Earnings Call: Q1 2012

May 10, 2012

Quarterly report

Greetings and welcome to the Martell Corporation First Quarter 2012 Earnings Call. Are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tom Gayner. Thank you, Mr. Gayner. You may begin. Thank you so much. Good morning and welcome to the Markel Corporation 2012 Q1 conference call. We are glad that you are joining us and we look forward to your thoughtful questions about our business. As is our custom, our Chief Financial Officer, Anne Wilelski will lay out the numbers from the Q1 followed by my Co Presidents, Mike Crowley and Richie Witt with comments about our international and domestic insurance operations. I will then discuss our investment and Markel Ventures operations a bit and then we will open the floor for questions. Before getting started, the rules say we need to repeat the Safe Harbor statement, so here goes. During our call today, we may make forward looking statements. Additional information about factors that could cause actual results to differ materially from those projected in the forward looking statements is described 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 on our website at w w w.marccellcorp.com in the Investor Information section under non GAAP reconciliation or in our quarterly report on Form 10 Q. With that, Anne? Thank you, Tom, and good morning, everyone. I plan to follow the same format as in prior quarters. I will start by discussing our underwriting operations followed by a brief discussion of our investment results and bring the 2 together with a discussion of our total results. I'm pleased to say that for 2012, we are off to a good solid start. Our total operating revenues grew 18% to $733,000,000 in 2012, up from $622,000,000 in 20 11. The increase is due to a 15% increase in revenue from our insurance operations and a 43% increase in revenue from our non insurance operations, which we refer to as Markel Ventures. Moving into the underwriting results. Q1 2012 gross written premiums were just under 650,000,000 dollars which is an increase of 10% compared to 2011. The increase in 2012 was due to higher gross premium volume in each of our 3 operating segments. Net written premiums were approximately $580,000,000 up 12% to the prior year. Retentions were up slightly in 2012 at 90% compared to 88% in 20 11. Earned premiums increased 14%. This increase was driven by a 23% increase in earned premium from the London Insurance Market segment. 1st quarter 2011 net written and net earned premiums for this segment were reduced by approximately $9,000,000 of reinsurance costs associated with losses incurred during the Q1 a year ago. Our combined ratio was 100% for 2012 compared to 112% in 2011. The combined ratio for 2012 includes $20,000,000 or 4 points of expense related to our prospective adoption of the new DAC accounting standard. The 20 11 combined ratio included 15 points of underwriting losses related to the 3 catastrophe events, which occurred last year in Australia, New Zealand and Japan. Excluding the impact of the prospective adoption of the new DAC accounting standard in the Q1 of 2012 and the effects of the catastrophes in the Q1 of 2011, our combined ratio improved by 1 point. This improvement was due to a lower expense ratio and a lower current accident year loss ratio, partially offset by less favorable development of prior year's loss reserves. The improvement in the expense ratio is primarily due to an increase in earned premium. The improvement in the current accident year loss ratio was due to lower attritional current year losses in the excess and surplus lines segment and to lower attritional and large energy losses in the London insurance market. Favorable redundancies on prior year's loss reserves decreased to $64,000,000 or 12 points of favorable development compared to $75,000,000 or 16 points of favorable development in 2011. The decrease was primarily due to less favorable development of prior year's losses in the Excess and Surplus Lawn segment. In the Q1 of 2011, we resolved a significant portion of our outstanding liabilities associated with an Arizona emissions program for mortgage servicing companies and as a result reduced loss reserves by $16,000,000 Next, I'll discuss the results of our non insurance $1,000,000 compared to $68,000,000 in 20.11. Net income to shareholders from our non insurance operations was $200,000 in 20.12 12 compared to $2,400,000 in 20 11. Revenues from our non insurance operations increased in 2012 compared to 20 11, primarily due to our acquisitions of Faking Technology Systems Incorporated and WIF Holdings Incorporated in late 2011. The decrease in net income to shareholders from our non insurance operations is a result of decreased shipments for the quarter in our manufacturing operations where we expect to see improvements as the year progresses. Turning now to our investment results. Investment income was up 14% in 2012 to just under $80,000,000 Net investment income included a favorable change in the fair value of our credit default swap of $11,000,000 During the Q1 of 2012, financial markets improved and credit spreads narrowed, which favorably impacted the CVS. Net realized investment gains were $12,000,000 compared to $11,000,000 in 20 11. There were no other than temporary impairments in either period. Unrealized gains