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MKL > SEC Filings for MKL > Form 10-Q on 6-Aug-2014All Recent SEC Filings

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Form 10-Q for MARKEL CORP


6-Aug-2014

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 (the Company).

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 the following critical accounting estimates and assumptions quarterly:
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, estimating reinsurance premiums written and earned and evaluating the investment portfolio for other-than-temporary declines in estimated fair value. Critical accounting estimates and assumptions for goodwill and intangible assets are reviewed in conjunction with an acquisition and goodwill and indefinite-lived intangible assets are reassessed at least annually for impairment. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.

Readers are urged to review our 2013 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. 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 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.

On May 1, 2013, we completed the acquisition of 100% of the issued and outstanding common stock of Alterra Capital Holdings Limited (Alterra), a Bermuda-headquartered global enterprise providing diversified specialty property and casualty insurance and reinsurance products to corporations, public entities and other property and casualty insurers. In conjunction with the continued integration of Alterra into our insurance operations, during the first quarter of 2014, we changed the way we aggregate and monitor our ongoing underwriting results. Effective January 1, 2014, we monitor and report our ongoing underwriting operations in the following three segments: U.S. Insurance, International Insurance and Reinsurance. In determining how to aggregate and monitor our underwriting results, management considers many factors, including the geographic location and regulatory environment of the insurance entity underwriting the risk, the nature of the insurance product sold, the type of account written and the type of customer served.

The U.S. Insurance segment includes all direct business and facultative placements written by our insurance subsidiaries domiciled in the United States. The International Insurance segment includes all direct business and facultative placements written by our insurance subsidiaries domiciled outside of the United States, including our syndicate at Lloyd's of London (Lloyd's). The Reinsurance segment includes all treaty reinsurance written across the Company. Results for lines of business discontinued prior to, or in conjunction with, acquisitions, will continue to be reported in the Other Insurance (Discontinued Lines) segment. Underwriting results attributable to Alterra, which were previously reported in our Alterra segment, are included in each of our underwriting segments effective May 1, 2013 (the Acquisition Date). All investing activities related to our insurance operations are included in the Investing segment.


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Our U.S. Insurance segment includes both hard-to-place risks written outside of the standard market on an excess and surplus lines basis and unique and hard-to-place risks that must be written on an admitted basis due to marketing and regulatory reasons. The following products are included in this segment:
catastrophe-exposed property, professional liability, products liability, general liability, commercial umbrella, marine, workers' compensation, classic automobiles and other coverages tailored for unique exposures. Business in this segment is written through our Wholesale, Specialty and Global Insurance divisions. The Wholesale division writes commercial risks, primarily on an excess and surplus lines basis, using a network of wholesale brokers managed on a regional basis. The Specialty division writes program insurance and other specialty coverages for well-defined niche markets, primarily on an admitted basis. The Global Insurance division writes risks outside of the standard market on both an admitted and non-admitted basis and is comprised of business previously written by Alterra. Global Insurance division business written by our U.S. insurance subsidiaries is included in this segment.

Our International Insurance segment writes risks that are characterized by either the unique nature of the exposure or the high limits of insurance coverage required by the insured. Risks written in the International Insurance segment are written on either a direct basis or a subscription basis, the latter of which means that loss exposures brought into the market are typically insured by more than one insurance company or Lloyd's syndicate. When we write business in the subscription market, we prefer to participate as lead underwriter in order to control underwriting terms, policy conditions and claims handling. Products offered within our International Insurance segment include primary and excess of loss property, casualty, excess liability, professional liability, equine, marine, energy and trade credit insurance. Business included in this segment is produced through our Markel International and Global Insurance divisions. The Markel International division writes business worldwide from our London-based platform, including Markel Syndicate 3000, through which our Lloyd's operations are conducted. Global Insurance division business written by our non-U.S. insurance subsidiaries, which primarily targets Fortune 1000 accounts, is included in this segment.

