Earnings Call: Q1 2015

May 7, 2015

Quarterly report

Good morning, and welcome to the Markel Corporation First Quarter 2015 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 call over to Mr. Tom Gayner, President and Chief Investment Officer. Mr. Gayner, the floor is yours, sir. Thank you so much. Good morning, and welcome to the 2015 Q1 conference call for the Markel Corporation. My name is Tom Gayner, and I'm joined as usual by Ann Wilevsky, Mike Crowley and Richie Whitt. Ann will brief you on the financial results. Mike and Richie will follow with some comments on our insurance operations, and then I'll finish with investment results and an update on Markel Ventures. As always, thank you for your interest and support of Markel, and we look forward to your questions. With that, Anne? Thank you, Tom, and good morning, everyone. I'm happy to report that we are off to a fantastic start in 2015 with our investing, underwriting and Markel Ventures operations all contributing to our success. While this is an exciting beginning, it's important to remember that there is a lot of year left to go. Let's jump into our Q1 results. Our total operating revenues grew 5 percent to $1,300,000,000 in 2015 from $1,200,000,000 in 2014. The increase is driven by higher revenues from Markel Ventures. Other revenues, which include revenue from Markel Ventures, were up just under 40% to $260,000,000 from $186,000,000 last year, primarily due to our acquisition of Cottrell in July 2014. Moving into our underwriting results, gross written premiums were 1,300,000,000 dollars for the Q1 of 2015 compared to $1,400,000,000 in 2014, a decrease of 8%, driven by a decline within our Reinsurance segment. During 2014, we ceased writing auto reinsurance in the UK, and we also decreased our non standard U. S. Auto reinsurance business. Foreign currency exchange rates had an unfavorable impact on the year over year change in gross written premiums. However, even at a constant rate of exchange, gross premium volume declined 5%. As Mike and Richie will discuss in more detail later, 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 Q1 of 2015 were approximately $1,000,000,000 down 9% from the prior year for the same reasons I just discussed. Net retention was down slightly in 2015 and 83% compared to 84% in 2014. Earned premiums decreased 1% to $944,000,000 for the Q1 of 2015. The decrease in 2015 was driven by the unfavorable impact of the U. S. Dollar strengthening against foreign currencies. At a constant rate of exchange, earned premiums for the Q1 of 2015 increased 1% compared to the same period a year ago. During the period, we saw organic growth in several product lines within our U. S. Insurance segment. Our consolidated combined ratio for the Q1 of 2015 was an 83% compared to a 95% a year ago. The decrease in the combined ratio was driven by a 7 point improvement in the prior accident year's loss ratio in 2015 compared to 2014. Also contributing to the decrease in the combined ratio was a 3 point improvement in the current accident year loss ratio and a 2 point improvement in the expense ratio in 2015. The improvement in the current year loss ratio was due to lower attritional losses in our U. S. Insurance and reinsurance segments in 2015 compared to 2014. The improvement in the expense ratio is primarily due to lower general expenses in 2015 compared to 2014. For the Q1 of 2015, prior year redundancies were $167,000,000 compared to $107,000,000 for the same period a year ago. The increase in prior year redundancies in 2015 was due in part to a decrease in the estimated volatility of our consolidated net loss reserves as a result of ceding a significant portion of our 19.92 and prior asbestos and environmental loss reserves to a third party during the Q1 of 2015. Due to the unique nature of asbestos and environmental exposures, the ultimate estimated value of these reserves is subject to greater uncertainty and other types of loss reserves that we hold. Once this transaction occurred, the resulting decrease in estimated volatility caused the confidence level on our consolidated net loss reserves to increase. As you've heard us say over the years, a core principle of our reserving philosophy is to maintain a margin of safety in our loss reserves such that those reserves will prove to be more likely redundant than deficient. We apply this reserving philosophy period over period and monitor the actuarially determined confidence level in our reserves, among other things, to ensure that we apply our judgments in this area consistently. Given these considerations and in an attempt to maintain a level of confidence in our loss reserves within a range consistent with historic levels, we reduced prior year loss reserves during the period by $36,000,000 which had a 4 point favorable impact to the combined ratio. In addition to this one time impact, we experienced more favorable prior year loss reserve development in our professional liability and workers' compensation product lines in the Q1 of 2015 than in the same period a year ago. Now I'll discuss the results of Markel Ventures. During the Q1 of 2015, revenues from Markel Ventures were $245,000,000 compared to $171,000,000 a year ago. That's a 43% increase. Net income to shareholders from Markel Ventures for the period was just under $11,000,000 in 2015, compared to