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MKL > SEC Filings for MKL > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for MARKEL CORP

Form 10-Q for MARKEL CORP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The accompanying consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and include the accounts of Markel Corporation and all subsidiaries.


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Critical Accounting Estimates

Critical accounting estimates are those estimates that both are important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of material contingent assets and liabilities, including litigation contingencies. These estimates, by necessity, are based on assumptions about numerous factors.

We review our critical accounting estimates and assumptions quarterly. These reviews include evaluating the adequacy of reserves for unpaid losses and loss adjustment expenses, the reinsurance allowance for doubtful accounts and income tax liabilities, as well as analyzing the recoverability of deferred tax assets, assessing goodwill and intangible assets for impairment and evaluating the investment portfolio for other-than-temporary declines in estimated fair value. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.

Readers are urged to review our 2011 Annual Report on Form 10-K for a more complete description of our critical accounting estimates.

Our Business

We are a diverse financial holding company serving a variety of niche markets. Our principal business markets and underwrites specialty insurance products and programs. We believe that our specialty product focus and niche market strategy enable us to develop expertise and specialized market knowledge. We seek to differentiate ourselves from competitors by our expertise, service, continuity and other value-based considerations. We compete in three segments of the specialty insurance marketplace: the Excess and Surplus Lines, the Specialty Admitted and the London markets. We also own interests in various businesses that operate outside of the specialty insurance marketplace. Our financial goals are to earn consistent underwriting and operating profits and superior investment returns to build shareholder value.

Our Excess and Surplus Lines segment writes property and casualty insurance outside of the standard market for hard-to-place risks including catastrophe-exposed property, professional liability, products liability, general liability, commercial umbrella and other coverages tailored for unique exposures. Our Excess and Surplus Lines segment is comprised of five regions, and each regional office is responsible for serving the wholesale producers located in its region. Our regional teams focus on customer service and marketing, underwriting and distributing our insurance solutions and provide customers easy access to our products.

Our Specialty Admitted segment writes risks that, although unique and hard-to-place in the standard market, must remain with an admitted insurance company for marketing and regulatory reasons. Our underwriting units in this segment write specialty program insurance for well-defined niche markets, personal and commercial property and liability coverages and workers' compensation insurance. Our Specialty Admitted segment is comprised of three underwriting units: the Markel Specialty and Markel American Specialty Personal and Commercial Lines units and our FirstComp workers' compensation insurance unit.

Our London Insurance Market segment writes specialty property, casualty, professional liability, equine, marine, energy and trade credit insurance and reinsurance on a worldwide basis. We participate in the London market through Markel International, which includes Markel Capital Limited and Markel International Insurance Company Limited, wholly-owned subsidiaries. Markel Capital Limited is the corporate capital provider for Markel Syndicate 3000 at Lloyd's, which is managed by Markel Syndicate Management Limited, a wholly-owned subsidiary.

For purposes of segment reporting, the Other Insurance (Discontinued Lines) segment includes lines of business that have been discontinued in conjunction with acquisitions. This segment also includes development on asbestos and environmental loss reserves.

Through our wholly-owned subsidiary Markel Ventures, Inc., we own interests in various industrial and service businesses that operate outside of the specialty insurance marketplace. These businesses are viewed by management as separate and distinct from our insurance operations. Local management teams oversee the day-to-day operations of these companies, while strategic decisions are made in conjunction with members of our executive management team, principally our President and Chief Investment Officer. The financial results of those companies in which we own controlling interests have been consolidated in our financial statements. The financial results of those companies in which we hold a noncontrolling interest are accounted for under the equity method of accounting.


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Our strategy in making these private equity investments is similar to our strategy for purchasing equity securities. We seek to invest in profitable companies, with honest and talented management, that exhibit reinvestment opportunities and capital discipline, at reasonable prices. We intend to own the businesses acquired for a long period of time.

