Markel Group Inc (MKL) 2006 Q3 法說會逐字稿

Greetings ladies and gentlemen, and welcome to the Markel Corporation third quarter 2006 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. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Steve Markel, Vice Chairman of Markel Corporation. Thank you, sir. You may begin.

And thank you, and I would like to thank all of you that are joining us today and welcome you to the Markel conference call. During our call today, we may make forward-looking statements.

In addition, additional information about factors that the could cause actual results to differ materially from those projected in the forward-looking statements, as described under the caption 'Risk Factors' and Safe Harbor and cautionary statements in our most recently filed Annual Report on Form 10-K, and Quarterly Report on Form 10-Q. Our Quarterly Report on Form 10-Q, which is filed on our website at www.MarkelCorp.com, also provides a reconciliation to GAAP of certain nonGAAP financial measures, which we may discuss in the call today.

Our program today is going to be very much like our prior conference calls. After I make a few comments, Richard Whitt will review the numbers, Tony Markel will review our operations, and Tom Gayner will bring you up to speed on our investment activities, and then I'll make a few final comments, and we will conduct a question and answer session.

As a brief introduction, the third quarter was very good for Markel. Net income was a record of of $100 million. The business was pretty much firing on all cylinders, obviously helped by the fact that it was a very benign hurricane season. Our investment returns were also strong, and growth in book value per share was right in-line with what we would like to see happen.

So we are real excited about the third quarter, and the prospects for the rest of the year and we are looking optimistically into the future, and with that I'll let Richard jump in and talk about the numbers.

Thank you, Steve, and good morning, everyone.

As I usually do, I will primarily focus my comments today on our year-to-date numbers. I will begin with our underwriting operations and follow that with a brief discussion of the investment results, and then bring the two together with a discussion of total returns for the nine months. I will also just make a couple comments related to cash flow and the balance sheet. Many of the themes that I will be talking about today for the nine months are very similar to those that we discussed at the end of last quarter, and for that fact, at the end of the first quarter.

Starting with gross premium volume, gross premium premium volume increased 9% to approximately $2 billion for the nine months of 2006. This was primarily the result of growth in new products, as well as increasing rates in many of our Cat exposed business lines. For the third quarter of 2006, growth did slowdown a little bit, as gross written premium increased about 4%, to a little over $600 million.

This was due to higher competition in some of our U.S. Professional liability and casualty lines, which partially offset the solid growth we have seen in the new products, as well as the Cat exposed property areas. Net written premiums increased 16% to approximately $1.7 billion for the nine months 2006.

Keep in mind that the third quarter of 2005, and the nine months was impacted by the 2005 hurricane season, and that included 54 million of reinsurance reinstatement premiums related to the hurricanes, as a result last year's number was depressed by that amount. But also the 2006 number is up due to growth in gross written premium for the factors previously discussed, and also as we have discussed many times, we continue to increase our retention on our book of business.

For the first nine months of this year, our retention rate was 86% of gross written premiums. This compares to about 84% before considering the effects of the 2005 hurricanes last year. We will continue to work to increase our retention rate was 86% of gross written premiums, this compares to about 85% before considering the effects of the 2005 hurricane last year, We will continue to work to increase our retention rates where appropriate.

Earned premiums increased 14% to approximately 1.6 billion. This again was a result of higher gross and net written premiums in the nine months. Again, keep in mind that 2005 was affected by the hurricanes, and the 54 million of hurricane reinsurance reinstatements last year.

Most importantly as related to our underwriting results, our combined ratio was an 88% combined for the nine months of 2006, and this compares to a 109 last year. Our 2006 combined ratio included 4 points, or approximately 53 million, of development on the 2005 hurricanes. The nine months of 2005 included 253 million, or 18 points, of hurricane losses. The 2006 prior year development on the hurricanes was more than offset by favorable prior year redundancies in other areas of our business.

The largest area where we saw prior year redundancies develop was in our Excess and Surplus Line segment, and again , specifically in our Professional and products liability unit. This is a theme that you will recall from both first and second quarter, and it continues. We would also like to point out in our underwriting areas that in the third quarter, all three underwriting segments, Excess and Surplus Lines, Specialty Admitted, and the London market segment, reported underwriting process, so very solid third quarter as Steve said.

Turning our attention to the investing side of the business, average invested assets increased to 6.7 billion at the end of the nine months of 2006. This compares to approximately 6.4 billion of average invested assets last year. The growth is primarily the result of operating cash flow for the first nine months. In addition, for the first time, the portfolio exceeded 7 billion. We were actually about 7.2 billion in the portfolio at the end of the third quarter.

