W. R. Berkley Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are to December 31, 2011. W. R. Berkley is a commercial property-and-casualty insurance holding company operating in Specialty, Regional, Alternative Markets, Reinsurance and International segments. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 / prior date |
|---|---|---|
| Gross premiums written | $1,401.5 | $1,269.9 |
| Net premiums written | $1,203.5 | $1,083.3 |
| Net premiums earned | $1,099.7 | $982.5 |
| Total revenue | $1,378.7 | $1,234.4 |
| Income before taxes | $187.3 | $159.2 |
| Net income to common stockholders | $135.3 | $115.6 |
| Diluted EPS | $0.94 | $0.78 |
| Net investment income | $157.6 | $146.1 |
| Operating cash flow | $73.8 | $55.4 |
| Cash and cash equivalents | $1,082.4 | $911.7 at Dec. 31, 2011 |
| Total assets | $19,133.6 | $18,403.9 at Dec. 31, 2011 |
| Total liabilities | $14,998.2 | $14,443.0 at Dec. 31, 2011 |
| Senior notes and other debt | $1,853.5 | $1,500.5 at Dec. 31, 2011 |
The consolidated loss ratio was 61.8%, expense ratio 34.7%, and GAAP combined ratio 96.5%, unchanged from Q1 2011. A combined ratio below 100% indicates underwriting profit; the 96.5% ratio implies underwriting profit before investment income. Net income was about 9.8% of revenue, versus about 9.4% in Q1 2011.
Operating cash flow was positive, while investing activities used $278.6 million, principally reflecting purchases of fixed maturities and a $93.9 million increase in loans receivable. Financing provided $366.5 million, including $354.3 million of net debt issuance. Cash increased $170.7 million during the quarter.
At March 31, total investments were $13,780.4 million, including $11,554.2 million of fixed maturities. Total equity was $4,135.5 million; common stockholders’ equity was $4,126.9 million, or $29.85 per outstanding share. Debt represented 34% of total capitalization, up from 30% at year-end. Outstanding debt had a carrying value of $2,097 million and face amount of $2,118 million. Approximately 84% of investments were in cash, cash equivalents and marketable fixed maturities.
Material changes versus the prior comparable period
- Gross premiums written rose 10% and net premiums written rose 11%; earned premiums increased 12%. Management attributed most written-premium growth to rate increases, with the remainder from higher volumes. Renewal retention was approximately 78% versus 79%; average renewal rates increased about 6.5%.
- Premium growth was strongest in International, where gross premiums rose 29%, and Specialty, up 8%. International earned premiums increased to $183.2 million from $137.0 million. Regional and Reinsurance combined ratios improved to 95.7% and 98.2%, respectively; International improved to 97.6%. Specialty’s ratio rose to 95.1% from 88.0%, while Alternative Markets was broadly stable at 99.1%.
- Net income increased 17%, supported by higher net investment income and net investment gains. Net realized investment gains were $43.5 million versus $29.3 million; total net investment gains were $47.5 million versus $29.3 million. Investment-fund income increased, while fixed-maturity income declined and its annualized yield fell to 3.8% from 4.0%.
- Losses and loss expenses increased to $679.5 million from $607.1 million, but the consolidated loss ratio remained 61.8%. Catastrophe losses fell to $4 million from $24 million, while favorable prior-year reserve development declined to $25.2 million from $51.3 million. Excluding catastrophes and favorable prior-year development, the loss ratio improved to 63.7% from 64.5%.
- The company issued $350 million of 4.625% senior notes in March, contributing to higher debt and interest expense. Interest expense was $28.8 million versus $28.1 million.
Outlook, management commentary and risks
- Management said market pricing began rising in 2011 and increases accelerated in Q1 2012, but loss costs were also increasing and prices in some lines remained below levels needed to meet its return objectives. The filing provides no specific earnings or revenue guidance.
- Management described the investment portfolio as highly liquid and said it seeks to align investment and liability duration; fixed-maturity portfolio duration was 3.4 years, versus 3.6 years at year-end. Low interest rates, credit quality, market volatility and foreign currency movements remain investment risks.
- Loss reserves are estimates subject to uncertainty, particularly for long-tail and assumed reinsurance business. Net loss reserves were $8.214 billion, including $1.415 billion for assumed reinsurance. Management disclosed that a 1% change in both frequency and severity for 2011 claims would change the estimate by approximately $56.1 million; larger changes could have greater effects. Q1 favorable development was concentrated in prior accident years, chiefly 2008–2010.
- Loans receivable increased to $357.1 million, net of a $12.9 million valuation allowance. Non-accrual loans were $13 million. The seven largest loans totaled $225 million in amortized cost and $208 million in fair value; management reported debt-service coverage above 3.0 for all but one, whose ratio was temporarily affected by a rate abatement.
- As a holding company, Berkley depends on subsidiary dividends, tax payments and fees to service debt. Approximately $417 million of subsidiary dividends could be paid without regulatory approval during 2012. The company stated that insufficient upstream cash could require capital raising, asset sales or debt restructuring.
- Ordinary-course insurance and reinsurance litigation and arbitration are reserved for; management did not expect a material adverse effect, while acknowledging adverse outcomes remain possible. No material risk-factor changes were reported. Disclosure controls were considered effective, with no material change in internal control over financial reporting.
Accounting and unusual items
Effective January 1, 2012, the company adopted revised insurance acquisition-cost guidance and retrospectively adjusted prior-period statements. Adoption reduced common stockholders’ equity by $55 million as of January 1, 2012; Q1 2011 net income was retrospectively reduced from $116.5 million to $115.6 million and diluted EPS from $0.79 to $0.78. The quarter also included a $7 million reduction in the mortgage-loan valuation allowance, netted against $3 million of other-than-temporary impairments in reported investment gains.
Important facts for investors to verify
- Whether premium rate increases keep pace with rising loss costs, and how renewal retention and growth in newer international markets develop.
- Whether reserve estimates remain adequate, given the long-tail exposure, assumed-reinsurance reporting delays and reduced favorable reserve development.
- The sustainability and composition of investment returns, including realized gains, investment-fund income and mortgage-loan credit performance.
- Debt levels, upcoming maturities, subsidiary dividend capacity and holding-company liquidity following the senior-note issuance.
- The effects of the acquisition-cost accounting restatement when comparing reported historical results and equity.