2023-12-06 18:08:36 ET
Summary
- Markel's Q3 earnings report showed worse than expected insurance results, causing the stock to drop over 12%.
- The Insurance segment, historically the best performing segment, experienced a slowdown in growth due to divergent pricing trends and discontinuation of a program.
- Despite the challenges, Markel's expertise, discipline, and ability to access multiple insurance platforms position it for long-term profitability.
I initiated coverage of Markel (MKL) with my article Markel: Set To Resume Historical Growth Rate As Headwinds Subside. In this article I discussed my thesis of why I believe Markel is a great company to hold for the long term, my reasons included; higher insurance profitability, ventures revenues continuing to grow along with strong capital allocation. Markel recently reported Q3 earnings, the stock dropped more than 12% after the earnings call due to the company reporting worse than expected insurance results, this large drop is very unusual for a company like Markel with a long term investor base, Although I've only recently covered the company, after such an unusual reaction I thought I should revisit the thesis.
In this article I will discuss Markel's Q3 results and why I still believe Markel can outperform over the long run.
Insurance
The biggest negative for the quarter was the Insurance segment which reported slow growth and a combined ratio of 99% . Historically the Insurance segment has been the best performing segment of the insurance business, with premium growth of 14.5% over the last 6 years and consistent underwriting profits due to a factor of; acquiring new insurance operations, writing new business and expanding into new product lines, along with pushing for rate adequacy.
The underwriting operation of the insurance engine focuses on specialty insurance products and reinsurance. The specialty insurance market differs from the standard market in that it provides coverage for hard-to-place risks that do not fit the underwriting criteria of standard carriers. Competition in the specialty insurance market tends to focus less on price and more on other value-based considerations, such as availability, service, and expertise. The underwriting operation seeks to manage these risks and achieve higher financial returns.
Premium growth
Insurance & Re-insurance gross premium volume (Stratosphere.io)
In the third quarter, the company experienced a 1% increase in gross premium volume, primarily fueled by growth in the Insurance segment of 3%, offset partially by reduced volume in the Reinsurance segment of 30%. Earned premium saw an 8% uptick, mainly due to heightened gross premium volume in recent periods. Year-to-date results reported a 5% increase in gross premium volume, with earned premium rising by 10%. The quarter and YTD outcomes reflect a shifting strategic approach to premium growth, with a focus on adapting to nuanced rate trends and ensuring rate adequacy across diverse product lines which is slowing overall growth. Notable rate increases were observed in property coverages and select marine and energy lines, while professional liability lines experienced modest rate decreases, prompting strategic adjustments in new premium writings and lapses. Despite global rate decreases in the cyber product line, the company views it as a long-term growth opportunity and has subsequently been expanding its offerings to new geographic regions. Looking ahead, I believe the company will remain in a lower premium growth period as pricing increases are being offset with lower rates in different lines of business. Despite this lower growth I am glad to see Markel demonstrating the discipline to not chase growth, focusing instead on profitability as the company rightly incentivizes to do so.
Combined ratio
In the third quarter, the company witnessed a notable shift in its combined ratio, which increased from 93.4% last year to 99.1%. The primary drivers behind this change were a heightened attritional loss ratio within the Insurance segment and adverse development on prior accident years loss reserves in 2023, compared to favourable development in the same period of 2022 within the Reinsurance segment. The underwriting results for Q3 2023 were marked by $46.2 million in net losses attributed to the Hawaiian wildfires and Hurricane Idalia, contributing to the overall increase in the consolidated combined ratio.
Within the Insurance segment, the combined ratio grew from 95% to 98.6% in Q3 and from 90.7% to 95.2% year-to-date. The unfavorable impact was evident in the third quarter and nine-month results, with $44.3 million of net losses related to the 2023 Catastrophes. Notably, $25M in losses on intellectual property collateral protection insurance in Q3 contributed to a three-point impact on the quarter-to-date combined ratio and a one-point impact on the year-to-date combined ratio. This loss was due to a $50M fraudulent letter of credit provided by Vesttoo as collateral. Despite favorable prior accident year development in certain lines, challenges persisted, notably in the general liability and professional liability product lines, where economic and social inflation led to higher losses. The company could also be on the hook for $77.8M of future losses which have not been recognized yet in connection with another Vesttoo letter. Although this is tough to see as a shareholder, I view this as a one-time event. Management has been candid in admitting mistakes and have historically learned from them and made the appropriate actions to not repeat them, and I expect the same thing to happen here. The underlying business continues to perform well, when excluding the 3 points of loss the business would have had a very similar combined ratio to Q3 from the prior year.
