UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the fiscal year ended December 31, 2014
Commission File Number 001-15811
MARKEL CORPORATION
(Exact name of registrant as specified in its charter)
A Virginia Corporation
IRS Employer Identification No. 54-1959284
4521 Highwoods Parkway, Glen Allen, Virginia 23060-6148
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (804) 747-0136
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, no par value
New York Stock Exchange, Inc.
(title of each class and name of the exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the shares of the registrant's Common Stock held by non-affiliates as of June 30, 2014 was approximately $8,808,000,000.
The number of shares of the registrant's Common Stock outstanding at February 9, 2015: 13,962,386.
Documents Incorporated By Reference
The portions of the registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 11, 2015, referred to in Part III.
Index and Cross References-Form 10-K Annual Report
Item No. | Page | ||||
Part I | |||||
1. | Business | 2-26, 127-128 | |||
1A. | Risk Factors | 22-26 | |||
1B. | Unresolved Staff Comments | NONE | |||
2. | Properties (note 6 and note 16) | 50-51, 68 | |||
3. | Legal Proceedings (note 16) | 68 | |||
4. | Mine Safety Disclosures | NONE | |||
Part II | |||||
5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 83, 127 | |||
6. | Selected Financial Data | 27-28 | |||
7. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 87-126 | |||
7A. | Quantitative and Qualitative Disclosures About Market Risk | 120-123 | |||
8. | Financial Statements and Supplementary Data The response to this item is submitted in Item 15 and on page 83. | ||||
9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | NONE | |||
9A. | Controls and Procedures | 85-86, 124 | |||
9B. | Other Information | NONE | |||
Part III | |||||
10. | Directors, Executive Officers and Corporate Governance* | 129 | |||
Code of Conduct | 128 | ||||
11. | Executive Compensation* | ||||
12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters* | ||||
13. | Certain Relationships and Related Transactions, and Director Independence* | ||||
14. | Principal Accounting Fees and Services* | ||||
*Portions of Item 10 and Items 11, 12, 13 and 14 will be incorporated by reference from the Registrant's Proxy Statement for its 2015 Annual Meeting of Shareholders pursuant to instructions G(1) and G(3) of the General Instructions to Form 10-K. | |||||
Part IV | |||||
15. | Exhibits, Financial Statement Schedules | ||||
a. | Documents filed as part of this Form 10-K | ||||
(1) | Financial Statements | ||||
Consolidated Balance Sheets | 29 | ||||
Consolidated Statements of Income and Comprehensive Income | 30 | ||||
Consolidated Statements of Changes in Equity | 31 | ||||
Consolidated Statements of Cash Flows | 32 | ||||
Notes to Consolidated Financial Statements | 33-83 | ||||
Reports of Independent Registered Public Accounting Firm | 84-85 | ||||
(2) | Schedules have been omitted since they either are not required or are not applicable, or the information called for is shown in the Consolidated Financial Statements and Notes thereto. | ||||
(3) | See Index to Exhibits on page 130 for a list of Exhibits filed as part of this report | ||||
b. | See Index to Exhibits and Item 15a(3) | ||||
c. | See Index to Financial Statements and Item 15a(2) | ||||
BUSINESS OVERVIEW
We are a diverse financial holding company serving a variety of niche markets. Our principal business markets and underwrites specialty insurance products. We believe that our specialty product focus and niche market strategy enable us to develop expertise and specialized market knowledge. We seek to differentiate ourselves from competitors by our expertise, service, continuity and other value-based considerations. We also own interests in various industrial and service businesses that operate outside of the specialty insurance marketplace. Our financial goals are to earn consistent underwriting and operating profits and superior investment returns to build shareholder value.
On May 1, 2013, we completed the acquisition of Alterra Capital Holdings Limited (Alterra), a Bermuda-headquartered global enterprise providing diversified specialty property and casualty insurance and reinsurance products to corporations, public entities and other property and casualty insurers.
Specialty Insurance and Reinsurance
The specialty insurance market differs significantly from the standard market. In the standard market, insurance rates and forms are highly regulated, products and coverages are largely uniform with relatively predictable exposures and companies tend to compete for customers on the basis of price. In contrast, the specialty market provides coverage for hard-to-place risks that generally do not fit the underwriting criteria of standard carriers.
Competition in the specialty insurance market tends to focus less on price than in the standard insurance market and more on other value-based considerations, such as availability, service and expertise. While specialty market exposures may have higher perceived insurance risks than their standard market counterparts, we seek to manage these risks to achieve higher financial returns. To reach our financial and operational goals, we must have extensive knowledge and expertise in our chosen markets. Many of our accounts are considered on an individual basis where customized forms and tailored solutions are employed.
By focusing on the distinctive risk characteristics of our insureds, we have been able to identify a variety of niche markets where we can add value with our specialty product offerings. Examples of niche insurance markets that we have targeted include wind and earthquake-exposed commercial properties, liability coverage for highly specialized professionals, equine-related risks, workers' compensation insurance for small businesses, classic cars and marine, energy and environmental-related activities. Our market strategy in each of these areas of specialization is tailored to the unique nature of the loss exposure, coverage and services required by insureds. In each of our niche markets, we assign teams of experienced underwriters and claims specialists who provide a full range of insurance services.
We also participate in the reinsurance market in certain classes of reinsurance product offerings, which were expanded in 2013 through the acquisition of Alterra. In the reinsurance market, our clients are other insurance companies, or cedents. We typically write our reinsurance products in the form of treaty reinsurance contracts, which are contractual arrangements that provide for automatic reinsuring of a type or category of risk underwritten by cedents. Generally, we participate on reinsurance treaties with a number of other reinsurers, each with an allocated portion of the treaty, with the terms and conditions of the treaty being substantially the same for each participating reinsurer. With treaty reinsurance contracts, we do not separately evaluate each of the individual risks assumed under the contracts and are largely dependent on the individual underwriting decisions made by the cedent. Accordingly, we review and analyze the cedent's risk management and underwriting practices in deciding whether to provide treaty reinsurance and in pricing of treaty reinsurance contracts.
Our reinsurance products are written on both a quota share and excess of loss basis. Quota share contracts require us to share the losses and expenses in an agreed proportion with the cedent. Excess of loss contracts require us to indemnify the cedent against all or a specified portion of losses and expenses in excess of a specified dollar or percentage amount. In both types of contracts, we may provide a ceding commission to the cedent.
We distinguish ourselves in the reinsurance market by the expertise of our underwriting teams, our access to global reinsurance markets, our ability to offer large lines and our ability to customize reinsurance solutions to fit our client's needs. Our specialty reinsurance product offerings include coverage for general casualty, professional liability, property, automobile and credit and surety risks.
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Markets
In the United States, we write business in the excess and surplus lines (E&S) and specialty admitted insurance and reinsurance markets. In 2013, the E&S market represented approximately $38 billion, or 7%, of the approximately $546 billion United States property and casualty industry.(1) In 2013, we were the sixth largest E&S writer in the United States as measured by direct premium writings.(1)
Our E&S insurance operations are conducted through Essex Insurance Company (Essex) and Alterra Excess & Surplus Insurance Company (AESIC), both domiciled in Delaware, and Evanston Insurance Company (Evanston), domiciled in Illinois. The majority of our specialty admitted insurance operations are conducted through Markel Insurance Company (MIC), domiciled in Illinois; Markel American Insurance Company (MAIC), domiciled in Virginia; FirstComp Insurance Company (FCIC), domiciled in Nebraska; Essentia Insurance Company (Essentia), domiciled in Missouri; and Alterra America Insurance Company (AAIC), domiciled in Delaware. Our United States reinsurance operations are conducted through Alterra Reinsurance USA Inc. (Alterra Re USA), a Delaware-domiciled reinsurance company.
