W. R. Berkley Corporation — Q2 2013 Form 10-Q
Business context and reporting period. W. R. Berkley is a commercial property-and-casualty insurance holding company operating through Insurance-Domestic, Insurance-International, and Reinsurance-Global. This filing covers the quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods unless noted. The segment presentation was reorganized in Q1 2013, with prior-period segment data recast.
Financial performance
- Quarter: Net premiums written rose 13% to $1.342 billion; net premiums earned increased 12% to $1.283 billion; total revenue increased 11% to $1.571 billion. Net income attributable to common stockholders was $116.0 million, up from $108.8 million, and diluted EPS was $0.82 versus $0.76.
- First six months: Net premiums written rose 14% to $2.719 billion; net premiums earned increased 12% to $2.515 billion; total revenue increased 10% to $3.078 billion. Common-stockholder net income declined to $232.6 million from $244.2 million, and diluted EPS declined to $1.65 from $1.70.
- Underwriting: The consolidated combined ratio improved to 96.6% for Q2 from 98.2%, and to 95.6% for the first half from 97.4%. Ratios below 100% indicate underwriting profit before investment income. For the first half, the loss ratio improved to 61.6% from 62.8% and the expense ratio to 34.0% from 34.6%.
- Investment income and gains: Net investment income fell 11% to $143.7 million in Q2 and 12% to $279.7 million for the first half. Management attributed the decline mainly to lower fixed-income interest income and weaker energy and real estate fund income. Net investment gains were $33.1 million for Q2, versus $24.3 million; first-half gains were $53.0 million, versus $67.8 million.
- Cash flow: First-half operating cash flow was $313.9 million, nearly unchanged from $312.4 million. Investing activities used $371.7 million and financing activities used $150.7 million. Cash and cash equivalents declined $246.8 million from year-end to $658.8 million.
- Balance sheet and liquidity: At June 30, total assets were $20.212 billion, total investments $14.558 billion, and total equity $4.266 billion. Common stockholders’ equity was $4.239 billion, or $31.33 per outstanding share. The company reported that approximately 81% of its investment portfolio was in cash, cash equivalents, and marketable fixed-maturity securities; fixed-maturity portfolio duration was 3.3 years.
- Debt: Senior notes, junior subordinated debentures, and other debt had a carrying value of $2.036 billion and face amount of $2.058 billion. Debt and junior subordinated debentures represented 32% of total capitalization, compared with 33% at year-end. In May, the company issued $350 million of 5.625% subordinated debentures due 2053 and prepaid $250 million of 6.750% subordinated debentures due 2045; it also repaid $200 million of senior notes at maturity in February.
Material changes and notable items
- Premium growth reflected rate increases and increased exposures, including expansion into new markets. Average renewal rates increased 6.5% in Q2 and 7.2% for the first half; renewal retention fell to 74.9% for the quarter and 75.2% for the half-year, from 76.7% and 77.3%, respectively. Management said cumulative average rates had risen 18% since 2010, but pricing in some lines remained below levels needed for its long-term return objectives.
- First-half favorable prior-year reserve development was $42.0 million, down from $54.8 million. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $39 million for the half versus $31 million. Management reported a $2.2-point improvement in the first-half loss ratio excluding catastrophe losses and prior-year development.
- Lower investment income and investment gains were the principal factors behind the first-half decrease in net income, partly offset by higher after-tax underwriting income. Management noted that fixed-income reinvestment yields were low and expected portfolio investment income to decline further if rates remained at those levels.
- In January 2013, Berkley acquired the remaining 51% of an aviation-related equipment and services business for $43 million, following its 49% acquisition in 2012. The acquisition contributed to higher revenues and expenses from wholly owned investees.
- Other comprehensive income was a loss of $218.4 million in Q2 and $255.4 million for the first half, primarily reflecting unrealized investment losses and currency translation adjustments. Accumulated other comprehensive income fell to $210.2 million from $465.6 million at year-end. Gross unrealized losses on securities were $79.1 million at June 30, versus $35.0 million at year-end; management characterized the losses as primarily temporary and reported no securities considered other-than-temporarily impaired.
- The company reported that a federal savings association it indirectly owned sold substantially all its assets in April, after which Berkley deregistered as a savings and loan holding company.
Outlook, risks, and contingencies
- No specific earnings or revenue guidance was provided. Management expected recent rate increases to flow into earned premiums over subsequent quarters and said the expense ratio could improve further if pricing increases continued. It cautioned that investment income could fall if low interest rates persisted.
- Key risks include competitive insurance pricing, rising loss costs, catastrophe exposure, long-tail claims and reserve-estimation uncertainty, reinsurance recoverability, investment and interest-rate risks, credit and market volatility, foreign-currency risks, and the success of acquisitions and new ventures. Management emphasized that actual reserve outcomes may differ from estimates, particularly for long-tail and assumed reinsurance claims.
- Net loss reserves were $8.537 billion; the company disclosed that a 1% change in both claim frequency and severity could change its estimate for 2012 claims by approximately $60.3 million. Legal disputes and arbitration arose in the ordinary course of business; management did not expect their ultimate outcome to materially adversely affect financial condition or results.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether premium-rate increases continue to exceed loss-cost inflation, particularly in lines management said remained underpriced relative to its return objectives.
- Whether reserve development remains favorable and whether reported reserve estimates adequately reflect long-tail and assumed-reinsurance exposures.
- Whether lower fixed-income yields and investment-fund volatility continue to pressure investment income; monitor portfolio marks and accumulated other comprehensive income.
- Whether cash generation, claims payments, and the debt maturity schedule remain manageable as cash balances decline and development projects require additional funding.
- How the aviation-related acquisition performs, including its contribution to earnings after its added revenue and operating costs.