Markel Group Inc (MKL) 2009 Q2 法說會逐字稿

Greetings, and welcome to the Markel Corporation second quarter 2009 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, Steve Markel, Vice Chairman for Markel Corporation. Thank you. Mr. Markel, you may begin.

Thank you, Operator, and I'd like to thank all of you who have joined us this morning 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 our -- the captions, Risk Factors and Safe Harbor and Cautionary Statements, and our most recent annual report on Form 10-K and quarterly report on Form 10-Q.

Our quarterly report on 10-Q, which is filed on our website at www.markelcorp.com, also provides a reconciliation to GAAP of certain non-GAAP measures, which we may discuss in our call today.

I think, overall, our quarter was pretty good; it certainly could always have been better. On the underwriting side, we continue to report profitable underwriting results, although not as good as we would like. The market is continuing to soften. We did have a couple of modest surprises in the quarter, which adversely affected the underwriting side.

But our disciplined underwriting approach, I'm extremely proud of. And we're not writing business at improper prices and we're starting to see some traction in improving rates. And the message is clearly out in our office is not to write business where we can't make a good return on our investment.

On the investment side of the business, things are looking much, much better. Tom will get into that in a few minutes; but the second quarter investment results were very gratifying and the markets continued to be kind to us in July. And we'll hear more about that later.

Our format today will be the same as always -- Richie Whitt will lead off with a financial review focusing primarily on the six-month numbers; Paul Springman will discuss the insurance business around the horn and what each of our divisions is doing; and Tom will follow that up with an investment report. I'll moderate questions and answers when they're through.

With that, Richie, I'll let you get on with the business.

Thank you, Steve, and good morning to everybody. I'm going to follow the same format as in past quarters, as Steve said. I'll focus my comments primarily on year-to-date results. Start with discussing our underwriting operations; follow that with a brief discussion of investments; and then, obviously, Paul and Tom will follow up with more specific comments in each of those areas. And then I'll finish up by bringing the two together with a discussion of our total results for the six months.

Through the first six months of 2009, economic conditions and strong competition continued to negatively impact our gross written premium volume. However, on a more positive note, the financial markets showed signs of stabilization and returns for the overall market; and more importantly, our portfolio were significantly positive through the first half of the year.

Starting out with underwriting, gross premium volume decreased 16% to $992 million in the first six months of 2009. This was partially due to the US dollar strengthening against other currencies over the past year. Excluding the impact of foreign currency, movements on our London Market business, Markel's gross written premiums were down approximately 13% in the first half of the year.

And this really could be summed up based on three factors. The first -- reduced business activity, as a result of the recession, has led to lower premium volume on new and renewal business. An example here would be our contractors book of business -- we have a very large book of contractor business. And obviously, that activity has slowed significantly with the recession.

Second, Markel made the decision back in the fourth quarter of the year to hold rates and, in certain lines of business, increase rates. Many of our competitors continue to be more aggressive on pricing, and as a result, we have lost some business to the competition. Markel's rates were basically flat in the first half of 2009 and may be inching up slightly.

Third, we successfully converted to the One Markel regional structure at the end of our first quarter. However, the transition to One Markel necessarily required us to divert some of our focus from our marketing efforts and to build-up to the go-live. Paul will be giving us an update on how we're doing in One Markel shortly.

Net written premiums decreased 14% to a little under $900 million in the first six months of 2009. However, retention increased to 90% in 2009 compared to 88% for the first six months of 2008. Earned premiums year-to-date decreased 9% to about $900 million compared to 2008. Our combined ratio was 97% for the first half of 2009 compared to 93% in 2008.

The increase in the combined ratio was primarily the result of a higher current accident year loss ratio of 69% in 2009 compared to 65% in 2008. This increase was due to price decreases over the past several years, as well as we saw some adverse trends and -- as a result of the current economic environment, in our architects and engineers and lawyers books of business.

The 2009 current accident year loss ratio was partially offset by favorable prior-year redundancies of $94 million or about 10 points on the combined. This was primarily in our excess and surplus lines segment on our professional products liability programs. This compares to $79 million of favorable development last year or approximately 8 points of favorable redundancies.