Our Reinsurance segment includes property, casualty and specialty treaty reinsurance products offered to other insurance and reinsurance companies globally through the broker market. Our treaty reinsurance offerings include both quota share and excess of loss reinsurance and are typically written on a participation basis. Principal lines of business include: property (including catastrophe-exposed property), auto, general casualty, credit, surety, workers' compensation, professional liability, and marine and energy. Our reinsurance product offerings are underwritten by our Global Reinsurance division, which is primarily comprised of business previously written by Alterra, and our Markel International division.

For purposes of segment reporting, the Other Insurance (Discontinued Lines) segment includes lines of business that have been discontinued prior to, or 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 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. (Markel Ventures), 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, healthcare, consumer 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. While each of these companies is operated independently, we aggregate their financial results into two industry groups: manufacturing and non-manufacturing. 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. 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.

In January 2014, we completed the acquisition of 100% of the share capital of Abbey Protection plc (Abbey), an integrated specialty insurance and consultancy group headquartered in London. Abbey's business is focused on the underwriting and sale of insurance products to small and medium-sized 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 and professional consulting services. Premiums associated with Abbey's insurance operations for 2013 were in excess of $60 million. Results attributable to Abbey's insurance operations are included in the International Insurance segment. Results attributable to Abbey's consultancy operations are reported with our non-insurance operations, which are not included in a reportable segment.


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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. Based on the nature of this business, we generally will experience higher claims activity during the second and third quarters of the year. Results attributable to Hagerty are included in the U.S. Insurance segment.

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 taxable equivalent 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 June 30,          Six Months Ended June 30,
(dollars in thousands)                    2014            2013             2014              2013
Underwriting profit (loss)           $    (10,794 )   $  (20,682 )   $      40,773       $   27,336
Net investment income                      92,169         77,979           178,884          142,596
Net realized investment gains               7,120         11,546            24,514           29,463
Other revenues                            194,083        157,425           380,254          330,168
Amortization of intangible assets         (13,488 )      (11,292 )         (27,487 )        (20,907 )
Other expenses                           (184,942 )     (140,759 )        (367,110 )       (293,076 )
Interest expense                          (29,789 )      (28,561 )         (59,488 )        (52,135 )
Income tax expense                        (13,218 )      (16,980 )         (41,698 )        (45,506 )
Net income attributable to
noncontrolling interests                   (1,073 )         (920 )            (858 )         (1,281 )
Net income to shareholders           $     40,068     $   27,756     $     127,784       $  116,658

The components of net income to shareholders are discussed in detail under "Underwriting Results," "Investing Results," "Other Revenues and Other Expenses" 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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Consolidated (as reported)
The following table presents selected data from our underwriting operations.

                                  Quarter Ended June 30,              Six Months Ended June 30,
(dollars in thousands)           2014               2013               2014               2013
Gross premium volume         $ 1,343,378        $ 1,100,980        $ 2,703,135        $ 1,844,280
Net written premiums           1,084,331            927,281          2,223,642          1,590,269
Net retention                         81 %               84 %               82 %               86 %
Earned premiums                  965,599            784,819          1,914,974          1,349,406
Losses and loss adjustment
expenses                         610,406            442,406          1,152,709            730,302
Underwriting, acquisition
and insurance expenses           365,987            363,095   (1)      721,492            591,768   (1)
Underwriting profit (loss)       (10,794 )          (20,682 )           40,773             27,336

U.S. GAAP Combined
Ratios (2)
U.S. Insurance                       100 %               94 %               98 %               92 %
International Insurance               96 %              103 %               93 %               99 %
Reinsurance                          100 %              125 %               97 %              118 %
Other Insurance
(Discontinued Lines)                  NM   (3)           NM   (3)           NM   (3)           NM   (3)
Markel Corporation
(Consolidated)                       101 %              103 %               98 %               98 %

(1) In connection with the acquisition of Alterra, we incurred transaction and other acquisition-related costs of $61.8 million for the quarter and six months ended June 30, 2013. Included in this amount are transaction costs totaling $16.0 million, which primarily consist of due diligence, legal and investment banking costs, severance costs totaling $28.2 million, stay bonuses of $6.1 million and other compensation costs of $11.5 million 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) 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 98%, respectively, for the quarter and six months ended June 30, 2014 compared to 103% and 98% for the same periods of 2013. Excluding the impact of transaction and acquisition-related costs and catastrophes from both periods of 2013, the consolidated combined ratio increased in both periods of 2014 primarily due to less favorable development on prior years' loss reserves in 2014 compared to 2013. The quarter and six months ended June 30, 2013 included transaction and other acquisition-related costs of $61.8 million related to the acquisition of Alterra, or eight points and five points, respectively, on the combined ratio. The combined ratio for the quarter and six months ended June 30, 2013 also included $25.4 million, or three points and two points, respectively, of catastrophe losses, all of which were included in the Reinsurance segment.

