W. R. Berkley Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless otherwise noted. W. R. Berkley is a commercial property-and-casualty insurance holding company operating in Specialty, Regional, Alternative Markets, Reinsurance and International segments.
Key financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net premiums written | $1.276bn | $1.126bn | $3.670bn | $3.267bn |
| Net premiums earned | $1.187bn | $1.056bn | $3.434bn | $3.056bn |
| Total revenues | $1.421bn | $1.280bn | $4.215bn | $3.785bn |
| Net income to common stockholders | $101m | $76m | $345m | $274m |
| Diluted EPS | $0.71 | $0.53 | $2.41 | $1.87 |
| Net investment income | $116m | $114m | $435m | $409m |
| GAAP combined ratio | 95.8% | 99.3% | 96.8% | 99.0% |
Combined ratios below 100% indicate underwriting profit. For the nine months, the loss ratio was 62.5% and the expense ratio was 34.3%. Consolidated net income growth reflected higher after-tax underwriting income, investment income and investment gains; diluted weighted-average shares also declined following repurchases.
Financial position, cash flow and liquidity
- At September 30, 2012, total assets were $19.93bn, total investments $14.29bn, cash and cash equivalents $1.19bn, and total equity $4.33bn. At December 31, 2011, the respective figures were $18.40bn, $13.44bn, $912m and $3.96bn.
- For the nine months, operating cash flow was $453m, down from $485m, primarily because income taxes paid increased. Investing activities used $413m; financing activities provided $243m. Cash increased $278m to $1.19bn.
- Senior notes and other debt were $1.88bn and junior subordinated debentures were $243m, for total carrying debt of about $2.12bn. Debt’s share of total capitalization rose to 33% from 31% at year-end 2011. The company issued $350m of 4.625% senior notes in March 2012; higher debt contributed to increased interest expense.
- Management reported that about 85% of the investment portfolio was in cash, cash equivalents and marketable fixed maturities. The fixed-maturity portfolio’s average duration was 3.3 years, versus 3.6 years at year-end. The company said it targets alignment of asset and liability duration and expects insurance subsidiaries’ cash flows and investments to fund claims and other obligations.
- Common stockholders’ equity was $4.3bn, or $31.81 per outstanding share. The company repurchased shares during the quarter; its authorization was increased to 10 million shares in August.
Material changes and operating drivers
- Nine-month gross premiums written grew 13% to $4.33bn; net premiums written grew 12%. Growth was strongest in International and Specialty, supported by rate increases, exposure growth and expansion into new markets. Average renewal rates increased about 6.4% for the nine months and about 7% in Q3; renewal retention was approximately 78%.
- Nine-month combined ratio improved to 96.8% from 99.0%. Catastrophe losses fell to $39m from $139m, while favorable prior-year reserve development decreased to $83m from $142m. Excluding catastrophe losses and prior-year development, the loss ratio improved modestly, to 63.8% from 64.4%.
- Segment results were mixed: nine-month combined ratios improved in Regional (97.3% from 107.7%), Reinsurance (98.6% from 101.6%) and International (98.7% from 101.5%); Specialty worsened to 94.6% from 90.7%, and Alternative Markets was 98.2% versus 98.7%.
- Nine-month net investment income rose 6%, chiefly due to higher investment-fund income. Fixed-maturity annualized yield declined to 3.8% from 4.0% amid lower reinvestment yields. Investment-fund income is more volatile and reported on a one-quarter lag.
- Net investment gains were $94m for the nine months, compared with $73m. The 2012 figure included a $9m net benefit from changes in valuation allowances, net of other-than-temporary impairments. Q3 net investment gains were $22m, compared with $21m.
- Loss reserves increased: gross reserves were $9.56bn versus $9.34bn at year-end; net reserves were $8.32bn versus $8.17bn. The company reported a net discount of $864m on excess and assumed workers’ compensation reserves.
Outlook, commentary and risks
- Management said pricing increases accelerated in the first nine months of 2012, but loss costs were also rising and prices in some lines remained below levels needed to meet the company’s return objectives. Recent premium increases are expected to flow into earned premiums over future periods. No specific earnings or revenue guidance was provided.
- Management identified reserve estimation as inherently uncertain, particularly for long-tail and assumed reinsurance business, where claims emerge slowly and estimates depend partly on information from ceding companies. A 1% change in both frequency and severity for 2011 claims was estimated to affect losses by $56m; larger combined changes could have substantially greater effects.
- Other stated risks include catastrophe losses, pricing and competition, claims inflation and legal developments, investment and credit risk, interest-rate and currency movements, reinsurance availability and collectability, regulatory changes, and access to capital. The company stated that risk factors had not materially changed from its 2011 Form 10-K.
- Ordinary-course insurance and reinsurance litigation and arbitration are reflected in reserves. Management did not expect the ultimate outcomes to materially adversely affect financial condition or results, while acknowledging adverse outcomes remain possible.
- Deferred acquisition cost accounting guidance adopted in 2012 was applied retrospectively and reduced stockholders’ equity by $55m as of January 1, 2012. The filing states that other recently adopted presentation guidance did not affect results, financial position or liquidity.
Important facts for investors to verify
- Whether premium growth and renewal-rate increases are keeping pace with loss-cost inflation and supporting adequate pricing.
- How much underwriting performance depends on lower catastrophe losses and favorable prior-year reserve development, and whether reserve assumptions remain adequate.
- Whether lower fixed-income reinvestment yields and volatile investment-fund results affect future investment income.
- Debt maturities, the effect of the 2012 note issuance on leverage and interest expense, and the capacity of insurance subsidiaries to remit dividends to the holding company.
- Credit quality and valuation of commercial real-estate loans, investment funds and securities with unrealized losses; the filing reports $31m of loans in non-accrual status.