Our expense ratio for the six months increased to 38% from 36% in 2008. The cost of implementing our One Markel business model and systems represents about 2 points on our expense ratio through the first half of the year. We currently estimate a 2 to 3 point impact to our expense ratio during the rest of 2009, as a result of the cost of One Markel.

Lower earned premiums also obviously adversely impacted the expense ratio. These two factors were partially offset by lower profit-sharing expenses in 2009, compared to 2008. That left us with -- again, with the 97 combined for the first six months compared to a 93 combined last year.

Turning to our investment results, investment income decreased to $134 million from $153 million in 2008. This decrease was due to lower yields on the investment portfolio and our increased allocation to relatively low-yielding cash and short-term investments.

Realized losses were $71 million in the first half of the year. This primarily was comprised of $63 million of write-downs for other-than-temporary declines in both equities and fixed securities. The most significant write-downs actually occurred in the first quarter of this year. We wrote down GE -- that was a $21 million write-down; and we wrote down our investment in UPS, which was a $10 million write-down. We continue to hold both of these investments.

On the bright side, unrealized gains increased to $172 million before taxes during the six months. And obviously, shortly, Tom will go into further detail in his comments regarding new investments.

Looking at our total results for the first half of 2009, we recorded net income of $49 million. This compared to $116 million of net income in the prior year. The book value per share increased 8% since December 31, 2008 to $240 per share at June 30.

Turning to the balance sheet, I just want to make a couple of comments about the balance sheet and cash flow. Regarding cash flows, operating cash flows were $114 million for the first six months of the year; this is compared to operating cash flows of $233 million last year. The decrease was primarily related to our lower premium volume in the first six months of the year.

Regarding the balance sheet, we held $818 million of cash and investments at our holding company at June 30 of 2009. We're very liquid as a holding company. We anticipate repaying the $150 million of revolving credit -- on our revolving credit facility that's currently outstanding. We will probably repay that this month.

At this point, I would like to turn it over to Paul and let him further discuss operations.

Thank you, Richie, and good morning, everyone.

You've just heard Steve's opening remarks and Richie's report on our numbers from the first half of the year. And in a few minutes, Tom Gayner will take us through the investment results. But today, it's my pleasure to give you a report from the operational side of our business and to update you on two or three important fronts.

The results from the first half clearly represent a mixed bag with continued competitive pressures from the marketplace. Our combined operating ratio for the six months, as Richie mentioned, is 97%. While this falls short of our ultimate goals, it is, nonetheless, an underwriting profit. And I can assure you, we'll do everything within our control to improve that number in the second half of the year.

My report today is an abbreviated one, primarily because market conditions are relatively static since our last visit during the conference call in May. If we were to go back to last fall, as we began our planning process, we had hoped for a market change or for some signs of improvement in the pricing environment by the middle of this year.

Although we budgeted conservatively and did not factor in those market changes, we are nonetheless disappointed that the marketplace remains as competitive as ever. Competition continues to emanate from standard carriers with extremely aggressive pricing, principally focused on large commercial accounts; continued expansion from both Bermuda-based reinsurers and London syndicates and the US domestic marketplace, and our normal day-by-day competitors from the specialty, and excess and surplus lines areas.

Last quarter, I reported that Markel's pricing levels had begun to move up and we began moving prices late last year. Most of our products are now reflecting single-digit price increases and are clearly headed in the right direction. While this has cost us some business -- as the rest of the marketplace is quite comfortable to renew businesses as is, and in many cases, continue to offer reduced pricing -- it's the right thing to do for us here at Markel.

In previous quarters, I quoted the CAID publication, which is one of the many sources that we track for market pricing indicators. Their most recent report, which covers the marketplace through the second quarter, shows the same trends that it did 90 days ago, which basically reflects that [in] the commercial marketplace, prices are continuing to decrease but are decreasing at a somewhat slower level.

Richie reported that our gross premium levels were down 16% over a comparable period from 2008. We face competitive marketplace, as I've mentioned, characterized by numerous competitors as well as the sluggish economy, to which he referred.

Much of Markel's third-party liability and professional lines coverages have rating [indices] of either gross receipts, payroll, or are fee-based. In today's economy, virtually all of this renewal business, and much of the new business that we see day by day, presents itself at a lower level than comparable offerings from 2007 and 2008.

