Markel Corporation
Q1 2016 Earnings Call Transcript

Published: 4 May 2016

[Operator:]

Good morning and welcome to the Markel Corporation First Quarter 2016 Conference Call. All participants will be in listen-only mode. During the call today we may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They are based on current assumptions and opinions concerning a variety of known and unknown risks. Actual results may differ materially from those contained in or suggested by such forward-looking statements. Additional information about factors that could cause actual results to differ materially from those projected in the forward-looking statements is included under the captions, Risk Factors and Safe Harbor and Cautionary Statement in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q. We may also discuss certain non-GAAP financial measures in the call today. You may find a reconciliation to GAAP of these measures in the Form 10-Q which can be found on our website at www.markelcorp.com in the Investor Information section. Please note this event is being recorded. I would now like to turn the conference over to Tom Gayner, Co-Chief Executive Officer. Please go ahead.

[Thomas S. Gayner:]

Thank you, Ellison. Good morning everyone and welcome to the 2016 first quarter conference call for the Markel Corporation. My name is Tom Gayner and I'm joined by my colleagues Anne Waleski, Mike Crowley and Richie Whitt. Anne will brief you on the financial results, Mike and Richie will discuss our insurance operations, and then I will return with comments on our investment results in Markel Ventures. As always, we thank you for your interest and support of Markel and we look forward to your questions. With that, Anne?

[Anne G. Waleski:]

Thank you, Tom, and good morning, everyone. Our first quarter results were very strong and are in many ways a continuation of the trends that we saw in 2015 with our investing, underwriting and Markel Ventures operations, all contributing to our success. I am also pleased to report that we have substantially completed the integration of two acquisitions that were closed late last year, reporting our first results during the quarter for both Markel CATCo and CapTech. Now, let's talk about our first quarter 2016 results. Total operating revenues grew 6% to just under $1.4 billion in 2016 from $1.3 billion in 2015. The increase is driven by a roughly 18% increase in revenue from Markel Ventures. This increase is primarily due to our acquisition of CapTech in the fourth quarter of 2015 and higher sales volume in our manufacturing operations. Moving into the underwriting results. Gross written premiums were $1.4 billion for the first quarter of 2016 compared to $1.3 billion in 2015, an increase of 11% driven primarily by an increase within our Reinsurance segment. The increase in the Reinsurance segment was due to new business and renewals of multi-year policies in our general liability and product line – property lines. In the U.S. Insurance segment, there was increased volume due to a later closing of our underwriting system in the first quarter of 2016 as compared to the same period a year ago. Excluding the impact of the timing difference, we experienced growth in our personal lines business as well as our general liability and property product lines. Foreign currency movements did not have a material impact on premiums in the quarter. Market conditions remained very competitive. Consistent with our historical practices, we will not write business when we believe prevailing market rates will not support our underwriting profit targets. Net written premiums for the first quarter of 2016 were $1.2 billion, up 14% from the prior year for the same reasons I just discussed. Net retention increased 2 points to 85% in 2016 compared to 83% in 2015. The increase was due to higher retentions in our Reinsurance segment primarily on our property book. Earned premiums increased 1% to $958 million for the first quarter of 2016. The timing difference I just mentioned had a negligible impact on earned premiums and the growth was driven by the higher volumes generated by our personal lines business as well as our general liability and property product lines. Our consolidated combined ratio for the first quarter of 2016 was an 88% compared to an 83% last year. The increase in the combined ratio was driven by 5 points less favorable development in the prior accident year loss ratio in 2016 compared to 2015. For the first quarter of 2016 prior year redundancies were $118 million compared to $167 million for the same period a year ago. As you may recall, redundancies on prior year loss reserves in the first quarter of 2015 included $36 million or 4 points attributable to a decrease in the estimated volatility of our consolidated net reserves for unpaid losses and loss adjustment expenses as a result of dealing (05

[F. Michael Crowley:]

