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MKL > SEC Filings for MKL > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for MARKEL CORP

Form 10-Q for MARKEL CORP


6-Nov-2013

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 its subsidiaries.

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, life and annuity reinsurance benefit reserves, 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, estimating reinsurance premiums written 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.

The following discussion should be read in conjunction with our 2012 Annual Report on Form 10-K, which provides a more complete description of our critical accounting estimates.

Reinsurance Premiums

Our reinsurance premiums are recorded at the inception of each contract based upon contract terms and information received from ceding clients and brokers. For excess of loss contracts, the amount of minimum and/or deposit premium is usually contractually documented at inception, and variances between this premium and final premium are generally small. An adjustment is made to the minimum and/or deposit premium, when notified, if there are changes in underlying exposures insured. For quota share or proportional reinsurance contracts, gross premiums written are normally estimated at inception based on information provided by cedants and/or brokers. We generally record such premiums using the client's initial estimates, and then adjust them as more current information becomes available, with such adjustments recorded as premiums written in the period they are determined. We believe that the ceding clients' estimate of the volume of business they expect to cede to us usually represents the best estimate of gross premium written at the beginning of the contract. As the contract progresses, we monitor actual premium received in conjunction with correspondence from the ceding client in order to refine our estimate. Variances from original premium estimates are normally greater for quota share contracts than excess of loss contracts. Premiums are earned on a pro rata basis over the coverage period. The impact of premium adjustments to net income may be mitigated by related acquisition costs and losses.

Life and Annuity Benefits

Prior to its acquisition, Alterra entered into long duration reinsurance contracts which subject us to mortality, longevity and morbidity risks. The related life and annuity reinsurance benefit reserves are compiled by our actuaries on a reinsurance contract-by-contract basis and are computed on a discounted basis using standard actuarial techniques and cash flow models. Since the development of our life and annuity reinsurance reserves is based upon cash flow projection models, we must make estimates and assumptions based on cedant experience and industry mortality tables, longevity, expense and investment experience, including a provision for adverse deviation. The assumptions used to determine policy benefit reserves were determined as of May 1, 2013 (the Acquisition Date) and are generally locked-in for the life of the contract unless a premium deficiency develops or another unlocking event occurs. As the experience on the reinsurance contracts emerges, the assumptions are reviewed by management, no less than annually, to determine whether the actual and anticipated experience indicates that existing policy reserves, together with the present value of future gross premiums and expected investment income earned thereon, are sufficient to cover the present value of future benefits, settlement and maintenance costs. If such a review produces reserves in excess of those currently held, then the lock-in assumptions are revised and a charge for life and annuity benefits is recognized at that time.

Because of the many assumptions and estimates used in establishing reserves and the long-term nature of reinsurance contracts, the reserving process, while based on actuarial science, is inherently uncertain. Actual results could differ materially from these estimates.


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Our Business

We are a diverse financial holding company serving a variety of niche markets. Our principal business markets and underwrites specialty insurance products. 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 historically competed in three segments of the specialty insurance marketplace: the Excess and Surplus Lines, the Specialty Admitted and the London Insurance Market segments. As a result of the acquisition of Alterra, we formed a new operating segment during the second quarter of 2013. The Alterra segment comprises all of the active property and casualty underwriting operations of the former Alterra companies. We also own interests in various industrial and service 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 hard-to-place risks outside of the standard market, 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: Markel Specialty, Markel American Specialty Personal and Commercial Lines and Markel FirstComp. In January 2012, we acquired Thompson Insurance Enterprises, LLC (Thomco), a privately held program administrator that underwrites multi-line, industry-focused insurance programs that complement the Markel Specialty product offerings. Examples include social service organizations, senior living, childcare and fitness centers. In January 2013, we acquired Essentia Insurance Company, a company that underwrites insurance exclusively for Hagerty Insurance Agency and Hagerty Classic Marine Insurance Agency (collectively, Hagerty) throughout the United States. Hagerty offers insurance for classic cars, vintage boats, motorcycles and related automotive collectibles. Results attributable to these acquisitions are included in the Specialty Admitted segment.

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.