And here again, as Richie mentioned, our construction business is particularly hard hit, with new home starts and new commercial buildings at a virtual standstill. We hope that this changes as we get into the latter half of 2009.

Last quarter, I also updated you on our new business model in our excess and surplus lines division, which we refer to as One Markel. The strategy is a simple one -- sell all of Markel's products in all of Markel's regions through all of Markel's broker clients to as many customers as possible. We've just crossed the four-month anniversary, and the initial response from the brokerage community has been overwhelmingly positive.

While we continue to fine-tune and tinker with our Service Center product offerings, our broker customers have been extremely receptive and very patient. As we refine this model through the remainder of this year, we believe the strategy and structure will suit us extremely well when market conditions change. And even without a significant improvement in the marketplace, this new model will begin to pay us dividends over the next few quarters.

On the Specialty Admitted front, we face the same competitive marketplace as in the excess and surplus lines area. We have been focusing our attention on adding new products, trying to develop new and existing broker relationships, and enhancing our existing product offerings.

Our service here continues to remain some of the absolute best in the industry, and our value-added services, such as our loss control and safety engineering to our camps and daycare clients, is one of the best in the industry as well. We believe that there will be improvement in these markets in the not-too-distant future.

The extremely good news that we have to share today is from our International division. Markel International has produced an underwriting profit in 12 out of the last 13 quarters. I'm delighted to report that all five of our major underwriting products are reporting price increases. and that two of them, Marine and Energy, and our Open Market Property division, are reporting double-digit price increases. Overall, our pricing levels at Markel International are up 8% over the same period last year.

I reported last quarter that the international marketplace seems to be firming much more rapidly than what we've experienced on this side of the Atlantic. And that seems to remain the case. Our international expansion teams continue to develop plans for our consideration in regards to China, India, Eastern Europe, and South America.

With Markel's Syndicate 3000, Markel is able to enter these marketplaces relatively quickly and easily, because of our Lloyd's Syndicate ownership position. Each of these geographical areas, as well as a handful of others, will be reviewed in detail during our 2010 planning process, which begins in the next 30 days.

While the current market conditions continue to be frustrating for our underwriters and our broker clients, we remain upbeat and optimistic because we know that better conditions will arrive soon. In spite of today's competitive pressures, Markel will continue to produce underwriting profits. We are investing our time today in new sales activities, improved customer service, more cross-selling initiatives, and training for our associates to better serve our customers.

I look forward to your questions and comments during our Q&A session after Tom's report, which follows now.

Thank you, Paul. Good morning. Well, it is sure more fun to now be bringing you some good news on the investment front after what seemed like a couple of dog years of [tough play].

Through the second quarter, our total investment return was a positive 5.1%. The elements that comprise that figure were equity returns for the first six months of negative 1.1%; fixed income returns of 4.8%; and foreign exchange translation benefits of 1.2%.

In reverse order, I'd like to comment on each of those components. First, the foreign exchange. When I reviewed my comments from last quarter, I see that the FX effect was a negative 0.3%. As I mentioned at the time, it was important to remember that whatever FX you see, it is only part of the picture. Negative FX on investment returns are marginally offset by gains in underwriting results, since we run as matched a book as possible.

Today, we have a positive FX effect to report of a 1.2% addition for our investment results. That positive, just like last quarter -- negative -- remains only half the story. Our underwriting results were penalized during the quarter by a roughly offsetting amount. In short, as always, please take out the FX effects, whether they are positive or negative. FX is a teeter-totter with investing on one side and underwriting on the other. We work to match our investment assets to our insurance liabilities such that they economically offset one another, and neither contribute nor detract from the real value of Markel.

In fixed income activities, we enjoyed another quarter of positive returns. For the year-to-date, we earned a total return of 4.8% and we are happy to see the improvement in overall credit markets take place. The crisis environment of the last year appears to be diminishing in its scope and fury. We are encouraged to be getting back to an environment of being able to accomplish our goal of simply earning the coupon from fixed income investments and being paid our principal when the securities mature.

We remain short in our duration compared to our historical averages, and we continue to believe it is wiser to forgo some current investment income in order to carry a fat wallet. We got through the last year by building and maintaining a fortress balance sheet with a focus on high credit quality and liquidity, and we are not planning on shifting away from that strategy.

