Earnings Call: Q4 2016

Feb 9, 2017

Good morning, and welcome to the Markel Corporation 4th 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 ks 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 press release, 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, sir. Thank you so much. Good morning. It's my pleasure to welcome you this morning to our year end 2016 conference call. We're pleased with our solid economic progress that we achieved in 2016, but we're not satisfied. What encourages me most is that we were able to earn these returns despite ongoing hyper competitive conditions in every market in which we compete. We also earned these returns despite some specific challenges in our underwriting results as well as from the modest uptick in interest rates that occurred at the back end of the year. I think these results stand as a testament to the hard work, creativity and adaptability of the people of Markel. These results also demonstrate the benefit of operating diverse lines of insurance, investment and industrial businesses. We're not reliant on any one market or industry. We continue to evolve and adapt as a corporation in the face of an ever changing business environment. The world is changing fast and so are we. This is what we've always done and it is what we will continue to strive to do. We appreciate your long term support and partnership as we do so. As is our usual practice in these calls, Anne Walensky, our Chief Financial Officer, will review the numbers, and then Richie Witt, our CEO, will discuss our insurance operations and then I'll make a few brief comments about our investments in Markel Ventures operations. After that, we'll open up the floor for questions. With that, let me turn it over to Anne. Thank you, Tom, and good morning, everyone. I'm happy to report that our financial performance for 2016 was strong across our underwriting, investing and Markel Ventures operations. We are pleased with our underwriting results for 2016, especially given the continued challenging market conditions that Tom mentioned. Markel Ventures revenue surpassed $1,200,000,000 which reflects organic growth and the addition of Capptec in late 2015. Book value per share was up 8% in 2016 and reflects strong performance in our investment portfolio driven by favorable movements in the equity markets. Total operating revenues grew 5 percent to $5,600,000,000 in 2016 from $5,400,000,000 in 2015. The increase is driven by a roughly 16% increase in revenue from Markel Ventures, which is primarily due to our acquisition of CapTec and higher sales volume from 1 of our transportation related manufacturing businesses. We dive into the underwriting results. Gross premium volume for 2016 increased 4% compared to 2015. The increase was attributable to the U. S. Insurance and Reinsurance segments, partially offset by lower gross premium volume in our International Insurance segment. Within the U. S. Insurance segment, we're seeing higher volumes within our personal and general liability lines of business in 2016 compared to 2015. As we discussed in previous calls, the increased volume in the U. S. Insurance segment is also due in part to closing our underwriting systems 1 week later in 2016 as compared to the same period a year ago. The increase in premium volume within the Reinsurance segment was due to new business and to the favorable timing of renewals of multiyear policies in our general liability and property lines in 2016. Lower premium volume for the International Insurance segment in 2016 was due to unfavorable movements in foreign currency rates of exchange as well as lower premium volume within our credit, surety and marine and energy product loss. Market conditions remain very competitive. Consistent with our historical practices, we will not rate business when we believe prevailing market rates will not support our underwriting profit targets. Net written premiums for the year were $4,000,000,000 up 5% from the prior year due to increases in gross premium volume as just discussed as well as an increase in net retention to 83% in 2016 compared to 82% last year. The increase in net retention for 2016 was driven by higher retention within all three of our segments, largely due to changes in mix of business. Earned premiums were up 1% in 2016 compared to the same period of 2015 due to higher premium volume in our U. S. Insurance segment. Our consolidated combined ratio for 2016 was 92% compared to an 89% last year. The increase in the combined ratio was driven by less favorable development on prior year loss reserves. In 2016, prior year redundancies were $505,000,000 compared to $628,000,000 last year. Redundancies on prior year loss reserves during 2016 were net of $71,000,000 or 2 points of adverse development on our medical malpractice and specified medical product line. Redundancies on prior year loss reserves in 2015 included $83,000,000 or 2 points of favorable development attributable to a decrease in the estimated volatility of our consolidated net reserves for unpaid losses and loss adjustment expenses as a result of ceding a significant portion of our asbestos and environmental exposures to a 3rd party in 2015. In our U. S. Insurance segment, prior year redundancies for 2016 were $205,000,000 compared to $299,000,000 a year ago. In 2016, this segment was impacted by adverse development on medical malpractice and specified medical product lines, as we discussed earlier during the year. We did not see additional adverse development on these lines in the 4th quarter. As a reminder, 2015 included $35,000,000 or 2 points of redundancies related to the decreases in reserve volatility. In our International Insurance segment, favorable development on prior year loss reserve was $165,000,000 down from $249,000,000 last year. This decrease in loss reserve redundancies was driven by less favorable development on our marine and energy and excess liability product lines in 2016. Additionally, 2015 included $32,000,000 of redundancies related to the decrease in reserve volatility. In our Reinsurance segment, we recognized $126,000,000 of prior year redundancies in 2016 compared to $98,000,000 in 2015. More favorable development on prior year reserves in 2016 was across various product lines, but this most significant year over year improvements were seen in our property product lines. 