Markel Group Inc (MKL) 2002 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the Markel Corporation Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If at any time during this conference you should need operator assistance, please press "*" "0" on your telephone key pad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Steve Markel, Vice Chairman of Markel Corporation. Thank you, Mr. Markel. You may begin.

Thank you very much. And thank all of you for joining us this morning. Before we begin, I would like to call your attention to our Safe Harbor and cautionary statements set forth in our press release in Forms 8-K, 10-Q and 10-K. The discussions today could be affected by the matters described in those statements and we encourage you to read those statements very carefully.

Joining me today on our conference, as is customary, Darrell Martin, our Chief Financial Officer, is with me and will be reviewing our financial results for the third quarter and nine months of the current year. Tony Markel will participate in the call and review our operations, both in the United States and internationally and make comments about the current market conditions. And Tom Gayner, our Chief Investment Officer is with and will review our investment activities. After we all make our brief presentations, we'll be available to respond to any questions that you may have.

To open I'd like to, again, advise everybody that this quarter we have both good news and bad. We're very disappointed to bring you the bad news. Third quarter included $44 million pre-tax of discontinued lines reserves strengthening, primarily related to the company's increase of reserves for asbestos and environmental exposures. The company's strengths in reserves for asbestos and environmental about $30 million, 20 million of that was in our United States/North American operations and 10 million of that was in our international operations. The remaining $14 million charge was related primarily to reserves for additional reinsurance cost and collection issues. These charges amount to $2.86 in after-tax per share earnings charges.

I know, understand and share everyone's frustration with bad news. It does seem sometimes that we take two steps forward and then one back. We've now owned Markel International for two and half years. I'd like to assure everybody that we continue to make extremely good progress in identifying and resolving problems from the past, our discontinued legacy. Both the number of issues and the size of exposures has been reduced very, very substantially over the last two and a half years as we resolved and settled these matters.

The good news we have to report is also important. Darrell, Tony and Tom will comment in more detail. But we have solid underwriting results in Markel North America and continued improvement in the underwriting results in our international operations and overall, our combined ratios are at profitable levels. We have exciting premium volume growth and exciting price improvements, which [indiscernible] very, very well for the future. We are enjoying great market conditions in the specialty market and we expect these conditions to continue.

Portfolio growth is also very strong. In the quarter our investment portfolio grew $250 million, year-to-date that number is $430 million. And we have an extremely bright future.

With that, I'll turn it over to Darrell Martin, our Chief Financial Officer, to review the numbers.

Thank you, Steve, and good morning. Before I get started, let me just highlight that our 10-Q will be available probably mid-week next week -- hopefully by Wednesday. As usual, my commentary's going to focus on year-to-date numbers with some reference perhaps to some quarterly activity, but most of my commentary will focus on year-to-date. And, as usual, I will break the conversation down between underwriting and investing activities on consolidated basis and Tony Markel then will follow up with some commentary on individual operating units.

For the nine months ended September 30, we recorded consolidated gross premium of $1.6 billion, a 29 percent increase over the prior year's $1.3 billion. The majority of that growth is coming from Markel North America activities, which enjoyed a 60 percent growth rate year-to-date and it's accelerating quarter over quarter volume growth. In the third quarter it was a 72 percent increase in Markel North America --very strong growth due both to pricing as well as increased activities and submissions. Markel International is very much in line with their expectations and as we have reported previously, we would expect total at gross premium for the year to be approximately $600 million to $650 million.

On a net basis we retained 1.2 billion of the 1.6 for 72 percent retention ratio, in line with the prior year and earned premiums were approximately $1.1 billion, a 26 percent increase over the prior year reflecting the growth on the top line. Again, very, very strong and consistent growth quarter-over-quarter.

As Steve mentioned, the real news this quarter is the reserves strengthening and the impact that had on our combined ration year-to-date. We're reporting a 105 percent combined ratio this year compared to 123 percent combined ratio a year ago. Both periods are impacted diversely by unusual items. In 2001 through September we had the World Trade Center losses of $75 million plus $68 million of other reserve strengthening that was included in the 123 combined ratio. Excluding those unusual items, our consolidated combined ratio last year was 107, excluding the 44 million in the current period, our combined ratio this year is 101. While we are not at an underwriting breakeven, we are realizing a six point improvement in our consolidated underwriting results year-to-date and very much in line with our expectations in that regard. Very strong performance and I think Tony will talk more about that, but I think it's also important to note that we're taking a recognized and very nominal benefits from any price increases that we're seeing in North America and in the international operations. We are being very conservative with our estimates relative to the loss ratios embedded in these combined ratios.

On the investment side, our investment portfolio increased to $4 billion at the end of September. As Steve mentioned, that's over a $400 million increase year-to-date and a $250 million increase in the third quarter alone. The volume growth and the increase writings and retentions is showing up and finding its way into our portfolio as volume increase. Net investment income is flat compared to the prior year, approximately $127 million in both periods. That's a result of lower yields in the investment arena, offset by the higher portfolio or average invested assets for those periods. Net investment income is flat, as I've said.

In addition, realized gains in the current nine-moth period were approximately $43 million, compared to $16 million in the prior year. That 43 is primarily generated by bond sales. As we mentioned, I think, last quarter, we have consolidated all the investment functions of Markel Corporation into central location here in Richmond and some of the fixed income securities that were held in the international operations have been redeployed over the past primarily two quarters. Those gains are highly volatile, as we mentioned in the past and primarily generated by a repositioning of the portfolio.

Change in unrealized in the current quarter was $14 million gain. Bonds are up and equities are down. Tom will refer to that in a little bit. And our total return for the quarter was 6.4 percent -- or year-to-date, I should say is 6.4 percent. A very strong performance in this market environment and we're very pleased with that.