In the equity market, we are now down 1.1% through June. After the 11.2% decline in the first quarter, the recovery in the second quarter is welcome relief. Obviously, since quarter end, equity markets have continued to improve and our results reflect those gains.

During the second quarter, we began to mildly and systematically add to our equity holdings. We will continue to be measured in increasing our equity allocation, but we did begin to allocate money to equities in the second quarter, and I would expect us to continue to do so.

As conditions in our insurance operations continue to improve, we will be more aggressive in adding to our equity holdings. We remain well below our capacity, with equities now representing roughly 45% of our total shareholders equity on June 30. Historically, that measurement would be between 70% and 80%. And over time I expect us to return to that level.

I think it's worth commenting that many financial market participants are focused on questions like -- is the economy bottoming out and getting better? Is the stock market up too far and too fast in the last few months? Or is it foretelling better conditions and underlying sales and earnings? Will we have inflation? Will we have deflation? And so on and so on.

These are all terribly important questions, and they will have a huge impact on future investment returns. The fact is, I don't know the answer to any of them and I don't believe anyone who claims that they do. Consequently, since we do not and cannot know the answers to these important questions, we try to invest in equities and fixed income securities that should be all weather craft and able to provide appropriate returns, no matter what unpredictable conditions we will face. Specifically, we have high credit quality and short duration fixed income securities, so that we can be assured of both the return of our money and the ability to reinvest quickly, should interest rates rise due to inflation or concerns about the dollar in various currencies.

We own a prudent amount of equities in companies with pricing power, valuable brand names, and solid balance sheets. They should be able to grow and produce shareholder value at steady and attractive rates, whether the economy reignites or stalls out; if oil prices are low or high; if deflation continues, or inflation returns; or any of the other important and unknowable big-picture economic forces manifest themselves. As an added bonus, these types of firms sell at historically reasonable valuations.

Owning interest in durable businesses with growing intrinsic value at reasonable valuations should produce returns we will enjoy as Markel shareholders. That remains the guiding principle for our investing activities, and I look forward to your questions in the Q&A session.

With that, let me turn it over to Steve.

Thank you, Tom. As I think most of you know, Markel thinks about our business and manages it with a view towards the long-term future success. We've focused on both the underwriting side as well as the investment side of the business, and seem to manage both intelligently.

I'm extremely proud that our underwriters are showing discipline on the underwriting side of the house, letting business go away where we cannot reach price levels that we need to have. We're confident that both the markets, the insurance markets and the economy, will improve, which will drive future volume.

In the meantime, we'll stick with our knitting and do what makes a lot of sense and underwrite profitably. Business coming on our books at combined ratios at or above 100 absolutely makes no sense. And so, it's not in our interest to write premium volume just have premium volume.

We believe that the progress we're making with One Markel is very, very good; that One Markel will kick in, in the next several quarters and we will be much more effective in the marketplace. And at the same time, there's no doubt that most of our irrational competitors will not be able to continue -- at least not be able to continue to be irrational.

On the investment side, we're seeing markets improving, and you heard Tom's comments. Additionally, as the markets improve and as the insurance environment improves, we'll start to think about moving some of our excess liquidity into longer-term and longer-duration assets, which will meaningfully improve the current yields on some of those securities.

At the current time, we continue to have and will have a fortress balance sheet. So, that's not any instant solution, but clearly, our current investment result in the first six months, we're penalized for our decision to have a significant amount of excess liquidity in the financial statements.

On the balance sheet, we're pleased to see book value per share at almost $240 a share at the end of June. The way the markets are heading, we expect that will continue to improve. Investment leverage at the end of June was slightly better than 3-to-1. Our loss reserves are as strong as ever -- possibly stronger.

And our current estimates on current business include significant margins. We've recognized the pricing reality of the past several years as well as our concerns for inflation. So we're continuing our conservative approach in establishing loss reserves, and expect that we will not be surprised by having been too optimistic or having put on rose colored glasses when making estimates about the current state of our business.

All of that adds up to a very optimistic future. We believe we'll continue to compound book value per share at a high rate over a long period of time. And again, I'd like to thank all of the Markel Associates for an extremely good effort in the first six months of the year, and expect more in the future.

With that, I'd like to open the floor for questions.

(Operator Instructions). Michael Nannizzi, Oppenheimer.

