Markel Group Inc (MKL) 2007 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Markel Corporation's second quarter 2007 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. Thank you. Mr. Markel, you may begin.

Thank you. I appreciate all of you joining us today for Markel's second quarter conference call. During our call today we may make forward-looking statements. Additional information about factors that could cause actual results to differ materially from those projected in the forward-looking statements is described under the caption, "risk factors and Safe Harbor cautionary statements" in our most recent 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 non-GAAP financial measures which we may discuss on the call today.

Well, enough with those formalities. Our process today will be the same as in prior quarters. Richie Whitt will lead-off and describe the financial results in the quarter. Tony Markel will talk about what's happening in the insurance world and our underwriting activities in our various business units. Tom Gayner will let us know what's happening in the investment world and with Markel's investment results, in particular. And I'll have a few comments at the end and moderate the questions and answers.

The quarter was a good one. We're off to a good start in 2007 and looking forward to a great year, and Richie, why don't you share with us the details.

Okay. Thanks, Steve. Good morning, everyone. I'm going to follow the same format as in the past quarters, and my comments will primarily relate to the YTD results. I'll start discussing our underwriting operations, followed by a discussion of investment results, and then I'll bring the two together with the discussion of our total results for the six months.

The song remains the same through the first six months of the year, despite softening market conditions and decreasing prices in many of our lines, we had a strong first six months of the year. Gross premium volume decreased approximately 6% to $1.3 billion in the first six months of the year. This was primarily due to competition in the U.S. and international professional liability and casualty lines, as well as certain property lines. Net written premiums decreased 4% to $1.1 billion, however, retentions were higher through the first six months of the year at 88% compared to 86% last year. Earned premiums were flat in the first half of the year compared to last year.

Our combined ratio was 88% for the first six months of 2007 compared to 90% last year. Our 2007 combined ratio included 8 points or approximately $84 million of prior year redundancies. And these redundancies included $5 million of development on the 2005 hurricane.

Our 2006 combined ratio included about 5 points or approximately $50 million of 2005 hurricane loss development. This was more than offset last year by prior year redundancies in other areas of our business. The largest area of prior year favorable redundancies in both periods was in our excess and surplus line segment, again, specifically in the professional and product liability [unit].

Markel International had another strong quarter of underwriting profitability, reporting a 96 combined in the quarter. Over the past four quarters Markel International's combined ratio has been 94%.

Our expense ratio increased in the first six months to 36% from 34% last year. This was primarily due to last earned premium and higher compensation costs in our operations.

Markel's current accident year combined ratio was 96% for the first six months of 2007, as compared to 94% in 2006. The increase was, again, related to higher expense ratio in the first six months of 2007.

Turning to our investment results, average invested assets increased 14% the first half of 2007 to $7.5 billion. Investment income increased 17% to $155 million, this was largely a result of the higher average invested assets but also yields are starting to pick-up. Realized gains were $62 million in the first half of the year, and these were primarily comprised of equity sales.

Unrealized gains decreased $116 million before tax. This was due primarily to declines in our fixed income portfolio and equity sales. Tom will go into further detail in his comments shortly.

Looking at our total results for the first six months of 2007 we reported net income of $220 million compared to $167 million in 2006. Book value per share increased 7% in the first six months to $246 a share at June 30th, 2007.

I just wanted to make a few comments on the cash flow and the balance sheet. Regarding cash flows, operating cash flows for the first six months was $237 million, this compared to about $168 million last year. The increase was primarily related to lower 2005 hurricane payments, so they're just starting to work their way through the system.

Regarding the balance sheet, two quick comments. Our reinsurance recoverables continued to decrease and are approximately 50% of shareholders equity at June 30th, 2006. This is the lowest level in a long time. In August we will be retiring approximately $73 million of senior debt for cash.

At this point, I'll turn it over to Tony and let him discuss our operations.

Thanks, Richard. As Richard (inaudible), the second quarter was another outstanding one with net income up 26% compared to the same quarter last year and 31% for the first half of the year compared to '06. From an operational perspective the combined ratios of 89% and 88% for the second quarter and first half, respectively, represent our continuing focus on underwriting results.

Gratifyingly, on another subject, the maturation and continuing profitability at Markel International was recently recognized by A M Best, which elevated the financial strength grading of our Markel International Insurance Company from A- to A, which is a further stride from our acquisition earlier in the decade.

As reported for the last eight or ten quarters, intense competition continues to be the order of the day in virtually every sector, with the exception of catastrophe exposed property, and even those rates are experiencing some moderate downward pressure. As a result, as Richie has reported, our gross written premium for the first six months was off 6% and our net written was down 4%.

Although I won't characterize the marketplace as anything but difficult, it's interesting to note that reduction in our property CAT writings due to some attrition because of our justifiably dramatic price increases, coupled with cancellation of a referenced large unprofitable habitational risk that was written in our alternative risk unit, SMART, make-up literally two-thirds of the dollars of premium reduction in the first six months.