In Europe, we participate in the London insurance market through Markel Capital Limited (Markel Capital) and Markel International Insurance Company Limited (MIICL). Markel Capital is the corporate capital provider for Markel Syndicate 3000, through which our Lloyd's of London (Lloyd's) operations are conducted. Markel Syndicate 3000 is managed by Markel Syndicate Management Limited (MSM). In 2013, our Lloyd's operations also included Lloyd's Syndicate 1400, which is also managed by MSM. Business previously written by Alterra on Lloyd's Syndicate 1400 is now being written on Markel Syndicate 3000 and MSM continues to manage the run-off of Lloyd's Syndicate 1400. Markel Capital and MIICL are headquartered in London, England and have offices across the United Kingdom, Europe, Canada, Latin America, Asia Pacific and the Middle East through which we are able to offer insurance and reinsurance. The London insurance market, which produced approximately $68 billion of gross written premium in 2013,(2) is the largest insurance market in Europe and third largest in the world.(3) In 2013, gross premium written through Lloyd's syndicates generated roughly 60% of the London market's international insurance business,(2) making Lloyd's the world's largest commercial surplus lines insurer(1) and fourth largest reinsurer.(4) Corporate capital providers often provide a majority of a syndicate's capacity and also generally own or control the syndicate's managing agent. This structure permits the capital provider to exert greater influence on, and demand greater accountability for, underwriting results. In 2013, corporate capital providers accounted for approximately 88% of total underwriting capacity in Lloyd's.(5) Through 2014, our other European insurance and reinsurance operations primarily have been conducted through Markel Europe plc (Markel Europe), which is headquartered in Dublin, Ireland. Beginning January 1, 2015, business previously underwritten by Markel Europe generally will be underwritten by MIICL.
In Latin America, we provide reinsurance through MIICL, using our representative office in Bogota, Colombia, and our service company in Buenos Aires, Argentina; through Markel Resseguradora do Brasil S.A. (Markel Brazil), our reinsurance company in Rio de Janeiro, Brazil; and through Markel Syndicate 3000, using Lloyd's admitted status in Rio de Janeiro. Additionally, MIICL and Markel Syndicate 3000 are able to offer reinsurance in a number of Latin American countries through offices outside of Latin America.
In Bermuda, we write business in the worldwide insurance and reinsurance markets. Bermuda's share of the global reinsurance market was approximately 8% in 2013.(6) We conduct our Bermuda operations through Markel Bermuda Limited (Markel Bermuda), which is registered as a Class 4 insurer and Class C long-term insurer under the insurance laws of Bermuda.
Our reinsurance operations, which include our operations based in the United States, the United Kingdom, Latin America and Bermuda, as described above, made us the 34th largest reinsurer in 2013, as measured by worldwide gross reinsurance premium writings.(4)
(1) U.S. Surplus Lines Segment Review Special Report, A.M. Best (September 15, 2014). |
(2) London Company Market Statistics Report, International Underwriting Association (October 2014). |
(3) UK Insurance Key Facts, Association of British Insurers (2014). |
(4) Global Reinsurance Segment Review Special Report, A.M. Best (September 8, 2014). |
(5) Lloyd's Annual Report 2013. |
(6) Bermuda Insurance Market Report 2014, Deloitte Limited (2014). |
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In 2014, 27% of consolidated gross premium writings related to foreign risks (i.e., coverage for risks located outside of the United States), of which 34% were from the United Kingdom and 10% were from Canada. In 2013, 25% of our premium writings related to foreign risks, of which 25% were from the United Kingdom and 13% were from Canada. In 2012, 30% of our premium writings related to foreign risks, of which 20% were from the United Kingdom and 16% were from Canada. In each of these years, there was no other individual foreign country from which premium writings were material. Premium writings are attributed to individual countries based upon location of risk.
Most of our business is placed through insurance and reinsurance brokers. Some of our insurance business is also placed through managing general agents. We seek to develop and capitalize on relationships with insurance and reinsurance brokers, insurance and reinsurance companies, large global corporations and financial intermediaries to develop and underwrite business. A significant volume of premium for the property and casualty insurance and reinsurance industry is produced through a small number of large insurance and reinsurance brokers. During the years ended December 31, 2014 and 2013, the top three independent brokers accounted for approximately 28% and 24%, respectively, of our gross premiums written.
Competition
We compete with numerous domestic and international insurance companies and reinsurers, Lloyd's syndicates, risk retention groups, insurance buying groups, risk securitization programs and alternative self-insurance mechanisms. Competition may take the form of lower prices, broader coverages, greater product flexibility, higher quality services or higher ratings by independent rating agencies. In all of our markets, we compete by developing specialty products to satisfy well-defined market needs and by maintaining relationships with agents, brokers and insureds who rely on our expertise. This expertise is our principal means of competing. We offer a diverse portfolio of products, each with its own distinct competitive environment, which enables us to be responsive to changes in market conditions for individual product lines. With each of our products, we seek to compete with innovative ideas, appropriate pricing, expense control and quality service to policyholders, agents and brokers.
Few barriers exist to prevent insurers and reinsurers from entering our markets of the property and casualty industry. Market conditions and capital capacity influence the degree of competition at any point in time. Periods of intense competition, which typically include broader coverage terms, lower prices and excess underwriting capacity, are referred to as a "soft market." A favorable insurance market is commonly referred to as a "hard market" and is characterized by stricter coverage terms, higher prices and lower underwriting capacity. During soft markets, unfavorable conditions exist due in part to what many perceive as excessive amounts of capital in the industry. In an attempt to use their capital, many insurance companies seek to write additional premiums without appropriate regard for ultimate profitability, and standard insurance companies are more willing to write specialty coverages. The opposite is typically true during hard markets. Historically, the performance of the property and casualty reinsurance and insurance industries has tended to fluctuate in cyclical periods of price competition and excess underwriting capacity, followed by periods of high premium rates and shortages of underwriting capacity. This cyclical market pattern can be more pronounced in the specialty insurance and reinsurance markets in which we compete than the standard insurance market.
We have experienced soft insurance market conditions, including price deterioration in virtually all of our product lines, since the mid-2000s. Beginning in 2012, prices stabilized and we have generally seen low to mid-single digit favorable rate changes in many of our product lines as market conditions improved and revenues, gross receipts and payrolls of our insureds were favorably impacted by improving economic conditions; however, during the latter part of 2013 and continuing into 2014, we have experienced softening prices on our international catastrophe-exposed property product lines and in our property reinsurance book. Despite stabilization of prices on certain product lines during the most recent three years, we still consider the overall property and casualty insurance market to be soft. We routinely review the pricing of our major product lines and will continue to pursue price increases for most product lines in 2015, when possible. However, when we believe the prevailing market price will not support our underwriting profit targets, the business is not written. As a result of our underwriting discipline, gross premium volume may vary when we alter our product offerings to maintain or improve underwriting profitability.
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Underwriting Philosophy
By focusing on market niches where we have underwriting expertise, we seek to earn consistent underwriting profits, which are a key component of our strategy. We believe that the ability to achieve consistent underwriting profits demonstrates knowledge and expertise, commitment to superior customer service and the ability to manage insurance risk. We use underwriting profit or loss as a basis for evaluating our underwriting performance. To facilitate this strategy, we have a product line leadership group that has primary responsibility for both developing and maintaining underwriting and pricing guidelines on our existing products and new product development. The product line leadership group is under the direction of our Chief Underwriting Officer.