Our Alterra segment writes specialty insurance and reinsurance on a worldwide basis from offices in the United States, Bermuda, the United Kingdom, Europe and Latin America. The Alterra segment's Lloyd's operations are conducted by Alterra at Lloyd's through Lloyd's Syndicates 1400 and 2526. At September 30, 2013, the Company's proportionate share of Syndicates 1400 and 2526 was 100% and approximately 20%, respectively. Alterra also has a 2% share in the 2012 and prior underwriting years of Syndicate 2525. Business written by the Alterra segment includes a wide range of commercial insurance and reinsurance products, including general and excess liability, property, accident and health, agriculture, auto, credit/surety, marine and energy, medical malpractice, professional liability and workers compensation coverages.

For purposes of segment reporting, the Other Insurance (Discontinued Lines) segment includes lines of business that have been discontinued in conjunction with acquisitions. Alterra previously offered life and annuity reinsurance products. In 2010, Alterra ceased writing life and annuity reinsurance contracts and placed this business into run-off. Results attributable to the run-off of Alterra's life and annuity reinsurance business are included in the Company's Other Insurance (Discontinued Lines) segment. This segment also includes development on asbestos and environmental loss reserves, none of which are related to the acquisition of Alterra.

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 and are comprised of a diverse portfolio of companies from different industries, including manufacturing, health care and business and financial services. 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.

On October 9, 2013, we made an offer to purchase the entire issued and to be issued share capital of Abbey Protection plc (Abbey), an integrated specialist insurance and consultancy group, for a total purchase price of approximately 116.5 million (approximately $187.4 million as of October 9, 2013). The acquisition is subject to a number of conditions, including shareholder and regulatory approvals in the United Kingdom. If approved, the transaction is expected to close in January 2014. Abbey's business is focused on the underwriting and sale of insurance products to small and medium enterprises and affinity groups in the United Kingdom providing protection against legal expenses and professional fees incurred as a result of legal actions or investigations by tax authorities, as well as providing a range of complementary legal, professional and reinsurance services.

Regulatory Environment

Our insurance subsidiaries are subject to regulation and supervision by the insurance regulatory authorities of the various jurisdictions in which they conduct business. As a result of our acquisition of Alterra, we became subject to regulatory authorities in Bermuda, Ireland and certain other foreign jurisdictions. The following discussion should be read in conjunction with our 2012 Annual Report on Form 10-K, which provides a more complete description of our regulatory environment.

Bermuda Insurance Regulation

The insurance and reinsurance industry in Bermuda is regulated by the Bermuda Monetary Authority (the BMA). Markel Bermuda is regulated by the BMA under the Insurance Act 1978 of Bermuda and its related regulations (collectively, the Bermuda Insurance Act). The Bermuda Insurance Act imposes solvency and liquidity standards and auditing and reporting requirements on Markel Bermuda and grants to the BMA powers to supervise, investigate and intervene in the affairs of Bermuda insurance and reinsurance companies.

Markel Bermuda's business is subject to enhanced capital requirements in addition to minimum solvency and liquidity requirements. The enhanced capital requirement is determined by reference to a risk-based capital model that determines a control threshold for statutory capital and surplus by taking into account the risk characteristics of different aspects of the insurer's business. If a company fails to maintain or meet the control level, various degrees of regulatory action may be taken by the BMA.

Markel Bermuda is also subject to the Insurance Code of Conduct (the Insurance Code), which prescribes duties and standards to be complied with to ensure that Markel Bermuda implements sound corporate governance, risk management and internal controls. Non-compliance with the Insurance Code could result in intervention by the BMA. The BMA also monitors each insurer's compliance with the Insurance Code and may use it as a factor in calculating the applicable operational risk charge in relation to that insurer's risk-based capital model.

In addition, our Bermuda incorporated entities are each required to comply with the provisions of the Companies Act 1981 of Bermuda (the Bermuda Companies Act). The Bermuda Companies Act regulates, among other things, the payment of dividends and making of distributions from contributed surplus.

