MKL: Markel (1)
Industry
Property and casualty (P&C) insurers in the US fall primarily into two categories: Admitted and Excess & Surplus (E&S). For admitted companies, the state’s regulators monitor the finances of the insurers, forms are highly regulated, products and coverages are largely uniform with relatively predictable exposures and companies tend to compete based on price. Examples of admitted companies are Geico (auto insurance) and Allstate (homeowner insurance).
However, there are some cases where admitted insurers cannot underwrite a risk because it may be too unusual, too big, or for other reasons. In these cases, those seeking to insure such risks can obtain a policy from an E&S insurer, they are free to draft their own insurance contracts and also E&S insurers have pricing freedom. This allows specialty insurers to accept hard-to-place risks that generally do not fit the underwriting criteria of admitted, or standard, insurers. Due to the greater flexibility and less competition, specialty insurance markets tend to focus less on price and more on value-based considerations such as availability, service, and expertise.
MKL writes on both an admitted and E&S basis but focuses on specialty markets (in both admitted and E&S) where it believes it can add value with specialty product offerings in niche markets. In 2022, Markel was the 2nd largest E&S writer in the US (1st: Alleghany, bought over by Berkshire) as measured by direct premiums, which is up from 6th place in 2013.
MKL also participates in the reinsurance market. Reinsurance is when an insurer contracts with another insurer or group of insurers to take on a specific amount of risk which it has underwritten. Typically, Markel’s reinsurance contracts provide for automatic reinsuring of a type or category of risk underwritten by the ceding insurers. Generally participation is in the form of a treaty with a number of other reinsurers, each with an allocated portion of the treaty with terms and conditions being substantially the same for each participating reinsurer. In 2022, Markel was the 40th largest reinsurer in the world as measured by gross premiums.
Most of Markel’s business is placed through insurance and reinsurance brokers. During 2021, 28% of MKL's gross premiums were accounted for by its top three independent brokers.
Product Segment
Within the Insurance Segment, MKL offers a list of products such as:
General and Professional liability
Property
Personal
Marine & Energy
Workers’ compensation
Specific types of coverage the segment offers, which demonstrate MKL niche focus include:
Environmental products including environmental consultants’ professional liability, contractors’ pollution liability and site-specific environmental impairment liability
Professional liability for a multitude of professions
Medical facilities such as home health agencies and senior living facilities
Data breach and privacy liability and electronic media coverage
Fine art on exhibition and in private collections, precious metals, jewelry, and cash in transit
Railroad related products including commuter and scenic and tourist railroads
Youth and recreation-oriented organizations and camps and child care operations
Museums and historic homes
Wineries
Small fishing ventures, charters, boat rentals, ocean cargo, boat dealers, yachts, and marina owners
Animal boarding and breeding and training facilities
Equine-related risks such as horse mortality, theft, infertility, and transit
Mortality coverage for farms, zoos, animal theme parks and safari parks
Accident and health coverage for sports groups
Property damage and business interruption related to political violence including terrorism and civil wars
Indemnity, directors’ and officers’ liability, errors and omissions, etc. targeting US and international public companies as well as large professional firms
Underwriting Profitability
Historically MKL has been a strong underwriter of risk. Over past 5 and 10 years period, combined ratios averaged 94% and 95% respectively. The industry averaged 98% and 97% over same periods. This underwriting discipline comes from MKL incentives structure which rewards based on profitability rather than volume. MKL consistently states that it will not write business if it doesn’t believe it can achieve its underwriting profit targets.
From 2006 annual report:
Whether it is our underwriting or investing operations, we believe that our discipline over long periods of time is what distinguishes us from our competitors.
At Markel, underwriting discipline represents both a philosophy and a process. Our philosophy is to work to achieve consistent underwriting profits in all products in all insurance market conditions. The process by which we achieve underwriting profits can be slightly different by underwriting unit but generally includes finding the answers to four questions:
Can we assess the risk we are taking?
Can we design the appropriate coverage for our client?
Can we price the risk to earn an underwriting profit?
Can we assess trends that may increase our risk in the future?
Investments
In addition to underwriting, MKL investing track record also stands out. First, it invests a larger percentage of its equity into stocks as compared to other P&C insurers, and second, it has produced outstanding results. It has historically invested around 100% of its float in fixed income and equities. The value of MKL stock portfolio ($7.5b) comprises 57% of book value as of Q4 2022.
MKL doesn’t equate volatility with risk. It views its equity as permanent capital and seeks to maximize its value in the long run by investing in the common stocks of quality businesses (and private businesses) run by talented managers.
