Earnings Call: Q3 2014

Nov 6, 2014

Quarterly report

Greetings, and welcome to the Markel Corporation Third Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Tom Gayner, President and Chief Investment Officer. Thank you, Tom. You may begin. Good morning. Thank you and welcome. We're glad that you're with us and we look forward to discussing our results from the 1st 9 months of 2014 as well as our thoughts on the business. Anne Wilevsky, our Chief Financial Officer will review the overall financial results and my Co Presidents, Mike Crowley and Richie Witt will then cover our insurance operations. Then I'll return to discuss our investments and Martell Ventures' activities. Before we get started, I'll remind you of the Safe Harbor statement. As a reminder, comments made on today's call may contain 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 our or suggested by such forward looking statements. Please refer to the full disclosure regarding the risks that may affect Markel, which may be found in our most recent annual report on Form 10 ks and quarterly report on Form 10 Q. With that, let me turn things over to Ed. Thank you, Tom, and good morning, everyone. I'm pleased to report that the positive momentum that we experienced in the first half of twenty fourteen has continued into the Q3. Our financial results for the 1st 9 months of the year are very solid. We produced underwriting profits in all three ongoing insurance segments and continue to align the legacy Alterra reserves with the Markel's reserving philosophy. Markel Ventures completed the acquisition of Cottrell Inc. During the period and continues to look for profitable growth opportunities. Our total operating revenues grew 25 percent to $3,800,000,000 in 2014 compared to $3,000,000,000 in the 1st 9 months of 2013. The most significant drivers of this increase continue to be the inclusion of 9 months of underwriting revenues from legacy Alpair product offerings in 2014, higher revenue from the Hagerty business and higher investment income due to our larger investment portfolio. Also contributing to the increase, other revenues were up 25 percent to $630,000,000 from $505,000,000 last year, primarily due to revenue growth within Markel Ventures. Moving into the underwriting results. Gross written premiums were $3,800,000,000 in 2014 compared to $2,900,000,000 in 2013, an increase of 30%. Net written premiums were $3,100,000,000 in the 1st 9 months of 2014, up 28% from the prior year and earned premiums increased 26% to $2,900,000,000 These increases were driven by the inclusion of 9 months of premiums from the legacy Ultera products in 2014 compared to 5 months of legacy Altera premium in 2013. Net retention was down slightly in 2014 at 82% compared to 83% in 2013. The slight decrease which is in line with our expectations is primarily due to higher use of reinsurance on certain insurance products previously underwritten by Ultera. Our consolidated combined ratio for the 1st 9 months was 97 in both periods 20142013. As a reminder, the 2013 combined ratio 13 combined ratio included transaction and other acquisition related costs of approximately $70,000,000 or 3 points related to the acquisition of Alterra. The combined ratio in 2013 also included approximately $32,000,000 or 1 point of catastrophe losses. Excluding the impact of catastrophe and transaction and acquisition related costs from the 2013 combined ratio, the combined ratio for 2014 increased 4 points compared to the prior year. This increase was primarily due to less favorable development on prior loss reserves in 2014 compared to 2013. The consolidated combined ratio for the 9 months ended September 30, 2014 included approximately $260,000,000 of favorable development on prior year loss reserves compared to $281,000,000 of favorable developments for the same period in 2013. The benefit of the favorable development on prior year loss reserves had less of an impact on the combined ratio in 2014 than in 2013 due to higher 2014. In addition, the U. S. Insurance segment had less favorable development due in part to adverse development on our architects and engineers product line in 2014 and less favorable development on Hurricane Sandy in 2014 compared to 2013. Now I'll move to the results of Markel Ventures. During the 1st 9 months of 2014, revenues from Markel Ventures was just over $16,000,000 in 2014 compared to $486,000,000 a year ago. Net income to shareholders from Markel Ventures was just over $16,000,000 in 2014 compared to $18,000,000 for the same period in 2013. EBITDA was $66,000,000 in 2014 compared to $64,000,000 in 2013. For the 9 months ended September 30, 2014 revenues were higher than the same period a year ago due to our acquisitions of Cottrell in 2014 and Eagle Construction in 2013. Likewise, EBITDA from AmeriMarkl Venture operations increased in 2014 compared to 2013, primarily due to the acquisition of Catrrell and Eagle, partially offset by less favorable results in our existing manufacturing operations. Moving to our investment results. Investment income was 2 $70,000,000 for the 1st 9 months of 2014 compared to $229,000,000 in the same period last