Ireland Insurance Regulation

The insurance and reinsurance industry in Ireland is regulated by the Central Bank of Ireland (the CBI). Our Irish operating subsidiary, Markel Europe plc (Markel Europe, formerly known as Alterra Europe), is subject to regulation by the CBI under a variety of Irish rules and regulations. Markel Europe must comply with the Irish Insurance Acts 1909 to 2011, regulations promulgated thereunder, regulations relating to insurance business promulgated under the European Communities Act 1972, the Irish Central Bank Acts 1942 to 2010, as amended, regulations promulgated thereunder and directions and guidelines and codes of conduct issued by the CBI (collectively, the Insurance Acts and Regulations).

Markel Europe is required to maintain statutory reserves, particularly in respect of underwriting liabilities, and a solvency margin as provided for in the Insurance Acts and Regulations. Assets constituting statutory reserves must comply with admissibility, diversification, localization and currency matching rules. Statutory reserves must be actuarially certified annually.


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Other Jurisdictions

As a global provider of specialty insurance and reinsurance, we must comply with various regulatory requirements in jurisdictions where we provide coverage or have activities in addition to the United States, the United Kingdom, Bermuda and Ireland. For example, Markel Europe and Alterra at Lloyd's must comply with applicable Latin America regulatory requirements in connection with our Latin American reinsurance operations, and Markel Europe must comply with applicable German and Swiss regulatory requirements in connection with its branch activities in those countries.

In addition to the regulatory requirements imposed by the jurisdictions in which a reinsurer is licensed, a reinsurer's business operations are affected by regulatory requirements governing credit for reinsurance in other jurisdictions in which its ceding companies are located. In general, a ceding company that obtains reinsurance from a reinsurer that is licensed, accredited or approved by the jurisdiction in which the ceding company files statutory financial statements is permitted to reflect in its statutory financial statements a credit in an aggregate amount equal to the liability for unearned premiums and loss reserves and loss expense reserves ceded to the reinsurer. Many jurisdictions also permit ceding companies to take credit on their statutory financial statements for reinsurance obtained from unlicensed or non-admitted reinsurers if certain prescribed security arrangements are made. Because Markel Bermuda is not licensed, accredited or approved in any jurisdiction other than Bermuda, in certain instances our reinsurance customers require Markel Bermuda to provide a letter of credit or enter into other security arrangements.

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. We measure investing results by our total investment return. These measures are discussed below 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)                     2013               2012                2013                 2012
Underwriting profit (loss)           $      34,225       $      (4,763 )   $        61,561       $        64,793
Net investment income                       86,192              64,438             228,788               207,834
Net realized investment gains               11,238               5,231              40,701                25,356
Other revenues                             174,512             165,569             504,680               385,778
Amortization of intangible assets          (16,848 )            (7,959 )           (37,755 )             (25,078 )
Other expenses                            (166,566 )          (145,339 )          (459,642 )            (343,462 )
Interest expense                           (30,619 )           (24,692 )           (82,754 )             (69,068 )
Income tax expense                         (25,167 )              (811 )           (70,673 )             (45,998 )
Net income attributable to
noncontrolling interests                    (1,368 )            (2,021 )            (2,649 )              (3,562 )
Net income to shareholders           $      65,599       $      49,653     $       182,257       $       196,593

Net income to shareholders for the quarter ended September 30, 2013 increased primarily due to more favorable underwriting results and higher investment income, partially offset by higher income tax expense compared to the same period of 2012. Net income to shareholders for the nine months ended September 30, 2013 decreased primarily due to an increase in amortization expense, interest expense and income tax expense, partially offset by higher investment income compared to the same period of 2012. In both periods of 2013, higher investment income and increased amortization expense, interest expense and income tax expense are due in part to including the results of operations of Alterra beginning May 1, 2013. 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."


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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.

The following table presents selected data from our underwriting operations.