Our non-insurance operations are comprised of a diverse portfolio of industrial and service companies from various industries, including manufacturers of dredging equipment, high-speed bakery equipment, laminated furniture products, food processing equipment and laminated oak and composite wood flooring used in truck trailers, an owner and operator of manufactured housing communities, a real estate investment fund manager, a concierge medical and executive health services company, a retail intelligence services company, a company that manages behavioral health programs and a manufacturer and lessor of trailer tubes used by industrial, chemical and distribution companies to transport gas and liquids.

Key Performance Indicators

We measure financial success by our ability to compound growth in book value per share at a high rate of return over a long period of time. To mitigate the effects of short-term volatility, we measure ourselves over a five-year period. We believe that growth in book value per share is the most comprehensive measure of our success because it includes all underwriting and investing results. We measure underwriting results by our underwriting profit or loss and combined ratio. These measures are discussed in greater detail under "Results of Operations."

Results of Operations

The following table presents the components of net income to shareholders.

                                         Quarter Ended September 30,           Nine Months Ended September 30,
(dollars in thousands)                     2012               2011                2012                 2011
Underwriting profit (loss)           $      (4,763 )     $         255     $        64,793       $       (66,639 )
Net investment income                       64,438              62,199             207,834               196,551
Net realized investment gains                5,231              12,839              25,356                25,423
Other revenues                             165,569              91,847             385,778               260,361
Amortization of intangible assets           (7,959 )            (6,023 )           (25,078 )             (17,586 )
Other expenses                            (145,339 )           (70,302 )          (343,462 )            (218,270 )
Interest expense                           (24,692 )           (23,656 )           (69,068 )             (64,516 )
Income tax expense                            (811 )           (12,490 )           (45,998 )             (19,145 )
Net income attributable to
noncontrolling interests                    (2,021 )            (1,405 )            (3,562 )              (4,329 )
Net income to shareholders           $      49,653       $      53,264     $       196,593       $        91,850

Net income to shareholders for the quarter ended September 30, 2012 decreased primarily due to less favorable underwriting results compared to the same period of 2011. Net income to shareholders for the nine months ended September 30, 2012 increased primarily due to more favorable underwriting results compared to the same period of 2011. The components of net income to shareholders are discussed in further detail under "Underwriting Results," "Investing Results," "Non-Insurance Operations" and "Interest Expense and Income Taxes."

Underwriting Results

Underwriting profits are a key component of our strategy to grow book value per share. We believe that the ability to achieve consistent underwriting profits demonstrates knowledge and expertise, commitment to superior customer service and the ability to manage insurance risk. The property and casualty insurance industry commonly defines underwriting profit or loss as earned premiums net of losses and loss adjustment expenses and underwriting, acquisition and insurance expenses. We use underwriting profit or loss as a basis for evaluating our underwriting performance.


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The following table presents selected data from our underwriting operations.

                                         Quarter Ended September 30,          Nine Months Ended September 30,
(dollars in thousands)                     2012               2011                2012                 2011
Gross premium volume                 $     610,833       $     584,635     $      1,906,373       $  1,772,611
Net written premiums                 $     539,624       $     524,678     $      1,687,404       $  1,574,378
Net retention                                   88 %                90 %                 89 %               89 %
Earned premiums                      $     530,537       $     509,203     $      1,573,189       $  1,462,515
Losses and loss adjustment expenses  $     303,459       $     306,632     $        813,074       $    927,643
Underwriting, acquisition and
insurance expenses (1)               $     231,841       $     202,316     $        695,322       $    601,511
Underwriting profit (loss)           $      (4,763 )     $         255     $         64,793       $    (66,639 )
U.S. GAAP Combined Ratios (2)
Excess and Surplus Lines                        89 %                89 %                 91 %               88 %
Specialty Admitted                             109 %               116 %                108 %              109 %
London Insurance Market                         92 %                99 %                 88 %              119 %
Other Insurance (Discontinued Lines)        NM (3)              NM (3)               NM (3)             NM (3)
Markel Corporation (Consolidated)              101 %               100 %                 96 %              105 %

(1) Effective January 1, 2012, we prospectively adopted Financial Accounting Standards Board Accounting Standards Update (ASU) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. At December 31, 2011, deferred acquisition costs included approximately $43 million of costs that no longer met the criteria for deferral as of January 1, 2012. Pursuant to the new guidance, these costs will be amortized primarily over the first nine months of 2012, consistent with policy terms. As a result of the prospective adoption of ASU No. 2010-26, underwriting, acquisition and insurance expenses for the quarter and nine months ended September 30, 2012 included $6.5 million and $41.1 million of costs that were deferred as of December 31, 2011 and no longer met the criteria for deferral.