Net income for the quarter was 48 -- $49 million, compared to an $81 million loss a year ago through the nine months. And conference of income was about $49.3 million for the nine-month period compared to a loss of 41.5 a year ago.

Core operations -- the focus that we look at in terms of measuring how we're doing, it excludes realized gains and amortization expense and any other non-recurring item. Earnings from core ops on a per-share basis is $2.66 for the nine months ended September 30, compared to a loss of $8.71 a year ago. As Steve mentioned, the charge that we're taking in the third quarter diminished those core operational earnings by $2.86 a share year-to-date and the quarter.

Shareholders equity book value increased to $1.1 billion or about $115.00 a share, up from 110 a year ago. A four percent increase in growth and book value year-to-date.

With that, I'll turn it over to Tony who, I think, will have some commentary and discussions about our core operations.

Thanks, Darrell. I'm joining you from Los Angeles so forgive me if I'm a little fuzzy this morning. But I tell you, clearly from an operational perspective, it was an outstanding quarter, consistent with the gratifying marketplace that we've reported in each of the last three or four quarters. The continuity, consistency and strength of relationships that we enjoy continue to drive outstanding results in the U.S. and this quarter showed solid additional progress toward underwriting profitability of Markel International. Let me split them and talk a little bit specifically about both sides of the operation.

In North America our gross volume, as Darrell indicated, was 1.139 billion for the first nine months, which is up 60 percent from the same period last year and probably just as worthy of note was the fact that that third quarter of some $445 million of written premium in our North American operations is up 21 percent from last quarter and I'll -- which clearly indicates to me that the marketplace is continuing to be right down our alley. Obviously, following that earned premium for the nine months in North America was 672 million, which was up 47 percent from the same period last year and a gain consistent with my comments about the third quarter compared to the second. Our earned premium of 255 million in North America for the third quarter was up 15 percent from just last quarter. The combined ratio for the nine months in our North American operations was 95 percent and 94 percent for the third quarter, clearly consistent with what we have come to expect from our U.S. operations in this marketplace.

The market continues to meet and exceed our expectations as reflected by the solid improvement in volume and combined ratios on a quarter-to-quarter basis, with the third quarter being better than the second, as I indicated, which was even better than the first. The rate environment seems to be holding extremely steady and the volume increase coupled with justifiable commission adjustments that we've made during the course of the year continued to reflect solid reductions and improvement in our expense ratio. I'll talk a little bit about the general market environment at the end of my remarks.

On the other side of the pond at Markel International, our gross volume on continuing products for the nine months was $467 million, which was down about 13 percent from the same period last year, indicative of a belt tightening and elimination of -- continued elimination of unprofitable products in the result of the downsizing that we started when we first landed over there. The earned premium for nine months was 393 million internationally, which was actually up 18 percent from the same period last year, in great measure, indicative of our reducing independence on reinsurance and bringing our risk bearing perspective to the table. The combined ratio of 106 percent from the -- for the third quarter was down from 107 percent last quarter, which was down from 110 percent in the first quarter. We continue to show solid movement toward gaining underwriting profitability.

The rate increases over there continue to stick very much consistent with the U.S. marketplace. The expense reduction initiatives are making steady progress and I've talked at length in prior conversations about the expense overhang that we're working on as a result of the downsize volume out of the chute. Lloyd's recently passed a resolution that was necessary to facilitate the fundamental change in oversight that we've been lobbying so hard for and, although the jury's still out as to whether or not they will add the teeth to that oversight and regulations, we're optimistic that they will bring strong regimen to the oversight of the syndicates and really create a new Lloyds that effectively has the benefit of solid oversight in the strong business [indiscernible] and is something that clearly is necessary and that we've been instrumental in lobbying for. Jeremy Cooke has been very, very integral on many of the commissions over there. That's the basic numeric backdrop to both sides.

Some general observations, as Darrell indicated, these results we think contain minimal projection of the substantial rate increases that we've enjoyed this year because of our conservative reserving approach and our resulting attempt to establish loss reserves that are more likely redundant than deficient. In addition to the strong organic growth that we've enjoyed because of the turmoil in the marketplace, new opportunities, both small, medium and large, continue to come out of the woodwork. Opportunities for additional distribution sources, new products, new clients -- it's an extremely exciting environment well beyond just the tremendous organic growth that we're enjoying.

We were named one of [Ward's] top 50 insurers for the year, which is quite a nice feather in our cap and I think I saw recent publication that showed, based on the 2001 volume figure, that we've now, as a group, risen to be the third largest surplus lines carrier in the country behind Lloyds and AIG. And in order broaden the scope of corporate oversight, Paul Springman has recently been promoted to Executive Vice President from his previous position of President in North America. And he's currently in London getting a crash course on that marketplace so he can assist me with the entire spectrum of operational issues.

As I eluded to a little bit earlier the instability and turmoil and repositioning in the marketplace has continued throughout the third quarter. Changes at the top at [Royal]. Changes at the top that are going to be necessary at [Chubb], both in its CEO and CFO position. The exiting of [Girling] from the U.S. reinsurance marketplace, changes at [Trenwick] where Chubb has stepped in to front for them. These were just third quarter changes that clearly indicate to me a continuing -- an unsettled environment which plays into our hands. As a matter of fact, I saw some report the other day that outlined 23 different changes in the CEOs of property and casualty insurance companies in the last 12 months. Clearly, this type of environment is good for us, especially a surplus lines carrier that has continuity of management, singularity of focus and a limited dependence on reinsurance and I think on both sides of the Atlantic, we are well-positioned to take advantage of it.