In the Reinsurance segment, the combined ratio witnessed a substantial increase from 83.4% to 102.1% in Q3 and from 92.8% to 95.8% year-to-date. The third quarter results included $23.3 million of adverse development on prior accident years loss reserves, driven by increased large claims frequency in the discontinued public entity product line from 2020, this increase caused 11 points of headwind to the combined ratio, without this the combined ratio would have been 91%. The decrease in the current accident year loss ratio was partially due to favorable impacts of assumed reinstatement premiums in 2023. However, adverse development related to the COVID-19 pandemic in the discontinued retrocessional reinsurance product line offset favorable development on property product lines. I believe some adverse developments from lines that the company does not underwrite anymore have hidden another profitable quarter for the reinsurance segment, I believe that the reinsurance segment will be able to get back to profitability
Long term thesis intact
In the past, Markel's growth in the insurance segment has been characterized by a combination of organic expansion and strategic acquisitions. The company has demonstrated a commitment to underwriting discipline, focusing on niche markets and specialty lines where it can leverage its expertise. This targeted approach has allowed Markel to carve out a unique position in the industry, catering to specific industries or risks that may be underserved by larger insurers.
Markel's historical growth also reflects its ability to adapt to market trends. The company has embraced technology and digitization to improve operational efficiency and enhance customer experiences. Investments in insurtech solutions and a focus on innovation have positioned Markel as a modern and forward-thinking insurer.
Furthermore, the company's emphasis on customer retention and upselling has contributed to its growth trajectory. By nurturing long-term relationships with clients and cross-selling additional products, Markel has not only expanded its premium volume but also solidified its reputation as a trusted insurance partner.
Overall, Markel's growth in the insurance segment has been a result of a well-balanced strategy that includes a focus on specialty markets, strategic acquisitions, technological advancements, and a customer-centric approach. The company's ability to sustain this growth will depend on its continued adaptability to industry dynamics, effective risk management, and successful execution of its growth initiatives in the future. Considering Markel's historical emphasis on adaptability, effective risk management, and strategic growth initiatives, I anticipate that the company will persist in demonstrating profitable growth in the future.
Markel ventures
Markel Ventures, a subsidiary of Markel Corporation, has consistently demonstrated robust growth since its establishment in 2005. Operating across diverse industrial and service sectors, the company's strategy revolves around acquiring and holding businesses for the long term. This disciplined approach has led to significant portfolio expansion through strategic acquisitions in manufacturing, consumer services, and healthcare.
Markel Ventures' historical growth trajectory is noteworthy, with revenues growing from $1.9 billion in 2018 to $4.8 billion in 2022, reflecting a 20% CAGR. This success is attributed to the company's meticulous acquisition strategy, despite high valuations, and its commitment to profitable and sustainable businesses. CEO Tom Gayner's 2013 criteria for investment, emphasizing profitable businesses, talented and ethical management, effective capital reinvestment, and fair pricing, has guided the company's decision-making.
In the quarter and nine months ending September 30, 2023, Markel Ventures reported a 3% increase in revenue. While this growth rate is lower than historical averages, the company witnessed substantial increases in operating income of 77%, EBITDA growth of 53%, and net income of 80%. These positive trends were primarily driven by strong performances in construction services, transportation-related sectors, and enhanced production in equipment manufacturing businesses. However, certain segments faced challenges, including decreased demand in specific consumer and building products businesses, consulting services, and one construction services business.
Markel Ventures has faced challenges over the last few years in acquiring new companies due to high private valuations. However, as valuations adjust, I believe Markel will seize potential opportunities. Although no recent acquisitions have materialized, during the Q2 2023 earnings call, CEO Tom Gayner highlighted an increase in inbound calls to Markel, signalling potential new additions to the portfolio in the latter part of 2023 and throughout 2024. Its proven acquisition strategy, and its unwavering commitment to a long-term perspective make the company well-positioned for continued success. Despite the current hurdles in the acquisition landscape, I maintain confidence that Markel Ventures will make strategic acquisitions in the future, ultimately benefiting shareholders as the company's discipline is rewarded .
Investor takeaway
In conclusion, while Markel Corporation is navigating challenges such as slower growth in its insurance segment, underwriting issues related to the Vesttoo bankruptcy, and a gradual pace of growth for Markel Ventures, there are key indicators that instill confidence in the company's ability to rebound and thrive. The company's acknowledgment of recent insurance missteps presents an opportunity for learning and improvement. Despite potential near-term losses and an anticipated higher combined ratio, Markel has a track record of adapting to industry dynamics.
Furthermore, Markel's commitment to wise capital allocation is evident through Tom Gayner's consistent insider purchases, demonstrating leadership's confidence in the company's future prospects. Gayner's recent stock acquisitions over six of the last seven quarters and the ongoing reduction of shares outstanding by approximately 2% annually reflect a strategic and shareholder-focused approach.
In light of these factors, including the company's disciplined culture, long-term focus, and commitment to continuous improvement, I remain optimistic about Markel Corporation's trajectory. While challenges may persist, the proactive measures taken, coupled with the potential for strong acquisitions in Markel Ventures and prudent capital allocation, position the company for success over the long term.
For further details see:
Markel: A Hiccup In The Insurance Engine, I'm Still Holding