Markel Corporation — Q1 2012 Form 10-Q
Business context and period: This filing is for the three months ended March 31, 2012, compared with Q1 2011, and the balance sheet date is March 31, 2012. The registrant’s name in the filing is Markel Corporation. Its principal activities are specialty insurance and ownership of industrial and service businesses through Markel Ventures. Interim results are unaudited and are not necessarily indicative of full-year results.
Key financial results
| Metric | Q1 2012 | Q1 2011 / prior date |
|---|---|---|
| Total operating revenues | $733.1 million | $621.6 million |
| Operating income | $96.7 million | $30.4 million |
| Net income to shareholders | $57.3 million; $5.94 basic and $5.92 diluted per share | $8.3 million; $0.85 per share |
| Comprehensive income to shareholders | $205.9 million | $24.7 million |
| Earned premiums | $529.6 million | $463.1 million |
| Net investment income / realized gains | $79.8 million / $11.9 million | $70.1 million / $11.2 million |
| Net cash used by operating activities | $64.4 million | $9.2 million |
| Cash and cash equivalents | $691.8 million | $775.0 million at December 31, 2011 |
| Total investments | $8.14 billion | $7.95 billion at December 31, 2011 |
| Senior long-term and other debt | $1.31 billion | $1.29 billion at December 31, 2011 |
| Shareholders’ equity / book value per share | $3.60 billion / $373.20 | $3.39 billion / $352.10 at December 31, 2011 |
Operating revenue rose about 18% and net income to shareholders increased substantially from the prior-year quarter. The consolidated underwriting result improved to a $2.4 million profit from a $53.6 million loss; the combined ratio was 100% versus 112%. The 2012 ratio includes roughly four points of expense from the accounting change described below. Operating cash flow was negative, primarily reflecting higher claims settlements, especially in the London market, as well as the timing of incentive compensation and pension payments. Cash declined by $83.2 million during the quarter.
Material changes and operating drivers
- Gross premium volume increased 10% to $648.6 million; net written premiums increased 12% to $581.2 million, and earned premiums rose 14%. Net retention increased to 90% from 88%.
- London Insurance Market improved to a 97% combined ratio from 152%, with Q1 2011 having incurred $67.0 million of catastrophe losses from Australian floods and the New Zealand and Japanese earthquakes and tsunami, plus $13.0 million related to the Gryphon vessel incident. The improvement also reflected favorable prior-year reserve development and higher earned premiums.
- Excess and Surplus Lines had a 96% combined ratio versus 84%; favorable prior-year reserve development was $30.6 million, compared with $56.8 million. Specialty Admitted deteriorated to 113% from 104%, reflecting large-loss frequency, business mix and expense factors; it reported a $14.5 million loss from underwriting and non-risk-bearing operations versus $6.2 million.
- Effective January 1, 2012, Markel prospectively adopted ASU 2010-26 on insurance acquisition costs. Q1 expenses included $20.3 million of costs that were no longer eligible for deferral. Approximately $43 million of previously deferred costs were expected to be recognized primarily over the first nine months of 2012.
- Markel acquired THOMCO on January 1 for total consideration of $108.5 million, including $100.5 million cash. The acquisition added $26.1 million of goodwill and $81.2 million of intangible assets and is included in Specialty Admitted.
- Markel Ventures revenue increased to $97.0 million from $68.0 million, mainly due to acquisitions completed in 2011, while its net income to shareholders decreased to $0.2 million from $2.4 million.
Investments, liquidity, debt and risk
Investment fair value increased to $8.14 billion. Equity securities were $2.17 billion, or 25% of invested assets, compared with 21% at year-end. The increase in comprehensive income chiefly reflected $145.4 million of after-tax unrealized investment gains; it should be distinguished from net income. The company reported $11.4 million of gross unrealized investment losses and no investment write-downs for other-than-temporary declines in Q1. Management said it reviewed loss-position securities and did not consider any declines other-than-temporary at quarter-end.
Debt to capital was 27%, versus 28% at year-end; management’s target capital structure includes approximately 30% debt. Management stated that liquidity was sufficient for capital needs and cited insurance-subsidiary dividends, holding-company invested assets, an undrawn revolving facility, and access to capital markets. Operating cash-flow weakness and the acquisition-related cash outflow merit attention alongside this assessment.
Net investment income included an $11.1 million favorable fair-value change on a credit default swap, compared with $1.7 million in Q1 2011. The swap’s fair value declined to $18.3 million from $29.3 million at year-end; it has $33.1 million notional exposure and is valued using significant unobservable assumptions. Management cautioned that its fair value could change significantly before its December 2014 termination. The investment portfolio also faces equity-price, interest-rate, currency and credit risks. Management cited municipal-bond and European sovereign-debt exposures; approximately 94% of fixed maturities were rated A or better, and less than 1% were unrated or below investment grade.
Outlook, contingencies and other disclosures
The filing provides no specific earnings or premium-volume guidance. Management described Q1 rate changes as generally flat to small single-digit favorable, compared with flat to small single-digit declines a year earlier, and said it would not write business when market pricing did not support underwriting targets. It cautioned that premium assumptions depend on market conditions and absence of significant catastrophes.
Key risks include catastrophe frequency and severity, reserve estimation and asbestos/environmental exposures, coverage litigation, inflation, reinsurance cost and collectability, regulatory constraints, investment-market volatility and sovereign credit concerns, economic conditions affecting Markel Ventures, technology and cybersecurity, acquisition integration, and changes in financial-strength or debt ratings. The filing states that ordinary-course contingencies were not expected to have a material impact. Disclosure controls were concluded effective, with no material Q1 change in internal control over financial reporting.
Important facts for investors to verify
- Whether the 100% combined ratio and underwriting improvement persist after adjusting for the $20.3 million ASU 2010-26 expense and favorable prior-year reserve development.
- How reserve development, current accident-year losses and Specialty Admitted performance evolve, including workers’ compensation conditions and large-loss frequency.
- Whether negative operating cash flow continues, and the effects of claims payments, acquisition spending and cash levels on holding-company liquidity.
- The sustainability and sensitivity of investment income, unrealized gains and the credit default swap valuation; review the swap’s Level 3 assumptions and potential earnings volatility.
- THOMCO integration, the realized contribution from recent acquisitions, and the recoverability and amortization of goodwill and intangible assets.
- Exposure to catastrophe losses, reinsurance recoverables, municipal and sovereign credit, and other market and reserve risks identified in the filing.