approximately $1,000,000 for the Q1 of 2014. EBITDA was $34,000,000 in 20 15 compared to $14,000,000 in 2014. The increase in each of these measures during 2015 was primarily due to our acquisition of Cottrell in July 2014 and improved results within our other manufacturing operations due in part to increased shipments in 2015 as compared to 2014. Now, we'll talk a little bit about our investment results. Investment income increased to $93,000,000 for the Q1 of 2015, compared to $87,000,000 last year. During 2014, we continued to replace lower yielding fixed maturity corporate and mortgage backed securities with higher yielding fixed maturity tax exempt municipal securities as part of our effort to reposition the investment portfolio acquired through the Altair transaction. We are seeing the benefit of that effort in the Q1 of 2015. Also contributing to the increase is higher dividend income on our equity portfolio due to a larger equity portfolio in 2015 compared to 2014 due in part to the restructuring of the Altair investment portfolio. Net realized investment gains for the Q1 of 2015 were $6,000,000 compared to $17,000,000 a year ago. Looking at our total results for the year, our projected effective tax rate was 19% in the first quarter of 2015 compared to 25 percent a year ago. The decrease in the effective tax rate in 2015 was driven by foreign tax credits for foreign taxes paid. In previous periods, taxes paid in foreign jurisdictions were not available for use as tax credits against our U. S. Provision for income In 2015, we anticipate a sufficient amount of earnings from our foreign operations will be taxable in the U. S. This will allow us to recognize the benefit of significant foreign tax credits against our U. S. Provision for income taxes. The recognition of these tax credits has a favorable impact of 8 points on our 2015 estimated annual effective tax rate. A similar benefit may not be available in future years. We reported net income to shareholders of $191,000,000 in the Q1 of 2015 compared to $88,000,000 a year ago. Comprehensive income for the period was $282,000,000 compared to $230,000,000 a year ago. And as a result, book value per share at the end of March 2015 was $5.64 an increase of 4% since the end of 2014. I'll make a couple of final comments about cash flows and the balance sheet. Net cash provided by operating activities was $23,000,000 for the first 3 months of 2015 compared to $22,000,000 for the same period of 2014. Operating cash flow for the Q1 of 2015 included higher cash flows from our Markel Ventures operations and investing activities, offset by lower payments for income taxes and employee profit sharing compared to the same period a year ago. Operating cash flow for the period was net of approximately $70,000,000 of cash paid in connection with the asbestos and environmental transaction that I previously mentioned. While we recognize that this transaction will have the short term impact of reducing investment income, we will have eliminated the uncertainty around these exposures and increased our flexibility regarding capital allocation. Historically, 1st quarter is our lowest cash generating quarter based on the timing associated with incentive compensation payments to our associates and to our brokers. Invested assets at the holding company were $1,400,000,000 at the end of March 2015 as compared to $1,500,000,000 at the end of the year. With that, I'll turn it over to Mike to talk about our U. S. Insurance segment. Thanks, Ann. Good morning. As we've outlined before, the U. S. Insurance segment comprises all direct business written on our U. S. Insurance companies and includes all of the underwriting results of our wholesale and specialty divisions as well as certain products written by our global insurance team. For the Q1, gross written premium was up 2% over prior year. We've seen some growth in our wholesale casualty lines and our specialty workers' comp line. This growth has been offset by lower premium volume from architects and engineers, where we have exited certain classes, and our wholesale property line where we've seen softening market conditions. The combined ratio for the quarter was 84% compared to 96% for the same period a year ago. In the quarter, we In the quarter, we benefited from lower attritional losses in our binding and brokerage property lines and program business, as well as more favorable prior year takedowns due in part to the change in volatility, which Anne just discussed. In our core product lines, we also saw a favorable development of prior year losses in our professional liability and workers' compensation books. Additionally, the expense ratio was better due to lower general expenses in quarter 1 compared to last year. Operationally, Brent Glesson is fully engaged in his new position as President of Markel Global, our large account business. We recently returned from the RINs conference in New Orleans, where our senior global underwriters had the opportunity to engage with a number of clients, brokers and prospects. And we continue to believe that, under better market conditions, we have the talent and products to grow this business. Matt Parker assumed the position of President of Markel Specialty April 1st, taking over from Greg Thompson, who is focusing his efforts finding new program opportunities for Markel. I'm very