The combined ratio is a measure of underwriting performance and represents the relationship of incurred losses, loss adjustment expenses and underwriting, acquisition and insurance expenses to earned premiums. A combined ratio less than 100% indicates an underwriting profit, while a combined ratio greater than 100% reflects an underwriting loss. In 2014, our combined ratio was 95%. See Management's Discussion & Analysis of Financial Condition and Results of Operations for further discussion of our underwriting results.
The following graph compares our combined ratio to the property and casualty industry's combined ratio for the past five years.
Underwriting Segments
In conjunction with the continued integration of Alterra into our insurance operations, during the first quarter of 2014, we changed the way we aggregate and monitor our ongoing underwriting results. Effective January 1, 2014, we monitor and report our ongoing underwriting operations in the following three segments: U.S. Insurance, International Insurance and Reinsurance. In determining how to aggregate and monitor our underwriting results, management considers many factors, including the geographic location and regulatory environment of the insurance entity underwriting the risk, the nature of the insurance product sold, the type of account written and the type of customer served.
The U.S. Insurance segment includes all direct business and facultative placements written by our insurance subsidiaries domiciled in the United States. The International Insurance segment includes all direct business and facultative placements written by our insurance subsidiaries domiciled outside of the United States, including our syndicate at Lloyd's. The Reinsurance segment includes all treaty reinsurance written across the Company. Results for lines of business discontinued prior to, or in conjunction with, acquisitions, are reported in the Other Insurance (Discontinued Lines) segment. The lines were discontinued because we believed some aspect of the product, such as risk profile or competitive environment, would not allow us to earn consistent underwriting profits. Underwriting results attributable to Alterra are included in each of our underwriting segments effective May 1, 2013. Alterra previously offered life and annuity reinsurance products. In 2010, Alterra ceased writing life and annuity reinsurance contracts and placed this business into run-off. Results attributable to the run-off of life and annuity reinsurance business are included in our Other Insurance (Discontinued Lines) segment.
See note 19 of the notes to consolidated financial statements for additional segment reporting disclosures.
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Markel Corporation
2014 Consolidated Gross Premium Volume ($4.8 billion)
U.S. Insurance Segment
Our U.S. Insurance segment includes both hard-to-place risks written outside of the standard market on an excess and surplus lines basis and unique and hard-to-place risks that must be written on an admitted basis due to marketing and regulatory reasons. Business in this segment is written through our Wholesale, Specialty and Global Insurance divisions.
Wholesale Division
The Wholesale division writes commercial risks, primarily on an excess and surplus lines basis. The E&S market focuses on hard-to-place risks and loss exposures that generally cannot be written in the standard market. United States insurance regulations generally require an E&S account to be declined by admitted carriers before an E&S company may write the business. E&S eligibility allows our insurance subsidiaries to underwrite unique loss exposures with more flexible policy forms and unregulated premium rates. This typically results in coverages that are more restrictive and more expensive than coverages in the standard market.
Our E&S business is written through two distribution channels, professional surplus lines general agents who have limited quoting and binding authority and wholesale brokers. The majority of our E&S business produced by this segment is written on a surplus lines basis through Essex, Evanston or AESIC.
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Specialty Division
The Specialty division writes program insurance and other specialty coverages for well-defined niche markets, primarily on an admitted basis. Our business written in the admitted market focuses on risks that, although unique and hard-to-place in the standard market, must remain with an admitted insurance company for marketing and regulatory reasons. Hard-to-place risks written in the admitted market cover insureds engaged in similar, but highly specialized activities who require a total insurance program not otherwise available from standard insurers or insurance products that are overlooked by large admitted carriers. The admitted market is subject to more state regulation than the E&S market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as state guaranty funds and assigned risk plans.
The majority of our business written in the Specialty division is written by retail insurance agents who have very limited underwriting authority. Agents are carefully selected and agency business is controlled through regular audits and pre- approvals. Certain products and programs are marketed directly to consumers or distributed through wholesale producers. Personal lines coverages included in this segment are marketed directly to the consumer using direct mail, internet and telephone promotions, as well as relationships with various motorcycle and boat manufacturers, dealers and associations.
The majority of the business produced by this division is written either through MIC, MAIC, FCIC or Essentia. MIC, MAIC and Essentia are licensed to write property and casualty insurance in all 50 states and the District of Columbia. MAIC is also licensed to write property and casualty insurance in Puerto Rico. Essentia specializes in coverage for classic cars and boats. FCIC is currently licensed in 28 states and specializes in workers' compensation coverage.
Global Insurance Division
The Global Insurance division writes risks outside of the standard market on both an admitted and non-admitted basis and is comprised of business previously written by Alterra. The portion of Global Insurance division business written by our U.S. insurance subsidiaries is included in this segment, and the remainder is included in the International Insurance segment. U.S. business produced by this division is primarily written on either AESIC or AAIC. AESIC is authorized to write property and casualty insurance in 49 states and the District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands. AAIC is licensed to write property and casualty insurance in all 50 states and the District of Columbia.
Our U.S. Insurance segment reported gross premium volume of $2.5 billion, earned premiums of $2.0 billion and an underwriting profit of $99.3 million in 2014.
U.S. Insurance Segment
2014 Gross Premium Volume ($2.5 billion)
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Product offerings within the U.S. Insurance segment fall within the following major product groupings:
• | General Liability |
• | Professional Liability |
• | Property |
• | Personal Lines |
• | Programs |
• | Workers' Compensation |
• | Other Product Lines |
General Liability product offerings include a variety of primary and excess liability coverages targeting apartments and office buildings, retail stores and contractors, as well as business in the life sciences, energy, medical, recreational and hospitality industries. Specific products include the following:
• | excess and umbrella products, which provide coverage over approved underlying insurance carriers on either an occurrence or claims-made basis; |
• | products liability products, which provide coverage on either an occurrence or claims-made basis to manufacturers, distributors, importers and re-packagers of manufactured products; |
• | environmental products, which include environmental consultants' professional liability, contractors' pollution liability and site-specific environmental impairment liability coverages; and |
• | casualty facultative reinsurance written for individual casualty risks focusing on general liability, products liability, automobile liability and certain classes of miscellaneous professional liability and targeting classes which include low frequency, high severity general liability risks. |
Professional liability coverages include unique solutions for highly specialized professions, including architects and engineers, lawyers, agents and brokers, service technicians and computer consultants. We offer claims-made medical malpractice coverage for doctors and dentists; claims-made professional liability coverage to individual healthcare providers such as therapists, pharmacists, physician assistants and nurse anesthetists; and coverages for medical facilities and other allied healthcare risks such as clinics, laboratories, medical spas, home health agencies, small hospitals, pharmacies and senior living facilities. Other professional liability coverages include union liability, executive liability for financial institutions and Fortune 1000 companies, and management liability. Our management liability coverages, which can be bundled or written monoline, include employment practices liability, directors' and officers' liability and fiduciary liability coverages. Additionally, we offer a data privacy and security product, which provides coverage for data breach and privacy liability, data breach loss to insureds and electronic media coverage.