2015 included $15,000,000 of redundancies related to the decrease in reserve volatility. Also worth noting, our 20 16 current accident year loss ratio included $69,000,000 or approximately 2 points on the consolidated combined ratio of underwriting loss related to Hurricane Matthew, which occurred in the Q4 and the Canadian wildfires that occurred during the Q2. These losses were more than offset by lower loss ratios across a number of products in all three of our underwriting segments in 2016 compared to 2015. Now we'll talk a little bit about the details of Markel Ventures results. Revenue from Markel Ventures increased to $1,200,000,000 that compares to $1,000,000,000 a year ago. We also saw increases in Markel Ventures net income to shareholders and EBITDA in 2016. Overall performance in 2016 was driven by higher sales volume in 1 of our transportation related manufacturing businesses, improved results across our non manufacturing businesses and the contribution of earnings from CapTech. Both 2015 2016 were impacted increases in contingent purchase consideration obligations and goodwill impairment charges. 2016 results included a $10,000,000 increase in our contingent consideration obligation related to our purchase of CapTech and a $19,000,000 goodwill impairment charge related to one of our manufacturing reporting units. 2015 included a $31,000,000 increase in our contingent consideration related to Xtrel and a $15,000,000 goodwill impairment charge to 1 of our healthcare reporting units. Now we'll talk for a few minutes about our investment results. Investment income increased 6% from $353,000,000 for 20 15 to $373,000,000 this year. Net realized investment gains for 2016 were $65,000,000 compared to net realized investment gains of approximately $106,000,000 a year ago. Net unrealized investment gains increased $242,000,000 in 2016 compared to a decrease of $320,000,000 in 2015. The increase in net unrealized investment gains this year was attributable to an increase in the fair value of our equity portfolio compared to prior year end. Given our long term focus, variability in the timing of realized and unrealized gains and losses is to be expected. Our effective tax rate was 27% in 2016 compared to 21% a year ago. The increase in the effective tax rate in 2016 compared to 2015 was primarily due to the impact of higher foreign tax credits in 2015. As you may recall, in 2015, we recognized non recurring foreign tax credits of approximately 8% of pretax income compared to 2% in 2016. Foreign tax credits of the magnitude recognized in 2015 are not expected in future periods. We reported net income to shareholders of $456,000,000 for 20.16 compared to $583,000,000 a year ago. Comprehensive income for the period was $667,000,000 compared to $233,000,000 a year ago. And as a result, book value per share at the end of 2016 was approximately $606 an increase of 8% since the end of 2015. To wrap up, I'll make a couple of comments on cash flows and the balance sheet. Net cash provided by operating activities was $535,000,000 for 2016 compared to $651,000,000 in 2015. Operating cash flows for 2016 included higher claims payments primarily in the U. S. Insurance segment and higher payments for employee profit sharing compared to 2015. Our holding company is $2,500,000,000 of assets at the end of 2016 compared to $1,600,000,000 at December 31, 2015. This increase was primarily the result of distributions received from our subsidiaries and net proceeds from the issuance of long term debt during the Q2 of 2016. With that, I'll turn it over to Richie to talk about our underwriting results. Thanks, Ann, and good morning, everyone. Today, my comments will focus on our 3 ongoing underwriting segments, U. S. Insurance, International Insurance and Reinsurance. As Ann commented, all three segments produced really solid underwriting profits in 2016. At the end, I'll also provide a brief update on Markel CATCo and a few market comments. And of course, in the question and answer, we're happy to talk about market conditions. So first, I'll start with the U. S. Insurance segment. Gross written premiums for the segment were up 3% for the quarter and 5% for the year compared to the same periods in 2015. For both the quarter the year, this increase continues to be driven by growth in personal lines, primarily the Hagerty Classic Car Program and personal property lines as well as our general liability lines, mainly excess and umbrella and brokerage and binding contractors. The combined ratio for the Q4 of 2016 was an 88% compared to 87% for the same period last year. For 2016, the combined ratio was 93% compared to 89% in 2015. The increase in the combined ratio for both periods of 2016 compared to 2015 is driven by less favorable development on prior year's loss reserves in 2016. This is partially due to the redundancies in 2015 related to the decrease in the volatility of our consolidated net reserves, which Anne just discussed and we've discussed for a number of quarters now. That added 3 points to the combined ratio in the quarter and 2 points for the year. Additionally, our Q4 2016 results include $18,000,000 of underwriting