In addition, as I mentioned, I'm out in Los Angeles, at the NAI convention and have had the chance to get sort of a flavor of what's happening in the marketplace over the last two or three days and my sense is that with the results that had over the last 15 years and the short-lived positive marketplace that we have that the environment is going to continue to play right into our hands. I sense a continuing strong resolve to concentrate on underwriting results and get adequate pricing. I mean, clearly, underwriting results have got to be the focus for the industry as investment returns on both the equity and fixed income side are less than overwhelming in spite of the new capital that is raised at the end of last year and the beginning of this year. Our case could clearly be made that the market has contracted rather than expanded. The new leadership in the industry has got to come in with an air of caution and conservatism and obviously, I've -- you've read articles, I'm sure on the reserve inadequacies that are being estimated. And I think all of that plus continuing asbestos, DNO, mold and terrorism issues clearly should discourage a return to aggressive pricing and risk selections. We think that this marketplace is solidly right down our alley. We are clearly well positioned in both sides of the Atlantic to take advantage of it. It think our results are indicative of the fact that we are taking advantage of it. And in short, we couldn't be more bullish about the future of our continuing operations.

I'll be more than happy to answer some specific questions when we get into the q-and-a, and with that, I'd like to turn it over to Tom Gayner to talk to your about the investment side.

Alright. Thank you, Tony. I'm pleased to report some pretty good results on the investment side. On the equities we were down 10.9 percent for the year versus an S&T of down about 27.9 percent for the year-to-date. In the quarter we were down about nine versus 19 percent. Now I don't like negative numbers, but I am pretty happy with the relative performance in a wickedly difficult investment environment. And fundamentally and importantly, I'm very optimistic about the companies and the businesses that we own. I'm confident that they're making solid gains and intrinsic value and that eventually always shows up in stock price.

On the fixed income side, we're up about 6.5 percent year-to-date. I consider that to be very strong performance and we remain focused on high quality fixed income security and maintaining the duration of between four and five years. I'm pleased to report to you that we don't have any credit losses or wipe outs in the fixed income portfolio despite the high levels of corporate defaults that you're seeing out there in the papers every day and that's because we steer clear of low quality credits and we maintain basically a balance between governments and agencies, municipals, mortgages and high quality corporate securities. In sum, on the investment side, common sense saves us a lot of tears in both the equity and the fixed income markets. We select every stock and bond on a bottom-up one-by-one basis and insist on a well thought out reason as to why we should own each and every stock and bond. And I'm very pleased with the results of this process through very difficult market and I'm optimistic about the opportunities to invest our substantial cash flow in the future.

In turning briefly to the notion of cash flow, as Steve, Darrell and Tony have all described, we do have some pretty significant cash flow coming in the front door these days given the price and volume that's exiting on the insurance side of the business. At September 30, total cash in investments topped $4 billion for over $400.00 a share, up from about 3.6 billion at year-end. During the second quarter, you might recall from the last conference call, I mentioned that we were starting to increase the cash flow allocated to equity and that continues to be the case. The current rate of cash into equities annualizes to about $100 million and we see that continuing in the third quarter, which combined with some appreciation somewhere along the line, should serve to increase the equity allocation percentage more towards a normal level of 20 to 25 percent of the portfolio from its current level of about 14 percent.

With that, let me turn it over to Steve.

Thank you, Tom. As all of Markel's long-term shareholders will know, we've long operated on what we describe as our model for profit. Markel is focused on earning consistent underwriting profits and superior investment returns to build shareholder value. Our goal is to compound book value at a high rate over a long period of time. Clearly, the results in the last couple of years, we've not achieved these long-term goals. However, I do believe and I think the record will show that we are strongly building an organization and our balance sheet to put up in a position to compound book value at a high rate over a long period of time.

Today, we're in a marketplace where earning consistent underwriting profits is, in fact, very, very doable. We've made tremendous progress in turning around the troubled turnover insurance organization and building Markel International into a fine specialty property, casualty organization that can operate in the international markets and international arenas with the same skill and expertise and consistent focus on profitability as our U.S. business. And, clearly, the U.S. business is in a position to fully capitalize on a very exciting turn in the property, casualty market, which is having an even amplified impact on the specialty segment.

We're enjoying very, very strong cash flow with the increased premium volumes and that money is in the hands of investment professionals, which probably doesn't exist in any other property, casualty insurance organization. And we're really focused and well situated to properly take advantage and continue to deliver the superior investment returns on a growing portfolio. The portfolio is now growing to the point where returning to that four to one portfolio to leverage -- portfolio-to-capital leverage is very, very realistic. Interest rates for fixed market returns are obviously depressed, but the potential for earning significant underwriting profits is very real. And as a result, I'm extremely bullish that we will, in fact, be successful in the next several years at compounding book values at the target rates that we've set in the past.

With that, we'll close our formal remarks and we'll open the floor to any questions that any of you might have. Operator, if you can open this call for the question period, I'd appreciate it.

Thank you, gentlemen. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press "*" "1" on your telephone keypad. To remove your question from the cue, please press "*" "2." For participants using speaker equipment it may be necessary to pick up your handset before pressing the "*" keys. Our first question comes from Mr. Marco Pinzon from Salomon Smith Barney. Sir, please state your question.

