W. R. Berkley Corporation — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods. W. R. Berkley is a commercial property-and-casualty insurance holding company operating in specialty, regional, alternative markets, reinsurance and international segments. Unless otherwise noted, amounts below are in millions of dollars.
Key financial results
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Total revenues | $1,270.9 | $1,163.1 | $2,505.3 | $2,316.6 |
| Net premiums written | $1,057.4 | $961.4 | $2,140.7 | $1,945.3 |
| Net premiums earned | $1,017.2 | $948.1 | $1,999.7 | $1,878.7 |
| Net investment income | $149.1 | $129.7 | $295.2 | $273.3 |
| Income before income taxes | $110.3 | $145.8 | $270.8 | $306.4 |
| Net income to common stockholders | $83.1 | $110.2 | $199.6 | $228.8 |
| Diluted earnings per share | $0.56 | $0.70 | $1.35 | $1.44 |
| Operating cash flow | Not stated by quarter | $216.4 | $186.7 |
Net income declined in both periods, primarily because underwriting results weakened; higher investment income and realized investment gains partly offset the decline. First-half net investment gains were $52.2 million versus $17.4 million a year earlier. The first-half effective tax rate was 26%, compared with 25%.
Underwriting and premium trends
First-half gross premiums written rose 12% to $2.515 billion; net premiums written increased 10%, and earned premiums increased 6%. Management attributed growth mainly to specialty and international expansion. Renewal retention was approximately 80% for policies expiring in the first half, and the average renewal rate increased 1.2%. Management said prices had begun to rise slightly, but loss costs were also increasing and pricing in some lines remained below levels needed to meet return objectives.
The consolidated first-half loss ratio rose to 64.1% from 59.6%; the expense ratio was 34.7% versus 34.6%, taking the combined ratio to 98.8% from 94.2%. For Q2, the combined ratio was 101.1% versus 94.4%, indicating an underwriting loss before investment income in the quarter. First-half catastrophe losses were $88 million, versus $53 million, and favorable prior-year reserve development fell to $86 million from $129 million. Management cited U.S. tornadoes and hailstorms and the March Japan earthquake among 2011 catastrophe events. Excluding catastrophe losses and favorable reserve development, the first-half loss ratio increased 0.3 percentage points to 64.0%.
| First-half segment combined ratio | 2011 | 2010 |
|---|---|---|
| Specialty | 90.3% | 90.8% |
| Regional | 106.3% | 95.2% |
| Alternative markets | 99.1% | 90.7% |
| Reinsurance | 101.3% | 95.5% |
| International | 102.6% | 106.8% |
Regional results deteriorated notably, with higher loss experience and reduced favorable reserve development. Alternative markets had unfavorable prior-year development, including higher excess workers’ compensation estimates associated with medical and pharmaceutical costs. International improved year over year but remained above a 100% combined ratio.
Financial position, liquidity and capital
- At June 30, 2011, total assets were $18.195 billion, total liabilities $14.275 billion and total equity $3.920 billion. Stockholders’ equity was $3.913 billion, or $27.77 per outstanding share.
- Cash and cash equivalents were $794.9 million, up from $643.0 million at year-end 2010. First-half operating cash flow was $216.4 million; investing activities used $34.4 million and financing activities used $44.0 million.
- Total investments were $13.361 billion, including $11.280 billion in fixed maturities. Management reported approximately 85% of the investment portfolio in cash, cash equivalents and marketable fixed-maturity securities, and a 3.5-year average portfolio duration.
- Senior notes, junior subordinated debentures and other debt had a carrying value of $1.744 billion and face value of $1.763 billion. Total capitalization was $5.7 billion; debt represented 31% of capital, compared with 32% at year-end.
- Gross loss and loss expense reserves were $9.196 billion, including $1.080 billion of ceded reserves; net reserves were $8.116 billion. The aggregate net discount on workers’ compensation reserves was $916 million.
- Loans receivable were $311.7 million, net of a $20 million valuation allowance; their estimated fair value was $284.7 million. The eight largest loans totaled $233 million at amortized cost and were secured by commercial real estate.
Outlook, risks and other notable items
- The filing provides no specific earnings or premium guidance. Management discussed modestly improving insurance prices, offset by rising loss costs, historically low interest rates and pressure on returns in certain lines.
- Management identified reserve estimation as a critical judgment area, particularly for long-tail claims and assumed reinsurance, where information from ceding companies can be delayed or inaccurate. It cautioned that actual reserve outcomes may differ from estimates.
- Investment risks include interest-rate and credit movements, municipal and mortgage-backed securities, loans, investment funds, real estate and arbitrage investments. At June 30, fixed maturities had $62.5 million of gross unrealized losses; management considered these primarily temporary and reported no securities in default or delinquent under financial covenants.
- In January 2011, the company acquired an inactive insurer for $23 million cash; the acquired entity had $21 million of cash and investments and no net loss reserves. Approximately $2 million was allocated to intangible assets.
- Ordinary-course insurance and reinsurance litigation and arbitration are reflected in reserves. The company did not expect these matters to have a material adverse effect, while acknowledging adverse outcomes remain possible. The filing reported no material change to previously disclosed risk factors.
- The board amended bylaws on August 2, 2011, including moving the annual stockholder meeting from April to May. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the deterioration in loss experience, particularly in the regional, alternative markets and reinsurance segments, persists; review subsequent combined ratios and catastrophe claims.
- Whether reserve assumptions remain adequate, including the sources and sustainability of favorable prior-year development and the effect of medical-cost inflation on workers’ compensation claims.
- Whether pricing increases keep pace with loss-cost trends and whether premium growth in specialty and international businesses translates into underwriting profit.
- Credit quality and recoverability of commercial real estate loans and reinsurance recoverables, along with valuation assumptions for less-liquid and Level 3 investments.
- Debt maturities, capital deployment and share repurchases. The filing reported 1.1 million shares purchased in June, while none of the quarter’s reported purchases were recorded as purchases under the publicly announced plan.