Investment income was up to 203 million. This was a result of both increase in yields, and increase in the size of the portfolio for the first nine months of the year. As Steve mentioned, the third quarter was a very good quarter for both the equity and bond markets, and our gross unrealized gains increased considerably for the third quarter and for the nine months. We are up about 64 million before tax, in terms of unrealized gains year-to-date. And I am sure Tom will speak more to this shortly.

Putting together both our underwriting and investing results and looking at our total results for the nine months, we reported record net income for both the third quarter and nine months of 2006. Nine months 2006 net income was 271 million, compared to 25 million in 2005. Again, 2005 was affected by the 2005 hurricane season. 253 million of pretax losses last year in the nine months. Most importantly, and the way we measure our success here at Markel, book value per share increased 17%, to slightly over $204 per share at the end of September.

Just a few comments about cash flow and the balance sheet. Operating cash flow, we generated 374 million of operating cash flow through the first nine months of 2006. This compares to about 429 million last year. The decrease is totally a result of the 2005 hurricane losses being paid out during 2006.

We have noted a decline in the effect of the hurricanes in both the second and third quarter, as payments slow down, and as reinsurance payments have reinsurance amounts have been collected. So we expect that the impact of the hurricanes will continue to decrease as we move forward.

In terms of the balance sheet, I will point out one thing related to reinsurance recoverables. Since the end of the year, our reinsurance recoverables have decreased by over 400 million. Two factors here driving this. Obviously the hurricane payments and the collections of the related reinsurance, but also we have completed several successful commutations of reinsurance balances since the beginning of the year. Both of these have the effect of significantly reducing the reinsurance leverage and collection risk on our balance sheet.

At this point, I would like to turn it over to Tony to discuss operations. Thank you.

Thanks, Richie. Obviously, it's a terrific quarter from our perspective. We reported another great quarter from the operational side, producing both revenue growth and outstanding underwriting results. As Richie pointed out, obviously Mother Nature cooperated, but I would also suggest that the results reflect the continuing maturation and continuity of our operational units and people, augmented by increased focus on Sales and Marketing.

As we pointed out, gross written premium was up 4% over the same quarter last year, and 9% over the first three quarters of '05, and because of our increased retentions in '06, the relative net written premiums were up 20% and 16% respectively over the same '05 periods, although that is a little bit of a lack of comparison, because of the reinstatement premiums on the property cat cover last year, but still, retentions are up very, very nicely by design.

Obviously, comparison of underwriting results with '05 become almost irrelevant, given the negative impact of the hurricanes last year, and the resulting attractive comparisons of '06, but most importantly, the 84% combined ratio that we posted this quarter, follows 86% in the second quarter, and 94% in the first quarter, giving us a nine month combined operating ratio of 88%.

From an operational perspective, sort of business as usual, but a couple of things worthy of note, although not particularly material yet. The new Markel international branches in Toronto, Madrid, and the three new UK branches are moving along quite nicely, as is the Brittany Property operation in Los Angeles, that was purchased by our Investors Underwriting managers unit earlier in the year.

It is also noteworthy and very favorable for the future that Markel Global Marine and Energy has started writing business, and is actively expanding it's product base now that it's finally up and running. There has really been no change in the marketplace from the last couple reports. I think Richie indicated that and rightly so, that there's continued strong pricing in Property catastrophe, or catastrophe exposed property, both wind and quake, along with solid pricing in some segments of the Marine and Energy lines, mitigated to a degree by moderate pressure on rates in Casualty and Professional lines.

As for the future of the market, who knows? After 43 years in this business, I have stopped trying to predict how the industry will react. I can tell you that have been advised that reinsurers are resolved, particularly on the Property lines, to keep solid rates in spite of the lack of hurricane activity, but we will see more about that as the January 1 renewal season starts heating up.

I think it's also interesting to note that we will see the effect of the recent Lloyd syndicate merger activity in London, and what that has, but our view early on is that it could create some interesting opportunities over there as well. Really, very short and sweet, and obviously I will try to answer any specifics that you got, but it's not a lot, real sexy report. The fundamentals of solid underwriting focus and niche product and service orientation continue to pay dividends this quarter.

With that, I will turn it over to Tom, and let him pick up the investment side.

Thank you, Tony. On the investment side, we are very pleased with the year-to-date results. They fully support the Markel Model for profit, and our long term comprehensive income financial goals.

On the equity side, we had a 9.9% year-to-date return for the third quarter. We are having a good year. Our focus on Global, Blue Chip, large companies, which we have had with new cash now for the last 18 to 24 months is starting to work out well. Also our financial insurance special situations are enjoying good performance.