Steve, could you talk a little -- or Paul, talk a little bit about the ENS business. You mentioned not writing business at unattractive margins, that -- and just want to understand -- you've got a loss ratio about 70 -- looks like 71% on a calendar year; 73% on accident year in the second quarter. Can you just kind of talk about that a little bit and what your outlook is for pricing in that segment?

Yes, I'll take the first stab at it and I'll let Paul pick it up after I'm through.

There are two or three different elements of that. And I think one area probably that had, in terms of our premium volume dollars, maybe a disproportionately large impact is our concern about the pricing in the cat-exposed areas of the marketplace -- both wind in the Gulf and on the Florida coast, as well as earthquake exposures in California and the Northwest and other places.

Our view is that we need to make underwriting profit over a long period of time and earn 20% return on the capital that we invest in those businesses. In any one year, you can write earthquake or wind-exposed business at ridiculously cheap prices and look like a hero. If there's no earthquake next year and you wrote a ton of business at pennies on the dollar, you still would look like a hero.

It makes no sense in our opinion to do that. And when we run our models and establish rates that we think are appropriate for those exposures, we're simply not willing to make stupid [guess] about the frequency or severity of those sorts of events. Today, broadly speaking, the marketplace has a much more optimistic view and, I think, is driven by a desire to sort of gamble that this year might be a good year.

So in those areas, we've seen probably -- we've taken a view that we need significant price increases to get where we want to go. The market is still very, very competitive. And unfortunately, we're losing business. It's not that our appetite for catastrophe-exposed business is any lower; our appetite to do silly things is nonexistent.

On the casualty front, our long tail book of business, we are very concerned that with the current economic environment, that we will see in the next three or five years, meaningful inflation. And lines of business where claims will not be settled in the next -- until the next three or five years, we're starting to build into our pricing formula in expectation that there will be some inflation.

The market generally is using models that extrapolate the last five or 10 years of actual experience, which includes virtually no inflation, into the future.

If you were to run a very simple model on most of the long-tail lines of business, and factor in 3% or 5% or 10% price reductions over the last three years, and add an inflation factor for the next three or five years of 2%, 3% or 4%, you would quickly come to the conclusion that most long-tailed casualty lines of business are not priced appropriately today. And so, we're being very cautious about that and very concerned about what are the impacts of inflation in our pricing models.

And finally, with an economic downturn, insurance claims typically increase in a time of a recession. We've seen it to a smaller extent in some of our architects' and engineers' business. And undoubtedly, it will show up in other places. But in an environment with unemployment rising, with the economy in a recession, the frequency and severity of insurance claims increases.

People are looking for a deep pockets and insurance companies happen to have deep pockets. A claim that might have been settled for $1,000 in a boom time is going to cost more if the guy doesn't have a job. And so the entire environment is suffering. We're trying to factor that in our pricing decisions as well.

Paul, I'll let you pick up from there.

Yes, Michael, I'd like to give you a real live example that just came to my attention this week, that sort of encompasses both the property and cat exposure as well as something's that's going on, on the liability side.

We had a relatively modest restaurant insured in Miami Beach, Florida, six miles from the coast. So clearly, in zone one. And I don't recall exactly if it was $1.5 million or $1.6 million of property value and a $1 million companion liability policy to go along with it.

We felt that the property was probably slightly underpriced and we wanted to take our property price from $25,000 to $32,000, and take our liability price from $21,000 to $22,000, making the overall total $54,000. And the client was able to find, in this marketplace, three different proposals for less than $40,000.

So, in this market, what happens is not only do we lose the property and catastrophe business, because we're pricing it to what we think is a reasonable return, we lose the liability business that goes along with it, because the appetite from a lot of the competitors is much stronger than what we believe right now.

And we're seeing that sort of compounding effect, especially in coastal areas where we're writing property and liability cover, that both -- that one leaves us, they both leave us. And that's part of the reason for the premium shortfall.

As far as your comments on the loss reserving side, I think Steve covered it in terms of our inherent conservatism with our more recent years.

Right. Well, I mean, if I could just follow-up a little bit then. I mean, I totally understand, I mean, you had lower top line and your expenses aren't as nimble as the top line, that you'll see the combined start to creep up, but I guess my question is the loss ratio is higher. And so it makes it -- I would think it would make it tough at a 71 or a 73 loss ratio to earn an underwriting profit on, just current year business.