Thanks, Anne. Good morning. U.S. segment is off to a very solid start in 2016. As a reminder, this segment comprises all direct business written on our U.S. insurance companies and includes all of the underwriting results for our Wholesale and Specialty divisions as well as certain products written by our Global Insurance team. Gross written premiums for the U.S. segment were $648 million, an increase of $62 million, or 11% compared to prior year. This increase was primarily due to the timing of closing of our underwriting systems for the quarter. However, excluding the additional booking time in the quarter all divisions recorded modest growth. We continue to see growth in our Hagerty classic car program and our workers' comp product lines within our Specialty division, as well as our property and casualty lines in the Wholesale division. Within the Wholesale division, we saw growth from both our binding and brokerage distribution channels. Another encouraging factor for our Wholesale division was the fact that 11 of our 12 largest relationships grew in the quarter. The combined ratio for the first quarter of 2016 was 89% compared to 84% for the same period a year ago. The 5 point increase in the combined ratio is primarily driven by less favorable development of prior accident year loss reserves and a slightly higher expense ratio, both of which were partly offset by lower current accident year loss ratio. First quarter of 2016 had 6 points less favorable development on prior year accident year loss reserves compared to 2015. Last year's results included $19 million or 4 points of redundancy on prior accident years due to the reduction in the estimated volatility of our net loss reserves. Additionally, during 2016 we saw adverse development within our medical malpractice and specified medical product lines due to increased claim frequencies on some classes of business. The current accident year was favorable to last year due to lower loss ratios across a number of product lines as Anne discussed in her comments. The rate environment continues to be very competitive. Rates for smaller accounts were flat in the quarter, large accounts in our global business remained a battlefield, reductions in modest single digits. In an effort to combat the competitiveness of the market, we enjoyed some success with new ways to sell our products. We're working with several large brokers on their initiatives to become more efficient in their delivery of our products to their clients. We're also participating in a new underwriting facility for property coverage and expect to see more of these facilities in the future. We're also exploring layered bundling approaches including a number of lines of coverage for large accounts. There were two key personnel changes in January. Robin Russo was promoted to Deputy Chief Underwriting Officer. Robin joined Markel in July of 1999. He has served in various key underwriting roles at Markel including Senior Vice President and Chief Underwriting Officer of Markel Insurance Company. Since 2010, he has served as Executive Underwriting Officer in the Product Line Leadership Group, assisting Gerry Albanese with developing and implementing underwriting strategies and best practices across Markel North America. Also in January, Linda Schreiner joined Markel as Senior Vice President, Strategic Management. Previously Linda was Chief Human Resource Officer and Chief Administrative Officer of MeadWestvaco Corporation. During her 15 year tenure at MeadWestvaco, Linda served as a Strategic Advisor to the Board and managed succession planning and talent management as well as communications and global facilities. As previously announced, Linda will assume the additional duties of Chief Human Resource Officer of Markel later in the year. Markel's ability to fill these key positions from within combined with our ability to attract top talent for expanded roles remains a very important strength of our organization. I'll now turn it over to Richie.

[Richard R. Whitt, III:]

Thanks Mike. Good morning, everyone. Today, I'll focus my comments on underwriting results for the first quarter for both International Insurance and the Reinsurance segments. Both segments are off to a very strong start and produced outstanding underwriting results for the first quarter. First, I'll start with the International Insurance segment which includes business written by our Markel International division as well as certain products written by our Global Insurance division. Gross written premiums were relatively flat to prior year at $291 million for the first quarter of 2016. As has been said a number of times already, market conditions continue to be difficult especially in London and in our global property products. I'll speak a little more about these headwinds later in my comments. The first quarter combined ratio was 95% compared to 73% for the same period a year ago. The increase in the segment combined ratio for the quarter was primarily driven by less favorable prior accident year takedowns in 2016. Prior accident year losses were unfavorable by 23 points for the quarter driven by lower redundancies most notably in our marine and energy lines. The segment also saw a benefit in the first quarter of 2015 related to the decrease in the estimated volatility of our net loss reserves. That contributed $17 million or 8 points, as Anne previously referred to that. The expense ratio increased 3 points compared to the first quarter of 2015 due to a 2 point increase in variable expenses related to an increase in earned premiums during the quarter on our marine and energy lines. Those lines carry a higher commission rate. Finally, these unfavorable movements were partially offset by a 5 point increase in our current accident year loss ratio. This was primarily driven by lower attritional losses on our property product lines. Similar to earlier comments, we've seen a decrease in our ultimate loss ratio picks across multiple product lines in both divisions in the first quarter. Next, I'll discuss the results of the Reinsurance segment, which includes treaty reinsurance program written by our Global Reinsurance division as well as those written by our Markel International division. For the first quarter gross written premium for this segment are up about $75 million or 20% compared to the first quarter of 2015. This growth is driven by a few large quota share reinsurance treaties within our property and general liability products as well as several two year treaties in general liability. Given how large quota share treaties can be, quarterly gross written premium can and will be volatile. In addition, when multi-year treaties are written, current period gross written premium benefits from this one-time increase. While we're certainly pleased with the results for the quarter, we continue to see extremely difficult market conditions and would not expect such significant growth during the rest of the year. The combined ratio for the Reinsurance segment was 82% for the first quarter of 2016 as compared to 89% for the same period last year. The 7 point reduction in the combined ratio was driven by a decrease in both our current and prior accident year loss ratios. The current accident year loss ratio decreased 5 points due to lower ultimate loss picks across multiple product lines as well as less earned premium from auto reinsurance business which carries a higher loss ratio. You'll probably recall, we talked a lot last year about the fact that we made the decision to reduce our auto writings due to poor results. Current accident year favorable loss development was $10 million higher in 2016 due to higher takedowns in our property and marine and energy product lines. Finally, these favorable movements were partially offset by a 3 point increase in our Reinsurance segment expense ratio. The increase over prior years relates to higher profit sharing in 2016 as well as higher variable expenses related to mix of business. I'll make a couple more quick comments on competition. Market conditions remained challenging with London market and larger account business under the most pressure. Competition (19