The consolidated combined ratio for the quarter and six months ended June 30, 2014 included $59.5 million and $166.9 million, respectively, of favorable development on prior years' loss reserves compared to $119.3 million and $204.1 million of favorable development for the same periods in 2013. Less favorable development on prior years' loss reserves is primarily attributable to our U.S. Insurance segment, due in part to adverse development on our architects and engineers and brokerage excess and umbrella product lines. Additionally, prior year losses for the quarter and six months ended June 30, 2014 included $27.2 million of adverse development on asbestos and environmental exposures within our Other Insurance (Discontinued Lines) segment. There was no comparable adverse development during the quarter and six months ended June 30, 2013.


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Consolidated (pro forma)
As a result of the acquisition of Alterra on May 1, 2013, the underwriting results for Alterra are included in our results for the quarter and six months ended June 30, 2014 and for the period from May 1, 2013 to June 30, 2013. To provide another basis for comparison for 2014, we have included our consolidated underwriting results for both periods of 2013 prepared on pro forma basis as if the acquisition of Alterra had occurred on January 1, 2012. The pro forma financial information is for informational purposes only and does not necessarily reflect the results that would have occurred had the acquisition taken place on January 1, 2012, nor is it necessarily indicative of future results. We have excluded certain charges from the pro forma results, including transaction costs incurred by the Company ($16.0 million) and Alterra ($23.0 million) totaling $39.0 million for both the quarter and six months ended June 30, 2013 and severance and stay bonuses attributable to the acquisition totaling $28.2 million and $6.1 million, respectively, for both the quarter and six months ended June 30, 2013. There were no other significant adjustments used to determine the 2013 pro forma underwriting results.
The following table presents the consolidated underwriting results on a pro forma basis for the quarter and six months ended June 30, 2013.

                                                                     Pro Forma
                                                        Quarter Ended       Six Months Ended
(dollars in thousands)                                  June 30, 2013         June 30, 2013
Gross premium volume                                   $   1,322,567        $   2,715,136
Net written premiums                                       1,066,320            2,188,370
Net retention                                                     81 %                 81 %
Earned premiums                                              888,161            1,798,009
Losses and loss adjustment expenses                          508,325              998,373
Underwriting, acquisition and insurance expenses             356,929   (1)        699,357     (1)
Underwriting profit                                    $      22,907        $     100,279

U.S. GAAP combined ratio (2)                                      97 %                 94 %

(1) In connection with the acquisition of Alterra, we incurred transaction costs of $16.0 million for the quarter and six months ended June 30, 2013, which primarily consist of due diligence, legal and investment banking costs. Additionally, we incurred severance costs of $28.2 million, stay bonuses of $6.1 million and other compensation costs totaling $11.5 million related to the acceleration of certain long-term incentive compensation awards and restricted stock awards that were granted by Alterra prior to the acquisition. The acceleration of compensation expense during the quarter and six months ended June 30, 2013 was attributable to the acquisition, however, the incremental expense recognized during the period only represents a timing difference in the recognition of expense. Therefore, it was not excluded from the pro forma underwriting results.

(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.

Our combined ratio was 101% and 98%, respectively, for the quarter and six months ended June 30, 2014. On a pro forma basis our combined ratio was 97% and 94%, respectively, for the quarter and six months ended June 30, 2013. For the quarter and six months ended June 30, 2014, the increase in the combined ratio from the pro forma combined ratio for the same periods of 2013 was driven by less favorable development on prior years' loss reserves. This was partially offset by a lower expense ratio in 2014, due in part to higher premium volume in 2014 and higher compensation costs in 2013 attributable to the acquisition of Alterra.