losses related to Hurricane Matthew, which increased the combined ratio 3 points in the quarter and 1 point for the year. Finally, our 2016 results were also impacted by adverse development in our medical product lines of $71,000,000 or 3 points, which occurred during the 1st 9 months of 2016. We did not record any additional reserve strengthening on medical lines in the 4th quarter. We took significant corrective actions on our exiting certain states and re underwriting and re pricing the ongoing book. The current accident year loss ratio decreased slightly in the quarter, but is flat for the year due to lower attritional loss ratios across a number of product lines, partially offset by higher loss ratios in the medical lines as well as the impact of Hurricane Matthew. The expense ratio for the U. S. Segment is in line with prior years. Now moving to the International Insurance segment. Gross written premiums for this segment were down 5% for the quarter and 4% for the year due in part to the strength of the U. S. Dollar during 2016. Additionally, we continue to experience very tough market conditions, especially within our marine and energy, professional liability and credit surety lines of businesses. The 4th quarter combined ratio of 9.2 compares to 83% for the same period a year ago. The combined ratio for 2016 was 94% compared to 86% for 2015. The increase in the segment combined ratio for both quarter and year was mainly driven by lower prior year redundancies in 2016, most notably in our marine and energy and excess liability lines. The segment also saw a benefit last year related to the decrease in estimated volatility of our net loss reserves as previously discussed, which contributed 7 points to the combined ratio for the quarter and 4 points to the combined ratio for the year in 2015. Those were benefits, I should be clear. Our current accident year loss ratio in 2016 was flat for the quarter and down slightly for the year due to decrease in management's best estimate of ultimate loss ratios on various product lines. This benefit is partially offset by $12,000,000 of underwriting losses related to Hurricane Matthew as well as higher losses on our marine and energy product line. The expense ratio increased slightly on both quarter year to date basis due to higher broker commissions and the write off of previously capitalized development costs in 2016. This was partially offset by lower profit sharing expenses in 2016. Finally, discuss the results of our Reinsurance segment. We continue to see growth in the Q4 and finished the year at over $1,000,000,000 of premium, which is up 8% for the year and 35% for the quarter. As I've discussed throughout 2016, the growth in premiums is driven by multiple large quota share reinsurance treaties within our property and general liability product lines as well as the timing impact of multiyear deals year over year. So I think I've talked about this in the past. It's going to be a little lumpy. 8% up for the year is not surprising, getting some of the larger contracts that we added to the portfolio during the year. I wouldn't expect next year. We would be hoping for sort of 3% to 5% growth depending on if we had a stable market in reinsurance. The combined ratio for the reinsurance segment was 87% for the 4th quarter of 2016 as compared to 83% for the same period a year ago. The combined ratio in 2016 was 87% compared to 90% last year. Favorable development on prior year loss reserves in 2016 was $3,000,000 higher in the quarter and $28,000,000 higher for the year. For both the quarter the year, we experienced higher loss reserve takedowns primarily in our product product property product line, excuse me. This favorability is partially offset by the impact of the decrease in the estimated volatility of net loss reserves. We get to stop talking about this The current The current accident year loss ratio on 2016 was flat for the quarter and down slightly for the year due to lower attritional loss ratios in 20 16 as well as lower ultimate loss ticks across multiple product lines in 2016. This favorability was partially offset by the impact of Hurricane Matthew, which added 8 points in the quarter and 2 points for the year. The 'sixteen results also include 2 points related to the Canadian wild fires that occurred in the Q2 of 2016. Finally, the 2016 expense ratio for the Reinsurance segment increased in the quarter and for the year, primarily due to higher profit sharing expenses in 2016 as compared to 2015. That's a good reason for expense ratios to go up, by the way. Finally, I'll end up with a couple of comments on market conditions in Markel CATCo. I have very little to add from the last couple of quarters in writing regarding pricing and competition. Mike and I obviously are available to answer questions in the Q and A. All markets remain extremely competitive. Hurricane Matthew had little or no impact on Florida property insurance or reinsurance pricing or property pricing in general. Pressure on pricing continued during the January 1 renewals. However, most lines could probably be described as flat to down 5% versus larger reductions in prior years. However, that's very dependent on the line of business. It's all over the map, but there does appear to be some stabilization. Finally, I'd like to make a few comments about our Markel CATCo operations. Assets under management ended the year at $3,600,000,000 up from $2,600,000,000 at the end of 'fifteen. We've seen increased demand from both cedents and investors heading into 2017. From the standpoint of impactful catastrophic losses, CATCo successfully navigated a pretty challenging 2016, posting solid returns for its investors. Also, just as a reminder, Markel continues to invest roughly $200,000,000 in