                                Quarter Ended September 30,             Nine Months Ended September 30,
(dollars in thousands)             2013                2012                2013                  2012
Gross premium volume         $    1,076,298        $  610,833        $    2,920,578          $ 1,906,373
Net written premiums         $      842,931        $  539,624        $    2,433,200          $ 1,687,404
Net retention                            78 %              88 %                  83 %                 89 %
Earned premiums              $      919,723        $  530,537        $    2,269,129          $ 1,573,189
Losses and loss adjustment
expenses                     $      533,372        $  303,459        $    1,263,674          $   813,074
Underwriting, acquisition
and insurance expenses       $      352,126   (1)  $  231,841   (2)  $      943,894    (1)   $   695,322   (2)
Underwriting profit (loss)   $       34,225        $   (4,763 )      $       61,561          $    64,793

U.S. GAAP Combined
Ratios (3)
Excess and Surplus Lines                 88 %              89 %                  81 %                 91 %
Specialty Admitted                       90 %             109 %                 101 %                108 %
London Insurance Market                  84 %              92 %                  88 %                 88 %
Alterra                                 104 %               - %                 118 %                  - %
Other Insurance
(Discontinued Lines)                     NM   (4)          NM   (4)              NM    (4)            NM   (4)
Markel Corporation
(Consolidated)                           96 %             101 %                  97 %                 96 %

(1) In connection with the acquisition of Alterra, we incurred transaction and other acquisition-related costs of $8.5 million and $70.3 million for the quarter and nine months ended September 30, 2013, respectively. For the nine months ended September 30, 2013, these costs include transaction costs totaling $16.0 million, which primarily consist of due diligence, legal and investment banking costs. The quarter and nine months ended September 30, 2013 also include severance costs of $3.5 million and $31.7 million, respectively, stay bonuses of $3.9 million and $10.0 million, respectively, and other compensation costs totaling $1.1 million and $12.6 million, respectively, related to the acceleration of certain long-term incentive compensation awards and restricted stock awards that were granted by Alterra prior to the acquisition.

(2) 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 policy acquisition costs included $43.1 million of costs that no longer met the criteria for deferral as of January 1, 2012 and were recognized into income during 2012, consistent with policy terms ($6.5 million and $41.1 million for the quarter and nine months ended September 30, 2012, respectively).

(3) 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.

(4) NM - Ratio is not meaningful.

Our combined ratio was 96% and 97%, respectively, for the quarter and nine months ended September 30, 2013 compared to 101% and 96%, respectively for the same periods of 2012. For the quarter ended September 30, 2013, the decrease in the combined ratio was driven by a lower current accident year loss ratio and a lower expense ratio, partially offset by a lower prior accident years loss ratio compared to the same period in 2012. For the nine months ended September 30, 2013, the increase in the combined ratio was due to a lower prior accident years loss ratio, partially offset by a lower expense ratio.

The decrease in the consolidated current accident year loss ratio for the quarter ended September 30, 2013 was primarily due to more favorable underwriting results within our Specialty Admitted segment compared to 2012. Additionally, the quarter ended September 30, 2012 included $8.8 million, or two points, of losses from Hurricane Isaac which occurred in August 2012.


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The consolidated combined ratio for the quarter and nine months ended September 30, 2013 included $77.3 million and $281.4 million, respectively, of favorable development on prior years' loss reserves compared to $69.3 million and $260.2 million of favorable development for the same periods in 2012. Favorable development on prior years' loss reserves for the quarter and nine months ended September 30, 2013 included $5.6 million and $19.7 million, respectively, of favorable development on Hurricane Sandy which occurred during October 2012. In both periods of 2013, the benefit of the favorable development on prior years' loss reserves had less of an impact on the combined ratio in 2013 compared to 2012 due to higher earned premium volume in 2013.

The decrease in the consolidated expense ratio for both the quarter and nine months ended September 30, 2013 was primarily driven by higher earned premiums in our Excess and Surplus Lines, Specialty Admitted and London Insurance Market segments compared to 2012, partially offset by the impact of transaction and other acquisition-related costs incurred by Alterra. Excluding transaction and other acquisition-related costs incurred in 2013, the inclusion of the results of operations of Alterra beginning May 1, 2013 had a favorable impact on the expense ratio for the quarter and nine months ended September 30, 2013, as Alterra has a lower expense ratio than we historically have had.

Underwriting, acquisition and insurance expenses for the quarter and nine months ended September 30, 2013 include transaction and other acquisition-related costs of $8.5 million, or one point, and $70.3 million, or three points, respectively. For the nine months ended September 30, 2013, these costs include transaction costs totaling $16.0 million, which primarily consist of due diligence, legal and investment banking costs. The quarter and nine months ended September 30, 2013 also include severance costs of $3.5 million and $31.7 million, . . .

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