[Thomas S. Gayner:]

Thank you, Richie. I'm happy to report to you that we're off to a good start in 2016. As we've talked about before, Markel benefits from a comprehensive approach to building the values of this company for our clients and customers and our associates; in doing so, we build financial value for our shareholders. We describe the values of this company in the Markel style and we talked about our belief in hard work and pursuit of excellence while keeping a sense of humor. We also consistently reiterate our creed of honesty and fairness in all of our dealings. There is no more important message that I can give you this morning than to tell you that we follow that formula to repeat (21

[Operator:]

And our first question will come from Jeff Schmitt of William Blair. Please go ahead.

[Jeff Schmitt:]

Hi. Good morning, everyone.

[Thomas S. Gayner:]

Good morning.

[Jeff Schmitt:]

Looking at Markel Ventures, the EBITDA margin moved up over 14%, looks to be about 14.5%, net profit margin at 5%. These look like the highest numbers at least that's the (27

[Thomas S. Gayner:]

It's Tom. The EBITDA margins are the more meaningful thing to look at as opposed to net income. Net income is heavily influenced by purchase accounting and the younger in the business to do part of Markel, the more purchase accounting will (27

[Jeff Schmitt:]

So do you view these levels as more of a run rate going forward? I mean, they are above-historical levels.

[Richard R. Whitt, III:]

I would think or appropriate to think of it as a run rate over long periods of time, but there will be a lot of volatility any (28

[Jeff Schmitt:]

Yeah.

[Richard R. Whitt, III:]

Just like insurance business. And net-net-net we don't judge ourselves or think about quarters too much. We think about rolling five-year periods and things like that. And over a rolling five-year period, yeah, low-to-mid teens EBITDA margins (29

[Jeff Schmitt:]

Okay, okay. Thank you.

[Operator:]

Our next question will come from John Fox of Fenimore. Please go ahead.

[John D. Fox:]

Okay. Thank you. Hello, everyone.

[Thomas S. Gayner:]

Good morning, John.

[John D. Fox:]

My question specifically I think is for Richie. There were a lot of good surprises in the results, but I was surprised by the amount of reinsurance – gross written reinsurance premiums. Certainly, it's well known that reinsurance premiums have been heading down particularly on the property side for a few years, and you mentioned retaining more of the property business. So could you just talk about the growth in reinsurance premiums, why you're writing more property at this point, as rates have been declining, and what you think kind of the risks are the in the property book at this point? Thank you.

[Thomas S. Gayner:]

Sure.

[Richard R. Whitt, III:]

Yeah. Thanks John. Like I tried to say in my comments, I think the headline number of 20% is probably a little more flattering than it really is. We had a couple large quota share deals that, the timing just happen to be, that we got them in the first quarter and so they – they sort of pumped up the first quarter volume. A couple of those situations, one in particular, we've been working on for three years and we finally were able to put the deal together and that fell into the first quarter. So there is a decent amount of timing there. In addition, we had quite a few – had become more and more popular just kind of with where the market is of multi-year deals. And we had a number of two-year deals that we booked in the first quarter. And what basically happens is, in terms of gross written premium, that all gets put into the quarter in which you write the deal. So first quarter has been flattered by those deals, first quarter next year will be lower as a result of not having that premium in the first quarter next year. So we definitely had a good first quarter in terms of writings, but at the same time we also stepped away from a number of programs or reduced on programs where we were comfortable with where the pricing had been (31

[John D. Fox:]

Okay, great. And how do you think about when you come into the year, the amount of property cat reinsurance you're willing to write. I mean, of course, there is a concept of PMOs of course and – but how do you guys think about it in terms of kind of, quote-unquote, what you're willing to lose if there is a large event or two or just how do you approach the property cat business risk?

