Markel Group Inc (MKL) 2014 Q3 法說會逐字稿

Greetings and welcome to the Markel Corporation third quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference to your host, Mr. Tom Gayner, President and Chief Investment Officer. Thank you, Tom, you may begin.

Good morning. Thank you and welcome. We're glad that you're with us and we look forward to discussing our results from the first nine months of 2014 as well as our thoughts on the business. Anne Waleski, our Chief Financial Officer, will review the overall financial results and my Co-Presidents, Mike Crowley and Richie Whitt, will then cover our insurance operations. And then I'll return to discuss our investments and Markel Ventures' activities.

Before we get started, I'll remind you of the Safe Harbor statement. As a reminder, comments made on today's call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They are based on current assumptions and opinions concerning a variety of known and unknown risks. Actual results may differ materially from those contained in or suggested by such forward-looking statements. Please refer to the full disclosure regarding the risks that may affect Markel, which may be found in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q.

With that, let me turn things over to Anne.

Thank you, Tom, and good morning, everyone. I'm pleased to report that the positive momentum that we experienced in the first half of 2014 has continued into the third quarter. Our financial results for the first nine months of the year are very solid. We produced underwriting profits in all three ongoing insurance segments and continue to align the legacy Alterra reserves with the Markel reserving philosophy. Markel Ventures completed the acquisition of Cottrell, Inc. during the period and continues to look for profitable growth opportunities.

Our total operating revenues grew 25% to $3.8 billion in 2014 compared to $3 billion in the first nine months of 2013. The most significant drivers of this increase continue to be the inclusion of nine months of underwriting revenues from legacy Alterra product offerings in 2014, higher revenue from the Hagerty business, and higher investment income due to our larger investment portfolio. Also contributing to the increase, other revenues were up 25% to $630 million from $505 million last year, primarily due to revenue growth within Markel Ventures.

Moving into the underwriting results, gross written premiums were $3.8 billion in 2014 compared to $2.9 billion in 2013, an increase of 30%. Net written premiums were $3.1 billion in the first nine months of 2014, up 28% from the prior year, and earned premiums increased 26% to $2.9 billion. These increases were driven by the inclusion of nine months of premiums from the legacy Alterra products in 2014 compared to five months of legacy Alterra premium in 2013.

Net retention was down slightly in 2014 at 82% compared to 83% in 2013. The slight decrease, which is in line with our expectations, is primarily due to higher use of reinsurance on certain insurance products previously underwritten by Alterra.

Our consolidated combined ratio for the first nine months was a 97 in both periods; 2014 and 2013. As a reminder, the 2013 combined ratio included transaction and other acquisition-related costs of approximately $70 million, or 3 points, related to the acquisition of Alterra. The combined ratio in 2013 also included approximately $32 million, or 1 point, of catastrophe losses.

Excluding the impact of catastrophe and transaction and acquisition-related costs from the 2013 combined ratio, the combined ratio for 2014 increased 4 points compared to the prior year. This increase was primarily due to less-favorable development on prior-year loss reserves in 2014 compared to 2013.

The consolidated combined ratio for the nine months ended September 30, 2014 included approximately $260 million of favorable development on prior-year loss reserves compared to $281 million of favorable development for the same period in 2013. The benefit of the favorable development on prior-year loss reserves had less of an impact on combined ratio in 2014 than in 2013 due to higher earned premium volume in all three of our ongoing underwriting segments in 2014.

In addition, the U.S. insurance segment had less-favorable development due, in part, to adverse development on our architect and engineers product line in 2014 and less-favorable development on Hurricane Sandy in 2014 compared to 2013.

Now, I'll move to the results from Markel Ventures. During the first nine months of 2014, revenues from Markel Ventures were $595 million compared to $486 million a year ago. Net income to shareholders from Markel Ventures was just over $15 million in 2014 compared to $18 million for the same period in 2013. EBITDA was $66 million in 2014 compared to $64 million in 2013. For the nine months ended September 30, 2014 revenues were higher than the same period a year ago due to our acquisitions of Cottrell in 2014 and Eagle Construction in 2013. Likewise, EBITDA from our Markel Ventures operations increased in 2014 compared to 2013 primarily due to the acquisitions of Cottrell and Eagle partially offset by less-favorable results in our existing manufacturing operations.