confident in Matt's ability to lead this division. Chad Bertucci replaced Matt in the leadership role at First Comp and is well prepared to continue that progress, having served in a number of different capacities at First Comp over the last few years. Market conditions throughout the U. S. Segment remain largely unchanged from the Q4 of 2014. We continue to generate modest rate increases on our smaller E and S and specialty accounts. The market is considerably tougher for the larger, more complex risks underwritten by our global division. Brian Sanders and his team in our wholesale division are focused on 3 key issues maintaining our relationships with our key wholesalers, continuing to communicate our underwriting appetite to these wholesalers and improving efficiency in our backroom processes. We held our binding and brokerage council meeting early in the quarter, and the feedback from our wholesale partners remains very positive. Jerry Albanese and our product line leadership initiated several changes to their structure to better align with certain segments of our business. The public entity team transferred to the Global Reinsurance division and the senior living team transferred to the Global Insurance division. We also added talent to our environmental and binding teams. All of the units in the U. S. Segment are currently reviewing their profiles, and we look forward to the rest of the year. I'll now turn the call over to Richie. Thanks, Mike, and good morning, everybody. Today, I'll focus my comments on the underwriting results for the Q1 of 2015 for both our International Insurance and Reinsurance segments. As Ann said, 2015 is off to a fantastic start. However, we all need to keep in mind 1 quarter does not make a year, and we all know there's a long way to go and a lot of hard work ahead of us. The International Insurance segment, which includes business written by our Markel International division as well as that written by our Global Insurance division, had a great Q1. Gross written premiums in the international insurance segment did decrease slightly by 2% to 289,000,000 dollars However, the combined ratio was 73% compared to 91% in the prior year. The decrease in premium writings is primarily due to the due to increased volume in our professional liability product lines, partially offset by decreases in our marine and energy product lines. The lower segment combined ratio was driven by more favorable prior accident year reserve takedowns and a lower current accident year loss ratio, partially offset by higher expense ratio. The decrease in the current accident year loss ratio was primarily driven by benign claims development and lower attritional loss ratios across a number of lines within our Markel International division. This segment included 8 points of favorable prior accident years movement related to the change in estimated volatility on our loss reserves that Ann discussed earlier. We also experienced favorable prior years development across our Global Insurance division, which reported adverse development last year. The expense ratio for this segment increased slightly due to higher general expenses. On the subject of volatility, it's worth pointing out that at least 2 types of volatility impact our underwriting results, business mix and reserve volatility. While they're closely related, they are different. We have discussed reserve volatility in great detail this quarter due to the movement in prior year reserves. Equally important, however, is the impact of business mix. With the acquisition of Alterra, which just celebrated its 2 year The addition of these divisions changed our business mix, adding larger excess limit Fortune 1,000 business with Global Insurance and additional catastrophe exposure and larger limits with Global Reinsurance. This change in business mix contributes to additional volatility in our underwriting results as demonstrated this quarter. Now, I'd like to discuss the reinsurance segment, which includes treaty reinsurance programs written by our global reinsurance division, as well as that written by our Markel International division. Gross premiums written during the quarter for this segment decreased to $378,000,000 for 20 15 from $490,000,000 a year ago. And mention this, the decrease in writings was driven by underwriting decisions to cease riding UK Motor Business and significantly reduce our writings of US nonstandard auto book business. The combined ratio for the reinsurance segment was 89% compared to 94% last year. Reduction in the combined ratio was driven by a lower current accident year loss ratio, driven by lower property losses in the Q1 of this year compared to last year. Finally, I'll touch on competition. As Mike and Ann both said, the market remains competitive. In the reinsurance segment, we saw pressure on terms and rates during the January 1 renewal process. As the years move forward, while still extremely competitive, it does appear that the decrease in rates and terms has slowed to some extent. We certainly believe there is very little left to give in reinsurance terms or rates, and it would appear that at least a few of our competitors feel the same way and are pushing back against additional decreases. In our international insurance segment, we continue to experience rate pressure with property and marine and energy being the most