the Markel CATCo funds. So with that, I'd like to turn it over to Tom. Thank you. Thank you, Richie. Pam gave you the detailed numbers, so I'll just add some color commentary on what I consider to be some of the key points on our investment and ventures operation. First, we earned 13% on our equity investments during the year, which exceeded the S and P 500 return of 12% by 100 basis points. More important than any 1 year though is the longer term record. With the 2016 results from the books, we now enjoy a 27 year record of excellent equity investment returns with that 100 basis point advantage in place for 27 years now. While there has been and will continue to be volatility in these results, this is an outstanding result, and we think it's reasonable to suggest that our disciplined, rational, long standing approach to investing works. Also, I think it's important to note that in my opinion, public equity markets offer more opportunity than many of our other capital allocation choices in today's environment. It is difficult, but not impossible when this is the SureTech acquisition to find attractive acquisition opportunities in our insurance and venture operations at good prices. Public equity pricing is more dispersed than what we generally find in insurance or private equity markets. That volatility of stock prices creates opportunities and we continue our practice of steady adding dollar cost averaging into equities. I expect this to continue into 2017. In our fixed income operations, we continue to own a very high quality portfolio with a duration and currency profile that is roughly matched to our insurance liabilities. For all of 2016, we earned 2.4% in local currency terms. While the mark to market price of that portfolio dropped a bit in the 4th quarter with rising interest rates, the reinvestment of new funds took place at higher rates. Over time, the volatility of returns diminishes almost completely, and we end up earning the coupon from our bonds. This has been and will continue to be our consistent approach. It's also worth noting that we continue to maintain a very liquid and conservative balance sheet that gives us the opportunity deploy capital when we see opportunities to do so. On the Markel Ventures front, we had a spectacular year. Revenues grew 20% from $1,000,000,000 to $1,200,000,000 and EBITDA grew 81 percent from $91,000,000 to $165,000,000 20 16 was a year in which our cyclical businesses enjoyed the good parts of their respective cycles. Our steady Eddie businesses continued to churn out solid results and we had some improved results at some units where we previously had faced challenges. I would also note that in 2016, this revenue growth and EBITDA improvement took place in a very capital efficient factor. We didn't buy any new businesses, although we tried to, and in fact, we dividend up money from Markel Ventures to the Holy Company during the year. My point is that the collection of Markel Ventures businesses are cash flow businesses that are quite capital efficient. The fundamental nature of them is different than what is the case in our insurance businesses and their cash flows can be earned with much less of a tie into their balance sheets than what would be the case in an insurance or financially based business. In a perfect world, we'd be able to continue to add to our Markel Ventures lineup of businesses, and we tried in 2016. We were outbid in several cases during the year, and that's okay. We continue to look and see potential deals to add profitable and interesting businesses to Markel. We think it is more important to remain disciplined and we are extremely pleased with how the managers of the various Markel Ventures companies ran their businesses in 2016. All in all, as I said at the beginning, we are pleased but not satisfied with our economic performance in 2016, and we look forward to facing the challenges of 2017 and beyond. Markel enjoys some spectacular competitive advantages, mainly a group of talented, dedicated and creative people and a long term time horizon as we make business decisions. Those factors have combined to produce wonderful economic results over a long period of time, and we continue to believe they will continue to do so. With that, we thank you for your long term partnership with shareholders, and we look forward to answering your questions. Denise will open the call for questions, please. Thank you, Mr. Gaynor. Ladies and gentlemen, we will now begin the question and answer And your first question will come from Jeff Schmitt of William Blair. Please go ahead. Hi, good morning, everyone. Good morning. It looks like the Investment Management revenue jumped to close to 34,000,000 dollars in the Q4. What sort of caused that jump? And how do we think is there seasonality there? How do we think about sort of the run rate of that? Yes, sure, Jeff. Yes, there's a lot of seasonality to that. We've taken the accounting position in terms of treatment of that. That is basically the performance fee that CATCo earned at the end of the year if they generated profits for the fund investors. So it's roughly 10% of the profit is the amount of that performance fee, and we wait until the stroke of midnight on December 31 to be certain nothing has happened somewhere in the world before we record that income. So that is a can be a very volatile from year to year based on what catastrophes occur, but it's basically 10% of the profit we create in the fund. Okay. Great. And then on the medical line, some of the issues that you're seeing there, is this driven by the litigation environment? I mean, are verdicts on the rise? Or is this more medical cost inflation is picking up or a combination of the 2? I think it's probably more suits being filed and those suits