Additionally, our small foray into private equity investments with large or controlling interests is off to a good start. In that arena, we are building the relationships and skills that we will need to do this in a larger way, from when the environment shifts from a sellers to a buyer's market. The shift hasn't happened yet, but I'm confident it will.

On a more important note, our long term record in the modern era of investments for Markel, with 17 years of data, and I defined the modern era of our investments, from the completion of the Shand acquisition to distinguish the term from it's usage by NASCAR fans, shows equity returns of 200 basis points plus of annual outperformance versus the S&P 500.

We are certainly pleased with this record which we don't think is common in the investment world. Equities currently stand at 77% of shareholders equity. The unrealized gains, which never appear in many return on equity calculations, is now over $500 million at quarter end, and we continue to have room to increase our holdings in our measured dollar cost averaging way of doing things, and I like the opportunities I see out there.

On the fixed income side, the decline in interest rates in the quarter allowed us to largely reverse the unrealized losses in the portfolio from the end of June. We remain high quality with an emphasis on governments, agencies, and munis, and our duration is roughly neutral, and matched with our insurance liabilities of about 4.5 years.

I look forward to any questions that you might have, and with that I'll turn it over to Steve.

Thank you, Tom. I think between Richie, Tony, and Tom, they pretty much said it all. We are very, very happy with the results of the quarter and for the nine months. It is nice to be lucky, when it comes to the weather that we deal with.

Clearly, it's due after we have a few bad years, it's not unrealistic to expect a few good years. I think the volatility in Cat exposed businesses, demonstrates the importance of looking at insurance companies, and we continue to feel the importance of managing our business over the long term, and seeking to grow book value per share at a high rate, and measure it over the long term, and not be focused too much on the short-term.

So the extraordinary benefits of this quarter probably shouldn't be expected in every quarter. We will have hurricanes in the future. I believe we are managing our exposure, so this will continue in the long term [inaudible-technical difficulties].

With that, I would like to open the floor to your questions.

Thank you. Ladies and Gentlemen, at this time we will be conducting a question and answer session. [OPERATOR INSTRUCTIONS]

Our first question comes from David Lewis with SunTrust Robinson Humphrey. Please state your question.

Good morning. This is actually [Eric Saxon] calling in for David. How is everybody doing today?

Good.

I've got two questions. My first is a two-part question. Can you expand on the competition that you mentioned that you are seeing in the casualty environment, and with that, and the calls effect positions, you take where you slowdown underwriting business in a more competitive environment, do you care to provide any gross written premiums outlook for maybe 4Q '06 or 2007?

I think it's fair to say we won't be making any premium volume in the forecast in the future. I think generally, and I will let Tony expand on this but generally, the casualty lines are showing more price competition, and of course, it's also very, very strong rates, and very, very strong underwriting margins, that we have enjoyed for the past several years, and so those margins are clearly getting tighter.

And it's also caused, in our case, by the fact that the standard markets are creeping back into some of the Specialty and Excess and Surplus areas, so that tension will always swing as the market moves from being hard to soft, and clearly, the standard companies today have a larger appetite for some classes of business, that two or three years ago, they were less inclined to write. Tony? Steve, I mean, that is basically it. I will say that in spite of the fact that there has been some moderate competition that has perhaps brought the rates down from their apex, in most of the areas, we still feel that there is solid adequacy in there, and the one thing that gives me a great opportunity to reiterate that when we see them dropping below the levels that we need to make solid shareholder returns, you will see us backing out of lines, but so far so good.

Okay. And my next question, involves your recently launched Global Marine and Energy underwriting unit. Could you provide a little bit more color to the progress made in the quarter, and the positive impact that you expect this unit to have on your results in the short and long term, and just one thing with that. I assume this is different from the Markel International Marine and Energy unit, which has been driving gross premiums this year?

Clearly different. We got an opportunity almost a year ago now, to hire a high-quality individual with a lot of experience in the entire international Marine and Energy field, and brought him aboard to start a U.S. presence in the Marine and Energy field, to compliment what we were already involved in in London as a result of our Terra Nova acquisition in March of 2000.

It has taken a little bit longer to get it off the ground than we thought, because of some IT issues, and a couple of other things, but it's a mile and a half, and it's not 6 furlongs and as I indicated, we started writing business now. It had absolutely no impact whatsoever in the third quarter, because we just started writing business, but candidly, with the success that we have enjoyed overseas and with the large universe and market over here, we will attempt almost to mimic and duplicate on a product by-product basis what we are doing in London, with focus on the U.S. marketplace.

