Business context and reporting period
Markel Corporation (now identified in the request as Markel Group Inc.) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. The business combines specialty insurance and reinsurance with Markel Ventures’ industrial and service businesses. Comparisons below are with the corresponding 2014 periods unless stated otherwise.
Financial and operating performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total operating revenues | $1,304.6 million | $1,259.0 million | $2,606.8 million | $2,498.6 million |
| Operating income | $129.6 million | $84.1 million | $398.4 million | $229.8 million |
| Net income to shareholders | $91.4 million | $40.1 million | $282.4 million | $127.8 million |
| Diluted earnings per share | $6.72 | $2.66 | $20.21 | $8.91 |
| Earned premiums | $957.6 million | $965.6 million | $1,901.2 million | $1,915.0 million |
| Underwriting profit | $41.7 million | Loss of $10.8 million | $197.7 million | $40.8 million |
| Consolidated combined ratio | 96% | 101% | 90% | 98% |
Net investment income was $90.6 million in Q2 and $183.5 million for the half-year. Net realized investment gains were $6.1 million and $11.7 million, respectively. Q2 comprehensive loss to shareholders was $132.9 million, and six-month comprehensive income was $148.9 million, reflecting declines in unrealized investment gains.
Cash flow, balance sheet and capital
Six-month operating cash flow was $238.0 million, compared with $237.1 million; investing cash outflow was $288.3 million and financing cash outflow was $48.3 million. Cash and equivalents were $1.853 billion at June 30, 2015, with $522.2 million of restricted cash and $2.185 billion of short-term investments. Total invested assets, including restricted cash, were approximately $18.5 billion.
Total assets were $25.366 billion and shareholders’ equity was $7.742 billion. Debt was $2.247 billion; the debt-to-capital ratio was 22%, versus 23% at year-end 2014. Book value per share rose to $554.97 from $543.96. The company reported sufficient liquidity and said it did not intend to renew its $550 million secured credit facility when it expires in December 2015, citing capacity under other facilities.
Material changes versus prior period
- Profitability improved substantially, with underwriting moving from a Q2 loss to a profit and the combined ratio improving from 101% to 96%. Six-month underwriting profit increased to $197.7 million from $40.8 million.
- Favorable development of prior-year loss reserves was higher. For the six months, management reduced prior-year reserves by $36.0 million after reassessing reserve confidence following the A&E reinsurance transaction; this reduction accounted for about two points of the consolidated combined ratio improvement.
- Gross premium volume fell 6% in Q2 and 7% for the half-year; at constant exchange rates, declines were 4% and 5%. Earned premiums declined about 1% in both periods, but would have increased 2% at constant exchange rates. Lower reinsurance volume, including changes to auto reinsurance business, was a key factor.
- Markel Ventures revenue increased, partly due to the 2014 Cottrell acquisition. Q2 Ventures net income was a loss of $2.6 million versus income of $4.1 million, primarily due to a $17.6 million increase in estimated Cottrell contingent consideration. Six-month Ventures net income was $8.0 million versus $5.1 million.
- Investment fair-value changes reversed: six-month unrealized investment gains decreased $186.7 million, compared with an increase of $515.0 million in 2014. Equity securities increased to 24% of invested assets from 22% at year-end.
Outlook, management commentary, risks and unusual items
No quantified earnings or premium guidance was provided. Management reported small price increases across many lines but continued pricing pressure in property, marine and energy, and large-account business; it said it would not write business when market prices do not support underwriting targets. Management expects continuing losses in the run-off life and annuity business as reserve discount accretion continues, with payouts forecast over 40 to 50 years.
- On March 9, 2015, Markel ceded pre-1992 asbestos and environmental liabilities for $89.0 million of consideration, including $69.9 million paid at closing, against $94.1 million of reserves. The $5.1 million deferred gain will be recognized as recoveries occur; formal transfer of the net reserves was expected during 2015.
- On April 24, 2015, a life and annuity reinsurance novation transferred $32.6 million of reserves for $29.0 million net cash consideration, producing a $3.6 million gain.
- Cottrell contingent consideration was valued at $31.1 million at June 30, 2015 and was expected to be paid in 2016; the amount remained subject to Cottrell’s results through year-end.
- The six-month effective tax rate was 16%, including an estimated approximately 12-percentage-point benefit from foreign tax credits. Management cautioned that similar credits may not be available in future years.
- Investment and reserve risks include equity-price and interest-rate volatility, foreign exchange exposure, catastrophe and large claims, uncertainty in reinsurance and A&E reserves, and reinsurer collectability. Unrealized investment losses were $63.8 million at June 30; management said it identified no other-than-temporary impairments at that date, but warned that further market declines could produce impairment charges.
- Management described ordinary-course contingencies as not expected to materially affect financial condition or results. Fixed maturities averaged AA, about 97% were rated A or better, and less than 1% were unrated or below investment grade. The company also cited municipal-bond exposure of approximately $4.0 billion.
Important facts for investors to verify
- How much of the underwriting improvement depends on favorable prior-year reserve development, including the $36.0 million reserve reduction, and whether current-year loss experience remains favorable.
- Completion and recoverability terms of the A&E reinsurance transfer, and the remaining exposure to A&E and other long-tail claims.
- Cottrell’s year-end performance and the final contingent consideration payable in 2016.
- Whether expected foreign tax credits are usable as forecast and how earnings would be affected without them.
- Investment portfolio sensitivity to market movements, given the 24% equity allocation and Q2 decline in unrealized gains, along with the December 2015 secured-facility expiry and replacement liquidity capacity.