increased $214,000,000 before taxes in 2012 driven by increases in equity securities. Tom will go into further details on investments in his comments. Looking at our total results for 2012, the effective tax rate was 23% in 2012 compared to an effective tax rate of 14% in 2011. The increase is primarily due to anticipating a smaller tax benefit related to tax exempt investment income as a result of projecting higher pretax income for 20 2011. We reported net income to shareholders of $57,000,000 compared to $8,000,000 in 20.11. Book value per share increased 6% to $3.73 per share at March 31, 2012, up from 3.52 dollars per share at year end. Finally, I'll make a few comments on cash flow and the balance sheet. Net cash used by operating activities was approximately $64,000,000 for the 3 months ended March 31, 2012 compared to net cash used by operating activities of approximately $9,000,000 for the same period of 2011. The increase in net cash used by operating activities was due to increased claims settlement activity, primarily in the London Insurance Market segment. Historically, Q1 is our lowest cash generating quarter as we pay employee bonuses, agent incentives, pension contributions and other items of that sort in the Q1. We would expect cash from operations to improve in the Q2. Investments in cash held at the holding company were approximately at in part to the purchase of Tomco in January 2012. Mike will discuss that acquisition further in his comments. And at this point, I will turn it over to Mike. Thanks Anne. Good morning. 1st quarter results for North American operations showed increases in gross written premiums for both the wholesale E and S and Specialty divisions. The wholesale gross written premiums increased 11% over the same period in 2011 and the Specialty division gross written premium increased 10% over the same period last year. Market conditions remain transitional with moderate increases in many lines. Rates for wind exposed property are climbing more significantly than other lines and yet some lines such as medical malpractice and specified medical remain very competitive. We see other insurance companies announcing rate increases. It's worth noting in our opinion that in our experience some insurance companies who are announcing rate increases on renewal business are continuing to price new business very aggressively. At Markel, we maintain the consistency of our underwriting discipline on both renewals and new business. We are seeking rate on both. With regards to the Wholesale division, during the quarter, the division conducted agency council candid feedback and I'm not suggesting that any of our agents on these councils are shy, they're not. The feedback that we received was generally positive and supportive of the 1 Marche model. Criticism was limited and mostly centered on response time and John Latham, the President of our Wholesale division and his team have initiated several projects to address the concerns raised and have already reported back to council members on their efforts. Marketing activities in our Wholesale division were divisions in all of our regions to serve our agents and brokers. In the specialty division, the increase in their gross written premiums was driven by growth in premiums at Markel American, our First Alliance division, Markel First Comp, the Agriculture division and our Carrier Alliance business. Offsetting some of the growth were declines in our accident health and program units. The AMH premium fell due to our exiting several programs due to lack of profitability and Markel programs also terminated several programs for the same reason. The significant highlight during the quarter was the closing of the Tomco acquisition in early January. Greg Thompson and his team are a terrific addition to the Markel family. Rick Glisson, our Chief Administrative Officer Robin Russo, our Executive Underwriter for Specialty and Tom Smith, of Sales and Marketing Corp. Rately are working closely with Greg and his team on the transition of Tomco's business. The moving of this business to Markel paper was light in the quarter, but will be accelerated during the remainder of the year with the full impact of the acquisition being felt in 2013. Also during the quarter, we announced several key executive promotions. Don Fason who joined the company in 1989 was promoted to lead Markel Specialty Commercial. Mark Nichols who also has been with the company over 20 years was promoted to oversee not only our A and H business, but our carrier alliance business and personal lines divisions. Audrey Henkin was promoted to President of Markel America. Audrey joined Markel America over 17 years ago and has played a key role in building our personal lines business. She previously served as Head of Underwriting and Product Development. Mary Pat Joyce was promoted to President of Prairie State, our carrier alliance business and she joined Markel in 1999 and most recently was Head of Operations at Prairie State. Matt Parker was promoted to President of Markel First Comp. Matt has been with First Comp for over 5 years and most recently was Chief Operating Officer. All of these individuals have significant experience in their respective areas and in the cases of Don, Mark, Audrey and Mary Pat significant tenure with Markel. Hopefully, these promotions