(2) The U.S. GAAP combined ratio is a measure of underwriting performance and represents the relationship of incurred losses, loss adjustment expenses and underwriting, acquisition and insurance expenses to earned premiums. A combined ratio less than 100% indicates an underwriting profit, while a combined ratio greater than 100% reflects an underwriting loss.

(3) NM - Ratio is not meaningful.

Our combined ratio was 101% and 96%, respectively, for the quarter and nine months ended September 30, 2012 compared to 100% and 105%, respectively, for the same periods in 2011.

The combined ratio for the quarter and nine months ended September 30, 2012 was impacted by prior year loss development, current year catastrophe losses, lower attritional losses, and the adoption of a new accounting standard, as discussed below:

The prior year loss development included $31.1 million, or 6 points and 2 points, respectively, of unfavorable development on asbestos and environmental exposures. See "Other Insurance (Discontinued Lines)." There was no comparable unfavorable development in the 2011 periods.

The combined ratio included $8.8 million of underwriting loss from Hurricane Isaac which occurred in August 2012. The total impact of catastrophe losses for the quarter and nine months ended September 30, 2012 was approximately two points and less than one point, respectively. The combined ratio for the quarter and nine months ended September 30, 2011 included $34.0 million, or seven points, and $133.0 million, or nine points, respectively, of underwriting loss related to natural catastrophes. The 2011 underwriting loss related to natural catastrophes included losses from Hurricane Irene in the third quarter and losses from the U.S. storms, Japanese earthquake and tsunami, Australian floods and New Zealand earthquake that occurred during the first six months of 2011. The combined ratio for the quarter and nine months ended September 30, 2012 also improved due to lower attritional losses in the Excess and Surplus Lines and London Insurance Market segments.

The combined ratio included $6.5 million, or one point, and $41.1 million, or three points, respectively, related to the impact of the prospective adoption of ASU No. 2010-26. Another factor contributing to the increase in the combined ratio for the third quarter of 2012 was higher profit sharing expense compared to the same period of 2011.


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Excess and Surplus Lines Segment

The combined ratio for the Excess and Surplus Lines segment was 89% and 91%, respectively, for the quarter and nine months ended September 30, 2012 compared to 89% and 88%, respectively, for the same periods in 2011. For the quarter and nine months ended September 30, 2012, a lower current accident year loss ratio was offset by less favorable development on prior years' loss reserves and a higher expense ratio compared to the same periods of 2011.

The current accident year loss ratio for the quarter and nine months ended September 30, 2012 included $3.0 million, or approximately two points and less than one point, respectively, of losses from natural catastrophes. The current accident year loss ratio for the quarter and nine months ended September 30, 2011 included losses from natural catastrophes of $11.3 million, or six points and $22.3 million, or four points, respectively. Excluding the impact of natural catastrophes, the current accident year loss ratio for the quarter and nine months ended September 30, 2012 improved due to lower attritional property losses compared to the same periods of 2011.

Favorable development on prior years' loss reserves for the quarter and nine months ended September 30, 2012 was $51.3 million and $132.6 million, respectively, compared to $60.5 million and $169.9 million for the same periods in 2011. In the first quarter of 2011, we resolved a significant portion of our outstanding liabilities associated with an errors and omissions program for mortgage servicing companies and, as a result, reduced prior years' loss reserves by $15.8 million. The favorable development on prior years' loss reserves experienced within the segment during 2012 and 2011 were most significant on our professional and products liability programs.

