Markel Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Markel markets and underwrites specialty insurance and also operates non-insurance businesses. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Total operating revenues | $515.4 | $522.4 | $1,052.1 | $1,017.6 |
| Earned premiums | $416.7 | $455.2 | $828.8 | $912.5 |
| Net investment income | $64.4 | $64.1 | $132.8 | $132.8 |
| Net realized investment gains (losses) | $(2.4) | $(15.4) | $13.3 | $(70.6) |
| Operating income | $48.2 | $52.3 | $128.8 | $88.2 |
| Net income to shareholders | $20.8 | $32.8 | $63.4 | $49.2 |
| Diluted earnings per share | $2.12 | $3.34 | $6.46 | $5.00 |
| Combined ratio | 103% | 99% | 102% | 97% |
| Operating cash flow | — | $63.6 | $115.3 |
Q2 shareholder net income fell 36%, as weaker underwriting and higher interest expense outweighed improved investment results. First-half net income increased 29%, mainly because investment impairments were substantially lower than in 2009; underwriting performance weakened.
- Q2 earned premiums declined 8% and first-half earned premiums declined 9% year over year. First-half net written premiums increased slightly to $900.7 million from $894.2 million, while gross premium volume rose 1%.
- First-half underwriting loss was $18.4 million, versus a $24.7 million profit in 2009. Consolidated combined ratio rose to 102% from 97%; above 100% indicates an underwriting loss.
- Segment combined ratios for the first half were 96% in Excess and Surplus Lines, 101% in Specialty Admitted, and 112% in the London Insurance Market, versus 99%, 99%, and 94%, respectively, in 2009.
- Interest expense rose to $36.3 million in the first half from $23.7 million, primarily due to the $350 million issuance of 7.125% senior notes in September 2009. The estimated annual effective tax rate was 31%, versus 23% a year earlier.
Financial position, liquidity and capital
- At June 30, total assets were $10.32 billion, total liabilities $7.46 billion, and total equity $2.87 billion. Shareholders’ equity was $2.85 billion.
- Debt was $1.00 billion, compared with $963.6 million at year-end 2009. Debt to total capital was 26%, unchanged from year-end; management cited a target capital structure of approximately 30% debt.
- Cash and cash equivalents were $686.7 million, down from $850.5 million at December 31. Short-term investments were $360.9 million. Total investments were $7.19 billion; MD&A reports invested assets of approximately $7.9 billion, including cash and related invested assets.
- Operating cash flow was $63.6 million, compared with $115.3 million in first-half 2009; the prior-year amount included a $33.6 million federal tax refund. Investing activities used $209.3 million, reflecting increased purchases of fixed maturities and equities. Financing activities used $9.4 million, including $24.3 million of share repurchases.
- A new $270 million revolving credit facility, expiring June 2013, replaced the prior $375 million facility. It was undrawn at quarter-end; capacity may be increased to $350 million subject to conditions. Management stated liquidity was sufficient for capital needs.
- Book value per share increased to $291.71 from $282.55 at year-end 2009. First-half comprehensive income to shareholders was $100.6 million, but Q2 comprehensive loss was $33.9 million, including a $52.9 million after-tax decline in unrealized investment gains.
Material developments, outlook and risks
- Catastrophe losses from the Chilean earthquake and Deepwater Horizon totaled $32.7 million in first-half underwriting losses, or four combined-ratio points. The London segment’s Q2 and first-half ratios included $15.7 million of Deepwater Horizon losses; first-half London results also included $17.0 million from the Chile earthquake.
- Prior-year reserve development was favorable overall, but included adverse development of $34.1 million in first-half on an Excess and Surplus Lines mortgage-servicing errors-and-omissions program. London increased prior-year reserves by $28.8 million in Q2 for Italian medical-malpractice and Australian construction-professional claims; Markel said it had stopped writing the Australian coverage in June.
- Management cited competitive pricing below its target levels and said it would forgo business when pricing does not support underwriting objectives. Lower premiums, higher profit-sharing and acquisition costs contributed to higher expense ratios. No numerical earnings or premium guidance was provided.
- Investment impairment charges were $6.3 million in first-half 2010, versus $63.5 million in first-half 2009. At June 30, gross unrealized investment losses were $35.9 million, less than 1% of invested assets. Markel cautioned that market volatility could produce further declines and impairment charges.
- On July 12, 2010, Markel agreed to acquire Aspen Holdings for approximately $135 million upfront, plus contingent value rights tied in part to reserve development and profit commissions. Closing was expected before year-end, subject to approvals and other conditions.
- A Guaranty Bank lawsuit concerning a mortgage-loan insurance program seeks premium refunds and continued coverage, with proposed additional fraud and statutory claims. The policy covered a loan portfolio of approximately $508 million, and estimated remaining liability for additional covered losses was approximately $103 million. Markel disputed the requested relief; mediation occurred in July and discussions continued. A Wisconsin insurance regulator investigation was settled without admission of violation for a $100,000 fine and a commitment not to write similar policies in the future.
- Other disclosed risks include catastrophe severity and frequency, reserve-estimation uncertainty, reinsurance costs and collectability, litigation, market and foreign-exchange volatility, regulation, and integration of acquisitions. Management reported effective disclosure controls and no material Q2 change in internal control over financial reporting.
Important facts for investors to verify
- How catastrophe claims, reinsurance recoveries and reserve development evolve, especially for Deepwater Horizon, Chile, mortgage-servicing E&O, and the cited London books.
- Whether underwriting margins recover as premium volume and pricing develop, and whether expense ratios remain elevated.
- Investment portfolio fair values, credit quality, impairment assumptions and the impact of equity-market changes on comprehensive income and book value.
- Liquidity and leverage after acquisitions, repurchases and any use of the revolving facility; confirm the final Aspen purchase terms and closing status.
- Developments in the Guaranty Bank litigation and the potential effect on coverage obligations, premiums, reserves and cash flows.