Clearly, the experience in continuity of our underwriting staff pays dividends in this type of soft environment. As they say in the southwest, "this ain't our first rodeo." In addition to our unwavering attention to adequate pricing and risk selection we are combating the competitive landscape on any number of fronts, as previously reported. As reported over the last couple of quarters, our increased marketing and sales effort at virtually every subsidiary, along with the creation of the [opposite] business development has dramatically enhanced space time with our agents and helped cushion the volume attrition.

Secondly, we continue to look for accretive, fairly priced acquisitions as exemplified by our second quarter closings on Black/White & Associates, a California based social services MGA, and the Cambridge Alliance, a Vermont based specialist in investment advisory E&O. Although these two additions are relatively small, merger and acquisition discussions and activity have been high on the agenda for, candidly, finding properties that both fit our requirements and are reasonably priced has proven difficult, and you can rest assured that we will not compromise and succumb to artificial pressure for top line growth.

Thirdly, branch expansion continues with gratifying growth in the five new International branches that were unveiled in late '05 and the recent announcement of a late '07 opening of our newest underwriting branch operation in Singapore.

In addition, we continue to judiciously increase our net retentions as reinsurance treaties expire which should translate into a moderately increasing net premium position, long time consistent with our long-term strategy.

Unfortunately, we don't expect the market to change in the near term, but you can rest assured that we'll continue to adhere to our longstanding underwriting precepts and continue our search for growth opportunities that meet both our operational standards and are rationally priced.

And, obviously, I'd be glad to answer any questions during the Q&A, and with that we'll turn it over to Tom for the investment side.

Thank you, Tony. Good morning. During the first half of 2007 total returns for the portfolio were 2.2%. Equities earned 3.5% and fixed income earned 1.2%. In the fixed income market the headlines these days are mortgage and credit related. I'm very proud of our fixed income team in that our returns were dominated by the movement in interest rates, not any deterioration of credit quality. As interest rates stabilized or moved back down our returns will accelerate. Deterioration in credit is another matter, that won't automatically come back with the passage of time. We are in excellent shape on our credit risks.

Specifically in response to many of your questions, we have almost no exposure to subprime, [no doc], [alt a], or any other [exotic] mortgage backed securities. We have restricted ourselves in recent years to conforming mortgages issued by agencies, like Fannie Mae, Freddie Mac, and Ginnie Mae. We have not relied on structures, traunches, financial engineering, credit ratings, or the siren songs of high-powered bond salesmen, hedge fund promoters, or investment bankers to allow ourselves to think that we could safely invest in more speculative areas. We are not yield hogs, and we did not compromise our underlying investment quality standards to stretch for yields in recent years.

Fortunately, this is not the first time we've avoided a lot of trouble in the fixed income market by staying away from a popular area. For example, we successfully avoided what some might remember as the telecom and technology boom and bust in the late '90s and early 2000s. We have a long history of conservative, thoughtful, and solid returns in our fixed income operations, and I'm pleased to be able to report to you that is continuing during the latest iteration of a heated up and down cycle.

On the equity side, we earned a total return of 3.5% during the first half of the year. While this trails the S&P 500 return of 6.9%, and it's always more fun to do better than worse, I'm confident about our long-term prospects. It's been 17 years, since 1990, we've outperformed the S&P in 9 years and underperformed in 8 years, only slightly better than 50% by that measurement. More importantly, over the 17 years we've cumulatively outperformed the S&P by about 350 basis points and added tremendous value to Markel shareholders. We've also done this in an incredibly tax efficient manner by buying and holding long-term positions.

At June 30 our gross unrealized gain on equity was over $600 million, a figure that exceeds the entire equity capital of Markel up until 2000. Our net realized gains of over $60 million in the first half of 2007 predominantly stems from equity gains and are within a few million dollars of the highest realized gains we've ever seen in any entire year in Markel. The majority of the gains stem from companies we've owned, being taken over, and forcing us to sell. We'd rather be able to buy and hold indefinitely but the regular addition of realized gains does tend to validate our investment approach over time.

I would also note that with our balance sheet and steady disciplined approach periods of equity market volatility create additional opportunities for us.

I remain optimistic about our holdings. The high quality, reasonable valuations, demonstrated earnings performance, and worldwide opportunities of the companies we own cause me to be excited and confident about our ability to continue to earn good returns on Markel's (inaudible) capital.

I'll be happy to answer any questions you have during the Q&A portion, and with that let me turn it over to Steve.

Thanks, Tom.

As you all know, Markel is in this business for the long term, and our goal is to build a great company. In the short run market competition and conditions, the fear of hurricanes or other catastrophes or events, investment scares of bubbles of subprime lending might all adversely impact the short-term stock price, but we've remained confident of our ability to build the long-term value of this organization.

With that, I'd look forward to answering your questions.

(OPERATOR INSTRUCTIONS.)

Our first question is from Mike Phillips with Stifel Nicolaus. Please go ahead with your question.

