After a nightmarish 2005 for property-and-casualty insurers and reinsurers, 2006 was like crawling across a desert and ending up in the crystal-clear waters of Lake Minnetonka. The weather for the year was extremely benign, a huge relief from the record-breaking losses that Hurricane Katrina and her sisters caused.
Furthermore, because 2005 was such a horrible year -- with some reinsurers, including Montpelier Re (NYSE:MRH), PXRE Group (NYSE:PXT), and Quanta Capital (NASDAQ:QNTA), taking some breathtaking losses -- property-and-casualty insurers who hadn't suffered too big a hit and still had capacity were able to jack up rates. That helped profitability, and to put some icing on the cake, U.S. stock indexes all rose by double digits. As a result, Markel (NYSE:MKL), with its significant equity exposure, posted a banner year.
For the year, Markel grew gross premiums by 6%, but by upping its retention rate 500 basis points to 87% (versus ceding to reinsurers), it increased net premiums by 11%. The combined ratio dropped a whopping 1,400 basis points (lower is better) to 87% from 101%, thanks to the relatively harmless catastrophe season.
This year, 3% of the combined ratio was due to last year's hurricanes, versus 12% last year, meaning that a net 9% decrease in the combined ratio was attributable to the lack of hurricanes. Markel's 2006 expense ratio increased 1% to 35%, partly because of higher bonus accruals thanks to the great financial results.
In all, net income for the year increased 265% to $392 million. Total comprehensive income, which includes the unrealized gains on Markel's equity portfolio, increased more than 800% to $525 million. This helped increase Markel's book value per share for the year by 32%.
This year's great results may make next year tougher on a comparable basis. In the fourth quarter, Markel's gross premiums written dropped 5% as competition heated up. Although Markel's specialty lines insulate it somewhat, it's almost inevitable that industry profitability will lead to fiercer price competition.
Lately, hedge funds and private-equity firms have thrown some capital into newly formed Bermuda reinsurers to take advantage of the favorable insurance pricing. However, management noted that it hasn't seen property-and-casualty rates pressured by this phenomenon yet. Management also said that catastrophe-prone areas, such as the Florida coast, have had their pricing hold up; however, other sectors were having some pricing pressure, such as non-catastrophe-prone geographies and casualty lines.
The year was also strong in terms of the investment portfolio, with a 25.9% return on the equity portfolio, 10.3% better than the S&P 500. Some strong performers in the portfolio included CarMax (NYSE:KMX), Fairfax Financial (NYSE:FFH), and a company to which Markel is often compared, Berkshire Hathaway (NYSE:BRK-A). Markel's equity portfolio, led by legendary Chief Investment Officer Tom Gayner, has beaten the S&P 500 by a remarkable 610 basis points over the past 10 years. In the earnings call, Gayner mentioned that like many other value investors, he sees opportunities in undervalued blue chips.
Although 2006 was a great year for Markel, and indicators show momentum carrying over into 2007, I wouldn't call this the most opportune time to invest in property-and-casualty insurers. A key value-investing principle is to invest at the sound of cannons and sell at the sound of trumpets. The property-and-casualty industry, according to the Insurance Information Institute, is set to report its best combined ratio since 1955 -- and that sounds a little more like trumpets than cannons to me. However, Markel is an insurance all-star, and some time in the coming decade or two, I'd like to buy shares in Markel at a discounted price.
For some related insurance industry commentary check out:
CarMax and Berkshire Hathaway are both Motley Fool Inside Value recommendations. Check out the Foolish newsletter service dedicated to finding the market's best values -- it's free for the first 30 days.
Fool contributor Emil Lee is an analyst and a disciple of value investing. He owns shares in Montpelier Re, a Motley Fool Hidden Gems recommendation. The Motley Fool has a disclosure policy. Emil appreciates your comments, concerns, and complaints.
