and karate studios - things that couldn't simply be priced by looking at some existing actuarial table. He would choose his clients wisely and charge enough to generate the Holy Grail of insurance - an underwriting profit. The investment side, run by Steve, would eschew the usual bond-heavy, cautious approach of the industry and buy stocks. Lots of them.

The result? Pure gold. Since 1991, Markel's book value has risen about 30 percent a year, and its earnings have nearly tripled, despite the fact that its work force has actually fallen slightly to 819. Its stock, meanwhile, is up over 1,000 percent, giving it a profile more like Microsoft than Prudential.

The problem with success, like a Tiger Woods tee shot, is that it makes a complex thing look far too easy. All insurance companies want underwriting profits and double-digit investment returns, but few achieve even one, let alone both.

To see how Markel does it, let's revisit summer camps. The list of exposures camps face is both long and scary: The bus on the way there and back is a serious risk. Then come the obvious drowning, poisoning, and falls from horses, ropes and rocks. Next there's abuse by counselors and the fact that camps are in rural areas with frame dwellings that lack fire protection. And because camps have in-firmaries, medical malpractice is an issue.

Calculating the likelihood and cost of each risk and setting a price that works for both camp and insurer is more akin to particle physics than actuarial tables. But it's precisely this difficulty that scares away the competition, making prices high enough for Markel to turn its required underwriting profit.

Markel also tries to lower the number of claims generated by its camp clients by helping them do a better job. One Markel employee, for instance, "does nothing but travel from camp to camp and do inspections all summer," Kirshner says.

Markel periodically stages, and invites its clients to witness, mock trials in which a camp is accused of things like sexual misconduct or negligence. The trials expose deficiencies in the hapless camp's procedures and end with a massive verdict for the plaintiff. Having gotten camp owners' attention, Markel's camp expert, Ed Schirick, then goes on to outline procedures that would have prevented the problem, or at least upped the odds of prevailing in court.

Camp directors like this hands-on ap-proach so much that despite its relatively high prices, Markel dominates the field.

But a focus on underwriting profit is a double-edged sword. Just as it pulls Markel into some lines, it forces the insurer out of others.

Here, Markel's diversity is its strength. "If we have 40 different products, we can be more cavalier when prices go below what's reasonable," Tony says. "We'll fight for market share, but we'll let it go if it becomes unprofitable."

A case in point: In the early 1990s Markel had a $25 million line covering architects and engineers. But as the field became more competitive, Markel refused to slash its prices and simply allowed the business to dribble away. It now does less than $2 million in that line.

This willingness to dump unprofitable lines creates a never-ending need for new markets. Not a problem, Tony says. The world is generating new insurance niches constantly, and his people are open to the smallest and most obscure.

For example, Markel is talking with a national association that represents family entertainment centers - everything from batting cages, kiddy rides and bumper cars to water slides and laser tag. It's a promising market, but one whose complexity dwarfs that of summer camps. "No two risks look alike, because this guy might have batting cages and video games and another guy might have laser tag and bumper cars," Tony says. In other words, it's perfect.

If Markel gets the association's endorsement, it will spend two or three months surveying the membership, collecting loss data and meeting with product manufacturers to determine where the exposures are. The result will be a preliminary take on the relationship of rates on, say, batting cages versus water slides versus laser tag. Then policies will be written and results tabulated, and the data updated. "Clearly it will need to be massaged, 'cause it's not gonna be right the first time," says Tony. "Our objective is to reward the better risks and charge adequate premiums for higher exposure."

What most people don't get about insurance is that underwriting is not where the money is made. Instead, think of policy premiums as the raw material that the investment experts use to manufacture cash.

By generating an underwriting profit, Markel essentially supplies its investment arm with capital for free. And the investment arm, led by Steve Markel, has done extraordinary things. By loading up on equities - a risky strategy that most insurance companies avoid - Markel has generated rates of return in the 20 percent range, more than twice what the average bond-laden insurance company portfolio achieves.

That provides Markel with massive annual increases in book value and all the internally generated capital it needs to expand its underwriting.

Markel's combination of conservative underwriting and aggressive investing has earned it some fans in the financial community. The A.M. Best insurance-rating agency ranks five of the company's six divisions A- or better, and the sixth is a still pretty good B++.

Scott & Stringfellow analyst Neal Kaplan, who's had a buy rating on Markel's stock since 1991, is looking for more of the same. "The story is intact. ... There are all sorts of new risks out there" for Markel to insure, more than enough to keep it growing.

And while Kaplan acknowledges that a big equity portfolio makes Markel's investment returns more volatile, "over the long run, stocks will outperform bonds." As long as Markel stays focused on underwriting profits, he says, it will continue to do well.

Meanwhile, this virtuous cycle - underwriting profits generating free money, which then generates big capital gains - is rapidly changing Markel's profile from an insurance company to an investment firm. Its investment portfolio, at more than $1.1 billion, is about twice the size of its annual gross premiums.

In fact, Markel is starting to attract comparisons to legendary investor Warren Buffett's Berkshire Hathaway - a sleepy little textile company that he turned into one of the world's great investment firms. The company, however, has a ways to go before the investment side becomes its defining characteristic, and if Markel does eventually become an investment company, Alan Kirshner is OK with it. "Tony and I are old-style touch-and-feel merchants. If we're just a conduit to feed an extraordinary investment operation, we'll still get our jollies playing in insurance."