Business context and reporting period
Markel Corporation is a financial holding company focused on specialty insurance, with additional industrial and service businesses through Markel Ventures. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2012; comparisons are to the same 2011 periods. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total operating revenues | $693.2 million | $647.2 million | $1,426.4 million | $1,268.8 million |
| Net income to shareholders | $89.7 million | $30.3 million | $146.9 million | $38.6 million |
| Diluted EPS | $8.42 | $3.11 | $14.35 | $3.95 |
| Underwriting profit (loss) | $67.2 million | $(13.3) million | $69.6 million | $(66.9) million |
| Combined ratio | 87% | 103% | 93% | 107% |
| Net cash from operating activities | — | $104.7 million | $100.3 million |
Earned premiums rose 5% in Q2 and 9% for the six months. Net investment income was $63.6 million in Q2 and $143.4 million year to date; net realized investment gains were $8.2 million and $20.1 million, respectively. Year-to-date net investment income included a favorable $12.2 million change in the fair value of a credit default swap.
At June 30, total assets were $12.0 billion, investments $8.0 billion, cash and cash equivalents $837.2 million, and shareholders’ equity $3.7 billion. Debt was $1.31 billion; the debt-to-capital ratio was 26%, versus 28% at year-end. Book value per share increased to $379.88 from $352.10. Six-month investing cash use was $16.8 million and financing cash use was $25.1 million; ending cash was $837.2 million.
Material changes versus the prior comparable period
- Higher underwriting results drove the earnings improvement. The consolidated combined ratio fell to 87% for Q2 and 93% year to date, from 103% and 107%.
- London Insurance Market results improved markedly: combined ratios were 74% for Q2 and 86% year to date, versus 110% and 130% in 2011, reflecting lower current-year losses and greater favorable prior-year reserve development.
- The 2011 comparison included significant catastrophe losses: $30.4 million in Q2 and $99.0 million year to date. 2012 results benefited from favorable prior-year reserve development, including $190.9 million across insurance segments for the first six months.
- Other revenues increased, principally reflecting growth and acquisitions in non-insurance operations. Those operations generated $191.2 million of revenue year to date but only $0.4 million of net income attributable to shareholders, compared with $4.7 million a year earlier.
- Comprehensive income to shareholders was $73.4 million in Q2, below $96.0 million in 2011, as investment-related other comprehensive income moved to a $13.6 million loss from a $65.2 million gain. Year-to-date comprehensive income rose to $279.4 million from $120.8 million.
Outlook, management commentary, risks and unusual items
- Management reported generally flat to small single-digit favorable rate changes in the first half of 2012, compared with flat to small single-digit declines a year earlier. It stated that it will not write business where prevailing prices do not support underwriting targets. No specific earnings or premium guidance was provided.
- The Specialty Admitted segment remained challenged, with combined ratios of 102% for Q2 and 108% year to date. Workers’ compensation had a $21.4 million underwriting loss for the first six months; management cited unemployment, economic conditions and difficult pricing.
- Prospective adoption of ASU 2010-26 increased 2012 underwriting expenses by $14.3 million in Q2 and $34.6 million year to date, approximately three combined-ratio points in each period. The company also cited a write-off of previously capitalized software costs in Specialty Admitted.
- Acquisitions included THOMCO, acquired January 1 for $108.5 million, and an 85% interest in Havco, along with manufactured housing communities. Acquisition-related goodwill and intangible assets were recorded; integration and valuation are relevant considerations.
- After quarter-end, Markel issued $350 million of 4.90% senior notes due 2022. It used $150 million of proceeds to redeem 7.50% debentures and planned to pre-fund repayment of $246.7 million of 6.80% notes due February 2013.
- Management stated that it believes liquidity is sufficient and described access to subsidiary dividends, invested assets, a revolving credit facility and capital markets. Risks include catastrophe losses, reserve-estimation uncertainty, reinsurance collectability and cost, investment-market volatility, municipal and sovereign credit exposure, and acquisition and operating risks. Management said ordinary-course contingencies were not expected to materially affect results.
- Net income per share reflects an $8.2 million adjustment for redeemable noncontrolling interests: adjusted shareholder income used in the EPS calculation was $81.5 million for Q2 and $138.8 million year to date, below reported net income to shareholders.
Most important facts for investors to verify
- How much of the earnings improvement is sustainable versus attributable to favorable prior-year reserve development and the unusually high catastrophe losses in the 2011 comparison.
- Whether Specialty Admitted underwriting performance, especially workers’ compensation, improves and whether the London segment’s strong reserve releases recur.
- The earnings and cash-flow contribution, integration progress and future redemption obligations associated with THOMCO, Havco and other acquisitions.
- The sensitivity of investment values and income to equity markets, credit spreads and the Level 3 credit default swap valuation; verify the swap’s $33.1 million notional exposure and $17.1 million fair-value liability.
- Execution of the post-quarter debt refinancing and the adequacy of liquidity and capital after acquisitions and debt repayment.