impacted. I don't see much in the way of change in the environment over the last quarter. In summary, and we've stated it many times, we're not going to chase premium when we feel that rates are inadequate. We continue to reinforce this message with our underwriting teams as is reflected in our Q1's gross written premium numbers. Now I'd like to turn it over to Tom. Thank you very much. Thank you, Richie. I'm going to try to set a record of brevity this morning in my investment and Markel Ventures comments. My colleagues in the room are placing bets as we speak. In short, we are earning positive and productive returns on our investment in Markel Ventures operations. I'm optimistic that we can continue to do so even in the face of the tectonic force of low interest rates. More importantly, our short duration fixed income portfolio, our percentage of equity capital invested in equities, and a range of possibilities that we can pursue in Markel Ventures and in our ongoing profitable insurance operations with the cash flow that they produce gives us great flexibility and many options as conditions and circumstances change. I'm highly confident that we will see change, and most of us will be surprised by the nature and speed of whatever comes our way. I also think it's fair to say that we are in a better position than many to take advantage of dynamic markets rather than just suffer blows. As to the current numbers, so far in 2015, we're continuing to see the trends that have been in place for the last several years. We've earned reasonable returns from our equity investing activities with a return of 2.3% in the Q1. In our fixed income operations, we earned 1.6% in the ongoing low, low interest rate environment, and we kept the duration at just over 4 years. The total portfolio earned 1.7% in local currency terms, but only 0.5% after currency effects from the higher U. S. Dollar. That currency drag on investment results is largely offset by the fact that we remain largely hedged in foreign currencies for our insurance reserves. As such, the dollar value of insurance liabilities diminishes by a similar amount. FX effects have been and remain largely neutral in our insurance operations. Those are the numbers and the facts. The game plan going forward on the investment side is as follows, and most of you will recognize these comments from previous quarters and years. A, we will continue to steadily and methodically increase our equity portfolio as we find suitable ideas. Will continue to come to work every day and sort and sift through our universe of opportunities to deploy capital in insurance, investing and Markel Ventures opportunities. B, we will continue to let the duration of our fixed income portfolio be less than our estimate of the duration of our insurance liabilities given the low level of interest rates. We simply don't think we're being paid appropriately to take the risk of higher rates. Also, the opportunity cost of holding the shorter duration portfolio remain minor since it's more of a yield line than a yield curve out there. C, we will continue to focus our fixed income holdings at the high end of the credit quality universe. Again, we just don't think we're getting paid to take on more risk, so we will not do so. Finally, I'm sure that if we were really smart and clever, we could find some alternative investment approach that would increase the yield on our short term portfolio from essentially nothing to something more than that. We're not that clever or smart, so we won't try to perform that sort of alchemy. We've seen enough of those experiments end badly to dissuade us from going down that path. As to Markel Ventures, we've got some unabashed good news. Our business has enjoyed a record quarter of profitability. Revenues grew 43% from $171,000,000 to 245,000,000 dollars and EBITDA grew 136 percent from $14,200,000 to $33,600,000 Our manufacturing operations in particular performed quite well. While several of our companies are cyclical and will have volatile results during an economic cycle, I can report to you that business is good right now and order books look encouraging as well. Given the overall pricing environment for new acquisitions, we're finding it tough to find new businesses to add to Markel Ventures at the moment. We are pleased with their organic growth though, and we are focused on running what we already have. We act in the same disciplined fashion all around Markel, whether you are talking about insurance underwriting, equity or fixed income investing, or within any corner of Markel Ventures. The good news for all of us as shareholders is that that approach continues to serve us well, and I expect it will continue to do so in the future. I think that we are in a relatively unique position where we can continue to earn positive returns in the current environment, and we have a wide range of flexibility and options as the environment inevitably changes. That is the long term story of Markel, and it continues to be the case. With that, we look forward to answering your questions. Thank you, sir. We will now begin the question and answer The first question we have comes from John Fox of Fenimore Asset Management. Please go ahead. Yes. Hi, good morning, everyone. I have two questions. First one is on the reserve releases, which over the last two quarters have been