Moving to our investment results, investment income was $270 million for the first nine months of 2014 compared to $229 million in the same period last year. The benefit of holding a larger portfolio was partially offset by lower yields. Net realized investment gains for the period were $29 million compared to $41 million a year ago. Included in net realized gains were $3.9 million of other than temporary impairments as compared to $4.6 million in 2013.

Looking at our total results for the year, net cash provided by operating activities was $537 million for the first nine months of 2014 compared to $543 million for the same period of 2013. The decrease is due to higher tax payments for our international operation partially offset by higher cash flows from investment income and underwriting activities due to the inclusion of Alterra.

Our projected effective tax rate was 25% in the first nine months of 2014 compared to 28% a year ago. The decrease in the effective tax rate in 2014 is primarily due to anticipating a larger tax benefit related to tax-exempt investment income and a decrease in the estimated foreign earnings subject to U.S. tax in 2014 as compared to 2013.

We reported net income to shareholders of $204 million in the first nine months of 2014 compared to $182 million a year ago. Comprehensive income was $517 million for the first nine months of 2014 compared to $253 million a year ago. Total value per share at the end of September 2014 was $514, an increase of 8% since the end of 2013.

With that, I'll turn it over to Mike to talk about the U.S. insurance segment.

Thanks, Anne. Good morning. The U.S. insurance segment, as we've pointed out before, comprises all direct business written on our U.S. insurance companies and includes all of the underwriting results of our wholesale and specialty divisions as well as certain products written by our global insurance team.

For the third quarter gross written premium was up 3% over prior year. Year-to-date gross written premiums have increased 13% over prior year. This increase was due in a large part to the Alterra lines of business that are now included in this segment. Excluding these lines, premium volume is up 5%. Keep in mind that we have been exiting or re-underwriting some lines in our specialty and wholesale divisions and this has impacted growth.

The combined ratio for the quarter was 95 for both 2014 and 2013. The combined ratio for the year was 97 as compared to 94 in 2013. As Anne pointed out, the higher insurance segment combined ratio was driven by less-favorable development of prior year losses due, in part, to adverse development in the architects and engineers line of business. Partially offsetting this impact was a lower year-over-year expense ratio. The improvement in the expense ratio was due to higher contribution of earned premium for the legacy Alterra in 2014 than in 2013 and due to non-recurring transaction costs recorded in 2013 associated with the Alterra acquisition.

The rate environment in the U.S. segment remains competitive. However, we continue to achieve modest single-digit rate increases on small- to medium-sized risk across the various divisions within the segment. Large accounts remained under competitive pressure and prices for property & casualty lines on Fortune 1000 business remained soft.

Operationally, during the quarter we combined our Atlanta and Richmond specialty program units under one management team and we expect this reorganization to improve our results in 2015 from both an underwriting and expense perspective. Also in the specialty division, year-to-date data revealed benefits from our initiatives to cross-sell and round accounts between first comp and Markel specialty programs. 566 accounts have added additional coverages through this rounding effort.

In our wholesale division, we continue to see strong growth in our binding P&C, environmental, and excess umbrella lines. Our E&S executive team had a very busy NAPSLO, holding over 350 face-to-face meetings with our wholesale partners. We continue to grow with our top wholesalers and this meeting provides the opportunity for an intense few days of one-on-ones. All five wholesale regions' volume is up year to date.

Also, our specialty and global and executive teams attended the annual CIAB conference which, like NAPSLO, allows us to visit face to face with many of our key brokers and agents. The broad array of Markel products in both large and small accounts has made us an attractive alternative for many agents.

Gerry Albanese, our Executive Vice President and Chief Underwriting Officer, presided over a number of product line leadership meetings during the quarter. These meetings were attended by our most senior underwriters and they provide a platform for communication between our underwriting leaders and our regional operations as we finalize business plans and budgets for 2015.

In summary, we remain focused on those same key objectives that have driven us throughout 2014; reassessment of some lines of business, expense reduction and control, attraction of talent, and aggressive sales and marketing.