Yes, thanks, everybody. A couple of questions. First, can you -- on the programs that were cancelled out of the Markel REIT, can you give us a dollar impact on I guess both premium and the reserve development there? I guess for the quarter and YTD if you have it?

Richie, you want to deal with that?

In terms of premium volume, I'd have to get back to you on that number, I don't have that off the top of my head. Oh, Tony just handed me a piece of paper and he says about $14 million for those two programs. In terms of development YTD on those programs that were cancelled, it was about $10 million.

$10 million for adverse development YTD; right?

Yes.

Okay. And the $14 million was YTD premium?

Yes.

That would be compared to last year.

$14 million decrease in premium this year.

Got you.

And $10 million of adverse developments.

Okay.

But that $14 million is through the second quarter, the program is a lot larger than that.

Yes, the program is probably around $30 million, but—

Okay, perfect. That helps. What about -- give us your thoughts on exposure you have to the UK flooding (inaudible), and I guess anything that's come out of the Los Angeles Archdiocese event?

In terms of the UK floods, I mean, obviously, there's been some pretty horrific flooding in the UK in the last several weeks. Because of the fact that the UK market was softening, the UK property market was softening rather quickly, we had reduced our [guidance] quite a bit. We clearly will have some losses, but they'll be fairly minor.

And anything with the LA stuff?

I'm sorry, what was the second thing?

Anything with the LA Archdiocese stuff?

I don't think so.

No? Okay. And, finally, you've talked a lot about in the past, you know, better, a little bit better growth internationally from your non U.S. business in the London market versus U.S. I guess you still say that, but could you give us your, I guess your overall split of what's the U.S. premium versus the non U.S. premium in your London market?

Yes, U.S. premium lies between 30 and 40%. Again, I don't have the exact number in front of me, but it's going to be in that range, 30 to 40%. And, Tony, do you want to talk about the growth prospects?

Yes, I mean clearly our, you know, we have -- we don't write any professional liability in London and the U.S. and a number of other areas because of the competition by the U.S. and our growth platform in International, although we [think] additional U.S. business has been really focused on International expansion, given the addition of three UK branches in Spain and Canada, and the additional announcement of Singapore. So we're not in London to really grow our U.S. presence, we're really in London to our grow our International presence.

Right. Okay. Thank you. That's all I have.

(OPERATOR INSTRUCTIONS.)

Your next question is from Mark Dwelle with Ferris, Baker, Watts. Please state your question.

Yes, good morning. I was wondering if you could just elaborate a little bit more about what you find attractive about the Cambridge Alliance of Vermont, and that would be my first question? And then the second question was, I know over the last many years you've been increasing your retentions, would there come a point with prices softening that you would look to go the other way with that and use more reinsurance support as a means to stay in certain lines of business or certain classes?

Mark, let me address the Cambridge situation. We think it's a wonderful little operation. It's not particularly consequential, but has a tremendous long suit of expertise in investment and analysts, it has a tremendous track record of profitability, the timing was right, the management at Cambridge is interested in assuring their prospects, having built a wonderful little business, and have agreed to stay on for an extended period of time in the transition, I'm talking three to five years, so nothing imminent. And it was just a natural given the fact that we are a major professional liability player and had little or no exposure in that arena, and their track record has been terrific.

In terms of the second question in terms of retaining as much of our premiums as we can, the corporate philosophy will continue that we want to be great at the underwriting business, we want to [fight] the business on a ground-up basis so that we can make an underwriting profit, and to the extent that we choose to share that premium with our reinsurers, if there's enough money in the pot so that they can also make an underwriting profit, but we clearly want to retain as much as we possibly can and that will continue.

So my sense is that we will continue to increase our retentions over time and that won't change, that corporate philosophy will not change. If the reinsurance markets were to get very, very cheap, we wouldn't try to leverage those cheap reinsurance prices to write more business, we're not going to change our corporate culture of commitment to underwriting profitability.

The only area where conceivably a new program could have a higher degree of reinsurance than something that's been on our books for a long period of time is the mere fact that it's moved, we may just being risk adverse choose to change -- to share part of that or a larger part of that with reinsurance partners or if the new program involved providing significantly larger limits than we're normally providing, we might choose to share a larger percent of that business with our reinsurance partners.

But, by and large, Markel's expertise is in smaller premium dollars, we're not anxious to write lots of $50 million and $100 million policies, that's not where we're -- our expertise lies, we try to write a lot of small policies, and our goal broadly is to retain a larger and larger share of the premiums that we write.

And has been, I mean that's been the [amount] since day one. We just don't play the reinsurance opportunistic game like some other carriers, we're closed line underwriters and trying to increase retentions.

Okay. Thanks very much, that's very helpful.

(OPERATOR INSTRUCTIONS.)

Well, I'd like to thank all of you for participating in today's conference. As you all know we're available if any of you would have further questions and want to call us in Richmond, we're here to answer your questions, and [we'd] be very helpful, but thank you for your participation today. We wish you a great day, and talk to you again soon.

Ladies and gentlemen, this does conclude today's teleconference. You may discuss your lines at this time. Thank you for your participation.