BERKLEY W R CORP quarterly report, Q3 FY2013

Business context and reporting period

W. R. Berkley Corporation is a commercial property-and-casualty insurance holding company reporting for the quarter and nine months ended September 30, 2013. Its segments are Insurance-Domestic, Insurance-International, and Reinsurance-Global. The interim financial statements are unaudited.

Key financial metrics

Combined ratios below 100% indicate underwriting profit. For the first nine months, the consolidated loss ratio improved to 61.1% from 62.5%, while the expense ratio edged down to 34.0% from 34.3%. Catastrophe losses were $52 million, compared with $39 million. Favorable prior-year reserve development was $75 million, compared with $83 million.

Balance sheet, debt and liquidity

At September 30, 2013, total assets were $20.524 billion and total equity was $4.395 billion. Cash and cash equivalents were $966 million. Total investments were $14.504 billion, including $11.612 billion of fixed maturities. Gross loss reserves were $10.061 billion; net loss reserves were $8.634 billion.

Debt, including junior subordinated debentures, had a carrying value of $2.036 billion and face value of $2.058 billion. Debt and junior subordinated debentures represented 32% of total capitalization, versus 33% at year-end 2012. The company reported $376 million of investing cash outflow and $186 million of financing cash outflow for the nine months; cash increased by $61 million to $966 million. Management stated that approximately 81% of the investment portfolio was in cash, cash equivalents and marketable fixed-maturity securities.

Material changes versus comparable periods

• Quarterly net income rose to $137 million from $101 million; management attributed the increase principally to higher after-tax underwriting income and investment gains. Nine-month net income increased to $370 million from $345 million, primarily on higher after-tax underwriting income, partly offset by lower after-tax investment income.
• Net premiums written rose 12% in the quarter and 13% year to date. Management cited rate increases and growth in exposures, including expansion into new markets. Average renewal rates increased 6.4% in the quarter and 6.9% year to date; renewal retention was 75% and approximately 76%, respectively.
• Nine-month investment income declined 7%, chiefly due to lower fixed-maturity income; the reported average annualized yield on fixed maturities fell to 3.5% from 3.8%. Quarterly investment income increased, supported by investment-fund income, while fixed-maturity income remained lower.
• Operating cash flow increased by $174 million year over year, which management attributed largely to lower paid losses; the paid loss ratio declined to 54% from 58%.
• Accumulated other comprehensive income fell to $217 million from $466 million at year-end 2012, primarily reflecting lower unrealized investment gains. The nine-month after-tax change in unrealized investment gains and losses was a $228 million loss.
• In January 2013, the company acquired the remaining 51% of an aircraft equipment supplier, following its 2012 purchase of a 49% interest. Revenues and expenses from wholly owned investees increased substantially, primarily reflecting this acquisition.

Outlook, management commentary and risks

No specific earnings or revenue guidance is provided. Management said insurance prices continued to rise, but loss costs were also increasing and prices in certain lines remained below levels needed to achieve long-term return objectives. It expects recent rate increases to flow into earned premiums over subsequent quarters. Management also warned that fixed-maturity investment income could decline further if interest rates remain low and expects greater fluctuations in investment-fund income.

Key stated risks include uncertain loss-reserve estimates—particularly for long-tail and assumed reinsurance claims—catastrophe losses, competition and pricing, investment and interest-rate risk, reinsurance recoverability, currency and political exposures, and litigation. Management reported $75 million of favorable prior-year reserve development for the first nine months, concentrated mainly in accident years 2006–2012 and partly offset by adverse development in older years; International had $7 million of unfavorable development.

A policyholder of an insurance subsidiary was found liable in an October 25, 2013 automobile accident. Before entry of judgment, damages were estimated as potentially reaching $151 million plus interest, while the policy limit was $1 million. The company may face extra-contractual exposure, said it had meritorious grounds to contest the matter, and stated its expected ultimate liability from such matters would not be material to financial condition; an adverse outcome could nevertheless materially affect a particular reporting period.

Other unusual items included $6.7 million of debt-extinguishment costs associated with prepaying $250 million of 6.750% subordinated debentures. The company issued $350 million of 5.625% subordinated debentures due 2053 and repaid $200 million of senior notes that matured in February 2013. Management stated disclosure controls were effective and there were no material changes in internal control during the quarter.

Important facts for investors to verify

• Whether underwriting improvement persists after adjusting for catastrophe losses and favorable reserve development, and how long-tail reserve estimates develop.
• The potential financial and legal outcome of the automobile-accident matter, including any extra-contractual exposure beyond the $1 million policy limit.
• Whether premium growth and renewal pricing remain adequate relative to loss-cost inflation, and how retention and ceded-reinsurance levels evolve.
• The effect of low reinvestment yields, market movements and the substantial decline in unrealized investment gains on future income and equity.
• Cash generation, liquidity and debt maturities, along with performance and funding needs of real estate projects and the acquired aviation-related business.