Sure. Good morning. I have a couple questions. Number one is on the international business, can you bring us up to date on when you think you might hit breakeven? It looks like the -- at least the sequential quarter-by-quarter improvement at combined ratio might have slowed down a bit. Number two is discontinued lines continues to be somewhat of a drag. Even if I pull out the 44 million in adverse loss reserve development, I come up with, I guess, $5 million or $6 million in underwriting loss. Can you give us some sense as to how long that's going to continue -- when that drag's going just kind of go away? And then, finally, the net-to-gross premium retention ratio on the international side is the lowest it's been in quite some time. Should we look at that as the kind of a reasonable level going forward for modeling purposes or what should we be doing there?

I'll deal with the first question about Markel International reaching its desired goal of underwriting profits and let Darrell deal with the discontinued and net-to-growth question on international.

I think first that the third quarter with international was pretty much on track with the sequential improvement we were expecting. The variation would have been in decimal points that we would not consider terribly significant. And we do believe that, and are very hopeful, that we will continue to see sequential improvement and we are absolutely dedicated to underwriting standards and pricing standards so that we will achieve underwriting profitability. Our actual results that we are reporting include, as we've mentioned in the past, a margin of safety on the selection and if we are lucky and if actual results come in at mid-point projections, we could already be at underwriting profits. Now that would not be a conservative way of measuring results and it seems that there's always more bad news than good news, so it's absolutely, in our opinion, appropriate to make loss reserves selections at something north of the midpoint. But we're very, very hopeful that we're very, very close to being there.

In terms of looking into 2003 for the international business, continued price increases, continued underwriting discipline and effective management of our costs, which is a key element that we do have some control over, I think will enable us to get there. We're working hard to make it happen and, unfortunately, I can't promise a specific date when it will occur, but the faster the better. I think in the aggregate picture, clearly, our domestic operations are growing at a much faster rate and so we, in the aggregate, Markel Corporation is now operating at an underwriting profit and I would expect that to continue and I would expect the margin of the aggregate underwriting profit to continue to get better.

With that, I'll let Darrell pick up on the two other questions you had about the discontinued and domestic.

Yeah. The first question relative to the discontinued lines dragged. You're right that if you go back over the past several quarters there has been $4 million to $5 million in round numbers loss associated with the discontinued operations each quarter. And those obviously pertain to run-off operations primarily in the international side and are comprised of two portions. One is an allocation of cost amongst the business units within the international operation. Part of that allocation does, in fact, go to the run-off side and part of it are direct costs that we are incurring to administer that business. Our expectation is over the next year or two or three, those things will continue to get less and less significant and, as a result of that, the charge that you're seeing should diminish as time goes on.

The second question relative to the retentions on the international side, it was low in the quarter due to additional reinsurance costs that we incurred purchases. I think on a go-forward basis, I think something in the 75 percent level in terms of net retention would be appropriate for the on-going international operations.

Darrell, let me add on that last issue. I don't have any of the numbers in front of me, but clearly, over the last two years, we have dramatically downsized the limits being put out and increased the nets consistent with our risk-bearing appetite and there's no question about the fact that our dependents on reinsurance or leveraging reinsurance is far diminished from what it was when we walked in over there. I think the nets will continue to rise. I don't know what the aberration was in this quarter, but, clearly, our objective is to retain more of the premium.

Okay. Fair enough. Thank you very much.

Our next question comes from Ms. Beth Malone with Advest Incorporated. Please state your question.

Thank you. Good morning. I have a number of questions. I'll just ask them one at a time. First, on the reserves for asbestosis, could you quantify or give us some sense of whether you -- how you see these reserves and how there were calculated and what confidence you have that the reserves that are set aside as adequate now and also a portion of those reserves came from North America. Could you give us some idea where those risks were? Are they -- were they from acquisition as a part of [Griffin] or some other source?

You want to go through all of them or do you want?

Well, I can go through all of them. Okay the next question would be on your commitment to Terra Nova, what became the international division, can you give us some sense of how much, if you count all the reserve additions that have been made in the discontinued, how much has been invested in Terra Nova and what kind of investment return has that generated to date. Third question is on cash contributions. How much cash flow has been contributed to investment income? And I have one last question is on the leverage. It looks like your -- the level or writing you're at right now could put you at two-to-one of premiums-to-surplus and are you comfortable with that level of leverage and could you comment on that? And those are my questions.

Okay. Let me deal with it in the same order you dealt them to us. First asbestos. The entire $30 million charge is related to not specific claims that have come in the front door, but related to forecast of what might happen in the future. Basically, our [indiscernible]. And what we've sought to do is to, as always, be more likely redundant than deficient. Unfortunately, in the world of setting reserves for environmental losses and asbestos losses, actual [indiscernible] techniques are very imprecise because we're dealing with a very different and changing environment. The legal system is changing. The nature of the claims are changing. And it is very, very difficult to forecast what this environment might look like two or three or five years from now. And, in fact, to establish these reserves, we're forecasting claims payments over the course of the next 50 years. And, Beth, as you know, none of these numbers are discounted at Markel to reflect that. This is 100 percent of what we think the ultimate cost is without any inferences for discounting.

During the last nine months of calendar year 2002, there have been a number of developments well reported in the press related to an increasing volume of claims related to asbestos. And one of the major things that's happened is a number of companies have gone into bankruptcy in the legal environment in bankruptcy has permitted literally hundreds of thousands of people who may have been exposed to asbestos because they were in an environment where asbestos may have occurred, but they're not ill. And the average settlements that these people are getting are sort of the in two or three thousand dollar range and it's a lottery. People can literally sign up to join a class action on an asbestos and without any demonstrated illness can collect funds. And it's really a -- it's an industry-wide and societal problem. Markel's in a wonderful position in that we have a tiny percentage of these exposures. Yeah, I can assure you that the risk of the next asbestos-type of event is something that we're putting in our pricing models today. We're the beneficiary of this sort of environment of fear and it's costing us something. It is absolutely costing us something. But we're, as a society, it's going to cost all of us more money to deal with these sorts of uncertainties. And I think, ultimately, Beth, the only solution is sort of a legislative action to dealing with this.