are evidence to you of Markel's ability to fill key positions from within, which is one of the defining strengths of our company. Announced to communicate to all of our underwriters. During the Q1 of 2012, all divisions Markel International Wholesale and Specialty showed positive rate increases. Given the results we saw in the quarter, we're optimistic that we can meet our rate increase targets in 2012. The product line leadership also initiated several process improvement and standardization projects to streamline our quote find and issuance capabilities. We officially launched myPLL website to all North American associates on March 30, establishing a protocol and standardization for underwriting guidelines across all product lines. We also established protocols for internal communication between regions and the PLL Group. All of this is being done to improve our speed and clarity when communicating quotes and other information to our agents and brokers. Other highlights include the addition of a contractor's police and liability policy to our binding offerings and developing an ISO claims made product form in addition to our proprietary form to meet the needs of our customers. While still spotty, we're pleased to see continued improvement in rate environment and growth in a number of product lines. However, be assured we will not lose our focus on our sales and marketing efforts. Being in front of our agents and brokers and improving our processes and speed of delivery remain at the forefront of what we do every day. I'll now turn the call over to Richie Witt. Richie? Thanks Mike and good morning everybody. What a difference the year makes. I'm pleased to report a solid start to 2012 at Markel International. Our combined ratio was 97% in the Q1 of 2012 and mentioned the prospective adoption of the new DAC accounting standard. The adoption of this standard added 3 points to International's Q1 combined ratio. You'll obviously recall that we got off to a difficult start in the Q1 of 2011 reporting a combined ratio of 152 percent with significant catastrophe losses from several events around the globe including the Australian floods and New Zealand earthquakes and the Japanese earthquake and tsunami. As compared to the start of 2011, the Q1 of 2012 was relatively quiet. And I can tell you in the insurance business, quiet is a good thing. In the Q1 of 2012, international gross written premiums were up 9% to $278,000,000 We continue to experience growth in our Marine and Energy division, most notably in our energy book. We're also seeing solid growth in our catastrophe exposed property writings. Premium growth in both of these areas were aided by rising prices. We're seeing single digit price increases on marine energy and liability business and increase is between 10% 20% on average for catastrophe Exposed Property Business. Unfortunately, the pricing environment in other areas of our book remains competitive. While prices no longer appear to be falling, competition remains strong for professional liability, equine, trade credit and in our various retail markets around the world. As Mike mentioned, there's always some differential between new business pricing and renewal business pricing. But there's been a bigger and bigger disconnect recently as what Mike said people seem to be getting tougher on renewals, but are being pretty aggressive on new business. Our international leadership team led by William Stouffman and Jeremy Brazil is focused on growing in the areas where appropriate prices are achievable and we're working to maintain our discipline in the areas that still remain competitive. Similar to the U. S, the pricing environment appears to be improving, but it's far from a hard market at this point. We also continue to focus on profitably to good starts. Our retail management team is also working to develop standardized processes and procedures to use across our retail branches in order to more efficiently write these small but profitable policies. In summary, we're happy to be off to a good start 2012 and we'll stay patient as this market continues to evolve. Now I'll turn it over to Tom. Thanks, Ricky. As you've heard so far, there's a lot of positive momentum around Markel these days and I'm glad to tell you that's true for our investment operations as well. On the investment front, we earned a total return of 4% for the Q1 with than I can believe now, interest rates started the period low and then went lower. As such, we earned a total return of more than what we should expect from the underlying coupon return of the bonds. We continue to believe that interest rates are unnaturally low and given that belief, we continue to choose to protect the balance sheet by maintaining our bond portfolio at a lower duration than what we would naturally like. In effect, we're incurring an opportunity cost to do so. This is consistent with our focus on the balance sheet at Markel. There will come a time when this decision should add meaningful value to our shareholders. We'll be the first to point that out to you when it does. On the equity side, we earned a total return of 11.5% for the quarter and we continued to steadily and methodically increase our equity investment commitment. It now stands at 59% of shareholders' equity, up from 54% at year end 2011. We have additional capacity