There are about 6 or 7 product lines including liability, offshore energy, haul, cargo, speci, these are all sort of the separate breakdowns that we use that will also be built one product at a time over here, and ultimately, we expect this to have some materiality to it.

We're very excited about it. It's taken longer to get off than we thought, but we are finally off and running and we expect it to make some solid additions to what we are doing in '07 and beyond.

Okay so even though this is called Markel Global, this one is for the U.S. Business?

Yes. It's focus is completely on U.S. business. We don't want to compete with ourselves, and obviously our London operation has an international focus.

Got it. That is all the questions I have. Thank you.

Our next question comes from Ron Bobman with Capital Returns.

Hi. Congratulations on a really fine quarter. Nice job.

Thank you.

I had a question I think for Tony, but whoever sees fit. From your comments about the competitive marketplace and the general sort of adequacy of rates and expected returns, it sounds like you would not describe sort of renewal account pricing, all that different from new account pricing, or expected losses on renewals, versus expected losses on new business different. Is that sort of an equal and fair description?

Well, Ron, you know, basically we're looking for pricing adequacy across the spectrum. Clearly, renewals provide a more solid historical perspective than new business does, but in either case, obviously we are looking for rate adequacy, and the types of returns that we hold ourself accountable for, and there is very, very little difference in our approach.

I will have to say that in some lines, there is a more distinct difference in the risks taken on new businesses than there is on renewals, but it is not a material difference, or a major difference in even those, so we are looking for rate adequacy across-the-board, and not making much distinction between new and renewal.

Thanks. A couple more questions. Would you describe any sort of the state of the trucking market?

I can't, because that is one of the few specialty markets that we have decided long ago not to get involved in. We do write a very, very profitable gratifying book of commercial auto physical damage, fire, theft, and collision, but the liability sector, which is what I presume you are probably most likely referring to, is something that we stay completely out, and so I really can't make much of a comment on it.

Okay, thanks. And the last question, I got on a little bit late. Was there some KRW adverse development this quarter, and was the comments that the favorable development in the E&F casualty was significantly more than any adverse development there?

In terms of the quarter, Katrina, Wilma, Rita, basically flat. It has developed in the Wilma, Rita, basically flat. It has developed in the first quarter of this year, about 50 million.

Okay that's exactly when I picked up the call. All right thanks a lot and continued great luck.

Thank you.

Our next question comes from John Fox with Fenimore Asset Management. Please state your question.

Hi, good morning. I have three questions. First, could you maybe expand on the growth in London, which had very good growth, and just where is that coming from at this point?

Absolutely, John. You know, we have stated for a long time that after sort of a rocky start with the acquisition, as staff settled down and really embraced the Markel style over there, and in typical fashion, if you go back and look at our history of acquisitions, we sort of backed off early on in the first couple of years, built the staff, built the culture, created a platform of understanding of what makes Markel tick, and we couldn't be prouder of our London people.

Once that stamp was in place, the opportunity to grow organically in the product lines that we inherited has really taken hold, and we have also taken advantage, because there is a fairly large property book over there, and you know what is, and particularly in the U.S. property, you know what's happened to U.S. property rates.

And the Marine and Energy area has also been one where we have gotten terrific organic growth, and consistent with our game plan when we bought Terra Nova, it is the platform for international expansion, and although as I indicated earlier, the three new UK offices, Madrid, and Toronto, which all report to London, have really not made material difference at this stage because of their infancy. It is part and parcel of the game plan, to use that as a real position and platform for growth. So it is coming together, and the team has really solidified over there.

Okay, and the Toronto and Madrid and other locations in the future will be reported through London?

They all are now and will continue to be. London is the hub for everything but our U.S. Operations.

Okay, great. And then on the Global Marine that you are starting up, and I know in '05, the industry took a lot of losses on Energy platforms. Can you talk about the catastrophe risks that you are assuming through the Global Marine and Energy units?

Well, we have not even started writing offshore in our Houston operation yet, so, but I can assure you similar to what we have done, because we do have a solid book of offshore energy in London, and it does include a fair amount of Gulf of Mexico, but as Steve indicated, in spite of the fact that we didn't incur any wind activity, or have not up to this point, I hate to count my chickens in the bottom of the eighth, but in spite of the fact that we haven't incurred any wind activity, we really feel like, that we have a very controlled disciplined approach to spread of risk down there, and when our U.S, Houston-based operation starts writing that, they will do it with sensitivity to what is already being written in London, and with the same type of discipline and oversight.

I had a question on the industry. Maybe it effects the London business but the Berkshire Hathaway Equitas deal, do you see that changing London at all, changing the marketplace at any challenges or opportunities?