Property coverages consist principally of fire, allied lines (including windstorm, hail and water damage) and other specialized property coverages, including catastrophe-exposed property risks such as earthquake and wind on both a primary and excess basis. Catastrophe-exposed property risks are typically larger and are lower frequency and higher severity in nature than more standard property risks. Our property risks range from small, single-location accounts to large, multi-state, multi-location accounts. Other types of property products include:
• | inland marine products, which provide a number of specialty coverages for risks such as motor truck cargo coverage for damage to third party cargo while in transit, warehouseman's legal liability coverage for damage to third party goods in storage, contractor's equipment coverage for first party property damage, builder's risk coverage and fine arts coverage; and |
• | railroad-related products, which provide first party coverages for short-line and regional railroads, scenic and tourist railroads, commuter and light rail trains and railroad equipment. |
Personal lines products provide first and third party coverages for classic cars and a variety of personal watercrafts including vintage boats, high performance boats and yachts and recreational vehicles, such as motorcycles, snowmobiles and ATVs. Based on the seasonal nature of much of our personal lines business, we generally will experience higher claims activity during the second and third quarters of the year. Additionally, property coverages are offered for mobile homes, dwellings and homeowners that do not qualify for standard homeowner's coverage. Other products offered include special event protection, supplemental natural disaster coverage, renters' protection coverage and excess flood coverage.
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Program business included in this segment is offered on a monoline or package basis and generally targets specialized commercial markets and customer groups. Targeted groups include youth and recreation oriented organizations and camps, child care operators, social service organizations, museums and historic homes, performing arts organizations, senior living facilities and wineries. Other program business written in this segment includes:
• | general agent programs that use managing general agents to offer single source admitted and non-admitted programs for a specific class or line of business; |
• | first and third party coverages for small fishing ventures, charters, utility boats and boat rentals; and |
• | property and liability coverages for farms and animal boarding, breeding and training facilities. |
Workers' compensation products provide wage replacement and medical benefits to employees injured in the course of employment and target main-street, service and artisan contractor businesses, retail stores and restaurants.
Other product lines within the U.S. Insurance segment include:
• | transportation-related products, which provide auto physical damage coverage for high-value automobiles as well as all types of specialty commercial vehicles, dealers' open lot and garagekeeper legal liability coverages, vehicular liability and physical damage coverages for local and intermediate haul commercial trucks and liability coverage to operators of non-emergency ambulances and multi-line specialty products designed for the unique characteristics of the garage industry; |
• | ocean marine products, which provide general liability, professional liability, property and cargo coverages for marine artisan contractors, boat dealers and marina owners including hull physical damage, protection and indemnity and third party property coverages for ocean cargo; and |
• | coverages for equine-related risks, such as horse mortality, theft, infertility, transit and specified perils. |
International Insurance Segment
Our International Insurance segment writes risks that are characterized by either the unique nature of the exposure or the high limits of insurance coverage required by the insured. Business included in this segment is produced through our Markel International and Global Insurance divisions.
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Markel International Division
The Markel International division writes business worldwide from our London-based platform, including Markel Syndicate 3000, through which our Lloyd's operations are conducted, and MIICL. The London insurance market is known for its ability to provide innovative, tailored coverage and capacity for unique and hard-to-place risks. Hard-to-place risks in the London market are generally distinguishable from standard risks due to the complexity or significant size of the risk. It is primarily a broker market, which means that insurance brokers bring most of the business to the market. Risks written in the Markel International division are written on either a direct basis or a subscription basis, the latter of which means that loss exposures brought into the market are typically insured by more than one insurance company or Lloyd's syndicate, often due to the high limits of insurance coverage required. When we write business in the subscription market, we prefer to participate as lead underwriter in order to control underwriting terms, policy conditions and claims handling.
Global Insurance Division
Global Insurance division business written by our non-U.S. insurance subsidiaries, which primarily targets Fortune 1000 accounts, is included in the International segment. The Global Insurance division is comprised of business previously written by Alterra and is written through Markel Bermuda and MIICL, as well as Markel Europe through 2014.
In 2014, 67% of gross premium written in the International Insurance segment related to foreign risks, of which 37% was from the United Kingdom and 14% was from Canada. In 2013, 68% of gross premium written in the International Insurance segment related to foreign risks, of which 24% was from the United Kingdom and 17% was from Canada. In 2012, 85% of gross premium written in the International Insurance segment related to foreign risks, of which 20% was from the United Kingdom and 18% was from Canada. In each of these years, there was no other individual foreign country from which premium writings were material.
Our International Insurance segment reported gross premium volume of $1.2 billion, earned premiums of $909.7 million and an underwriting profit of $67.3 million in 2014.
International Insurance Segment
2014 Gross Premium Volume ($1.2 billion)
Product offerings within the International segment fall within the following major product groupings:
• | Professional Liability |
• | Marine and Energy |
• | General Liability |
• | Property |
• | Other Product Lines |
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Professional liability products are written on a worldwide basis and include professional indemnity, directors' and officers' liability, errors and omissions, employment practices liability and intellectual property. Our target industries include U.S. and international public companies, as well as large professional firms, including lawyers, financial institutions, accountants, consultants, and architects and engineers.
Marine and energy products include a portfolio of coverages for cargo, energy, hull, liability, war, terrorism and specie risks. The cargo account is an international transit-based book covering many types of cargo. Energy coverage includes all aspects of oil and gas activities. The hull account covers physical damage to ocean-going tonnage, yachts and mortgagees' interests. Liability coverage provides for a broad range of energy liabilities, as well as traditional marine exposures including charterers, terminal operators and ship repairers. The war account covers the hulls of ships and aircraft, and other related interests, against war and associated perils. Terrorism coverage provides for property damage and business interruption related to political violence including war and civil war. The specie account includes coverage for fine art on exhibition and in private collections, securities, bullion, precious metals, cash in transit and jewelry.
General liability products are written on a worldwide basis and include general and products liability coverages targeting consultants, construction professionals, financial service professionals, professional practices, social welfare organizations and medical products. We also write excess liability coverage, which includes excess product liability, excess medical malpractice and excess product recall insurance in the following industries: healthcare, pharmaceutical, medical products, life sciences, transportation, heavy industrial and energy.
Property products target a wide range of insureds, providing coverage ranging from fire to catastrophe perils such as earthquake and windstorm. Business is written primarily on an open market basis for direct and facultative risks targeting Fortune 1000 and large, multi-national companies on a worldwide basis. We also provide property coverage for small to medium-sized commercial risks on both a stand-alone and package basis.
Other product lines within the International Insurance segment include:
• | crime coverage primarily targeting financial institutions and providing protection for bankers' blanket bond, computer crime and commercial fidelity; |
• | contingency coverage including event cancellation, non-appearance and prize indemnity; |
• | accident and health coverage targeting affinity groups and schemes, high value and high risks accounts and sports groups; |
• | coverage for equine-related risks such as horse mortality, theft, infertility, transit and specified perils; |
• | specialty coverages include mortality risks for farms, zoos, animal theme parks and safari parks; and |
• | short-term trade credit coverage for commercial risks, including insolvency and protracted default as well as political risks coverage in conjunction with commercial risks for currency inconvertibility, government action, import and export license cancellation, public buyer default and war. |
Reinsurance Segment
Our Reinsurance segment includes property and casualty treaty reinsurance products offered to other insurance and reinsurance companies globally through the broker market. Our treaty reinsurance offerings include both quota share and excess of loss reinsurance and are typically written on a participation basis, which means each reinsurer shares proportionally in the business ceded under the reinsurance treaty written. Our reinsurance products may include features such as contractual provisions that require our cedent to share in a portion of losses resulting from ceded risks, may require payment of additional premium amounts if we incur greater losses than those projected at the time of the execution of the contract, may require reinstatement premium to restore the coverage after there has been a loss occurrence or may provide for experience refunds if the losses we incur are less than those projected at the time the contract is executed. Our reinsurance product offerings are underwritten by our Global Reinsurance division and our Markel International division. The Global Reinsurance division operates from platforms in the United States, Bermuda and Europe and is primarily comprised of business previously written by Alterra. Business written in the Global Reinsurance division is produced through Alterra Re USA and Markel Bermuda. Alterra Re USA is licensed or accredited to provide reinsurance in all 50 states and the District of Columbia. The Markel International division conducts its reinsurance operations from its London- based platform, as described above, and from its platform in Latin America, which includes Markel Brazil.
