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
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
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:
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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.
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