There is clearly, Steve will probably have a comment on distributors, it is clearly a major sigh of relief, because Equitas created a potential overhang, that had everybody concerned about the long range implications, so I think it's, I really do feel from my perspective, Steve can look at it from a little bit more of a financial community side, but from my perspective, we have been gratified with what management at Lloyd's and the progress that they have made over the last three or four years, we were pretty vocal early on about some inadequacies, and they've really done a fine job of positioning themselves, and I think this is one more sort of air clearing event that frankly will continue to solidify Lloyd's future.

Steve? Do you have any other thoughts on it? Not a whole lot. I think it's clearly a signal that Equitas over the last I guess now 12 years, has done a heck of a good job of putting the worst of their problems behind it, and I think that the $7 billion that Berkeley will receive for the transaction, will earn a better rate of return than what Equitas was earning on that money, and it will be good for all parties, the only bad news and it's very immaterial, but Markel was getting ready to launch an indemnity product insuring names of Lloyd's prior to '92, against, called against the failure of Equitas, and that product probably won't sell now that Lloyd's is taking it on. [laughter]

Okay, thank you very much.

Our next question comes from Daniel Baransky with Fox-Pitt Kelton. Please state your question.

Yes, I have some questions on the quarter. Do you happen to have the reserve action by segments, and also what you are seeing in those various segments, that would be underlying those reserve actions?

Daniel, I think probably the best I can do is point you to our segment disclosure footnote.

Yes, I looked at your 10-Q, and it says you you have 56 million of favorable E&S and there's really no quantification in the other two write-offs.

Yes. Pretty much, in terms of E&S, the lion's share is at Shand, our Professional liability operation, in terms of the Specialty Admitted segment, to be honest with you, it's pretty much in our program business, the prior year redundancies, and I would say it's pretty similar to what we would have seen in 2005, so no real news there I would say, so business as usual.

And then in London, it continues to be small releases from prior years, related to the areas that we have written since 2002, the hard market sort of areas that we have talked about in prior quarters, but again, nothing particularly stands out. The real news in terms of prior year redundancies is at Shand Professional products liability.

Am I missing something then? It seems like in one part of the 10-Q it said that you that you had 40 million total favorable development in the quarter, and then in your E&S write-up it says you had 56 million favorable, so was there adverse development somewhere I'm missing?

Well there was, I am having a hard time following your numbers, and maybe we can talk later today.

Okay.

But we did have 16 million of APH, or asbestos, that we put up in the quarter, and without looking at your numbers I have a hard time saying, but there was 16 million of development in the asbestos area due to our third quarter review.

That quantifies it. And E&S commentary you provided on sort of the standard market and creeping back in, you mentioned two or three classes that you are seeing the most creepage, I guess. Could you mention what those were?

You know, it's hard really to be so specific. Clearly, the standard markets have broadened their appetite from where they were two or three years ago, but it is lily across a number of lines. I would think in general, on the Casualty side, there's a little stronger appetite to maybe take a little bit more risk to be a little more aggressive, in terms of what they will consider and what they wouldn't consider before, but at this stage of the game as I indicated earlier, it's only effecting us moderately.

Okay. And I guess the last question would be what do you see out there I guess on the M&A front, and I kind of phased out when I think you were mentioning something in London and perhaps Lloyd's. I'm not sure if I followed that commentary.

As we said in the past, because of what we have done, particularly during the '90s culminating with the acquisition of Terra Nova in 2000, there are very few specialty opportunities, specialty market opportunities for acquisitions that don't come across our desk, we have continued, we think the pipeline looks pretty good for sort of moderate, small, little strategic stuff, similar to what I mentioned earlier, with regard to the acquisition of the Brittany Property operation in Los Angeles earlier this year.

There is nothing particularly major out there, but obviously our appetite for acquisitions is no less strong than it has been in the past, but our hurdles are no less strong than they have been in the past.

Okay, great. And I guess the last thing, and as far as the competition out there, are you seeing anything in terms and conditions that is deteriorating, or no?

Primarily it's just price at this stage of the game.

Okay, great. Thanks.

Okay.

Our next question comes from Beth Malone with KeyBanc Capital Markets. Please state your question.

Thank you, congratulations on the quarter! And I just wanted to dispute something that Tony said. You said that this wasn't a very sexy quarter, but $204 book value sounds pretty sexy to me.

Well, Beth, at my age, everything is relative!

Oh, okay. Alright, so on to a real question! On the reinsurance, as I know your strategy is to try and rely less and less on reinsurance, but as you start to write some of these newer markets, like the Global Energy, are you going to also try to contain more of these new markets too, or are you going to take a more conservative approach?

