It was another blowout quarter for Markel (NYSE: MKL), with investment income up 16%, the combined ratio down roughly 7.5 points, and net income up 29%.
The improvement in the combined ratio was due to $40 million favorable development on prior year claims -- mostly in the professional and products liability lines. On an accident year basis (excluding prior year developments), the combined ratio for the first quarter was flat at 94%, compared to the prior year period.
Pressure on pricing
Although property and casualty reinsurers such as Montpelier Re (NYSE: MRH) and RenaissanceRe (NYSE: RNR) have reported rational pricing, Markel's management noted in the earnings call that pricing, as well as contract terms and conditions, in its primary specialty lines has veered toward irrational in the latest quarter.
Management also noted that the latest Council of Insurance Agents and Brokers survey showed an 11.3% decline in average premiums in the first quarter. Part of the problem is that competitors in standard lines (including four or five based in Bermuda) have salivated at Markel's returns and decided to enter the specialty markets. Because new entrants need to build critical mass, they are pricing lower and contributing to the soft market. In the long term, this is likely to unwind, but for now it has pushed Markel to walk away from some business, resulting in 4% reduction in gross and net written premiums for the quarter.
Management also noted it had had discussions with William Berkley of WR Berkley (NYSE: BER) regarding proposed changes in the taxation of Bermuda insurers, but didn't elaborate further.
And now, a word from Mr. Gayner
On a more positive note, by listening to Markel's earnings calls, you get free commentary from investing legend Tom Gayner. Although the investment portfolio's returns were "uneventful" for the quarter, Gayner reiterated his belief that quality is cheap in the current market, noting that the best companies with the best balance sheets are at the cheapest relative valuations in decades. Gayner notes that he looks for double-digit EPS growers, with 15% returns on equity, or drug companies with strong dividends and worldwide platforms.
In terms of powerful trends, Gayner believes that the emergence into the top tier of developing countries such as Brazil, Russia, India, and China is inevitable, and that companies poised to capitalize on this continuing development will be the prime beneficiaries.
Gayner also noted that the key to Markel's investment success is risk management -- he attributes 30% of its success to picking the right securities, and 70% to avoiding catastrophes.
As an example of a cheap, quality stock, Gayner noted that Markel has been buying shares of General Electric (NYSE: GE). This ties in to the trend of the improving fortunes of emerging countries as well as his belief that many citizens of emerging countries, thanks to their improving fortunes, will be buying or experiencing their first refrigerators, toasters, plane rides, or purified water -- and that GE has a strong grip on many of these international markets. Some other high-quality companies with international exposure in Markel's portfolio as of the December 13F filing, are life insurer Aflac (NYSE: AFL), American Express (NYSE: AXP), Budweiser (NYSE: BUD) and Berkshire Hathaway (NYSE: BRK-B).
Montpelier Re is a Hidden Gems recommendation. Anheuser-Busch and Berkshire Hathaway are Motley Fool Inside Value recommendations. Aflac and Montpelier Re are Stock Advisor recommendations. Try any of our investing services free for 30 days.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He owns shares in Montpelier Re. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.
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