year. The benefit of holding a larger portfolio was partially offset by lower yields. Net realized investment gains for the period were $29,000,000 compared to $41,000,000 a year ago. Included in net realized gains were 3.9 $1,000,000 of other than temporary impairments as compared to $4,600,000 in 2013. Looking at our total results for the year, net cash provided by operating activities was $537,000,000 for the 1st 9 months of 2014 compared to $543,000,000 for the same period of 2013. The decrease is due to higher tax payments for our international operations partially offset by higher cash flows from investment income and underwriting activities due to the inclusion of Alterra. Our projected effective tax rate was 25% in the 1st 9 months of 2014 compared to 28% a year ago. The decrease in the effective tax rate in 2014 is primarily due to anticipating a larger tax benefit related to tax exempt investment income and a decrease in the estimated foreign earnings subject to U. S. Tax in 2014 as compared to 2013. We reported net income to shareholders of $204,000,000 in the 1st 9 months of 2014 compared to $182,000,000 a year ago. Comprehensive income was $517,000,000 for the 1st 9 months of 2014 compared to $253,000,000 a year ago. Book value per share at the end of September 2014 was $514 an increase of 8% since the end of 2013. With that, I'll turn it over to Mike to talk about the U. S. Insurance segment. Thanks, Ann. Good morning. The U. S. Insurance segment as we pointed out before comprises all direct business written on our U. S. Insurance companies and includes all the underwriting results of our wholesale and specialty divisions as well as certain products written by our global insurance team. For the Q3, gross written premium was up 3% over prior year. Year to date, gross written premiums have increased 13% over prior year. This increase was due in a large part to the Altero lines of business that are now included in this segment. Excluding these lines, premium volume is up 5%. Keep in mind that we have been exiting or re underwriting some lines in our Specialty and Wholesale divisions and this has impacted growth. The combined ratio for the quarter was 95% for both 20142013. The combined ratio for the year was 97% as compared to 94% in 2013. As Anne pointed out, the Higher Insurance segment combined was driven by less favorable development of prior year losses due in part to adverse development in the architects and engineers line of business. Partially offsetting this impact was a lower year over year expense ratio. The improvement in the expense ratio was due to higher contribution of earned premium for the legacy Ultera in 2014 than in 2013 and due to non reoccurring transaction costs recorded in 2013 associated with the Alterra acquisition. The rate environment in the U. S. Segment remains competitive. However, we continue to achieve modest single digit rate increases on small to medium sized risk across the various divisions within the segment. Large accounts remained under competitive pressure and prices for property and casualty lines on Fortune 1,000 business remained soft. Operationally during the quarter, we combined our Atlanta and Richmond Specialty Program units under one management team and we expect this reorganization to improve our results in 2015 from both an underwriting and expense perspective. Also in the Specialty division, year to date data revealed benefits from our initiatives to cross sell and round accounts between 1st comp and Markel Specialty Programs. 566 accounts have added additional coverages through this rounding effort. In our wholesale division, we continue to see strong growth in our binding TMC, environmental and excess umbrella lines. Our E and S executive team had a very busy app slow holding over 350 face to face meetings with our wholesale partners. We continue to grow with our top wholesalers and this meeting provides the opportunity for an intense few days of 1 on 1. All five wholesale regions volume is up year to date. Also our specialty and global and executive teams attended the annual CIEB conference, which like NAPSLO allows us to visit face to face with many of our key brokers and agents. The broad array of Markel products for both large and small accounts has made us an attractive alternative for many agents. Jerry Albanese, our Executive Vice President and Chief Underwriting Officer, presided over a number of product line leadership meetings during the quarter. These meetings were attended by our In summary, we remain focused on those same key objectives that have driven us throughout 2014: reassessment of some lines of business, expense reduction and control, attraction of talent and aggressive sales and marketing. I'll now turn the call over to Richie. Thanks, Mike, and good morning, everyone. Following on from comments by Ann and Mike, I'd sum up the 1st 9 months the year in Markel's underwriting operations as solid or business as usual. I think this is a really important statement when you consider that we are establishing consistent with our historical practices a loss reserve margin of safety on legacy Ultera business. Turning specifically