So I'm just trying to understand -- it sounds like all of those things make a lot of sense, and those are controls that you put in place to make sure that you don't write business that's not profitable. But I'm just wondering about the business that is on your books, and whether or not I'm thinking about that correctly.

I think probably the answer to the question would be that in the 71 loss pick, we are assuming those factors are in place, where others may be writing the exact same business and not making those assumptions, and making initial selections that could be 10 points lower.

There's no way to measure that precisely. But our reserving is very, very conservative and it's based upon trying to make as close to the worst-case assumptions that makes sense.

Sam Hoffman, Lincoln Square.

I just had a couple of quick questions. Can you comment on what percentage of your reserves comes from contracting business, roughly? And also what the loss ratio and the combined ratio is booked on that business.

We wouldn't have those -- they would have those in the room right now. We could probably look into it and get something back to you.

I think generally the segments that we report are about as much detail as you'll get as it relates to a specific line of business. But I think it's fair to say we do write a meaningful amount of contractors business. The volume is disproportionately adversely affected because of the lack of activity in the industry. So we're seeing a decline in premium volume because of the decline of the activity in the industry.

Converting that to the outstanding claims is a little bit more complicated. And our loss experience historically has been generally good with contractors. And it's only going to be affected by the same things that I made comments to before, relative to inflation and the like. But our percent of reserves for contractors wouldn't be disproportionately higher or lower than the amount of business we write.

Okay. My second question is, can you comment on how much excess capital you're maintaining relative to what you think you need? And also related to that, I think there was something by S&P that was announced that you may have been put on some kind of negative outlook or watch, and to what extent that's going to require you to keep more excess capital, and also maintain the level of equity investments in your investment portfolio lower than you might otherwise keep it?

Yes, I think I'll try to deal with several of those parts and Richie can pipe in specifically with regard to S&P.

Today, we have $800 million of excess -- of cash and liquid securities at the Holding Company, which is a multiple of two or three times what we would normally and historically have had of excess cash at the Holding Company. We have capacity to take dividends out of the regulated subsidiaries, and so the number of excess capital, depending upon how you define it, would be plus or minus something relative to those numbers.

The more practical answer to your question is that, as of -- as we're looking at the marketplace today, and given the economic downturn and given some of the irrational behavior we're seeing in the marketplace, it's our view -- we are going to have some very interesting and exciting opportunities to put that capital to work.

And so if you were to ask me how much of that $800 million is excess, I would say, none. Because I believe every single penny of it is going to find its way into an opportunity sometime in the next 12 or 24 months, in the terms of either expanding our business, acquiring something, or doing something else that's pretty exciting to build a valuable organization.

As it relates to Standard & Poor's, they did release, the last couple of days, a review -- Standard & Poor's does not follow or cover Markel's insurance companies and does not give Markel a claims-paying rating. We decided some time ago that we would sort of allocate the money we spent for ratings judiciously.

Our view is that the rating agency should charge us nothing in fees for their services. The standards of the world require that you pay rather high fees if you want to get a rating and we wanted to sort of allocate the limited budgets we [wanted] to spend. And so we rely on others to do claims paying ratings and have excluded S&P from that process.

But on an unsolicited basis, Standard & Poor's does rate Markel's long-term debt. And if I recall reading the report, it broadly said that the insurance marketplace is in a downward draft and that was the primary reason for the negative outlook. As I read the report, it sort of sounded to me that that was more of an industry-wide comment than a Markel-specific comment; but you need to talk to them to find out if that's true or not.

And secondarily, they made a reference to our slightly more aggressive than normal investment activity, which really simply refers to a propensity to have a long-term view on the investment world, and to want to invest a meaningful amount of our shareholders equity and long-term common stocks. At the end of March, when they were reviewing the numbers, when markets were probably at their worst, not unlike someone with a deer with lights -- in the headlights.

We'd say, boy, it's stupid to invest in common stocks. It was sort of interesting that they would publish it at the end of July, after we've had several hundred million dollars of appreciation in our equity portfolio.