to increase our equity holdings and we continue to do so as we have for the last few years. We believe that our portfolio of global dominant profitable companies represents the best big opportunity to earn good long term rates of return. And as such, we continue to steadily and methodically add them to equity investment portfolio. On the Markel Ventures front, during the Q1, revenues were just shy of $100,000,000 and are included in the other revenues line of our income statement. EBITDA totaled 9,400,000 dollars As always, a reconciliation of EBITDA to GAAP net income is available on the website. Frankly, the Q1 EBITDA levels were below our budgeted expectations. This was due to a combination of normal seasonality, our lumpy businesses not getting as many lumps of business as is often the case and the expensing of some meaningful growth opportunities at certain of the ventures companies. We remain optimistic about meeting our annual goals since the seasonality should improve as the year goes on and we have good order books and backlogs in some of the lumpy businesses. Also the growth initiatives and associated expenses will continue, but they should begin to bring appropriate revenues and profits with the passage of time. Additionally, just after the quarter ended, we added Markel Ventures family. HAVCO is the leading manufacturer of wood flooring for the trailers tractor trailers and has a multi decade history of leading market share and profitability. HAVCO is led by Bruce Bader and a well established management team will be staying and leading HAPCO into the future. We are proud of the ongoing continuity of management at all of the Markel Ventures companies and are glad to welcome Bruce and his team to the family. I am confident they will earn fine rates of return on our capital. In order to give you some frame of reference about the magnitude of the growing Markel Ventures operations, I'll tell you at this point, the annualized revenue run rate of Markel Ventures should approach $500,000,000 and we continue to expect double digit EBITDA margins from the collection of these businesses. Please remember that the Safe Harbor statement that I started out with, I hope that information is somewhat helpful as you consider the size and scale of this growing component of value creation for Markel's shareholders. To summarize, we're optimistic about what is going on at Markel these days. As Mike and Richie reported, we're seeing better insurance markets and we're continuing to refine and improve on every aspect of our operations. We're off to a great start on the investment side and we look forward to reporting a full year of operations from the Markel Ventures Group of Companies. We appreciate the long term nature of our shareholders who are interested in owning a successful long term business and we now look forward to your thoughtful questions. With that, we'll open the floor for Q and A. Thank you, sir. We'll now be conducting a question and answer session. Our first question is coming from Mark Hughes from SunTrust. Please proceed with your question. Yes. Thank you very much. The expense ratio on the specialty admitted was up a bit year over year. Is that higher level going to be sustained going forward? There were 3 things that were unusual in the quarter. The DAC expense which Ian talked about, we had some severance in the quarter and we had the down of some systems in the quarter. So the DAC could be sustained perhaps but the others not? That's correct. Of the increase how much was the DAC? I'm sorry if I missed that. For Specialty Admitted, hang on one second. I'm going to shuffle some papers around. You can expect that the DAC piece will be larger the first and second quarter than it will be in the later half of the year. So it's about 4 points on specialty admitted in the Q1. Okay. And then the London, the current year losses were quite low as low as we've seen in some time. I know that's a volatile business, but any reason to assume that will change? Current accident year would should we keep it at above 67%? Well, there's a couple of things going on there. We've over the last few years added some businesses that have fairly low loss ratios, but maybe slightly higher expense ratios. And the 2 that I'm thinking about are Elliott Special Risk and the Trade Credit businesses. They have low loss ratios, but higher than typical expense ratios. So there's a bit of a mix thing going on there. Also it was a very quiet quarter in terms of catastrophes. So that also is impacting. It. So I think that was a it was a good quarter in terms of the current accident year. I don't know that we could expect that every quarter going forward during the year. And then just any thoughts on the pace of favorable development going forward? It's down a little bit year over year, but still at a very healthy level. What can you say about that? I think we expect it to continue to be healthy. So I'm not expecting any big differences in the future quarters. But and the only thing I'd add to that Mark is the market's been softening for 5, 6 years now. So while we always attempt to establish a fairly consistent margin of safety with the market margin shrinking, I think it's likely unless the market starts to tick up, which we think it's starting to, those things will continue to drift down a little