Well, in general, our appetite for net risk, we are a gross line underwriter, and we protect our reinsurers, and we try to under write through an underwriting profit on the gross premium, but in general, and you have seen it over time as long as you followed us, our appetite for net risk has increased consistent with our growing financial wherewithal, and that's still true today.

I would have to say on the newer product lines, we are probably more conservative for obvious reasons, than we are on some of the more mature stuff that we have really done for a long period of time, and although we are taking more net on the new Markel Global Marine and Energy operation than we would have 5 years ago obviously, it's still probably is a more conservative play, than some of our historic product lines.

Okay, thanks, and then a question for Tom. Could you just talk about, is there anything different in your strategy in this market condition, than you have taken on in the past? Are you still looking at mostly financial and large-cap type stories now?

Yes, I can talk about it. No, there is nothing different, and the financials in large caps for the last couple of years have been sort of where the best bargains are, and the good news about the way think about investments is the same way we think about underwriting.

The financial discipline is to make the best returns that are out there, and at different times you emphasize different areas, but the global, large cap, and financial just seems to me to be the best value that is out there right now. The strategy won't change two, three, five years from now. Probably the arenas where you find them will.

Okay. Thank you very much.

Our next question comes from David West with Davenport & Company. Please state your question.

Good morning. Maybe a little different form of question from John Fox's on the Berkshire Equitas transaction. You did have some negative development as you noted that on the asbestos and environmental side. Given Berkshire's increasing role I guess and interest in settling asbestos suits, could you comment upon your thinking about possible development in that area in the future?

I think broadly, the pendulum swung pretty hard in a negative way a couple years ago with increasing litigation, and more problems over asbestos claims, all of which date back many, many years, and I think it's slowing down a whole lot. I think some of the judicial decisions that have come down recently, I think you could make, I wouldn't make it myself but I think it's not unreasonable, to make a case that it is time for the pendulum to swing the other way.

Clearly, it doesn't make sense for our society to pay unimpaired individuals huge sums of money for fears associated with potential exposures to asbestos, that might have occurred 20 years ago, and that was happening, and it doesn't make sense for that to continue to happen, and certainly not at the expense of paying people who are truly are injured, so, I mean, I think the tort reform that's going on is having a positive impact, and my guess is that Berkshire certainly knows about these issues, better than than I, and they now have a very large, and disproportionally large share of the issues. They will be in a better position I think to settle these claims, in many respects than maybe Equitas would.

Makes a lot of sense. In your Q, you mentioned I think that Markel American has been underwriting a new lumber product. Could you talk about what that product insures, and the relative magnitude of that program?

Yes, David, it is actually Markel Insurance Company and our program business. We were presented with an opportunity by an agent in the western part of New York, who specialized in that class for a long period of time, we write a comprehensive number of coverages, you know, package, automobile, everything but worker's compensation. It's off to an excellent start, but I wouldn't suggest that it's significantly material.

It's a nice little niche that is going to add nicely to what we do, but will never be more than probably the 25 or $30 million in premium volume, which is a nice position, but not for so material.

Okay, very good and I guess for Richie. You mentioned that I guess the year-to-date computation activity, were there any material commutations in the third quarter?

David, we did a few in the third quarter. I wouldn't say anything was material, but sort of like when you add them up over the year, it becomes a bigger number, and it's been nice because what it does for us, obviously is it removes the credit risk, and pulls that leverage out of the balance sheet, so it's been a good year for those sorts of things.

And I take it there wasn't any material gain or loss?

No. Given all that we have done this year, there's been very little in the way of gain or loss.

Thanks so much.

Our next question comes from Mark Dwelle with Ferris Baker, Watts. Please state your question.

Yes, good morning. bit by bit, most of mine have been taken, but one other thing I just wanted to talk about was you said you had a small tax benefit in the quarter related to closing 2002. Could you just talk about that a second?

Mark, basically just that year, the statutes run on that year, and we had a huge amount obviously, but we obviously had contingencies that we were holding reserves against, and once the year closed, we were able to release those. Just a continuation of our attempt to be conservative in all areas of the balance sheet.

Okay. That really is all my questions. Thanks.

Okay.

[OPERATOR INSTRUCTIONS]

Our next question comes from Chuck [Acre, Acre] Capital Management. Please state your question.

Good morning. I have got a couple. Your combined ratios are wonderful, and I wonder if you think from a business point of view, there is a level that they need to not go below, in order to stay competitive in the market? I can remember discussions of that sort of thing in other lines of business, not at your Company in years past, and yours are terrific, do you have any thoughts on that?