But whatever S&P may think, we will continue to take a long-term view and manage our assets intelligently. And that undoubtedly will include a meaningful allocation to the long-term investments like common stocks. And I don't think the S&P rating will have one iota of negative impact on Markel's business.

Okay, and finally, you benefited from a lower tax rate in the quarter. Can you give us some guidance as to whether the tax rate will revert to the historical, I guess 26% to 30%, or whether this is a new run rate?

Well, the issue with the tax rate really is with the lower pretax, we continue to increase our allocations in the municipal portfolio, which is tax damage. And so as muni income makes up a bigger portion of our pretax income, that's going to drop the rate.

So through the first six months of the year, we were below sort of what we would have budgeted for pretax income and that drove that rate down. To the extent we have a better second six months in terms of pretax income, that rate will start to come up as that municipal investment income becomes a smaller percentage of the pretax.

So we've historically been in the 28% to 30% range. And I think we were 22% through the first six months. If we do what we plan on doing, which is increase the pretax income in the second half of the year, that rate will start moving towards the 28% to 30%. I don't know that it will completely get there by the end of the year, though.

Meyer Shields, Stifel Nicolaus.

I guess, let me start -- I don't know if this is for Paul or for Steve, but you talked about the architects and engineers, and lawyers seeing an uptick in claims activity and that affected loss ratio. If you're expecting the same sort of uptick because of the economy in general in special liabilities, should that have affected loss ratio as well?

We have seen a slight increase in frequency. And we are addressing that with increased pricing in virtually all of the Professional Liability lines. Architects and engineers, and lawyers, in particular, had some unusual activity over the last couple of quarters.

But we've seen an increase in frequency in our employment practices liability claims. When people lose their job for whatever reason, and more importantly, can't find a comparable job in three months or six months, they have a tendency to turn around and look to their former employer, that it was their former employer's fault, not their own.

We've seen a slight increase in some of our medical claims in terms of frequency; people just seem to be getting injured a little bit more frequently today. And it's not surprising that a lot of people that present medical claims are people that are unemployed as well.

So, we could give you example after example; but we've addressed virtually all of the lines with the appropriate pricing increases where needed. And I would like to remind you that this historically has been one of our most profitable segments inside of Markel for a number of years. And we continue to have a high degree of confidence that overall, professional lines will produce healthy margins for us again in 2009.

Okay. That's helpful. A question for Tom. You always focus on the quality of the management team when you make your investments. Can you share with us your thoughts on (inaudible) because some of the noise -- or on some of the noise of the management changes there seem to imply they're planning for (inaudible) of it. it.

I'm sorry, you broke up a little bit at the end.

I'm sorry. I guess, just with the movement of putting [Dave Focal] in charge of [SS]. I'm just wondering how you're looking at possible management succession.

Right. Well, in terms of quality in management, I think you would be hard-pressed to find a better example of quality management at Berkshire. The old saying the proof of the pudding is in the eating. The results that they've put on the books over the years are as good as they get. The culture that the company has and continues to build throughout the organization is certainly something I'm entirely comfortable with. It's our largest holding and continues to be so. And I would expect that would continue to be the case.

Okay, that's it. Thanks so much.

Jay Cohen, Banc of America.

Most of my questions have actually been answered, but maybe just a follow-up with Tom. If you could talk about going forward, some of the industries that you find attractive from an equity standpoint, that might be interesting.

Yes, Jay, I think the main thing that I'm looking for these days is Steady Eddie. And in fact, in making the presentation to our Board, I talked about what I called the Silver Medalist Strategy. And what I'm looking for is not the person who's going to get the gold; but the person who's going to -- or the company and the type of industry that's likely to win the silver medal.

And what I mean by that is that I think that the dispersion of possible outcomes is very, very wide right now. Because either you can think about logically, a situation where the economy gets better, you have a real inflation dynamics start to take place with everything that's going on with the government. Or on the other hand, you can -- people can and do argue fairly cogently and intelligently that there are deflationary forces at work that are still very, very large and out there in a big way.

And under both of those macro environments, there are very, very different winners and losers. But if you had inflation and you knew you were going to have inflation, you would want to own a bunch of gold, commodities, natural resources -- things that had pricing power. And the last thing in the world you would possibly want is a government bond. You're going to get killed with long-term government bonds in an inflationary environment.