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In 2014, 43% of gross premium written in the Reinsurance segment related to foreign risks, of which 31% was from the United Kingdom. In 2013, 42% of gross premium written in the Reinsurance segment related to foreign risks, of which 27% was from the United Kingdom. In 2012, 55% of gross premium written in the Reinsurance segment related to foreign risks, of which 22% was from the United Kingdom. In each of these years, there was no other individual foreign country from which premium writings were material.
Our Reinsurance segment reported gross premium volume of $1.1 billion, earned premiums of $908.4 million and an underwriting profit of $38.9 million in 2014.
Reinsurance Segment
2014 Gross Premium Volume ($1.1 billion)
Product offerings within the Reinsurance segment fall within the following major product groupings:
• | Property |
• | Casualty |
• | Auto |
• | Other |
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Property treaty products are offered on an excess of loss and quota share basis for catastrophe, per risk and retrocessional exposures worldwide. Our catastrophe exposures are generally written on an excess of loss basis and target both personal and commercial lines of business providing coverage for losses from natural disasters, including hurricanes, wind storms and earthquakes. We also reinsure individual property risks such as buildings, structures, equipment and contents and provide coverage for both personal lines and commercial property exposures. Our retrocessional products provide coverage for all types of underlying exposures and geographic zones. A significant portion of the property treaty business covers United States exposures, with the remainder coming from international property exposures.
Our casualty treaty reinsurance programs are written on a quota share and excess of loss basis and include general liability, professional liability, workers' compensation, medical malpractice and environmental impairment liability. General liability reinsurance includes umbrella and excess casualty products that are written worldwide. Our professional liability reinsurance programs are offered worldwide and consist of directors and officers liability, including publicly traded, private, and non-profit companies in both commercial and financial institution arenas; lawyers errors and omissions for small, medium and large-sized law firms; accountants errors and omissions for small and medium-sized firms; technology errors and omissions and cyber liability focusing on network security and privacy exposures. Our workers' compensation business includes catastrophe-exposed workers' compensation business. Medical malpractice reinsurance products are offered in the United States and include quota share, excess of loss and stop loss coverage for physician and surgeon medical malpractice specialty writers, member-owned hospital writers focusing on small-to-medium size facilities, national hospital writers focused on primary or lower excess layers on medium size facilities and long-term care writers focused on privately held, religious based or state sponsored non-profit programs. Environmental treaty reinsurance provides coverage for pollution legal liability, contractors pollution and professional liability exposures on both a nationwide and regional basis within the United States.
Auto reinsurance treaty products are offered on a quota share and excess of loss basis and include commercial and non standard personal auto exposures predominantly in the United States. Commercial auto coverage is provided to national and regional carriers while non standard personal auto coverage is offered to regional and single state ceding companies. Our auto reinsurance treaty products previously included exposures in the United Kingdom; however, we ceased writing any new auto business in the United Kingdom in 2014.
Other treaty reinsurance products offered in the Reinsurance segment include:
• | aviation, which includes commercial airline hull and liability coverage as well as general aviation for risks worldwide; |
• | structured and whole turnover credit, political risk, mortgage and contract and commercial surety reinsurance programs covering worldwide exposures; |
• | onshore and offshore marine and energy risks on a worldwide basis, including hull, cargo and liability; |
• | agriculture reinsurance for Multi-Peril Crop Insurance, hail and related exposures, covering risks located in the United States and Canada; and |
• | public entity reinsurance products, which offer customized programs for government risk solutions, including counties, municipalities, schools, public housing authorities and special districts (e.g. water, sewer, parks) located in the United States. Types of coverage include general liability, property, environmental impairment liability, data breach, workers' compensation and errors and omissions. |
Ceded Reinsurance
We purchase reinsurance and retrocessional reinsurance to manage our net retention on individual risks and overall exposure to losses, while providing us with the ability to offer policies with sufficient limits to meet policyholder needs. In a reinsurance transaction, an insurance company transfers, or cedes, all or part of its exposure in return for a portion of the premium. In a retrocession transaction, a reinsurer transfers, or cedes, all or part of its exposure in return for a portion of the premium. Following the acquisition of Alterra, we have more insurance and reinsurance products that have typically required higher levels of reinsurance than our historical product offerings required. We purchase catastrophe reinsurance coverage for our catastrophe-exposed policies, and we seek to manage our exposures under this coverage so that no exposure to any one reinsurer is material to our ongoing business. Net retention of gross premium volume was 82% in 2014 and 83% in 2013. We do not purchase or sell finite reinsurance products or use other structures that would have the effect of discounting loss reserves.
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Our ceded reinsurance and retrocessional contracts do not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear collection risk if the reinsurer fails to meet its obligations under the reinsurance agreement. We attempt to minimize credit exposure to reinsurers through adherence to internal ceded reinsurance guidelines. To participate in our reinsurance program, prospective companies generally must: (i) maintain an A.M. Best Company (Best) or Standard & Poor's (S&P) rating of "A" (excellent) or better; (ii) maintain minimum capital and surplus of $500 million and (iii) provide collateral for recoverables in excess of an individually established amount. In addition, certain foreign reinsurers for our United States insurance operations must provide collateral equal to 100% of recoverables, with the exception of reinsurers who have been granted authorized status by an insurance company's state of domicile. Lloyd's syndicates generally must have a minimum of a "B" rating from Moody's Investors Service (Moody's) to be our reinsurers.
When appropriate, we pursue reinsurance commutations that involve the termination of ceded reinsurance and retrocessional contracts. Our commutation strategy related to ceded reinsurance and retrocessional contracts is to reduce credit exposure and eliminate administrative expenses associated with the run-off of ceded reinsurance placed with certain reinsurers.
The following table displays balances recoverable from our ten largest reinsurers by group at December 31, 2014. The contractual obligations under reinsurance and retrocessional contracts are typically with individual subsidiaries of the group or syndicates at Lloyd's and are not typically guaranteed by other group members or syndicates at Lloyd's. These ten reinsurance groups represent approximately 63% of our $2.0 billion reinsurance recoverable balance before considering allowances for bad debts.
Reinsurers | A.M. Best Rating | Reinsurance Recoverable | |||
(dollars in thousands) | |||||
Fairfax Financial Group | A | $ | 203,119 | ||
Munich Re Group | A+ | 200,172 | |||
AXIS Capital Holdings Limited | A+ | 156,005 | |||
Lloyd's of London | A | 136,340 | |||
Alleghany Corporation | A | 133,683 | |||
Partner Re Group | A+ | 116,218 | |||
Platinum Underwriters Holdings Ltd | A | 110,898 | |||
Swiss Re Group | A+ | 83,354 | |||
XL Capital Group | A | 68,609 | |||
Arch Insurance Group | A+ | 68,042 | |||
Reinsurance recoverable on paid and unpaid losses for ten largest reinsurers | 1,276,440 | ||||
Total reinsurance recoverable on paid and unpaid losses | $ | 2,030,688 | |||
Reinsurance recoverable balances in the preceding table are shown before consideration of balances owed to reinsurers and any potential rights of offset, any collateral held by us and allowances for bad debts.
