Asmus Puhl Finance Blog

In the last 8 years Markel’s (NYSE:MKL) combined ratio has varied considerably:

(Source: Markel Annual Report 2008)

The 2000 combined ratio was affected by the acquisition of Terra Nova and Gryphon which today form Markel International. Markel had to turn these companies around from insurance underwritten at unprofitable rates.

2001 was hit by a loss on the World Trade Center and another writedown at Markel International.

Despite the losses on hurricanes Katrina and Rita the combined ratio of FY 2005 was not worse than 101%.

In 2008 Markel achieved a combined ratio of 99% despite $ 95 mil of hurricane losses and competitive market conditions

Over the past 20 years Markel produced underwriting profits in 14 out of 20 years.

But the most appealing aspect of Markel is its ability to produce consistently superior investment income!

Like Buffett’s Berkshire Hathaway and unlike most insurers, Markel makes significant equity investments.

Roughly said Markel’s equity investments equal its stockholder’s equity. Its fixed income portfolio equals the float from policy holders.

The above mentioned Thomas Gayner is chief investment officer of Markel.

……. continues ……

Markel (NYSE: MKL) covers risk which larger more standardized companies are unwilling to cover.

As a speciality insurer its key competitive advantage is the expertise and experience of its specialist underwriters and its relationships with brokers and with the covered groups of clients. In many of its product lines it has an incredible retention rate of 90% or higher.

In its speciality markets Markel faces less competitors and less price competition than others in the standard insurance market.

Nevertheless Markel is so disciplined that it will not cover risk if the premium it can get is not adequate to compensate for it.

But the most interesting aspect of an insurance company is its ability to use “float” in order to generate investment income.

Oh .…. what is float?

Premiums are paid upfront to an insurer. This money is essentially free money that the insurer can invest until it has to be paid out for incurred losses of its policy holders.

Isn’t it incredible?

In virtually no other business than insurance clients give free money to a company so that it can earn a return of investment on it in order to keep it.

And this money is free if the insurer is able to maintain a combined ratio of 100 or less:

Oh ….. so what is that, a combined ratio?

Combined ratio is the combination of the “expense ratio”

(the percentage of underwriting expenses to net earned premiums)

and the “loss ratio”

(the percentage of insurance losses to net earned premiums).

If this combined ratio is 100 the insurer does not earn or lose money with its insurance activities. If the combined ratio is less than 100 the insurer already earns money before any investment return. The cost of capital received by its policy holders is negative.

For more on the importance of float read the letters to the shareholders of Berkshire Chairman Warren Buffett. A lot of the investment success of Berkshire Hathaway bases on the superior investment returns of the float of its insurance subsidiaries.

….. continues …..

When we recently discussed Colfax Corp. (NYSE: CFX) on this blog we pointed out that Tom Gayner, chief investment officer of Markel Corporation (NYSE: MKL), is one of its board members.

So why not take the opportunity and have a look at Markel itself?

Markel was founded by Sam Markel in the 1920’s as an insurance broker catering to the transportation industry. He organized the first mutual insurance company for operators of “jitney buses“ in the US.

You can read more about the interesting history of Markel here:

http://www.markelcorp.com/AboutMarkel/History/Pages/History2.aspx

The company remained mainly an insurance broker until going public in 1986.

By then Markel was convinced it had so much underwriting expertise in insuring unusual risks that the strategic focus of the company began to shift from insurance brokerage and services to underwriting.

Markel expanded rapidly as a speciality insurer in a variety of niche markets and with its Terra Nova acquisition in 2000 it entered the international market.

Two grandsons of Sam Markel still serve as vice chairmans of the board.

Markel’s underwriting business is subdivided in 3 categories:

DIVISIONS	GROSS PREMIUMS in FY 2008	EARNED PREMIUMS in FY 2008
US Excess & Surplus	1,164 $ mil	1,029 $ mil
Speciality Admitted	355 $ mil	321 $ mil
International Markets	693 $ mil	618 $ mil

(source: MKL – 10K 2008)

As we can see more than half of Markel’s business falls into the  “US Excess & Surplus“ category.  It provides additional coverage in excess of standard insurance contracts which the larger insurance companies are not willing to provide.

This requires exactly the specialized underwriting knowledge and experience in niche markets which Markel built up for years.

“Speciality admitted“:  In this category Markel operates as a licensed insurer for hard-to-place insurance as mobile homes, health and fitness facilities, horse farms etc.

“Markel International” operates in the London market and covers hard-to-place insurance on an international level.

… continues …

Colfax is intensifying its presence in the middle east oil production market:

http://ir.colfaxcorp.com/releasedetail.cfm?ReleaseID=389586

… this is just another little step in positioning itself in a growth region. It is done by its already strong Allweiler division.

I am curious in what sector they will do the next acquisition!

So far in 2008 and at the beginning of 2009 we have witnessed one of the most severe bear markets of all times as we were near the collapse of the financial system and we saw the beginning of a severe worldwide recession.

Since March 2009 the stock market recovered from its all time lows.

So, is the worst over? Is this the beginning of a substantial market recovery or is it a bear market rally and will we see another severe market correction?

The problem is:

predict the short time gyrations of the stock market is next to impossible.

A lot of experts and economists recently predicted another correction, but the market moves up slowly or holds steady.

An intelligent forecaster once said to Peter Lynch: „If you must forecast, forecast often!“

(cited from „One up on Wall Street“)

Certainly, a partial market sell off caused by window dressing activities of investment funds before the HY 2009 deadline of June 30th is possible.

But otherwise there is still a lot of institutional money waiting on the sidelines to be reinvested in the stock market.

So please follow the best possible advice:  Do not ask!

• Invest in companies not in the stock market.

• Invest for the long term.

• Do your due diligence and buy quality companies at reasonable prices.

But anyway, if you are interested in market timing why don’t you start looking at companies with cyclical businesses?

Even the most severe recession will end some day and the stock market is a leading economic indicator:

it generally starts rising about 6 months before the end of a recession!

Be prepared!