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Why is this speciality insurer so special?

June 24th, 2009

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 …..

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