bit, yes. Okay. Thank you. Thank you. Our next question is coming from Jade Cohen from Bank of America Merrill Lynch. Please proceed with your question. Hi, thanks. It's Allison Jacobowitz actually. Just a more specifics on the DAC accounting change and how it's going to come through the rest of the year. I think you said something in the Q about $43,000,000 over 9 months. We've got $20,000,000 in the Q1. Is it that $23,000,000 we should look for, for the next couple of quarters? And how should we look at that? And then also I don't think I heard it if you could talk about the favorable change in the swap this quarter that added the $11,000,000 to investment income. I'm sorry I don't have the quarterly history, but just I'm sure that's lumpy, but how you might be thinking about that, if there's anything you can put around that? Okay. Allison, relative to the DAC question, there's about 4 points in the Q1. My best swag would be that you could take 3 points in the Q2 then 2 points then 1 point and it may move around a little bit, but that'd be a reasonable swag. Relative to the credit default swaps, it has moved around a fair amount quarter to quarter. The markets just to add to that. The history is that every quarter there's movement. It was net towards 0 over time. Okay, great. Thank you very much. Thank you. Our next question is coming from Scott Hyliniak from RBC Capital Markets. Please proceed with your question. Yeah, good morning. I was wondering if you could touch on the a little more on the comments you made about new business being a lot more competitive. I'm assuming that's been a change over the last couple of quarters. Just curious if you could sort of touch on what areas that you're seeing that increase new business competition? Is it by class or is it small versus medium or large? Just a little bit color on that. Yes. Scott, this is Mike. I don't know that we're saying that it's increased over the last couple of quarters. What my point is what we're seeing is that our underwriting discipline is consistent on new business as it is on renewal business. And what we're seeing when we read the press releases, we see in comments by competitors saying that they're raising rates. And we see and we hear from our agents and it's pretty much across the board large, small whatever, but particularly on the business that we're in, which is medium sized to small risk. We're hearing from our agents that some of the carriers that have been very aggressive in the past during the soft market are raising rates substantially on renewals. And yet, we see them in the marketplace where we philosophy. It's not I don't see that the aggressiveness on new business has not increased in the quarter. It's been aggressive. Okay. Okay. Just pointing out the difference between our underwriting philosophy and maybe some others. Right. Okay. That's clear. And then just wondering if you could touch on whether you're seeing any big changes on policy terms and conditions over the past few months as the markets improved a little bit. Any movement there? Nothing of real significance. No. Okay. Only other thing I had was just a couple of numbers questions. Were there any catastrophe losses in the quarter? There were nothing of any materiality. There were a couple of the tornadoes that have been classed as catastrophes, but nothing material in our numbers. Okay. And just one other thing too. The Markel Ventures you talked about some of the seasonality of the be the sort of the seasonally weakest or softest quarter and it improves in the second and third quarter? How should we think about the seasonality of that business top and bottom line? Our experience so far is Q1 is indeed the lowest quarter we've Thank you. Our next question is coming from Meyer Shields from Stifel Nicolaus. Please proceed with your question. Thank you. Good morning, everyone. Hey, Lars. Good morning. I think it was a question for Mike. The 10Q noted $14,500,000 first time related loss. Was any of that adverse reserve development? No, I don't think so. I think mostly it came out of just where we're carrying in their loss ratio. The reserves have held in there pretty good. Okay. So this is just looking at Martell level? Yes. I think the other thing you got to think about there is last year as we were bringing that business California was a relatively small portion of it. Now that we're keeping 100% of the business, California is kind of fully loaded in there. And our California loss ratios just because of what the California market's been in the last few years, we're carrying higher loss ratios there. But we've been raising prices and we've been working really hard on California. So we're optimistic they'll come down in the future. But California we're carrying at a pretty high loss ratio. Okay. That's helpful. Tom, I'm not even sure how to phrase this question, but whether it's the Buffett Rule or something similar to that, are you worried about in general equities or equity prices getting a hit if the associated taxation for real life gains or dividends changes over the next year? Not really. I mean, the number of factors, the number of variables that go into what a given price of any given equity is going to sell for any given day is about $1,000,000 So while those might be bad factors, I don't think they're the exclusive drivers on why