Reinsurance and retrocessional treaties are generally purchased on an annual basis and are subject to yearly renegotiations. In most circumstances, the reinsurer remains responsible for all business produced before termination. Treaties typically contain provisions concerning ceding commissions, required reports to reinsurers, responsibility for taxes, arbitration in the event of a dispute and provisions that allow us to demand that a reinsurer post letters of credit or assets as security if a reinsurer becomes an unauthorized reinsurer under applicable regulations or if its rating falls below an acceptable level.
See note 15 of the notes to consolidated financial statements and Management's Discussion & Analysis of Financial Condition and Results of Operations for additional information about our ceded reinsurance programs and exposures.
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Investments
Our business strategy recognizes the importance of both consistent underwriting and operating profits and superior investment returns to build shareholder value. We rely on sound underwriting practices to produce investable funds while minimizing underwriting risk. The majority of our investable assets come from premiums paid by policyholders. Policyholder funds are invested predominantly in high-quality corporate, government and municipal bonds with relatively short durations. The balance, comprised of shareholder funds, is available to be invested in equity securities, which over the long run, have produced higher returns relative to fixed maturity investments. When purchasing equity securities, we seek to invest in profitable companies, with honest and talented management, that exhibit reinvestment opportunities and capital discipline, at reasonable prices. We intend to hold these investments over the long term. Substantially all of our investment portfolio is managed by company employees.
The investment portfolio acquired through the Alterra acquisition was comprised of hedge funds, equity method investments and fixed maturities that were generally longer duration than our historical fixed maturity portfolio. In order to align the acquired investment portfolio with Markel's investment philosophy and target investment portfolio allocations, we have liquidated substantially all of the hedge fund portfolio and continue to increase our holdings in equity securities and fixed maturity tax-exempt municipal securities.
We evaluate our investment performance by analyzing taxable equivalent total investment return. Taxable equivalent total investment return includes items that impact net income, such as coupon interest on fixed maturities, dividends on equity securities and realized investment gains or losses, as well as changes in unrealized gains or losses, which do not impact net income. Certain items that are included in net investment income have been excluded from the calculation of taxable equivalent total investment return, such as amortization and accretion of premiums and discounts on our fixed maturity portfolio, to provide a comparable basis for measuring our investment return against industry investment returns. The calculation of taxable equivalent total investment return also includes the current tax benefit associated with income on certain investments that is either taxed at a lower rate than the statutory income tax rate or is not fully included in federal taxable income. We believe the taxable equivalent total investment return is a better reflection of the economics of our decision to invest in certain asset classes. See "Investing Results" in Management's Discussion & Analysis of Financial Condition and Results of Operations for further detail regarding the components of taxable equivalent total investment return. In 2014, net investment income was $363.2 million and net realized investment gains were $46.0 million. During the year ended December 31, 2014, net unrealized gains on investments increased by $981.0 million. We do not lower the quality of our investment portfolio in order to enhance or maintain yields. We focus on long-term total investment return, understanding that the level of realized and unrealized investment gains or losses may vary from one period to the next.
We believe our investment performance is best analyzed from the review of taxable equivalent total investment return over several years. The following table presents taxable equivalent total investment return before and after the effects of foreign currency movements.
Annual Taxable Equivalent Total Investment Returns
Weighted Average Five-Year Annual Return | Weighted Average Ten-Year Annual Return | ||||||||||||||||||||||||
Years Ended December 31, | |||||||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | |||||||||||||||||||||
Equities | 18.6 | % | 33.3 | % | 19.6 | % | 3.8 | % | 20.8 | % | 20.4 | % | 13.4 | % | |||||||||||
Fixed maturities (1) | 6.5 | % | 0.0 | % | 5.1 | % | 7.6 | % | 5.4 | % | 4.7 | % | 4.8 | % | |||||||||||
Total portfolio, before foreign currency effect | 8.9 | % | 6.9 | % | 8.6 | % | 6.7 | % | 8.1 | % | 7.9 | % | 6.5 | % | |||||||||||
Total portfolio | 7.4 | % | 6.8 | % | 9.0 | % | 6.5 | % | 7.9 | % | 7.4 | % | 6.2 | % | |||||||||||
Invested assets, end of year (in millions) | $ | 18,638 | $ | 17,612 | $ | 9,333 | $ | 8,728 | $ | 8,224 | |||||||||||||||
(1) | Includes short-term investments, cash and cash equivalents and restricted cash and cash equivalents. |
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We monitor our investment portfolio to ensure that credit risk does not exceed prudent levels. S&P and Moody's provide corporate and municipal debt ratings based on their assessments of the credit quality of an obligor with respect to a specific obligation. S&P's ratings range from "AAA" (capacity to pay interest and repay principal is extremely strong) to "D" (debt is in payment default). Securities with ratings of "BBB" or higher are referred to as investment grade securities. Debt rated "BB" and below is regarded by S&P as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal. Moody's ratings range from "Aaa" to "C" with ratings of "Baa" or higher considered investment grade.
Our fixed maturity portfolio has an average rating of "AA," with approximately 97% rated "A" or better by at least one nationally recognized rating organization. Our policy is to invest in investment grade securities and to minimize investments in fixed maturities that are unrated or rated below investment grade. At December 31, 2014, less than 1% of our fixed maturity portfolio was unrated or rated below investment grade. Our fixed maturity portfolio includes securities issued with financial guaranty insurance. We purchase fixed maturities based on our assessment of the credit quality of the underlying assets without regard to insurance.
At December 31, 2014, we held fixed maturities of $7.7 million, or less than 1% of invested assets, from sovereign and non-sovereign issuers domiciled in Portugal, Ireland, Italy, Greece or Spain and $1.9 billion, or 10% of invested assets, from sovereign and non-sovereign issuers domiciled in other European countries including supranationals. At December 31, 2013, we held fixed maturities of $45.7 million, or less than 1% of invested assets, from sovereign and non-sovereign issuers domiciled in Portugal, Ireland, Italy, Greece or Spain and $2.0 billion, or 12% of invested assets, from sovereign and non-sovereign issuers domiciled in other European countries including supranationals.
The following chart presents our fixed maturity portfolio, at estimated fair value, by rating category at December 31, 2014.
2014 Credit Quality of Fixed Maturity Portfolio ($10.4 billion)
See "Market Risk Disclosures" in Management's Discussion & Analysis of Financial Condition and Results of Operations for additional information about investments.
Markel Ventures
Through our wholly-owned subsidiary Markel Ventures, Inc. (Markel Ventures), we own interests in various industrial and service businesses that operate outside of the specialty insurance marketplace. These businesses are viewed by management as separate and distinct from our insurance operations. Local management teams oversee the day-to-day operations of these companies, while strategic decisions are made in conjunction with members of our executive management team, principally our President and Chief Investment Officer.
Our strategy in making these investments is similar to our strategy for purchasing equity securities. We seek to invest in profitable companies, with honest and talented management, that exhibit reinvestment opportunities and capital discipline, at reasonable prices. We intend to own the businesses acquired for a long period of time.