Well, they are not there yet. But having said that, we are looking to compound book value at a high rate over a long period of time, and between the margins for underwriting profit, and the expected yields on the portfolio, we want to earn the high rate of return on capital.

Today, I think we would be thrilled to have combined ratios consistently in the low 90s, and so we can make our targets at that level. We don't need to have them quite as good as they were this quarter, but of course this quarter as you know was positively impacted by a lack of hurricanes, and clearly in Cat exposed businesses, we expect to have very, very good margins in years where there are no events, because we fully expect to pay claims for years that there are events, but overall I think we're pretty comfortable and Tom? Did you want to add anything?

Yes, the one point I wanted to add, and Chuck it's nice to hear your voice, because you represent a very long term shareholder, when we had those discussions about those kind of levels, we were probably going back 10 or 15 years, and interest rates were significantly higher back then, than they are now, so I think really it's relevant to think about the industry as a whole, and Markel relative to the industry.

We needed to be better than the industry back then, we needed to be better than them now, and in an absolute sense, the industry needs lower combined ratios than what it did when we first started talking about this kind of thing.

Absolutely, and your model, of course, allows you to get to your book value changes annually almost at a breakeven combined. That's part of it.

You know, Chuck, we set our targets every year based on our investment environment particularly on the fixed income portfolio, and the pressure on underwriting profits, ebbs and flows with the returns on the bond portfolio, but --

At any rate, the bottom line is, that you don't have anything in your mind right now that says we could be more aggressive in pricing, in order to take a higher combined, in order to make this thing work right, or something like that?

We always look on a per product basis, and if we think we can reach our goals and write a hell of a lot more business by moderating our product, and still continue to produce the ROEs we are looking for, we give it serious consideration.

Great. Well, a couple more questions. I guess did the commutations primarily account for the total reduction in the insurance recoverables?

No. I would say, Chuck, that the hurricanes were probably over 2/3 of it.

Okay.

And the 25% or so was probably the commutations.

Next question, on Shand. You know, Shand has been the gift that keeps on giving here for some time. Are they at a point now, that they will be close to running out of these great reserve releases, or do you have an expectation that that is going to continue?

I think the magnitude will probably slowdown a little bit, and we fully expect that it is a gift that will continue to keep on giving. You know fundamentally, when we are establishing reserves, our goal is to set reserves at levels that are more likely to be redundant and efficient. When that proves to be true, which we hope happens most of the time, there will be releases, but likewise, we are putting up similar margins in the current period.

I think it's fair to say that the releases this quarter were slightly higher than the margins we put up this quarter, and so we're benefiting to some extent from better than expected profits on the business we wrote in 2002 and 2003, and overall, the margins are not as good today as they were then, but overall, I mean as we look in the future, we would expect to see a continuation of some benefit from prior year periods. We haven't moderated our hurdles. They continue to just perform beautifully.

Two more questions. I noticed an increase in underwriting expenses in your E&S and a couple other lines, relative to premiums written up, both in absolute dollars, as well as percentages. Is that higher commissions or what kind of, what's it?

Primary driver there, Chuck, is the fact that we are retaining more of the business and when we see reinsurance, we get ceding commissions, which at least offset our expenses, in some cases, we actually more than offset our expenses when we cede premiums, so but we believe it's worth keeping the underwriting risk.

We will make more on the underwriting side keeping both the risk than we would getting a ceding commission from the reinsurer, so the expense is ratio going up in the hopes that that would benefit the loss ratio.

And Chuck, I might add that, you know, we're never going to be the low cost provider.

Oh, I understand that.

And although we manage the heck out of our expenses and stay on top of it, the fact is that we think that oversight of the underwriting side pays terrific dividends, and are willing to spend the extra money for that additional oversight.

Well, just as an example in the E&S line on basically flat gross written, you know, your underwriting expense went from 92 million to 102 million, up $10 million, and Richie, your suggestion is that's mostly the absence of the ceded reinsurance commission?

Yes, that is a big chunk of it.

Great. And then last question, Tom commented that the equities, the shareholder equity was now at 77%. Is your business model such today, your business mix, your balance sheet, and everything else, do you consider taking that up to 100% of shareholder equity at any point in time?

That's always been sort of the theoretical maximum with 80% as a margin of safety in reserves. If the investment leverage diminishes over time, the amount of margin of safety you would have to have on that particular metric would diminish as well, so a combination of that plus whatever the opportunities happen to be, could push us a little closer that way.

Got you. Thanks very much.

Our next question comes from [Michael Phillips] with Stifel Nicolaus. Please state your question.