[Thomas S. Gayner:]

Sure. Well, we set on various metrics of corporate appetite, how much we're willing to lose in a certain size event, how much of our shareholders' equity we're willing to expose, and we monitor those metrics very carefully. And I can tell you, just given the state of the property market and what – as you mentioned what's been happened in the last few years, we are well below with our appetite with the – in a more – in a better pricing environment. So we're well within those metrics today. Property, we basically – I don't think we've written much – probably about flat to last year in total in the first – or what we think we'll write this year. There were some timing differences in terms of the first quarter bookings. So we're, as I said, well below our theoretical maximum appetite in a better market, and I don't really see us pushing the gas pedal to speak as we go through this year.

[John D. Fox:]

Okay. Thank you.

[Operator:]

Our next question will come from Mark Dwelle of RBC Capital Markets. Please go ahead.

[Mark Dwelle:]

Yeah. Good morning. I have kind of three questions, I guess. The first one relates to the U.S. business. You commented about timing difference there in terms of keeping the underwriting book on (34

[F. Michael Crowley:]

Yeah, it is right, Mark. It's Mike. But even – but we had an extra week of bookings. But even excluding that extra week, the revisions (34

[Mark Dwelle:]

Okay. So there was a little bit of growth in the quarter, but I mean the difference between a little bit and 11% or whatever the total was, is really almost entirely that extra week?

[F. Michael Crowley:]

Yeah.

[Mark Dwelle:]

Okay.

[F. Michael Crowley:]

Yeah. I think that's a good assessment. We had – I'd like to say modest single-digit growth excluding that.

[Mark Dwelle:]

Okay. All right. The second question, I guess this is in the other revenues and expenses table in the queue. You break out the investment management segment, which, I guess, I assume is probably the CATCo unit. And that unit showed a small loss for the quarter. Was there a certain amount of acquisition or integration related expenses or, I guess, I wouldn't assume that making a loss is your normal state of play in that unit?

[F. Michael Crowley:]

No, that wouldn't be the goal. I can assure you Mark. You're right, that is a portion of it. And I think this first year will be a learning experience for everybody that kind of get used to have the pattern of earnings on CATCo. But there's a couple of things going on. There is a seasonality to the earning of the management fees at CATCo, and first quarter and fourth quarter are the lowest, second quarter and third quarter are the highest kind of corresponding with – the wind risk is in the portfolio. So relatively low management fees compared to what we'll see in the next two quarters at CATCo, that's part of it. You mentioned and that you are correct, there are some acquisition costs – related costs going through this year, state bonuses, incentives, planned bonuses, those will be recurring for the rest of the year. And then, probably the biggest thing is, we're only recognizing in revenue the management fees as we go through the year. If we get through the year and have a solid year in the fourth quarter at the stroke of midnight on December 31, we will go ahead and recognize performance fees as well. There is some leeway in terms of accounting. We chose the preferred method, which was wait until you're absolutely certain that's earned. So our fourth quarter has the potential to be where most of the revenue is booked into CATCo.

[Mark Dwelle:]

Okay. That's helpful. Probably that's something I can easily model in advance, but at least that understands how the flow of the numbers is going to go?

[F. Michael Crowley:]

We heard the ball dropping in Times Square. It means a lot to us this year.

[Mark Dwelle:]

All right. Thanks. The last question I had – and I think you touched on it in terms of the tax rate, the tax rate in the quarter was sort of in the in between space between sort of where it used to be and where it was last year. Could you just go through again how – what benefit, if any, was from the foreign tax paid in the quarter?

[Anne G. Waleski:]

Well – so last year we had benefit from the foreign tax credits of about, I think, 8%. So this year you're right, we're sort of at the level we are – we're a little bit lower than we had been historically, but moving back into that space, 24%. And I think it would be our expectation that we would be in the mid-to-high 20%s this year.

[Mark Dwelle:]

Okay. So the thing – the factor that was making it a little bit lower this quarter was a little more one-time in nature than being part of just kind of the ongoing assessment?

[Anne G. Waleski:]

No, no, no, no. That would have been the impact to last year's number. So the comparison would be the 24% this quarter versus the 19% last quarter – last year's first quarter. And last year's first quarter would have benefited from those tax credits that we took advantage of.