The increase in the expense ratio was due in part to the impact of prospective adoption of ASU No. 2010-26, which added approximately $2.1 million, or one point, and $16.7 million, or three points, respectively, to the segment's combined ratio for the quarter and nine months ended September 30, 2012. Excluding this impact, the segment expense ratio increased two points for the third quarter of 2012 and decreased one point for the nine months ended September 30, 2012 compared to the same periods last year. The increase for the third quarter was due to higher profit sharing costs in 2012 while the decrease for the first nine months was due to a reduction in general expenses partially offset by higher profit sharing costs compared to a year ago.

Specialty Admitted Segment

The combined ratio for the Specialty Admitted segment was 109% and 108%, respectively, for the quarter and nine months ended September 30, 2012 compared to 116% and 109%, respectively, for the same periods of 2011. For the quarter and nine months ended September 30, 2012, the decrease in the combined ratio was primarily due to a lower current accident year loss ratio and more favorable development on prior years' loss reserves partially offset by a higher expense ratio compared to the same periods in 2011.

The current accident year loss ratio for the quarter and nine months ended September 30, 2012 included $2.8 million, or two points and one point, respectively, of losses from natural catastrophes compared to $5.6 million, or four points, and $9.6 million, or two points, for the same periods of 2011. Before considering the impact of natural catastrophes in the third quarters of both 2012 and 2011, the current accident year loss ratio for the quarter improved approximately four points compared to the same period last year due to improved underwriting performance for two programs within our accident and health liability class.

The Specialty Admitted segment's combined ratio for the quarter and nine months ended September 30, 2012 included $11.5 million and $27.7 million, respectively, of favorable development on prior years' loss reserves compared to $6.0 million and $7.9 million of favorable development for the same periods in 2011. The favorable development on prior years' loss reserves experienced within the Specialty Admitted segment during the quarter and nine months ended September 30, 2012 were most notable on the 2011 accident year across several product lines.

For the quarter and nine months ended September 30, 2012, the increase in the expense ratio was primarily due to the impact of prospective adoption of ASU No. 2010-26, which added approximately $2.6 million, or two points, and $12.9 million, or three points, respectively, and higher profit sharing costs compared to the same periods in 2011. Also contributing to the increase in the expense ratio for the nine months ended September 30, 2012 was the write off of previously capitalized software development costs.


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London Insurance Market Segment

The combined ratio for the London Insurance Market segment was 92% and 88%, respectively, for the quarter and nine months ended September 30, 2012 compared to 99% and 119%, respectively, for the same periods of 2011. For the quarter ended September 30, 2012, the decrease in the combined ratio was due to a lower current accident year loss ratio partially offset by a higher expense ratio compared to the same period of 2011. The decrease in the combined ratio for the nine months ended September 30, 2012 was due to a lower current accident year loss ratio and more favorable development of prior years' loss reserves, partially offset by a higher expense ratio compared to a year ago.

The combined ratio for the quarter and nine months ended September 30, 2012 included $3.0 million, or two points and less than one point, respectively, of underwriting loss from Hurricane Isaac which occurred in August 2012. The combined ratio for the quarter ended September 30, 2011 included $17.1 million, or ten points, of underwriting loss related to natural catastrophes. The combined ratio for the nine months ended September 30, 2011 included $101.1 million, or twenty points, of underwriting loss related to natural catastrophes and also included $22.7 million, or five points, of underwriting loss related to two large losses in the Marine and Energy division. Excluding the impact of natural catastrophes and the two large losses, the current accident year loss ratio for the quarter and nine months ended September 30, 2012 improved primarily due to lower attritional losses in the Elliott Special Risks division and lower attritional property losses in the Specialty division, within the London Market Segment.

The London Insurance Market segment's combined ratio for the quarter and nine months ended September 30, 2012 included $32.7 million and $119.0 million, respectively, of favorable development on prior years' loss reserves compared to $34.7 million and $70.0 million of favorable development for the same periods in 2011. Favorable development of prior years' loss reserves in 2012 was primarily on the 2006 to 2009 accident years and occurred in a variety of programs across each of our divisions. The favorable loss reserve development for the quarter and nine months ended September 30, 2012 also included $4.8 million and $23.0 million, respectively, on the 2001 and prior accident years.