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Our Markel Ventures operations are comprised of a diverse portfolio of industrial and service companies from various industries, including manufacturers of dredging equipment, high-speed bakery equipment, food processing equipment and car hauler equipment and parts, an owner and operator of manufactured housing communities, a residential homebuilder, a manager of behavioral health programs and a manufacturer of laminated oak and composite wood flooring used in the assembly of truck trailers, intermodal containers and truck bodies, among others. While each of the companies in our Markel Ventures operations are operated independently from one another, we aggregate their financial results into two industry groups: manufacturing and non-manufacturing.
In 2014, our Markel Ventures operations reported revenues of $838.1 million and net income to shareholders of $9.6 million.
See note 20 of the notes to consolidated financial statements and Management's Discussion & Analysis of Financial Condition and Results of Operations for additional information about our Markel Ventures operations.
Shareholder Value
Our financial goals are to earn consistent underwriting and operating profits and superior investment returns to build shareholder value. More specifically, we measure financial success by our ability to compound growth in book value per share at a high rate of return over a long period of time. To mitigate the effects of short-term volatility, we generally use five-year time periods to measure ourselves. We believe that growth in book value per share is the most comprehensive measure of our success because it includes all underwriting, operating and investing results. For the year ended December 31, 2014, book value per share increased 14% primarily due to net income to shareholders of $321.2 million and a $661.7 million increase in net unrealized gains on investments, net of taxes. For the year ended December 31, 2013, book value per share increased 18% primarily due to equity issued in connection with the acquisition of Alterra, which was accretive to book value, net income to shareholders of $281.0 million and a $184.6 million increase in net unrealized gains on investments, net of taxes. Over the past five years, we have grown book value per share at a compound annual rate of 14% to $543.96 per share.
The following graph presents book value per share for the past five years as of December 31.
Book Value Per Share
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Regulatory Environment
Our insurance subsidiaries are subject to regulation and supervision by the insurance regulatory authorities of the various jurisdictions in which they conduct business. This regulation is intended for the benefit of policyholders rather than shareholders or holders of debt securities. The jurisdictions of our principal insurance subsidiaries are the United States, the United Kingdom and Bermuda.
United States Insurance Regulation
Overview. Our U.S. insurance subsidiaries are subject to varying degrees of regulation and supervision in the jurisdictions in which they do business. Each state has its own regulatory authority for insurance that is generally responsible for the direct regulation of the business of insurance conducted in that state. In addition, the National Association of Insurance Commissioners (NAIC), comprised of the insurance commissioners of each U.S. jurisdiction, develops or amends model statutes and regulations that in turn most states adopt. While the U.S. federal government and its regulatory agencies generally do not directly regulate the business of insurance, there have been recent federal initiatives that impact the business of insurance.
State Insurance Regulation. In the United States, authority for the regulation, supervision and administration of the business of insurance in each state is generally delegated to a state commissioner heading a regulatory body responsible for the business of insurance. Through this authority, state regulatory authorities have broad regulatory, supervisory and administrative powers relating to solvency standards; the licensing of insurers and their agents; the approval of forms and policies used; the nature of, and limitations on, insurers' investments; the form and content of annual statements and other reports on the financial condition of insurers; and the establishment of loss reserves. Our U.S. insurance subsidiaries that operate on an admitted basis are typically subject to regulatory rate and form review, while our U.S. excess and surplus lines insurance subsidiaries generally operate free of rate and form regulation.
Holding Company Statutes. In addition to regulatory supervision of our domestic insurance subsidiaries, we are subject to state statutes governing insurance holding company systems. Typically, such statutes require that we periodically file information with the appropriate state insurance commissioner, including information concerning our capital structure, ownership, financial condition, material transactions with affiliates and general business operations. In addition, these statutes also require approval of changes in control of an insurer or an insurance holding company. Generally, control for these purposes is defined as ownership or voting power of 10% or more of a company's voting shares. Additional requirements include group-level reporting, submission of an annual enterprise risk report by a regulated insurance company's ultimate controlling person and information regarding an insurer's non-insurer affiliates.
Risk Based Capital Requirements. The NAIC uses a risk based capital formula that is designed to measure the capital of an insurer taking into account the company's investments and products. These requirements provide a formula which, for property and casualty insurance companies, establishes capital thresholds for four categories of risk: asset risk, insurance risk, interest rate risk and business risk. At December 31, 2014, the capital and surplus of each of our United States insurance subsidiaries was above the minimum regulatory thresholds.
Excess and Surplus Lines. The regulation of our U.S. insurance subsidiaries' excess and surplus lines insurance business differs significantly from the regulation of our admitted business. Our surplus lines subsidiaries are subject to the surplus lines regulation and reporting requirements of the jurisdictions in which they are eligible to write surplus lines insurance. Although the surplus lines business is generally less regulated than admitted business, regulations apply to surplus lines placements under the laws of every state.
Dividends. The laws of the domicile states of our U.S. insurance subsidiaries govern the amount of dividends that may be paid to our holding company, Markel Corporation. Generally, statutes in the domicile states of our insurance subsidiaries require prior approval for payment of extraordinary, as opposed to ordinary, dividends. At December 31, 2014, our United States insurance subsidiaries could pay up to $310.6 million during the following 12 months under the ordinary dividend regulations.
Trade Practices. State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing marketing and sales practices, data security, policyholder services, claims management, anti-fraud controls and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations.
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Investment Regulation. Investments by our domestic insurance companies must comply with applicable laws and regulations that prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, mortgage loans, real estate and certain other investments, subject to specified limits and certain other qualifications.
The Terrorism Risk Insurance Act. The Terrorism Risk Insurance Act of 2002, as amended (TRIA), has established a federal program that provides for a system of shared public and private compensation for certain insured losses resulting from acts of terrorism. In early 2015 the program was extended for another six years, and is now scheduled to expire in 2020. In addition, the most recent extension of TRIA (1) raises the threshold for the program to go into effect (the triggering event) from $100 million in losses to $200 million, in $20 million increments starting in January 2016 and (2) increases the amount that insurers must cover as a whole through co-payments and deductibles, which is known in the industry as the aggregate retention. The aggregate retention amount will rise by $2 billion a year to $37.5 billion from $27.5 billion, starting in 2016. TRIA is applicable to almost all commercial lines of property and casualty insurance but excludes commercial auto, burglary and theft, surety, professional liability and farm owners' multi-peril insurance. Insurers with direct commercial property and casualty insurance exposure in the United States are required to participate in the program and make available coverage for certified acts of terrorism. Federal participation will be triggered under TRIA when the Secretary of Treasury certifies an act of terrorism.
Federal Regulation. Although the federal government and its regulatory agencies generally do not directly regulate the business of insurance, federal initiatives could have an impact on our business in a variety of ways. The Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was enacted in 2010 and effected sweeping changes to financial services regulation in the United States. The Dodd-Frank Act created two new federal government bodies, the Federal Insurance Office (FIO) and the Financial Stability Oversight Council (FSOC), which may impact the regulation of insurance. Although the FIO is prohibited from directly regulating the business of insurance, it has authority to represent the United States in international insurance matters and has limited powers to preempt certain types of state insurance laws. The FIO also can recommend to the FSOC that it designate an insurer as an entity posing risks to the United States financial stability in the event of the insurer's material financial distress or failure. We have not been so designated.