In terms of the quality of our reserves -- well, first, in terms of the location, ten million is related to our international operations. In Markel International we have no asbestos exposures. In our Lloyds business because of the creation of [Equitas] in 1992 and 1993, all of the prior-period Lloyds' exposures to asbestos were transferred and reinsured into Equitas. Terra Nova Insurance Company does have a relatively modest exposure to some of these asbestos claims and we've increased our reserves here by $10 million in the '70s and '80s. Terra Nova Insurance Company, as a reinsurer, was involved in both the marine and non-marine reinsurance business and that's where these exposures come from. The good news from [Artel] is that in that period of time, Terra Nova was primarily a property reinsurer and most of their business was in -- in that period of time, was in the property, catastrophe reinsurance market where there's very, very little exposure. So Terra Nova's exposure, while not insignificant, is very, very modest by industry standards.

In the United States, we've added $20 million to our reserve and that is split between the Associated Insurance Company, which was the old Griffin and also the [Evanston Insurance Company], which was the [Shan Morehand] acquisition. And, again, both Evanston and Associated were involved in some lines of business that had some exposure to these coverages, but, again, in the period of time when those exposures were causing claims today, our exposure is very, very modest relative to the industry.

We typically have small shares of excess layer treaties. We're almost never -- very, very rarely involved in the first dollar or primary levels and I don't think we have -- and we have more exposure to frequency than severity, but what's happened is as claims have grown, they've reached into the higher limits where some of our companies have participated in reinsurance layers.

In terms of our ability to quantify the numbers, it's very subjective. We think that we've very, very conservative as it relates to the industry. And we feel like we're trying to stay in front of it so we don't have to play catch up.

In terms of the second question you asked related to the returns that we've earned at Terra Nova relative to our investment. Obviously, until Terra Nova reach and Markel International reaches underwriting profit, we would be very disappointed in the total returns. The two and a half years we've owned the company we've not yet earned any meaningful returns. Our expectation is that the company will, in fact, achieve underwriting profitability. The investment portfolio attributable to the Markel International operations is -- I don't have the number in front of me, but close to $1.5 billion and we're earning very, very solid returns on that portfolio. In the fourth -- in the third quarter, the cash flow on that business was positive and we expect it to continue to grow at this point in time. The premium volume, as you know, we've -- has declined from the $1 billion level. We expect this year to write about 650 million and we would expect that to begin to grow in 2003 and going forward. And as a result of that, we would expect the portfolio to also grow. The jury's still out in terms of when and how profitable that transaction will be, but we are very, very optimistic about that.

And finally, your question about leverage in terms of total premiums that Markel's writing to capital. I think you're right that we're approaching that two-to-one level. The good news is that the quality of the premium that's coming in is sufficiently strong and our confidence in its profitability is sufficiently strong that we are very, very excited about the opportunity to fully take advantage of this marketplace. We feel like we're strongly capitalized to deal with the business plans we have for the next year or so. Clearly, a 70 percent growth in premium that we enjoyed in the third quarter is not something we would expect to continue for a long period of time, but we do expect the fourth quarter and 2003 to remain very, very strong with pricing very, very solid and we believe that we're fully capable of taking advantage of the marketplace.

Okay. Well thank you.

Our next question comes from [Chuck Aquree] with [Aquree Management]. Please state your question.

Good morning. Couple questions. Let's see, just starting from Beth's last question, how do the rating agencies discuss your approaching two-to-one ratio with you in terms or your capital structure? Second question is on the undiscounted reserves that you talk about in your gap statements, what is the difference in that on your tax books? Number three, just a question about these reserve additions for the asbestos and environmental, are any of those places where you had previously muted your reinsurance and, if so, how has the math worked out in the interim? And I think you covered this, but I just wanted to make sure that you're still thinking about being at sort of a breakeven level in international by the fourth quarter, at least on a run rate business. And then one last question on the reinsurance receivable reserve that you took the $14 million, can you identify who you've taken those against and whether or not you have any additional exposure in those names? Thanks.

We'll try to deal with those and ask my colleagues to jump in and help me if I miss one of them. First on the question about rating agencies. It think it's fair to say that the rating agencies don't look at any one measure to make a call. It's a function of the quality of the business, the quality of the balance sheet, as well as the raw premium volumes, so the models that all of the agencies use for risk base capital include comprehensive review of the business and I believe that Markel will continue to score very, very well in that regard because of our conservative accounting and reserving policies. We don't use any [stop law stinite] financing types of reinsurance coverage that -- on an off-balance sheet basis leverage the balance sheet. Our investment portfolio is solid and well managed -- conservatively managed, but yet, consistently earns great returns. And the pricing in the specialty marketplace is such that the probability that the business we're writing today is profitable as much greater and we've got solid people in underwriters. I'm not terribly concerned. It's obviously an important element to make sure we continue to communicate with the rating agencies and make sure they understand what we're doing and why we're doing it. But premium volume, per say, will not drive the bus there.

The loss reserves, as we've stated, are at -- on our gap books at 100 percent. As you pointed out, the current tax law does require that there be a discounting and I believe the discounting for taxes is somewhere in the range of 82 to 84 percent. I guess that's an 18 percent discount -- 16 to 18 percent discount for tax purposes that shows up in our deferred tax liability.