For the quarter and nine months ended September 30, 2012, the increase in the expense ratio was primarily attributable to the impact of prospective adoption of ASU No. 2010-26, which added approximately $1.8 million, or one point, and $11.6 million, or two points, respectively, and to higher profit sharing costs compared to the same periods of 2011.

Other Insurance (Discontinued Lines)

The Other Insurance (Discontinued Lines) segment produced an underwriting loss of $26.7 million and $20.2 million for the quarter and nine months ended September 30, 2012, respectively, compared to an underwriting loss of $1.5 million and an underwriting profit of $2.5 million for the same periods of 2011.

The underwriting loss for both the quarter and nine months ended September 30, 2012 included approximately $31.1 million of loss reserve development on asbestos and environmental exposures. We complete an annual review of these exposures during the third quarter of the year unless circumstances suggest an earlier review is appropriate. Over the past two years, the number of asbestos and environmental claims reported each year across the property and casualty industry has been on the decline. However, at the same time, the likelihood of making an indemnity payment has risen, thus increasing the average cost per reported claim. During our 2012 annual review, we reduced our estimate of the ultimate claims count, while increasing our estimate of the number of claims that would ultimately be closed with an indemnity payment. As a result, prior years' loss reserves for asbestos and environmental exposures were increased. During our 2011 review, we determined that no adjustment to loss reserves was required. Asbestos and environmental loss reserves are subject to significant uncertainty due to potential loss severity and frequency resulting from an uncertain and unfavorable legal climate. Our asbestos and environmental reserves are not discounted to present value and are forecasted to pay out over the next 50 years. We seek to establish appropriate reserve levels for asbestos and environmental exposures; however, these reserves could be subject to increases in the future.

Adverse development of asbestos and environmental reserves for both the quarter and nine months ended September 30, 2012 was partially offset by the other favorable movements in prior years' loss reserves and allowances for reinsurance bad debt related to discontinued lines of business originally written by Markel International.


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Premiums and Net Retentions

The following tables summarize gross premium volume, net written premiums and
earned premiums by segment.

                                                Gross Premium Volume
   Quarter Ended September 30,                                                  Nine Months Ended September 30,
      2012              2011               (dollars in thousands)                 2012                   2011
$       253,014     $   236,639           Excess and Surplus Lines         $        705,849       $        663,989
        167,747         153,753              Specialty Admitted                     496,019                431,604
        190,071         194,210           London Insurance Market                   704,511                676,893
              1              33     Other Insurance (Discontinued Lines)                 (6 )                  125
$       610,833     $   584,635                    Total                   $      1,906,373       $      1,772,611

Gross premium volume for the quarter and nine months ended September 30, 2012 increased 4% and 8%, respectively compared to the same periods of 2011. The increase in gross premium volume for the third quarter of 2012 is due to increases in the Specialty Admitted and Excess and Surplus Lines segments. The increase in gross premium volume for the nine months ended September 30, 2012 was attributable to higher gross premium volume in each of our three operating segments. Excess and Surplus Lines segment premiums increased for the quarter and nine months ended September 30, 2012 due to an increase in gross premium volume for the brokerage property line. For the quarter and nine months ended September 30, 2012, the Specialty Admitted segment included $17.1 million and $43.4 million of gross premium volume attributable to THOMCO, which was acquired in the first quarter of 2012. For the nine months ended September 30, 2012, the Specialty Admitted segment also included $197.2 million of gross premium volume attributable to our workers' compensation product line, compared to $170.3 million for the same period of 2011. Foreign currency exchange rate movements did not have a significant impact on gross premium volume for the quarter and nine months ended September 30, 2012.

During the latter part of 2011, we saw price declines stabilize and achieved modest price increases in several lines, most notably the marine and energy products within the London Insurance Market segment. During 2012, we have generally seen flat to small single digit favorable rate changes compared to flat to small single digit rate declines in 2011.

When we believe the prevailing market price will not support our underwriting profit targets, the business is not written. As a result of our underwriting discipline, gross premium volume may vary depending on the competitive environment.

                                                Net Written Premiums
     Quarter Ended September 30,                                                  Nine Months Ended September 30,
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