[Mark Dwelle:]

Okay. I probably asked the question poorly. If you're going to get to a mid-to-high 20%s for the full-year, the balance of the year will need to be relatively higher than the first quarter. Is that a fair way to think of it?

[Anne G. Waleski:]

No, I don't think so. I mean, I think the 24% is our expected tax rate for the year. It's a little bit lower than we would have historically had. And that is being driven by a decrease in earnings that we expect to be taxed at a 35% rate.

[Mark Dwelle:]

Okay. All right. Thanks for that. Those were all my questions. Thank you.

[Operator:]

Our next question is a follow-up from John Fox of Fenimore. Please go ahead.

[John D. Fox:]

Yeah. So good (39

[F. Michael Crowley:]

Sure. Thanks John. You're right. Really I think the way to think about CATCo and what it means to Markel is

[John D. Fox:]

Okay. Just curious the $200 million is where on the balance sheet?

[Anne G. Waleski:]

In the investment portfolio.

[John D. Fox:]

In equity investments or?

[Anne G. Waleski:]

I think $175 million of it John is in equity and the other is in equity method that was (42

[John D. Fox:]

That's close enough. And $44 million early extinguishment of debt, is that pre-tax?

[Anne G. Waleski:]

It is. Yes, it's pre-tax and it will come through in the second quarter.

[John D. Fox:]

Right. Thank you.

[Operator:]

Our next question is from Mark Hughes of SunTrust. Please go ahead.

[Kevin Alloway:]

Hi. This is actually Kevin Alloway on for Mark Hughes. Just a question about current year – for current accident year loss, it seem kind of lower generally across the board, is that a sustainable level or is this more of a one-time phenomenon.

[Anne G. Waleski:]

I think it is a trend we started to see in the fourth quarter a little bit. So we think it is attritional losses as well as lower loss ratios across product lines. So we believe it's sustainable, but we will look at it every quarter.

[Kevin Alloway:]

Okay. Thank you.

[Operator:]

Our next question will come from Rob Hauff of Wells Fargo Securities. Please go ahead.

[Rob G. Hauff:]

Yes. Good morning. Had a quick question on the large quota share that you mentioned. I'm curious was that with a new or existing customer to Markel?

[F. Michael Crowley:]

That was a new customer. It was a customer we have been quoting for probably three years now and we're finally able to breakthrough and have success. And that's sort of the nature of that business. There is a long lead time sometimes on putting those deals together, and when they come they can be pretty substantial. That was roughly a $20 million deal in the first quarter.

[Rob G. Hauff:]

Okay, great. Thank you very much. And then I don't want to focus too much on this, but just, if you could give us a little bit of color on the adverse development in the medical lines. Was that concentrated in certain accident years. Is there any – was it concentrated in certain customer types, that it emerged (44

[F. Michael Crowley:]

Yeah, sure. I think there are some specific areas we saw and then I think also there is some general trend there. The specific areas we saw were some areas like correctional medicine, we saw some uptick in losses in that area, and that's an area we've written a decent amount of premium in, in the past. The other thing I would just say is just the general state of healthcare. There has been a trend from solo practitioners into larger practices, into practices being brought into hospitals. And I don't think we've got our hands totally around it at this point, but we do believe that is leading to higher trend in terms of the medical lines. So we are looking at it very carefully. We've taken a lot of corrective actions and we think we're on top of it.

[Rob G. Hauff:]

Great. And then, last question. Just wondering if you could just update us on your thoughts on the M&A landscape, whether it'd be valuations, the pipeline you guys are being shown or whether or not you're seeing better opportunities in the underwriting business versus the ventures business. Thanks.

[Thomas S. Gayner:]

In general prices are high across the board. (46

[Rob G. Hauff:]

Great. Thank you very much.

[Richard R. Whitt, III:]

The one thing I will add to that is and Tom is absolutely right, prices do seem to be high across the board and expectations seem to be high across the board. Probably the other side of that coin at lease in insurance is organic growth is going to be very, very difficult to come by. And so if you are setting out growth targets for yourself, acquisition is the other way to do it. So at some point people will come to a meeting of the minds on that and we might see some deals. But right now I think just given what the future looks like, people expect a little too much for their companies.

[Rob G. Hauff:]

Makes sense. Thank you.

[Operator:]

Having no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Tom Gayner for any closing remarks.

[Thomas S. Gayner:]

Thank you very much. Glad you joined us. We look forward to standing with you next quarter. Take care.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.