over $300,000,000 And I imagine you could have started that process instead of the Q4 last year, the Q2 last year or maybe the Q2 of this year. And I understand there's always a margin of safety in the reserves. But other than the expense this transaction, what's been the catalyst or the reason why you feel comfortable taking the size of reserve releases that you have taken in the last two quarters? Did something change? Did you just feel you got to your margin of safety level? Or is there some other catalyst? And then I have another question. Thank you. Good morning, John. I don't think anything has changed. I think overall, the experience that we have seen in the loss reserves has been positive. I do think we have a tendency to wait until the second half of the year to look real hard as we have historically at A and E or different things. But I don't think anything in the process or our approach has changed at all recently or over the long term, nor do I think it will. I think we have seen the Alterra portfolio experience be maybe better than we expected takedowns have been significant, but I don't think there's anything different happening here. John, Ritchie. I'll just add to that. I talked about volatility. And as an example, in our global insurance division, last year, we had prior year development. This year, we had prior year redundancies. And that sort of gets back to that business is it's excess limit, large limit business, and it's just simply more volatile. So that was just a complete turnaround year to year and one of the drivers. Okay. And Richie, my second question is on reinsurance. Should we expect to see the magnitude of decline in gross written that we saw this quarter, which I applaud if you're not getting the adequate rate. So should we think about that line being down 20% year over year or something of that nature? It's a little hard to say. I mean, we're going to have to see how the rest of the year goes, John. We've made 2 pretty fundamental decisions over the last number of months in terms of exiting UK Motor and significantly reducing US non standard simply because we couldn't make we didn't think we could make money in either of them the way we needed to. We're going to look at every contract that comes up on its own merits. Those were obviously 2 pretty big items, and we'll just have to see how the rest of the year goes. Okay. Thank you for the terrific results. Thank you. Next we have Mark Dwelle of RBC Capital Markets. Yes, good morning. A couple of questions. Going on that last one, the U. K. Motor book that you had exited in at the end of last year, is that a quota share book or an excess book, which is to say, is it something that's going to affect all of the forward quarters of this year? Or it something that's kind of 1 and done? Mark, it's mostly renewed January 1. There are some renewals throughout the year, but a big renewal date on that business is January 1. It is excess loss business. It's not quota share business. Okay. Thank you. The second question relates to the tax rate. And I think you kind of described how it works. Is it right or at least reasonable to assume that 19% is going to be the run rate for this year unless something changes otherwise? I know you true it up later in the year, but as a starting point, is that where we should begin thinking? That's what our expectation is and we'll true it up each quarter, but you're right. Okay. And then finally on the asbestos retrocession transaction, what portion of overall asbestos reserves were transferred? And I guess if it's not 100%, why not 100%? Well, it was about 35%. Yes. It was, Mark, as they had said, 35%. The reason for the 3rd is this would be all of the asbestos and environmental reserves that resided in our UK insurance company, Markel International Insurance Company. And what it really does is it cleans up and removes all of that best as an environmental and in fact all 92 and prior exposures from that balance sheet. And it was just an opportunity to we've been working for 15 years to sort of clean up the legacy that we purchased with Terra Nova. And this is the culmination, if you will, of those efforts. And the guys over there did an absolutely fantastic job cleaning that up. Okay. But you didn't really this was just opportunistic with respect to that book. Did you consider getting rid of the U. S. Portion as well? Or that just wasn't really what was on the table? That wasn't what was on the table at the time. I mean, we've been running that book that legacy position down for a long time over there, and it was an opportunity to complete it, if you will. In the U. S, I mean, we certainly I mean, obviously, we look at it all the time to decide whether you're better off running it off or you're better off letting someone else run it off, but we're perfectly comfortable keeping the rest of it. At this time, we're showing no further questions. We'll go ahead and conclude today's question and answer session. I would now like to turn the conference back over to Mr. Tom Gayner, President and Chief Investment Officer, for any closing remarks. Sir? Thank you very much for joining us. We look forward to catching up next quarter. Take care. And we thank you, sir, and to the rest of the management team for your time also today. Again, the conference call has concluded. At this time, you may disconnect.