getting further and ending up with more damages being awarded. In the past, maybe those suits would have been dismissed earlier. Now they're getting further, and so they're incurring more legal expense. And then some of the suits are actually ending up in verdicts for the plaintiffs. So that market changed. I mean, the biggest issue we had there was in the correctional medical facility market. We've withdrawn from that market given the rapid deterioration in it. And in the other areas where we were also having some heartburn such as contract staffing, things of that sort, we've looked at the types of doctors we're covering and we've refined that and we've refined and we're just going to continue to monitor it. Yes. And we're just going to continue to monitor it. And are you seeing this sort of a more active litigation environment beyond medical? I mean, are you seeing it in other lines as well? We've been wondering when we would just call that trend, when trends would pick up in the business. And there's probably been some pickup in trends, but it hasn't been tremendous. So I don't see a huge difference in that regard, Mike. No, I agree. I agree. Okay. Thank you. Thank you. The next question will come from Mark Dwelle of RBC Capital Markets. Please go ahead. Yes, good morning. Just a few questions. With respect to the CATCo, I mean, I understand that the most of the increase was because of the performance fee. So I'll ask the question this way. I guess the normal run rate of revenues in that was kind of $8,000,000 or $7,000,000 to $8,000,000 So the whole increment over that kind of core quarterly run rate was all the performance fee? Yes, pretty much, Mark. Yes. Okay. Obviously, we're getting more management fee because assets under management have grown, but that happened during 2016. So the full effect really hasn't been felt in the management fee numbers. So we would expect management fees to go up in 2017, some. And then performance fee is going to be what performance fee is at the end of the year. Okay. That makes sense. The second question, you commented about the reinsurance premiums in the quarter. Were there any actual new contracts in the quarter or these are just the continued benefits from contracts written previously? I think most all of them were quarter shares, so just kind of continue to roll through the numbers. Yes. No, there were some new contracts. I mean, the plus 8% or whatever we were for the full year in reinsurance, it kind of it masked a lot of surgery we were doing on the portfolio to move away from areas we felt were too competitive and try to move on to deals that we felt were better priced. So net net, we were up 8%, but there were a lot of accounts we moved away from and there were a number of accounts we moved to, to try to optimize the portfolio as best we could. Is the character of the book still primarily a liability oriented book or is, I guess to say, is the property been the portion that's been dialing down? Yes. No, there has been some effort to increase the percentage of property a little bit in terms of the makeup of the portfolio, but it's roughly 60% casualty and professional and then specialty lines like surety, things like that and then 40% property. Okay. That's very helpful. Since you mentioned surety, maybe a few comments or observations about SureTech? Yes. Well, we're delighted to welcome John Knox and the SureTech team to Markel. That was a I'll say that was a very quick courtship. We were introduced back late in the year, and we're able to spend some time together here in Richmond and then go spend some time and I went down and spent some time with John and his team in Houston. And very quickly, we all felt like it was the right fit for both organizations. As you know, Mark, I mean, we don't do any surety other than we do some surety reinsurance. We do no primary surety. And this was a team that, I mean, has just had fabulous results ever since their founding. And they're our kind of guys in terms of that underwriting discipline and the way they think about business. So we're delighted to add Surety to our portfolio of products. Yes, I wanted to add, again, this is a spectacular example of where the culture of Markel really pays dividends over a long period of time. So John Knox contacted us directly, made the trip up here. Rich and I went to Houston. So we were able to sit down principal to principal and work this out very quickly. And it's delightful to be approached by someone of his caliber and quality. And we see that on the venture side, we see it on the insurance side, and it's the sort of thing that validates our approach to doing business. Can you provide any kind of I mean, that's great. Can you provide any kind of ballpark kind of census data sort of ballpark of premium revenues, ballpark of historical combined ratios, anything like that? Yes. Well, premium revenue is $75,000,000 to $80,000,000 I think in 2016. Combined ratio is very attractive. I'm looking at mid-70s to 80s, so significant underwriting profitability in the book. And obviously, John and his team have done a great job of growing SureTech, but we just believe bringing them into the Markel fold, introducing them to our contacts, use of our balance sheets, we think there's a huge opportunity even in a very competitive surety market to continue to see profitable growth. Okay. I appreciate the answers. Thanks very much. And ladies and gentlemen, this will conclude our question and answer session. I would like to hand the conference back over to Mr. Tom Gayner for his closing remarks. Thank you very much for joining us. Consider those the closing remarks. We'll see you next quarter. Thanks. Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. You may now disconnect your lines.