I'll now turn the call over to Richie.

Thanks, Mike, and good morning, everyone. Following on from comments by Anne and Mike, I'd sum up the first nine months of the year in Markel's underwriting operations as solid or business as usual. I think this is a really important statement when you consider that we are establishing, consistent with our historical practices, a loss reserve margin of safety on legacy Alterra business.

Turning specifically to the results of the international insurance and reinsurance segments, the international insurance segment, which includes business written by our Markel international division as well as that written by our global insurance division, has performed well so far this year. During the nine months of 2014, gross written premiums in the international insurance segment increased 13% to $653 million.

The combined ratio was 95% compared to 92% in the prior year. The increase in premium writings is primarily due to the global insurance division, which was created after the acquisition of Alterra, and contributed nine months of business in 2014 compared to only five months of business in 2013. The higher segment combined ratio was driven by a higher current accident year loss ratio partially offset by a favorable expense ratio. The improvement in the expense ratio was due to transaction costs of the Alterra merger back in 2013 and higher earned premiums from the global insurance division, which carry a lower expense ratio.

Now I'll turn to the reinsurance segments, which includes reinsurance programs written by our global reinsurance division as well as that written by our Markel international division. Gross written premiums for this segment were $999 million for the first nine months of 2014 and that was up from $443 million a year ago. The increase in premium writings was primarily due to including nine months of writings from products previously written by Alterra in 2014 compared to five months of writings in 2013.

The combined ratio for the reinsurance segment was a 97 as compared to a 108 last year. Last year's combined ratio included 7 points of catastrophe losses, really very minor catastrophe losses this year really of the attritional nature, I would say, and approximately 10 points of non-recurring costs associated with the acquisition of Alterra.

Operationally, during the quarter in the first nine months of the year, we recently announced that Dave Kalainoff will be retiring from Markel Re in June of next year and that Jed Rhoads will be taking over responsibility for all of Markel Re. I can't thank Dave enough for all that he's done to ensure the smooth transition of Alterra reinsurance operations into our Markel Re division. Also, I know Jed will do a fantastic job leading our reinsurance team into the future.

Markel International's integration of its Abbey acquisition continues to go well. We've added marketing and sales resources as well as some new product capabilities to the Abbey team. Abbey is a wonderful franchise and, with the additional resources that Markel can bring to the table, we believe that solid growth is possible.

As Mike said, all areas of the P&C market remain competitive. The only difference, really, is the degree to which they're competitive. The international insurance and reinsurance segments are probably among the most competitive in the market today. We're in the process of completing budgets and plans for 2015 and, barring any significant market changes, organic growth is going to be difficult to come by in 2015.

As a result, as Mike alluded to, we're focused on controlling our expenses, finding efficiencies, and emphasizing risk selection and portfolio management. In soft markets, we will always choose underwriting discipline over growth. Despite these difficult market conditions, we still believe there's great opportunities available to us and believe we've built the platforms to pursue those opportunities.

With that, I'd like to turn it over to Tom.

Thank you, Richie. My comments this morning will be brief since our news is good and straightforward. I'm happy to answer any questions or cover any details when we get to the Q&A.

On the investment side of the house, we earned 7.3% on our equity investments and 4.5% on our fixed-income portfolio during the first nine months, which produced a gross total return of 5.2%.

In the equity portfolio we continued to methodically add to our holdings steadily throughout the year. Between purchases of roughly $300 million so far, as well as appreciation of the portfolio, we've now got roughly 52% of our shareholders' capital invested in equities compared to 48% a year end 2013.

We continue to have an unusual combination of investment ideas that we're confident about, positive cash flows from our insurance and ventures businesses, and some sense of overall caution and wariness about investment markets overall. The net effect of these cross currents is that we continue to steadily (inaudible) our way and into building positions. We think that approach prudently protects our balance sheet and leaves us with the ability to be able to invest more money in equities as opportunities present themselves. Expect us to continue our steady, consistent approach in building the equity portfolio.

In our fixed-income operations, we earned a total return of 4.5% as low interest rates that prevailed at the end of 2013 went under an even lower limbo stick by the time we got to the end of September. That meant we got some capital appreciation in the portfolio in addition to recurring interest income.