One final question on the creeping in of the standard players. I'm just curious, because you say it doesn't affect you guys that much, but when that starts to happen, is that typically across-the-board with account size, or is that more with larger accounts first?

I'm sorry, I didn't pick up on the question.

Sorry, can you hear me now?

Yes.

Okay. The creeping in of the standard players, I'm just curious, I know you said it doesn't impact you guys that much, but when that happens is it more across-the-board with account size, or does it start with the larger accounts first, or how does that work?

Well, clearly the industry has always has always been enamored with the premium, and so the bigger accounts, one of the reasons it doesn't impact us perhaps as much as it might some other specialty carriers, is that if you look at our business, it really is not made up of major accounts with very, very few exceptional categories.

We're mostly in the small to medium risk, so when the standard markets increase their appetite, and as you pointed out, do write more of the business, and I guess effectively bring back more of the businesses that have crept into the specialty marketplace, those that rely on big accounts I think are much more effective than we are, but that would be their first choice is the big stuff.

Okay, perfect. Thanks. That's all I had.

Our next question comes from Matthew Heimermann with JP Morgan. Please state your question.

Hi, good morning, everyone. I wanted to follow-up on a previous question that I guess it really gets to the investment leverage. If I recall correctly, one of the things that really built the investment leverage over time was the really good organic growth you had, plus the combination of certain of your acquisitions, and I guess now that the business growth outlook looks to be a little bit more stable, is there a point at which investment leverage would hit a threshold where you'd actually consider potentially looking at alternative ways to grow your investment portfolio, rather than just manage the equity side of the leverage equation?

Matt, I think it's fair to say that we want to continue to grow. I mean, growth is an important aspect. We would never try to grow at the expense of underwriting margins, and obviously we like lines of business that contribute to the investment leverage. I think at the end of the third quarter, our portfolio is slightly larger than 3.6 times book value, and that's probably lower than it's been, but it's lower for probably a good reason.

We are growing equity pretty quickly right now and so that's not a bad thing, but we will manage the numbers, and as that leverage ratio comes down, we can put more money into equities, if the insurance business is not growing as fast, we can also do more on the investment side of the business, and when we have opportunities to apply our other businesses to grow the insurance business, we will certainly do that as well. We also have the option of repurchasing shares at any point in time, if that becomes an important metric to manage the capital for the Company.

But overall, I think we are pretty comfortable with where we are today. Clearly, we have a sufficient amount of investment leverage, and a sufficient underwriting margin that our model will certainly work, and obviously we need to tweak the model so that all of the factors are coming into play, and it makes sense and we are consciously aware of that.

Okay, that makes sense. The other question, I joined the call late so I apologize if this has been asked already, but you know, you were one of the first companies that started to talk about kind of the creep of the standard market back into I guess the [DMZ] of standard and E&S market.

Have you also seen, can you just talk a little bit about what you' have seen in terms of E&S competition, just in terms of the number of competitors, and what appetite has looked like? Have you seen it, how you've seen companies maybe enter in to new product areas, and what product areas particularly you have been seeing that?

Clearly there are more players today than in the recent past, and probably there will be more formed in the next few years, so it's constantly a churn of new players, and other people getting into the business and fortunately, we have been able to continue to maintain our position and improve our position in the marketplace over time, but it's easy enough to get into this business, and people choose to do so, so we're not without competition. But it's not unusually worse today than it was five or ten years ago, and in fact, I think our organization has a lot of strengths today than didn't exist five or ten or 15 years ago.

First and foremost, we are one of the survivors and winners of the class of 1986, or whatever it was, when we launched our expansion into this business, and so we are now enjoying the benefits of that, and there are plenty of benefits to being larger and stronger, and we certainly will continue to try to capitalize on that. I don't really have anything to add. You know, there have been some new players, some of the new Bermuda start-ups have decided that they needed a direct E&S component, and they've come in and some of the London syndicates have actually opened offices in the U.S. Those are probably the two most noteworthy expansions of competition, but as Steve pointed out, we've been in this business a long time, and never lacked for competition, and stick to our knitting, and I don't think it's anymore unusual today than it has been in the past.

That's fair. There's still a lot of room between you and the #1 share in the market anyway.

That's for sure!

Appreciate your time. Thanks.

Thank you, Operator I think we have time for just one more question.

Sir, there are no further questions at this time.

Then thank you very much, everyone. We appreciate your long term support of Markel. If any of you have further questions or comments, don't hesitate to contact us directly, and again, we appreciate your loyal, long term support, and we will do our very, very best to provide similar performance in the quarters ahead.

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