Next question you raised related to relative to the asbestos charge. What was the impact on commuted reinsurance and the $30 million charge is not only or original net, but our current net, as a result of our current belief in either reinsurance that we actually legally commuted so it becomes our net or reserves that we put up for bad debts on reinsurers that might not pay. And of the $30 million, it is a significant number that relates to reinsurance that's not collectible in 2002 relative to what it would have been five years ago or something. We've made that provision and it's included in the $30 million.

I can't give you a specific answer on when we will hit that underwriting breakeven. I was hopeful that it would be on December 12, but it might be January 4, but we will work diligently to make it happen as absolutely quickly as possible. We're very much on track. A large part of it is a subjective judgment about what we think the margins of safety should be. My guess is that in the fourth quarter, Markel International will not report 99.9, but hopefully it will occur in the not too distant future.

And your final question was related to the $14 million charge at Markel International discontinued which relates to reserves for additional reinsurance cost as well as collection issues. Chuck, that relates to several different items and there is no one name or highlight issue that we need to talk about, but it does, I think, bring closure, at least, from an accounting and accrual perspective to a number of issues that we've been dealing with at Markel International so that we can continue to make settlements and resolve problems from the past and put issues behind us. We've made tremendous amount of progress in that arena in the last two and a half years. The laundry list of things we're working on to identify, analyze and put to bed, we continue to resolve more and more and more of the issues. I think virtually all of the sort of the big issues, in fact, aren't -- are now sort of largely behind us, as best as I can tell. The frequency of new things coming up that we have to talk about is, in fact, smaller, and so I'm very, very hopeful that we will see closure very, very soon. And having said that, it's been two and a half years in a project that will go on more than that. And hopefully we're 90 percent the way through the process or even further. But it is an unknowable thing.

Chuck, I might add, as it relates to the question concerning profitability [indiscernible] that without exception we feel extremely good about our pricing levels and our risk selection in every one of the continuing products that a long-term franchises and I would refer you to Steve's comments concerning the fact that the results that we're posting, we think, contain really a minimal projection of the rate increases that we're been getting in an effort to try to create more of a lien toward redundancy than deficiency and it's an unscientific balancing act obviously.

Our next question comes from [Renee Sinto] with [Sinto Capital]. Please state your question.

Good morning. I was wondering if you could just remind me in terms of the amount of goodwill that was booked with the Terra Nova transaction?

We had $275 million still on our books relative to that goodwill.

I was just wondering in terms of any impairment of the goodwill. What is the main criteria that you used to assess potential impairment?

We measured that when we implemented 142 in the first quarter and the discounted cash flow methods that we used indicated that really are -- was no impairment of goodwill indicated at that point. We also will be remeasuring goodwill in the fourth quarter based on September 30 numbers and we have not completed that process yet, but given the various assumptions that were embedded in our original test, I think those original assumptions still hold up in today's environment.

Is cash flow from Terra Nova -- that is your main, correct?

That's correct.

Okay. And what's happened in the cash flow from Terra Nova over the last two quarters?

It's up.

It's up.

It's up. Okay. Thank you very much.

Our next question comes from [Matthew Hennerman] with Goldman Sachs. Please state your question.

Good morning. I had three questions. First, how comfortable are all of you with your previous reserve increases over the past several quarters and are the trends progressing, I guess, as you expected when you made the additions? Secondly, the state of the CNS market in the U.S., can you just give us an idea of how big it is relative to the standard market at this point and how much further you expect that market to grow? And then, finally, with regards to [Corey France], are -- what's your appetite to kind of increase ratings there given some of the stresses in the market over the past quarter?

Okay. I will deal with those. And, Tony, I'll ask you to chime in on the CNS issue.

Okay.

First, in terms of reserve increases, quarter by -- at the end of every quarter, we set the reserves at a level that we think is the right level. And so at the end of the first quarter we were comfortable. At the end of the second we were comfortable. And, today, I think we're also very, very comfortable with our reserve levels and continue to be very diligent to try to get the reserves right and put up whatever we think is appropriate as soon as we think it's appropriate. I feel very comfortable with where we stand today and I'm hopeful that we never have any more surprises. The real world is that this business isn't quite that simple.

In terms of Corey France, the business is fairly small. I think we'll be writing about $30 million U.S. in premiums at Corey France this year. And the expectation is that for 2003 that their business will be strong and continue to grow and at prices that are very, very attractive. While it's in our discontinued operations and is still being held for sale, we are very much supportive of the management team and are very enthusiastic about the market opportunities and are not holding that operation back at all in terms of providing it our support for its future. We really do believe, although modest, it will serve a very, very important function and will build and grow and in turn, grow in value fOR Markel.

The excessive of surplus lines market was reported fairly recently as being, I think, about $15 billion and its growth rate is clearly -- in the United States and it's growth rate has been significantly higher than the rest of the standard market and there's no doubt that premium volume is flowing from standard lines into excess and surplus lines and the DNS market is growing at a much faster rate. Unfortunately, there are no very specific measures or no bright line definition of what is specialty business is as opposed to standard business. And there's a lot of specialty business that's written in standard line's markets. And so it gets to be a very subjective matter. I've always felt that, on average, somewhere between 15 and 20 percent of the entire market would be specialty lines and that would imply, I think the property, casualty market today is somewhere around $300 billion and so if you took 15 or 20 percent of that number, you would have a much, much larger number. But the specialty lines and the excess and surplus lines today are growing at a much faster rate and our expectation is that will continue.

Tony, do you want to pick up on that and do you have any other [multiple speakers].