On the other hand, if you have deflation, the gold medal winner are going to be government bonds. That is what you would want the most. And natural resources companies and things like that would be absolutely killed. So given the fact that it's impossible to know with precision who would be the gold medal winners in either one of those scenarios, the more important thing is to make sure that you don't have what would be a big loser in either environment.

So what that reduces to, for me, is companies that have pricing power and the ability to pass through whatever costs they have, which protects you in inflation, plus our necessary good, viable, durable businesses that are going to continue to do business, even if you're in a slower economic environment.

What I read about specifically, and it's one of our large holdings, is Wal-Mart. As I talked about, nobody goes to Wal-Mart because they dream of going there. They go there because Wal-Mart sells what people need. And that will happen no matter what the economic environment is. And they have a low-cost system to deliver those goods into the hands of people all around the world.

So that's sort of the connecting theme, is to look for the silver medallist that's not going to win the gold in either one of those environments, but sure is going to be there close at the finish line and not run any risk of a wipeout.

Appreciate it as usual, Tom. Thank you.

David West, Davenport and Company.

In your 10-Q, you've talked about two unfavorable court rulings that went against you. I wonder if you could talk about those a little bit and what impact that had on your reserving this quarter.

Yes, Dave, I'll talk a little bit about that, but I don't want to get into too much detail because those are still in litigation. But yes, it was two sort of unusual events in two senses, given the size of them and just we don't rarely see these sorts of things happen. So they were unusual in terms of the size and just the fact that they don't happen very often.

In terms of their impact on the quarter, they were about $25 million in the quarter between the two of them. But as it says in there, it was litigation issues that went against us. And we decided to take fairly conservative positions in terms of what we needed to reserve for them.

And was this largely seen in the higher loss rates in the ENS units?

Yes, it was.

Okay, very good. Kind of tackling, I guess, the contractors comments a little bit more, could you -- I know it runs across multiple lines of business for you, but is there any way to characterize your book in terms of largely residential exposure, infrastructure, commercial -- something along those lines?

The majority of our book, David, are small artisan contractors, anywhere from one to five-person firms. We have, over a period of time, done some residential contractors, some commercial contractors, but it's normally plumbers, electricians, window washers, tree trimmers, janitorial services -- things like that; small independent firms as opposed to big international companies.

We clearly have the underwriting expertise and the appetite to write larger, more complicated accounts, but that seems to be where the competitive pressures are the strongest right now. Historically, we've done well on all of those classes of business, but a lot of it is -- the results are tied to the economy, and the ups and the downs of what goes on in segments that we have absolutely no control over.

Very good. I guess, Richie, this is probably one for you. The expense ratio overall came in a little less then I would have thought. And I think you mentioned a lower profit sharing contribution. Can you give us an idea of roughly in dollar size how much lower that was versus the prior year?

Versus the prior year, it was, I think, $30 million -- is that correct? Approximately $30 million less than prior-year.

Okay. And is this kind of a once-a-year true-up? Or is this going to have a continuing impact on these (multiple speakers) --?

We're going to look at it every quarter. I mean, clearly, we're running behind what our goals were for the year. The years not over; we've still got six months. We can make up a lot of ground in the second half of the year. So, as the results start to get more in line with what we were looking for as we entered the year, we'll start moving that number back up. But we look at it every quarter.

And the third million, we had some bigger than expected bonuses for the year before. And so that sort of contributed to the size of that difference between the two years.

Very good. And lastly, you've mentioned you may go ahead and pay off your $150 million on your line of credit perhaps in the next month or so. Can you remind us what the current rate is you're paying on that line of credit?

Roughly 1%.

Big number there.

Yes, yes.

Sure you want to give that back?

Well, for a little while.

All right. Thanks very much.

Thank you. Our final question is from the line of Mark Dwelle with RBC Capital Markets. Please proceed with your question, sir.

I think Dave actually picked off all my last questions, but for one. Tom, you'd given the year-to-date return on the equity portfolio, and I just missed that number.

All right -- through June, it was a negative 1.1%.

1.1%?

Correct.

Okay. That is actually all my questions. Thanks.

Thank you all very, very much. We appreciate your participation today. As always, if you have any further questions, don't hesitate to call us here at our offices in Richmond. And we wish you a very, very good day. Thanks a lot.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.