to the results of the International Insurance and Reinsurance segments. The International Insurance segment, which includes business written by our Markel International division as well as that written by our Global Insurance division has performed well so far this year. During the 9 months of 2014, gross written premiums in the International Insurance segment increased 13% to $653,000,000 The combined ratio was 95% compared to 92% in the prior year. The increase in premium writings is primarily due to the global Insurance division, which was created after the acquisition of Ultera and contributed 9 months of business in 2014 compared to only 5 months of business in 2013. The higher segment combined ratio was driven by a higher current accident year loss ratio, partially offset by a favorable expense ratio. The improvement in the expense ratio was due to transaction costs of the Ultera merger back in 2013 and higher earned premiums from the Global Insurance division, which carry a lower expense ratio. Now I'll turn to the Reinsurance segment, which includes reinsurance programs written by our Global Reinsurance division as well as that written by our Markel International division. Gross written premiums for this segment were $999,000,000 for the 1st 9 months of 2014 and that was up from 4 $43,000,000 a year ago. The increase in premium writings was primarily due to including 9 months of writings from products previously written by Altaira in 2014 compared to 5 months of writings in 2013. The combined ratio for the reinsurance segment was a 97% as compared to 108% last year. Last year's combined ratio included 7 points catastrophe losses, really very minor catastrophe losses this year really of the attritional nature I would say. And approximately 10 points of non recurring costs associated with the acquisition of Ultera. Operationally, during the quarter and the 1st 9 months of the year, we recently announced that Dave Kalanoff will be retiring from Markel Re in June of next year and that Jed Rhodes will be taking over responsibility for all of Markel Reade. I can't thank Dave enough for all of these done to ensure the smooth transition of Ultera Reinsurance operations into our Markel Re division. Also, I know Jed will do a fantastic job leading our reinsurance team into the future. Markel International's integration of its AbbVie acquisition AbbVie is a wonderful AbbVie is a wonderful franchise and with the additional resources that Markel can bring to the table, we believe that solid growth is possible. As Mike said, all areas of the P and C market remain competitive. The only difference really is the degree to which they're competitive. The International Insurance and Reinsurance segments are probably among the most competitive in the market today. We're in the process of completing budgets and plans for 2015 and barring any significant market changes, organic growth is going to be difficult to come by in 2015. As a result, as Mike alluded to, we're focused on controlling our expenses, finding efficiencies and emphasizing route selection and portfolio management. In soft markets, we will always choose underwriting discipline over growth. Despite these difficult market conditions, we still believe there are great opportunities available to us and believe we've built the platforms to pursue those opportunities. With that, I'd like to turn it over to Tom. Thank you, Richard. My comments this morning will be brief since our news is good and straightforward. I'm happy to answer any questions or cover any details when we get to the Q and A. On the investment side of the house, we earned 7.3% on our equity investments 4.5% on our fixed income portfolio during the 1st 9 months, which produced a gross total return of 5.2%. In the equity portfolio, we continued to methodically add to our holdings steadily throughout the year. Between purchases of roughly $300,000,000 so far as well as depreciation of the portfolio, we've now got roughly 52% of our shareholders' capital invested in equities compared to 48% at year end 2013. We continue to have an unusual combination of investment ideas that we're confident about, positive cash flows from our insurance and venture businesses and some sense of overall caution and weariness about investment markets overall. The net effect of these crosscurrents is that we continue to steadily dollar cost average our way and into building positions. We think that approach prudently protects our balance sheet and leaves us with the ability to be able to invest more money in equity as opportunities present themselves. Expect us to continue our steady, consistent approach in building the equity portfolio. In our fixed income operations, we earned a total return of 4.5% as low interest rates that prevailed at the end of 2013 went under an even lower limbo stick by the time we got to the end of September. That meant we got some capital appreciation in the portfolio in addition to recurring interest income. We remain cautious as we have been for multiple years about the balance between risk and reward in bonds. Long term rates just don't have that much room between where they are and 0. They have a lot of room between where they are and where I've seen them in my career. Consequently, we keep the duration of our bond portfolio a bit shorter than the duration of our insurance liabilities. Including cash, the duration stood at roughly 4.25 years at September 30 and we do not plan to go longer than that in the current interest rate environment. We also remain committed to safety first. In addition to not stretching for yield by extending the duration, we don't stretch for it by reducing credit quality either. 