Yes, Steve, I can't add a lot to it. I mean I think that the market, as I eluded to in my comments, stem -- still continues to be very much in a repositioning mode. I think there are a lot of coverages and segments of the market that are being tossed out by the [Hartfords], the Travelers, the CNAs of the world and in spite of the very gratifying growth that the specialty, excess and surplus lines segment has enjoyed over the last couple of years, we think there's still more growth available relative to the rest of the marketplace because we think there are a lot of things that are still being tossed out in repositioning of the standards. We clearly don't think we've apexed relative to this marketplace in comparison to the whole.

Another thing, Matthew, that's happening that sort of doesn't affect the overall size of that custom, surplus market, but certain affects our share is that there are a number of large standard companies who've had modest involvement in the excess and surplus lines markets that are withdrawing from those markets. And so there's been a lot of -- within the excess and surplus lines market, there's been a fair amount of disruption of companies pulling back and repositioning and so Markel and other companies who've really focused on this marketplace are enjoying the benefit of that as well. It's both [indiscernible] at the same time.

Okay. Thank you.

Our next question comes from [Jerry Hefferman] with [Alord Abbott]. Please state your question.

Good morning, fellows. Hey, I'd like to talk about this discontinued line again, if I could. Unfortunately, it is -- it just seems to be a thorn that reoccurs every quarter and I'd just like to get better view of when is discontinued actually to be discontinued or if it is something that actually may be around for a long time. And I guess part of this comes into the reserve adjustment -- a big part of that being for North America business, but yet, still ending up in the discontinued line and if that is for claims that are incurred, but not reported, is this something that's going to be around for a long time and, if not, shouldn't it actually be just part of the operations line?

Well, I think to answer your first question -- the administrative cost that are charged to the run-off of lines of business that we have exited, that is the primary cost that you would see unless there are reserved increases or reserved charges for lines that we in fact have exited. As long as it takes us to wind those operations down, there will be a cost associated with that activity. In terms of totally getting out and resolving any open claims or any open cases in those discontinued lines. As it relates to the asbestos and environmental charge we took in the current quarter, for North American, for example, the reason it is in discontinued lines, we, in fact, had not written any of that business in a long, long, long time. The [Shan Program] was in the early '80s. The activities that were associated with Associated Insurance Company -- the Griffin acquisition, again, those were exposures and coverages from many, many years ago that we no longer write at all. We believe it is appropriate that they be categorized as discontinued operations as well.

Okay. Well, and Corey France is in there too, right?

That is correct.

And that's where the premium aspect of discontinued is?

A large part of the premium, but not all.

Okay. And what's the rest of the premium?

The run-off lines primarily at Markel International that are -- I mean that part of the premium should, in fact, disappear.

Okay. At what point should the premium in the discontinued line be only Corey France?

I hope next year.

Okay. And then after that we will have just the expenses of these no longer written lines of business.

That's correct.

And any associated reserve increases.

And that expense level should be very, very modest.

Okay. Could you review again, why is Corey France being held for sale, particularly if you -- as per our previous answer, seem to be kind of excited about its opportunities? I mean certainly you have bought companies of this size in the past.

I guess it's the nature of its business is not really specialty.

Okay.

It's a very -- I mean it's a great company. It does reinsurance and it does it primarily Europe and Asia and South America very, very modest in the United States. But it takes a very, very small piece of a lot different contracts and it's not a specialty organization. It's a generalist in the broad reinsurance market. And we might well chose to sort of bring it in the fold and identify slightly different business plan, but the way it's currently organized, I think it probably still might have more value at the right time to someone else. But in the meantime, it's a well managed, conservatively underwritten, conservatively reserved business, very, very good, solid insurance people dedicated to making good returns and in the current market environment, it should do very, very well. But it will be a very cyclical business that it will need to pull back when the market softens very, very dramatically.

Cyclical in terms of the premium line?

Right.

Right. Okay. Fair enough. But, still I come back, if it is such a good company as you described, there's seems like there'd be a natural buyer particularly in this current market. I mean there's people all over the place trying to get into different areas of different markets of reinsurance, not to mention a couple of Bermuda guys who don't know what to do with their cash coffers.

Yeah.

Why does there seem to be an issues with finding the right sale price here?

I guess you hit it at the very end when you said the right price. The company could be sold very, very quickly at a very, very cheap price, but a price that representative of its value would be a little bit more challenging. I think a large part of the problem is that it is very, very small. And the second problem is that the European reinsurance market is really, really on its heels, which is the reason why the opportunity for us to continue to operate it is so great. I saw some statistics the other day that the average stock price of the European insurance market was down 50, 60, 70 percent from their highs a year or two ago. And so there's -- the European reinsurance environment is -- there's not too many people flushed with cash over there right now. They're, in fact, more sellers than buyers. And the number of other larger, more substantial reinsurance properties that have been on the market. There are a lot of troubled reinsurers out there looking for capital. The list is pretty long of reinsurers that are in trouble and that need money.

Okay.

The environment for selling it really is not -- in spite of the prospects, the environment is not really all that great for doing a transaction right now.

Okay. In regards to a previous question or asking about the time at which the international business would be at a 100 combined ratio, if we go back to your investors meeting of last November, you had indicated at that point that management's goal is to have this at a 100 percent combined ratio by the end of '02. Is that still a goal and is that still an attainable goal?

Absolutely, it's a goal. Is it attainable in the next three months or the next now 45 days, my guess is that it's unlikely that we would report a 99.9 in the fourth quarter for Markel International.

Well, I'll give you that, but actually, what I'll give you is what you stated at the meeting was that you would end '02 on 100 percent combined ratio, not report 100 percent in the fourth quarter '02. I'm looking further ahead, basically in '03. Will we begin to see, everything else being the same, 100 percent combined ratios in '03?

