W. R. Berkley Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; balance sheet compared with December 31, 2015. The company is a commercial property-and-casualty insurance holding company operating in Insurance and Reinsurance segments.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net premiums written | $1.607 billion | $1.571 billion | $4.914 billion | $4.690 billion |
| Net premiums earned | $1.586 billion | $1.532 billion | $4.673 billion | $4.497 billion |
| Total revenues | $2.020 billion | $1.861 billion | $5.683 billion | $5.395 billion |
| Net income to common stockholders | $220.7 million | $152.6 million | $449.1 million | $393.9 million |
| Diluted EPS | $1.72 | $1.18 | $3.50 | $3.02 |
| GAAP combined ratio | 93.9% | 93.7% | 94.1% | 94.0% |
- Underwriting: Combined ratios below 100% indicate underwriting profit, excluding investment income. For the first nine months, Insurance’s ratio was 93.5% versus 93.6%; Reinsurance’s worsened to 99.7% from 96.7%. Consolidated loss ratio was 61.0% versus 60.8%.
- Cash flow: Operating cash flow was $726.5 million for the first nine months, up from $620.3 million. Investing activities used $801.9 million; financing activities provided $184.4 million. Cash and equivalents ended at $873.1 million, up from $763.6 million at year-end 2015.
- Balance sheet and liquidity: Total assets were $23.35 billion, up from $21.72 billion; total investments were $16.83 billion, up from $15.35 billion. Total liabilities were $18.38 billion and total equity $4.96 billion. Management reported approximately 82% of the investment portfolio in cash, cash equivalents and marketable fixed-maturity securities.
- Debt and capital: Debt carrying value was approximately $2.49 billion, with $2.525 billion face amount. Debt and subordinated debentures represented 34% of total capitalization, versus 32% at year-end. The company issued $400 million of subordinated debentures due 2056 and repaid $83 million of debt during 2016.
- Investment income: Nine-month net investment income rose 5% to $404.9 million; the annualized yield was 3.3% versus 3.2%. Average invested assets at cost were $17.0 billion versus $15.9 billion.
Material changes and unusual items
- Q3 and nine-month earnings benefited substantially from investment gains, including a $134.9 million gain on the July sale of Aero Precision Industries and related aviation services. Nine-month net realized investment gains were $207.5 million versus $113.0 million; Q3 gains were $175.7 million versus $66.4 million.
- Management attributed the 45% Q3 increase in net income primarily to higher after-tax investment gains and investment income. The nine-month increase was 14%, also primarily reflecting investment gains and income.
- Premium growth was moderate: nine-month gross premiums written rose 5%, while average renewal rates adjusted for exposure increased only 0.2%. About 77% of expiring policies renewed, versus 78% in 2015. Management said pricing increases have slowed and some lines remain below levels needed for its long-term return objectives.
- Nine-month catastrophe losses, net of reinsurance, were $68 million versus $46 million. Favorable prior-year reserve development was $41.6 million versus $48.8 million; favorable development in Insurance was partly offset by adverse development in commercial auto and medical professional liability.
- Other-than-temporary investment impairments were $18.1 million in the first nine months, related to common stocks; none were recorded in Q3. The company reported $45.2 million of gross unrealized losses on securities at September 30, down from $113.9 million at year-end.
- The company acquired an 85% interest in a promotional merchandise distributor and acquired a specialty P&C insurer in 2016. In October, after quarter-end, it sold approximately 2.2 million HealthEquity shares and recognized an approximately $65 million gain; it planned to account for its remaining investment at fair value.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided. Management notes persistently low fixed-income yields, competitive pricing and loss-cost inflation; it says it selectively reduces business where pricing is inadequate and expects alternative investments to cause greater income variability.
- Principal risks include uncertain loss-reserve estimates, long-tail claims and social/economic inflation, catastrophe losses, reinsurance recoverability, investment and interest-rate risks, foreign currency and political risks (including Brexit), competition, and regulatory or legal developments. Management highlights the greater uncertainty in assumed reinsurance reserves due partly to information from ceding companies.
- Net prior-year reserve development was favorable, but reserve estimates remain judgmental. Management’s sensitivity analysis indicates that a 1% change in both claim frequency and severity for 2015 claims would affect the loss estimate by approximately $374.5 million; impacts across multiple accident years could differ.
- Ordinary-course insurance and reinsurance litigation is considered in loss reserves. Management expects ultimate liability not to be material to financial condition, while noting adverse outcomes could materially affect results in a particular period.
- Management stated disclosure controls were effective and there were no material changes in internal control during the quarter. The filing reports no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring underwriting and investment income versus the Aero sale and other realized investment gains.
- Whether renewal pricing and retention remain adequate relative to loss-cost trends, and whether Reinsurance’s combined-ratio deterioration persists.
- Subsequent development of loss reserves, especially commercial auto, medical professional liability and assumed reinsurance, and the effects of catastrophe claims.
- Investment portfolio performance and exposure to low yields, alternative assets, merger arbitrage, credit, real estate and currency risks.
- Debt-service and capital implications of the new long-dated subordinated debentures, and the realized gain and remaining exposure related to the HealthEquity share sale.