things sell for what they do. So we are we tend to be bottom up people rather than top down people. If you worry about the Buffett rule, the changes in tax, whether it goes on in European politics etcetera, etcetera, I think you go in a hole and never do anything. And I don't think that would be a productive way to proceed. Okay. And one last question if I can. I think we started off with the discussion of agency feedback on One Markel some positives, some negatives. Was growth in the quarter impacted I would say on the negative side at all because I would say it was impacted on the positive side. Really the feedback is very good on the 1 Markel results and we're seeing almost all of our large wholesale producers' books grow with us. There are a couple that haven't, one because they lost a lot of business themselves. But we got I might not have worded that as well as I could have just trying to be candid. Really the only negative response was just trying to help us continue to speed up our response to them in terms of buying the issue. But the response on the One Markel and their availability of all Markel products for these agents and brokers has been terrific. Okay. Thanks for clarifying. Thank you. Our next question is coming from John Fox from Fenimore Asset Management. Please proceed with your question. Okay. Thank you. I have a few questions. One, thank you for the disclosure on the accounting change. That's appreciated. In Specialty, I was under the impression that last year you were going to put some reserves up at first time or bring it up to Markel's standards of about $30,000,000 last year. And then of course it's in this quarter or this year. So is my impression that that's last year wrong? Or is there something else going on there in terms of bringing it up to Markel's standards in addition to what Rich has said about California? 2 things there John. When we purchased 1st comp, we put some reserves up to get the historical reserves where we thought they needed to be and in line with our more likely than not redundant in margin and safety philosophy. In all our lines of business at Markel as we go forward, we build in a margin of safety on the loss reserves on the loss ratio, because things happen. And so that is part of our more likely redundant than deficient philosophy to have that margin but on an ongoing basis, we will continue to put a margin of safety on first comp just like we do all our other businesses. That could potentially decrease the amount of the margin could decrease as we become more comfortable with that business. But it's no different than what we do everywhere else, I guess I'm saying. Okay. And is there anything else in the segment? I mean even if you add back the 14% that wrote it at underwriting loss, are there other lines of business or any other trends that are significant there? No, nothing really. We feel good about it. We're getting priced wherever we can. And with regard to 1st comp, I mean they are focused on improving pricing. They're focused on their risk selection. They're focused on the their agency plant management. And they're also focused as Richie mentioned on their geographical mix. They went into 2 new states, Louisiana and Alaska last year and we saw some nice growth there. So, no I don't think so. Okay. And then Tomco is in that segment. I thought I heard that's going to impact next year? No. Tomco very little of the Tomco business transitioned in the Q1. We'll be transitioning those programs that are moving to Markel paper during the course of the year. Some of the bigger programs are later in the year. Their largest program I think we start transitioning in September. So we won't feel the full impact. I think what we in previous disclosures was that we expect about $60,000,000 direct to hit in 2012 with the full impact of the acquisition hitting in 2013. Okay. So that's like an MGA situation rolling onto your paper? Right. Exactly. Okay. And then for Tom Gayner, for ventures, I believe Havco was in the Q2. Is that right? That's correct. That didn't close until April. Okay. Did you close anything in the Q1? No. Okay. And so the acquisitions line, the cash flow statement is really for Tomco? Right. Correct. Not for Ventures? Correct. Correct. Okay. Thank you. Thank you. Thank you. Our next question is a follow-up from Meyer Shields from Stifel Nicolaus. Please proceed with your question. Thanks. Just one brief one. When we look at the underwriting profit or the underwriting profit in the discontinued line, is that sort of sporadic? Or is there some sort of ongoing theme that we should look Bayer that's going to be very sporadic. Those lines are discontinued. It's really legacy reserves that are now running off. And I think it's I think the small positives you've seen sporadically over the last several quarters is really just the more likely redundant than deficient philosophy of Markel playing out as we're settling out those legacy reserves. We're seeing bits and pieces of redundancy. So I wouldn't even attempt to project what that could look like going forward. All right. Fair enough. Thank you. Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for any further or closing comments. Thank you very much. We look forward to updating you next quarter. See you soon. Bye bye. Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.