I mean my goal, my expectation would be to see some sequential improvement quarter to quarter to quarter to quarter. I mean the business isn't going to be like that being there's going to be ups and downs and blips. But the picture I would draw and the picture I think we're building towards is the trend line that we've seen in the last for our continuing operations in international to basically continue.

Okay. And, Steve, the final question, in regards to the asbestos reserve strengthening, why now? For that matter, if it's an incurred but not reported and every month there's another article or decision on -- and something to do with asbestos, why isn't there just a continual reserve review monthly or something so we don't get these periodic shocks?

It's a good question because we do, in fact, effectively review all of the continuing operations on a monthly basis and try to -- literally, we have a formal meeting on a quarterly basis, but we're looking at claims and changes in the marketplace on a monthly basis, a daily basis on all the other lines. The problem is that one event in a closed book of business like asbestos, doesn't necessarily -- it doesn't mean anything. If, for instance, our forecast for future asbestos claims was that we would see 25 new reports in calendar year 2003 -- and I'm making up numbers so they're not intended to be meaningful.

I understand.

That's not necessarily going to happen -- two in January, two in February, two in March. And so if it's three in January and one in February and four in March, there's really not enough information to make a judgment about it. I mean in the past year, the settlement on PPG, which we participated in, I think, occurred in the first quarter, and we did, in fact, say okay, we're paying a meaningful amount of money to settle PPG, which we did. And what was the impact on our carried reserves and I think the cash that we spent on that settlement would have been in the neighborhood of $6 million or $7 million, but the impact on our reserves was fairly modest. I think our -- and I don't have this number in front of me, but I think we probably increased our asbestos reserves on a case basis -- the net cost to us wasn't the six or seven million we spent, but probably somewhere between 500,000 and a million or a million and a half, in terms of the change in our outlook. And, in fact, I thought about that settlement. I mean our exposure to PPG might have been 10 million, just to pick a number.

Mm-hmm.

And so it wasn't a bad settlement and it didn't, in our view, materially impact our outlook on the overall asbestos situation. We were -- I thought pretty well reserved for it and we might have been short by a few hundred thousand dollars, but not a significant amount. And it took that information we looked at -- we said does it change things? And we said we don't think so. But the cumulative effect of a number of items and so we do have -- I guess we do look at it monthly and quarterly.

Well, then, Steve, I guess --

We have more sophisticated review on an annual basis.

Right. What happened most recently since that was a very real situation to give you a review of your reserve status, what has happened more recently to say that you needed this 40 million increase -- or 30 million increase, I'm sorry.

There's simply been -- the frequency of incidents that are being reported. They don't necessarily have any reserves associated with them today.

Mm-hmm.

Are just increasing very, very significantly. We're seeing a whole lot more -- a larger frequency of claims and the legal environment is just very, very different in terms of the nature of a settlement. It used to be, five years ago, that if you were ill from asbestos, you'd bring a claim and somebody would have to deal with it. Today, in the case of a bankruptcy, because of the need to reach finality in the context of a bankruptcy, anyone who has a potential future claim is seeking compensation. And the whole thought process about that is different than it used to be with handling asbestos claims. Today, anytime there's a bankruptcy, anyone who may have a future claim --

Mm-hmm.

Lines up and says give me a piece of this action.

Right.

And so you don't need to have an injury. I mean in theory, anybody that goes bankrupt, you could say, gee, I flew on that airline 20 years ago and maybe the air in the cabin was full of smoke and I want to get paid in case I get cancer.

No. Yeah, I understand.

And so -- and our plaintiffs' attorneys are smart enough to figure out a way to bring hundreds of thousands of people into the courtroom and, unfortunately, that's not a very efficient way of spending money. Again, the good new for Markel is that we have a relatively small exposure to the industry to the problem and a relatively large exposure to the current business environment where we can, if you will, capitalize on the fear that's taking place.

Steve, editorially, I think the landscape in that whole asbestos situation has changed over the last 12 to 18 months. I mean --

Yeah. Absolutely.

The dynamics of reports and the whole issue has forced everybody to take another look at it because of changing environment. I might also add, relative to the stated targets of underwriting profitability in '02, I would state it in another way. I think we've been consistent in saying that during '02 we expect it to price and select that business to produce an underwriting profit and I think we're there.

I think, Jerry, the best way to summarize it is we rather take the steps today to be in front of it than to try to have to worry about it tomorrow.

Well, no. I mean I understand that. I agree with that. I think just this point --

Our number one goal is not to have to talk about it in the fourth quarter or in '03. We're trying to stay in front of this stuff as best we can.

Right. I understand that. I just think at this point, from an investor's point of view, it would be more palatable if you just said, "and once again, we add another $2 million to asbestos reserves" -- and just every quarter just. I mean it sounds ridiculous but that seems to be the ball field we're playing in.

Well, I guess that would be an alternative that just sort of arbitrary put up x million dollars every quarter for it, but from an accounting perspective, that's actually not proper. If you think you got to put two million a quarter for the next four quarters, the right answer, from an accounting perspective, is you put up eight million today. And that's -- I mean we struggle with that every single day on every one of these issues, but the right answer from an accounting perspective is if you think it's eight, you put up eight.

Okay. I think we've pretty much killed this topic.

Okay. Thank you, Jerry. I appreciate your support.

Gentlemen, there are no further questions at this time.

Thank you very much. I appreciate everyone's support. Again, we're disappointed with having to bring you bad news, but I hope you can discern that we're extremely optimistic and positive and enthusiastic and excited about our business prospects. Thank you for your support and if you have any further questions, don't hesitate to give us a call.

This concludes today's conference. Thank you for your participation.