From 2012 annual report:
Over the years, we’ve never made decisions based on our forecasts of what was ahead for the economy, governmental policies, tax rates, currency values, interest rates, technological changes or other incredibly important but fundamentally unknowable future developments. Instead, we’ve simply looked at individual companies, one at a time, and asked ourselves a few questions. By considering four basic types of questions about individual companies and securities we try to develop enough confidence to make a decision.
Our first question is, “Is this a profitable business with good returns on capital without using too much debt?”
Second, we ask ourselves, “Is the management team equally and sufficiently talented and honest?”
Third, we ask, “What are the reinvestment dynamics of the business and how do they manage capital?” and finally we ask, “What is the valuation and what do we have to pay to acquire ownership in the business?”
While these are four simple questions, the process of thinking deeply about them tends to produce robust results over time as demonstrated by our long-term record. Those questions also tend to encompass consideration of some of the macroeconomic factors that tend to cause so much worry and anxiety for so many investors.
Ventures Segment
In addition to its insurance and investing operations, MKL also has a third component of its business established in the early 2000s called Markel Ventures, which owns controlling or 100% stakes in private businesses. It is no secret that Tom Gayner has stated in the past that MKL is pretty much running the same playbook as Berkshire with its focus on buying private companies. MKL has put significant capital to work into Ventures in the past few years to the point where Ventures is now a substantial component of the company.
MKL has invested a total of about $3.2b into Ventures acquisitions and Insurance Linked Securities (ILS) deals (eg. Nephila, CatCo, and State National), notably, with no stock issuance.
Although the Ventures companies are boring, operating in industries such as leather goods, house plants, baking equipment, dredges, homebuilders, manufactured housing communities, auto transport equipment, etc., MKL has generated value through acquiring and operating these businesses. Ventures segment’s free cash flow compounded at 12% since 2013 from $76m to $187m (2021).
Gayner said the following about Markel’s non-insurance businesses at the 2019 Markel Omaha Brunch:
We do have hundreds of millions of dollars coming in of cash flow that is not connected to our insurance business. One of the fun things about being at Markel is the non-insurance things that we are doing create opportunity and credibility for the insurance business by day to day execution of that, which creates investable cash flow which we use to our mutual benefit and it is a multiplicative thing. And again, there are very few organizations that have the architecture and structure in place where instead of isolating the streams and having them operate in completely, one-off, siloed ways, by joining these streams you are not adding one and one and getting two, you are multiplying 1.2 times 1.2. And any multiplicative process which is more than one point zero creates a geometric value explosion, not just a linear mathematical one.
Insurance Linked Securities (ILS)
ILS are financial instruments which are sold to investors and whose value is affected by an insured loss event. The ILS asset class consists of catastrophe bonds, collateralized reinsurance instruments and other forms of risk-linked securitization.
They are investment assets generally thought to have little to no correlation with the wider financial markets as their value is linked to insurance-related, non-financial risks such as natural disasters, other insurable specialty risks and life and health insurance risks including mortality or longevity.
Like securities, some ILS (mainly catastrophe bonds) can be and are traded among investors and on the secondary market.
They allow insurance and reinsurance companies to transfer risk to the capital markets and raise capital.
MKL receives management fees for investment and insurance management services provided through these operations based on the net asset value of the accounts managed, and for certain funds, incentive fees based on the annual performance of the funds managed. MKL also provides general agent services and receive commissions based on the direct written premiums of the insurance contracts placed.
Related to a mistake in ILS space, MKL is in the process of winding down CatCo operations (acquired in 2015). Although there are offsetting benefits from Nephila portfolio, the ILS portfolio as a whole generally operates at a small underwriting loss.
Valuation
We like to put the valuation section at the bottom of a rather lengthy write up of the business, because we believe that understanding what you are buying and whether it is within your circle of competence is much more important than doing a math model.
Now we like to value MKL by parts because the 3 drivers of the business: Insurance, Investments, Ventures have their own distinct way of analysis.
In the recent 10K (Q4 2022), we can derive the total investments (with cash, excluding equities) to be about $20b. The unpaid losses and loss adjustment expenses on the balance sheet is $21b. We will work with the assumption that these investments which comprises of fixed income and cash can offset the liabilities on claims.
This means that we can subtract out the equities portfolio value from market cap, which leaves us with $10.5b of value for the Insurance and Ventures segments.
Then we can check the current year operating income of both segments.
(a) Insurance $1.1b
(b) Ventures $0.3b
So we’re paying $10.5b for these segments which generate $1.4b of operating income, that is a 7.5x multiple.
In conclusion, we feel that current price of $1,330 is still a reasonable price to pay.