We remain cautious, as we have been for multiple years, about the balance between risk and reward in bonds. Long-term rates just don't have that much room between where they are and zero. They have a lot of room between where they are and where I've seen them in my career. Consequently, we keep the duration of our bond portfolio a bit shorter than the duration of insurance liabilities. Including cash, the duration stood at roughly 4.25 years at September 30, and we do not plan to go longer than that in the current interest rate environment.

We also remain committed to safety first. In addition to not stretching for yield by extending the duration, we don't stretch for it by reducing credit quality either. 97% of the portfolio is rated A or better, but we don't stop there and rely solely on the rating agencies. We do our own credit analysis on top of that to make sure that we are comfortable with the credit risks we take. As always; safety first.

In Markel Ventures, we purchased Cottrell Industries during the third quarter. Only five weeks of their results are included in our third quarter numbers and you'll see more from them as well as the rest of the Markel Ventures companies in the fourth quarter. Cottrell is the leading manufacturer of car-hauling trailers and equipment and we welcome them to the Markel family. As we state in the Markel style, we seek to be a market leader in each of our pursuits. I can assure you that Cottrell fits that description as well as other elements of the Markel style.

For the nine months to date, you could see the imaginatively named other revenues on our income statement of $630 million versus $459 million a year ago. Anne gave you the portion from Markel Ventures and you can see the vast majority of those revenues, indeed, relate to Markel Ventures operations. Our EBITDA from the group was $66 million versus $64 million in 2013 which is a much smaller percentage increase than the full-year results.

When you add all of our activities together from insurance, investing, and Markel Ventures, we get to the bottom line of comprehensive income. Comprehensive income through the first nine months at Markel exceed $0.5 billion. As it shows in the Q in round numbers, the drivers of comprehensive income came from pre-tax underwriting profits of over $70 million, pre-tax investment income and gains of about $300 million, increased pre-tax unrealized gain from the portfolio of almost $350 million, and pre-tax cash flows of over $70 million from Markel Ventures and non-cash intangible amortization. We then paid gobs of taxes and provided for the rest of what we owe. Some of those items comes to the $0.5 billion of comprehensive income we earned. We're pleased with that result and we hope you are as well.

Looking forward, every insurance, investment, industrial, and service business that we own or operate in faces challenging and competitive markets. They always have and they always will. Despite those facts, we continue to produce solid returns for you as our shareholders and we expect to continue for that to be the case over time. We're grateful for the opportunity to do so and we now look forward to answering your questions.

With that, John, could you be so kind as to open the Q&A period?

Thank you. At this time, we will be conducting a question and answer session. (Operator Instructions). Vincent DeAugustino, KBW.

Hi. Good morning, everyone.

Good morning.

I'll start off. So, last quarter you had talked about the reinsurance environment kind of theoretically being at bottom if everybody was being disappointed. I'm just wondering if, at this point, there's any change in kind of that assessment or if it's one of these things where we have to really wait for 1/1 to play out before we can get a true test; if we're going to be at bottom and potentially rebound or go lower.

This is Richie. You know, I think it's a little early to say. Like you say, I think we've got to see what happens with the 1/1 renewals. But, a lot of people are talking about it being the bottom. I wouldn't look for a bounce at this point. I think there's too much capital out there for there to be any sort of bounce.

You know, if I had to guess, you might just see a little more reduction, but I just can't imagine the kinds of reductions we've seen in the last two years. And, certainly, if people are looking for those kinds of reductions at 1/1, we will probably be coming off of some business. So, it feels like we're getting close to a bottom, but I'd like to see those 1/1 renewals before I commit to that.

Okay, good deal. And then just to switch over, two questions on the Markel Ventures side. I'm sorry if I missed this. I know you said you look forward to kind of giving us the full-year numbers But with Cottrell and Eagle, just where, roughly with those two businesses, should that put us on an annualized EBITDA and net income basis?

Annualized run rate of the revenues should be a round number of $1 billion, plus or minus. There's cyclicality to that. And that's looking into 2015. And we would expect double-digit EBITDA earnings from that mixed collection of businesses.

