Markel Corporation (now Markel Group Inc.) — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. The interim financial statements are unaudited. The company is a specialty insurer and also owns industrial and service businesses.
Financial performance and position
- Revenue: Total operating revenues were $765.8 million for Q3, up 13% from $676.1 million; nine-month revenue was $2.192 billion, up 13% from $1.945 billion. Earned premiums rose 4% in Q3 and 8% year to date.
- Profit and EPS: Q3 net income attributable to shareholders was $49.7 million, down from $53.3 million; diluted EPS was $5.32 versus $5.48. Nine-month shareholder net income rose to $196.6 million from $91.9 million, and diluted EPS was $19.67 versus $9.42.
- Underwriting and margins: The consolidated combined ratio was 101% in Q3 versus 100% a year earlier, indicating an underwriting loss; the nine-month ratio improved to 96% from 105%. Underwriting result was a $4.8 million loss in Q3 versus $0.3 million profit, but a $64.8 million profit year to date versus a $66.6 million loss.
- Investments: Nine-month net investment income was $207.8 million, up from $196.6 million. Net realized investment gains were $25.4 million, essentially unchanged. Invested assets were $9.2 billion at September 30, including equity securities of $2.3 billion, or 25% of invested assets.
- Cash flow: Nine-month operating cash flow was $239.5 million versus $261.1 million. Investing activities used $354.0 million, including $246.2 million for acquisitions; financing activities provided $170.6 million. Cash and equivalents ended at $834.8 million, up from $775.0 million at year-end 2011.
- Debt and liquidity: Debt was $1.511 billion, compared with $1.294 billion at year-end 2011. The debt-to-capital ratio was 28%, unchanged from year-end and near management’s approximately 30% target. Management said available liquidity was sufficient for capital needs.
- Equity and book value: Shareholders’ equity was $3.806 billion, up from $3.388 billion. Book value per share increased to $395.48 from $352.10, primarily reflecting nine-month comprehensive income of $426.8 million.
Changes versus comparable periods
- Q3 shareholder net income declined despite higher revenues, primarily due to weaker underwriting results and higher other expenses. Nine-month earnings improved substantially, mainly from better underwriting.
- Q3 underwriting included $31.1 million of unfavorable asbestos and environmental reserve development, $8.8 million of Hurricane Isaac losses, lower attritional losses in some businesses, and acquisition-cost accounting effects. The prior-year period included materially higher catastrophe losses.
- The London Insurance Market’s nine-month combined ratio improved to 88% from 119%, helped by lower catastrophe losses and favorable prior-year reserve development. Specialty Admitted remained above 100% at 108% year to date; Excess and Surplus Lines was 91%.
- Other revenues and expenses increased significantly, partly reflecting growth and acquisitions in non-insurance operations. Non-insurance revenue was $153.8 million in Q3 and $345.0 million year to date, with acquisitions contributing to the increase.
Outlook, risks and unusual items
- The filing provides no specific numerical earnings or premium guidance. Management described market pricing in 2012 as generally flat to small single-digit favorable, compared with flat to small single-digit declines in 2011, and said it would not write business when pricing failed to meet underwriting targets.
- Effective January 1, 2012, the company prospectively adopted ASU 2010-26, narrowing which insurance acquisition costs qualify for deferral. This increased reported underwriting expenses by $6.5 million in Q3 and $41.1 million for nine months; it also recognized previously deferred costs. Comparability with prior periods is affected.
- The company issued $350 million of 4.90% senior notes due 2022, redeemed $150 million of 7.50% debentures, and intended to use part of the proceeds to pre-fund repayment of $246.7 million of 6.80% notes due February 2013. The redemption generated a $4.1 million loss.
- Acquisitions included THOMCO, Havco, manufactured housing communities, Tromp Bakery Equipment and Reading Bakery Systems. Purchase accounting for Tromp and Reading was incomplete at quarter-end.
- After quarter-end, Hurricane Sandy caused losses in the Northeast; the company said it had exposure but could not yet estimate losses. Asbestos and environmental reserves remain uncertain, with potential for future increases and estimated payouts over the next 50 years.
- Other risks cited include catastrophe severity and frequency, reserve-estimation uncertainty, reinsurance recoverability and cost, investment-market and credit volatility, municipal and sovereign debt exposure, economic conditions, acquisition integration, regulatory constraints, and technology and personnel risks. Management reported effective disclosure controls.
Important facts for investors to verify
- Subsequent estimates of Hurricane Sandy losses and any effect on reserves or earnings.
- Further development in asbestos and environmental reserves, and the assumptions underlying long-duration claims.
- Underlying underwriting performance excluding reserve releases, catastrophe losses, and the ASU 2010-26 transition impact.
- Acquisition purchase-price allocations, integration results, and the performance of Markel Ventures businesses.
- Debt repayment and refinancing plans, interest costs, and the company’s ability to maintain targeted leverage and liquidity.
- Valuation sensitivity of the investment portfolio and credit default swap, including the impact of market movements and realized or impairment losses.