U.S. Insurance Segment

The combined ratio for the U.S. Insurance segment was 100% and 98%, respectively, for the quarter and six months ended June 30, 2014 compared to 94% and 92%, respectively, for the same periods of 2013. For both the quarter and six months ended June 30, 2014, less favorable development of prior accident years' loss reserves was partially offset by a lower expense ratio.


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The U.S. Insurance segment's combined ratio for the quarter and six months ended June 30, 2014 included $37.9 million and $81.4 million, respectively, of favorable development on prior years' loss reserves compared to $79.9 million and $142.3 million of favorable development for the same periods in 2013. The redundancies on prior years' loss reserves experienced within the U.S. Insurance segment during 2014 and 2013 were most significant on our casualty product lines across several accident years. In both periods of 2014, favorable development on our casualty product lines was partially offset by adverse development on our architects and engineers product line, primarily on the 2008 through 2013 accident years and on our brokerage excess and umbrella product line, primarily on the 2012 and 2013 accident years. For the quarter and six months ended June 30, 2014, the combined adverse development on these product lines totaled $12.9 million and $23.3 million, respectively. The adverse development on both of these product lines was driven by an increase in the frequency of high severity claims. Based on this experience, our actuaries increased their estimates of ultimate losses and management increased prior years' loss reserves accordingly. The quarter and six months ended June 30, 2013 included $5.4 million and $14.8 million, respectively, of favorable development on Hurricane Sandy.

The improvement in the U.S. Insurance segment's expense ratio for the quarter and six months ended June 30, 2014 was due in part to higher earned premiums compared to 2013. The increase in earned premiums was driven by a higher contribution of earned premiums attributable to Alterra in 2014 compared to 2013 and higher earned premiums from our Hagerty classic car program. Additionally, the quarter and six months ended June 30, 2013 included $10.5 million, or three points and one point, respectively, of transaction and acquisition-related costs attributable to the acquisition of Alterra.

For the quarter ended June 30, 2014, the decrease in the U.S. Insurance segment's current accident year loss ratio was driven by lower attritional losses on several product lines within our Specialty division in 2014 compared to 2013. For the six months ended June 30, 2014, the decrease in the U.S. Insurance segment's current accident year loss ratio was driven by a favorable impact from higher earned premiums attributable to Hagerty, which carries a lower loss ratio than other product lines in the U.S. Insurance segment.

The favorable impact of these product lines on the current accident year loss ratio in both periods of 2014 was offset by an increase in the contribution of premium from the Global Insurance division compared to the same periods in 2013, primarily on our marine and professional liability product lines, which generally have higher attritional loss ratios than other products in the U.S. Insurance segment.

International Insurance Segment

The combined ratio for the International Insurance segment was 96% and 93%, respectively, for the quarter and six months ended June 30, 2014 compared to 103% and 99%, respectively, for the same periods of 2013. For the quarter ended June 30, 2014, a lower expense ratio and and a lower current accident year loss ratio were partially offset by less favorable development of prior years' loss reserves. For the six months ended June 30, 2014 a lower expense ratio was partially offset by a higher current accident year loss ratio.

The improvement in the International Insurance segment's expense ratio for the quarter and six months ended June 30, 2014 was primarily due to the impact of transaction and acquisition-related costs in 2013. The quarter and six months ended June 30, 2013 included $11.8 million, or six points and three points, respectively, of transaction and acquisition-related costs attributable to the acquisition of Alterra. The improvement in the expense ratio for both periods of 2014 was also due in part to higher earned premiums compared to 2013 and a favorable impact of higher earnings from the Global Insurance division in 2014. The Global Insurance division uses higher levels of reinsurance than the rest of the International Insurance segment, and the related ceding commissions result in a lower overall commission rate. The increase in earned premiums was driven by higher earned premiums attributable to the Alterra acquisition in 2014 compared to 2013.

The decrease in the International Insurance segment's current accident year loss ratio for the second quarter of 2014 was driven by lower attritional losses on our professional and financial risks, marine, and retail units compared to the second quarter of 2013. This favorable experience in 2014 was partially offset . . .

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