97% of the portfolio is rated A or better, but we don't stop there and rely solely on rating agencies. We do our own credit analysis on top of that to make sure that we are comfortable with the credit risk we take. As always, safety first. In Markel Ventures, we purchased the Cottrell Industry during the Q3. Only 5 weeks of their results are included in our Q3 numbers and you'll see more from them as well as the rest of the Markel Ventures companies in the Q4. Cottrell is the leading manufacturer of car hauling trailers and equipment and we welcome them to the Markel family. As we stated in the Markel style, we seek to be a market leader in each of our pursuits. I can assure you that Cottrell fits that description as well as other elements of the Markel style. For the 9 months to date, you can see the imaginatively named other revenues on our income statement of $630,000,000 versus $459,000,000 a year ago and gave you the portion from Markel Ventures and you can see the vast majority of those revenues indeed relate to the Markel Ventures operations. Our EBITDA from the group was $66,000,000 versus $64,000,000 in 2013, which is a much smaller percentage increase than the increase in revenues. We got off with a slow start in the Q1 of this year and have been making up ground ever since. I assure you that I look forward to reporting the full year results. When you add all of our activities together from insurance, investing and Markel Ventures, you get to the bottom line of comprehensive income. Comprehensive income through the 1st 9 months at Markel exceeded $500,000,000 As I chose in the queue in round numbers, the drivers of comprehensive income came from pretax underwriting profits of over $70,000,000 pre tax investment income and gains of about $300,000,000 increased pre tax unrealized gains on the portfolio of almost $350,000,000 and pre tax cash flows of over $70,000,000 from Markel Ventures and non cash intangible amortization. We then paid jobs of taxes and provided for the rest of what we have. Some of those items comes to the $500,000,000 of comprehensive income we earned. We're pleased with that result and we hope you are as well. Looking forward, every insurance, investment, industrial and service business that we own or operate in faces challenging and competitive markets. They always have and they always will. Despite those facts, we continue to produce solid returns for you as our shareholders and we expect to continue to that to be the case over time. We're grateful for the opportunity to do so and we now look forward to answering your questions. With that, John, if you'd be so kind to open the Q and A period. Thank you. At this time, we will be documenting a question and answer Our first question comes from the line of Vincent de Agostino from KBW. You may state your question. Hi. Good morning, everyone. Good morning. Good morning. Just to start off, so last quarter you guys had talked about the reinsurance environment theoretically being at bottom if everybody was being disappointed. I'm just wondering if at this point there's any change in kind of that assessment or if it's one of these things where we have to really wait for oneone to play out before we can get a true test if that's going to kind of if we're going to be at bottom and potentially rebound or go lower? This is Richie Vincent. I think it's a little early to say. Like you say, I think we've got to see what happens with the oneone renewal. But a lot of people are talking about it being the bottom. I wouldn't look for a bounce at this point. I think there's too much capital out there for there to be any sort of bounce. If I had to guess, you might could see a little more reduction, but I just can't imagine the kinds of reductions we've seen in the last 2 years. And certainly, if people are looking for those kinds of reductions at oneone, we'll probably be coming off of some business. So it feels like we're getting close to a bottom, but I'd like to see those oneone renewals before I commit to that. Okay. Good deal. And then just to switch over two questions on the Markel Venture side. Tom, sorry if I missed this. I know you said you look forward to kind of giving us the full year numbers. But with Cutrel and Eagle, just where roughly with those two businesses should that put us on an annualized EBITDA and net income basis? Annualized EBITDA I mean annualized run rate of the revenues should be a round number of $1,000,000,000 plus or minus. There's cyclicality to that and that's looking into 2015. And we would expect double digit EBITDA earnings from that mix collection of business. Okay. Cool. Thank you. And