Okay, cool. Thank you --

Round numbers; a lot of zeroes involved, yes.

Good deal. Just a theoretical question between the split, in terms of when you're speaking with investors, between Markel Ventures and the equity portfolio. Do you feel that you get more credit for the Ventures income stream versus the public equities since, on the Ventures, you don't have to do the whole equity look for earnings add-back?

Yes.

Alright. Take care, guys. Thank you.

Thank you.

Mark Dwelle, RBC Capital Markets.

Good morning. Just a few sort of numbers questions because, as you said, it was a pretty straightforward quarter. In the discontinued lines segment, there was a $6.8 million of adverse development. Was that just a true-up of the asbestos study from the second quarter or was it something different?

No, that's actually some development that we saw on the discontinued businesses from the Alterra acquisition that occurred during the quarter.

Okay. The figure for the remaining amortization of the premium in the investment portfolio, is that number somewhere in the 10-Q? I haven't found it, if it is.

It's not and I don't have the number with me, Mark. But, given the amount of the portfolio that we have turned over, the number that's left has gotten smaller. But I don't have the specific number with me and it's not in the Q.

Okay. And then, finally, was there any meaningful amount of catastrophe loss across any of the businesses? I know Richie mentioned in the reinsurance there was not. Just asking around the other units.

Nothing to speak of.

You know, we always have a bit of attritional amount of catastrophes built into our assumptions and I would say it was even probably a light attritional quarter from that standpoint.

Okay. Those are all my questions. Thank you.

Thank you.

Jay Cohen, Bank of America Merrill Lynch.

Yes, thank you. In the reinsurance segment, the expense ratio in the third quarter dropped, I guess, about 4 points from the first half. In the Q, you suggest there was an increase in experience-related funds or something. I forget exactly the phrase. But I'm wondering how much of an impact that had on the expense ratio in the quarter in the reinsurance segment.

Yes, I would say the impact to the quarter was probably not significant.

So do you see the third quarter number as a reasonable run rate going forward? Because it was about 30 versus nearly 34 in the first half.

No, I do not think that it is a reasonable run rate. I think you can take the earlier quarters and use those. This would be a non-recurring, one-time adjustment that we make and then we'll trend in going forward, but I think you can use the earlier quarters' indication.

That's helpful. And I guess for the overall company, when you think about the expense ratio; given the market conditions internationally and in reinsurance, should we expect any improvement at all in the expense ratio going forward? Or should we just kind of assume it stays reasonably flat?

This is Richie, Jay. Obviously we continue to work to reduce the expense ratio, but it's fair to say we don't expect it to have a whole lot help in that effort from growth next year. So growing the top line if the markets stay like this, that's going to be difficult so we're going to have to do it the old-fashioned way, which is spending less. So, admittedly, it's going to be difficult. What did we have, like 37, a little over 37 this quarter?

Yes.

You know, I think that's probably fair for next year and we're going to work hard and see if we can reduce it.

That's great. If I could squeeze one more in. Markel Ventures, as you had mentioned, the improvement was pretty noticeable versus the first half and specifically in the manufacturing segment where the net income, the GAAP income went from a little above $4.5 million in the first quarter up to $21 million this quarter. So, pretty impressive. Does seasonality play a role there and should we think about the third quarter, again, as a reasonable run rate going forward?

Seasonality plays a small role, but I would say it's much more economically cyclical than what I would describe as seasonal. And, frankly, the first quarter was low. We were in the midst of integrating some acquisitions and there's always a little bit of indigestion and process that's connected with that. And, as we've gone through the year, those issues are starting to resolve themselves in we're getting to a more normal basis.

I really would steer you towards EBITDA because, given the amortization, purchase accounting, and that sort of stuff, the true catch that's being produced by the business is best represented by the EBITDA and that's what we hold the managers accountable for because they can't control tax rate. They're very lightly levered. We're not borrowing a bunch of money. So, that really does describe the cash flows of the business.

Fair enough. Thanks, Tom.

Okay.

(Operator Instructions). Management, at this time, there seems to be no more further questions. Would you like to make any closing remarks?

Thank you very much and we look forward to chatting with you next quarter. Take care.

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