then just a There are numbers where a lot of zeros involved there. Good deal. Just a theoretical question between the split in terms of when you're speaking with investors between Markel Ventures and Equity Portfolio. Do you feel that you get more credit for the ventures income stream versus the public equities since on the ventures you don't have to do the whole equity look for your earnings add back? Yes. All right. Take care guys. Thanks. Thank you. Our next question comes from the line of Mark Dwelle of RBC Capital Markets. Please state your question. Hey, good morning. Just a few sort of numbers questions because as you said it was a pretty straightforward quarter. In the discontinued lines segment, there was a $6,800,000 of adverse development. Was there was that just a true up of the asbestos study from the Q2? Or was it something different? No. That's actually some development that we saw on the discontinued businesses from the The figure for the remaining amortization of the premiums in the investment or the premium in the investment portfolio, Is that number somewhere in the 10 Q? I haven't found it if it is. It's not. But given the and I don't have the number with me Mark, but given the amount of the portfolio that we have turned over, the number that's left has gotten smaller. But I don't have the specific number with me and it's not in the Q. Okay. And then finally was there any meaningful amount of catastrophe loss across any of the businesses? I know Rich you mentioned in the reinsurance there was not just asking on the other units. Nothing that we've got. No. We always have a bit of an attritional amount of catastrophe built into our assumptions. And I would say it was even probably a light attritional quarter from that standpoint. Okay. Those are all my questions. Thank you. Thank you. Our next question comes from the line of Jay Cohen of Bank of America Merrill Lynch. Please state your question. Yes. Thank you. In the Reinsurance segment, the expense ratio in the 3rd quarter dropped, I guess, about 4 points from the first half. In the Q, you suggest there was an increase in experience related funds or something, I forget exactly the phrase. But I'm wondering how much of an impact that had on the expense ratio in the quarter in the Reinsurance segment? Yes. I would say the impact for the quarter was probably not significant. So do you see the 3rd quarter number as a reasonable run rate going forward? Because it's about 30 versus nearly 34 in the first half. Yes. No, I do not think that it is a reasonable run rate. I think you can take the earlier quarters and use those. This would be a non recurring one time adjustment that we make and then we'll trend it going forward. But I think you can use the earlier quarters indications. That's helpful. And I guess for the overall company, when you think about the expense ratio, given the market conditions internationally and in reinsurance, should we expect any improvement at all in the expense ratio going forward? Or should we just kind of assume it stays reasonably flat? Well, this is Richie Jay. Obviously, we continue to work to reduce the expense ratio. But it's fair to say, we don't expect to have a whole lot of help in that effort from growth next year. So growing the top line, if the market stay like this that's going to be difficult. So we're going to have to do it the old fashioned way, which is spending less. So admittedly it's going to be difficult. What did we have like 30 7, little over 37 this quarter. I think that's probably fair for next year and we're going to work hard to see if we can reduce it. That's great. If I could squeeze one more in. Markel Ventures, Tommy, as you had mentioned, the improvement was pretty noticeable versus the first half. And specifically in the manufacturing segment where the net income or GAAP income went from about $4,500,000 in the Q1 up to $21,000,000 in this quarter, so pretty impressive. Does seasonality play a role there? Should we think about the Q3 again as a reasonable run rate going forward? Seasonality plays a small role, but I would say it's much more economically cyclical than what I would describe as seasonal. And frankly, the Q1 was low. We were in the midst of integrating some acquisitions and there's always a little bit of indigestion and process that's connected with that. And as we've gone through the year, those issues are starting to resolve themselves and we're getting to a more normal basis. I really would steer you towards EBITDA, because given amortization, purchase accounting and that sort of stuff, the true cash that's being produced by the business is best represented by the EBITDA and that's what we hold the managers accountable for because they can't control the tax rate. They're very lightly levered. We're not borrowing a bunch of money. So that really does describe the cash flows of the business. Fair enough. Thanks, Management, at this time, there seems to be no more further questions. Would you like to make any closing remarks? Thank you very much and we look forward to chatting with you next quarter. Take care. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.