On December 12, 2013, the FIO delivered a report to Congress on how to modernize and improve the system of insurance regulation in the U.S. The report recommended that, in the short term, the U.S. system of insurance regulation can be modernized through state-based improvements combined with certain federal actions. The report identified areas for direct federal involvement in international standard setting, the FIO participation in supervisory colleges, which monitor the regulation of large national and internationally active insurance groups, and federal pursuit of international covered agreements to afford nationally uniform treatment of reinsurance collateral requirements. The report also made several recommendations for state reform of insurance regulation, including changes to the state regulation of insurance company solvency, group supervision and corporate governance. The FIO report stated that the system of U.S. insurance regulation can be modernized and improved in the short-term, while warning that if the states do not act in the near term to effectively regulate matters on a consistent and cooperative basis, in the FIO's view there will be a greater role for federal regulation of insurance.
United Kingdom Insurance Regulation
Under the Financial Services and Markets Act 2000 (FSMA), it is unlawful to carry on insurance business in the United Kingdom without permission to do so from the relevant regulators. Before April 1, 2013, the Financial Services Authority (FSA) was responsible for supervising all securities, banking and insurance business in the United Kingdom. With the enactment of the Financial Services Act 2012 (which amended FSMA), the FSA was replaced by two regulators: the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). An independent Financial Policy Committee (FPC) at the Bank of England supervises the financial services sector at a macro level, responding to sectoral issues that could threaten economic and financial stability.
Since April 1, 2013, when regulatory responsibility for the insurance firms in the United Kingdom was given to the PRA and the FCA, MIICL and MSM, our Lloyd's managing agent, have been "dual regulated firms"; each firm is authorized by the PRA and regulated by both the PRA and the FCA. In addition, in January 2014, we completed the acquisition of Abbey Protection plc (Abbey), an integrated specialty insurance and consultancy group headquartered in London. Abbey Protection Group Limited, a wholly-owned subsidiary of Abbey, is an FCA-authorised insurance intermediary that produces insurance to both MIICL and third party insurance carriers in the UK.
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The PRA is a subsidiary of the Bank of England and is responsible for the prudential regulation and supervision of banks, building societies, credit unions, major investment firms and insurers, including the Society of Lloyd's and managing agents that participate in the Lloyd's market. The two statutory objectives of the PRA are to promote the safety and soundness of the firms it regulates and, specific to insurers, to contribute to securing an appropriate degree of protection for those who are, or may become, policyholders. The FCA, which is separate from the Bank of England, is accountable to HM Treasury and ultimately the United Kingdom Parliament. The FCA supervises the day-to-day conduct of insurance firms and other authorized firms operating in the United Kingdom, including those participating in the Lloyd's market and UK insurance intermediaries. The overarching strategic objective of the FCA is to ensure that the relevant markets function well. The FCA also has three operational objectives: securing an appropriate degree of protection for consumers, protecting and enhancing the integrity of the UK financial system, and promoting effective competition in the interests of consumers.
The PRA oversees compliance with established periodic auditing and reporting requirements, minimum solvency margins and individual capital assessment requirements and dividend restrictions, while both the PRA and the FCA oversee compliance with risk assessment reviews, restrictions governing the appointment of key officers, restrictions governing controlling ownership interests and various other requirements. In addition, both the PRA and FCA have arrangements with Lloyd's for cooperation on supervision and enforcement of the Lloyd's market. MIICL must provide 14 days' advance notice to the PRA for any dividends from MIICL. MSM is required to satisfy the solvency requirements of Lloyd's. In addition, our United Kingdom subsidiaries must comply with the United Kingdom Companies Act of 2006, which provides that dividends may only be paid out of profits available for that purpose. MIICL must also provide 14 days' advance written notice to the PRA of any transaction or proposed transaction with a connected or related person.
Bermuda Insurance Regulation
The insurance and reinsurance industry in Bermuda is regulated by the Bermuda Monetary Authority (BMA). Markel Bermuda is regulated by the BMA under the Insurance Act 1978 of Bermuda and its related regulations (Bermuda Insurance Act). The Bermuda Insurance Act imposes solvency and liquidity standards and auditing and reporting requirements on Markel Bermuda and grants to the BMA powers to supervise, investigate and intervene in the affairs of Bermuda insurance and reinsurance companies.
Markel Bermuda is subject to enhanced capital requirements in addition to minimum solvency and liquidity requirements. The enhanced capital requirement is determined by reference to a risk-based capital model that determines a control threshold for statutory capital and surplus by taking into account the risk characteristics of different aspects of the insurer's business. At December 31, 2014, Markel Bermuda satisfied both the enhanced capital requirements and the minimum solvency and liquidity requirements.
Under the Bermuda Insurance Act, Markel Bermuda is prohibited from paying or declaring dividends during a fiscal year if it is in breach of its enhanced capital requirement, solvency margin or minimum liquidity ratio or if the declaration or payment of the dividend would cause a breach. If an insurer fails to meet its solvency margin or minimum liquidity ratio on the last day of any financial year, it is prohibited from declaring or paying any dividends during the next financial year without the approval of the BMA. Further, Markel Bermuda is prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus as set forth in its previous year's statutory balance sheet unless at least seven days before payment of those dividends it files with the BMA an affidavit stating that it will continue to meet its solvency margin and minimum liquidity ratio. Markel Bermuda must obtain the BMA's prior approval for a reduction by 15% or more of the total statutory capital as set forth in its previous year's financial statements. In addition, as a long-term insurer, Markel Bermuda may not declare or pay a dividend to any person other than a policyholder unless the value of the assets in its long-term business fund, as certified by Markel Bermuda's approved actuary, exceeds the liabilities of its long-term business by the amount of the dividend and at least the prescribed minimum solvency margin. At December 31, 2014, Markel Bermuda could pay up to $472.7 million during the following 12 months without making any additional filings with the BMA.
Other Insurance Jurisdictions
A major regulatory initiative currently under way in the European Union (E.U.) is the Solvency II Directive (Solvency II), a new set of capital adequacy and risk management regulations that will directly impact our European based subsidiaries. Solvency II will replace existing insurance directives to create a pan-European, risk based solvency regime and affects all insurers and reinsurers throughout the E.U. and is scheduled to enter into force on January 1, 2016. The Solvency II regime is based on three pillars: financial requirements; governance and risk management requirements; and disclosure requirements. The European Commission is developing detailed rules that will complement the high-level principles of the Solvency II directive. It is possible that Solvency II may affect the U.S. parents of European subsidiaries, depending partly on whether U.S. insurance regulations are deemed equivalent to Solvency II.
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In addition, as a global provider of specialty insurance and reinsurance, our insurance subsidiaries must comply with various regulatory requirements in jurisdictions where they conduct business in addition to the jurisdictions in which they are domiciled. For example, our Lloyd's operations must comply with applicable Latin America regulatory requirements in connection with our Latin American reinsurance operations. In addition to the regulatory requirements imposed by the jurisdictions in which an insurer or reinsurer is licensed, a reinsurer's business operations are affected by regulatory requirements governing credit for reinsurance in other jurisdictions in which its ceding companies are located. In general, a ceding company that obtains reinsurance from a reinsurer that is licensed, accredited or approved by the jurisdiction in which the ceding company files statutory financial statements is permitted to reflect in its statutory financial statements a credit in an aggregate amount equal to the liability for unearned premiums and loss reserves and loss expense reserves ceded to the reinsurer. Many jurisdictions also permit ceding companies to take credit on their statutory financial statements for reinsurance obtained from unlicensed or non-admitted reinsurers if certain prescribed security arrangements are made. As an example, Markel Bermuda is currently not licensed, accredited or approved in any jurisdiction other than Bermuda. As a result, many of our reinsurance customers require Markel Bermuda to provide a letter of credit or enter into other security arrangements.
Other Regulation
Solicitors Regulation Authority. In connection with our acquisition of Abbey Protection plc in January 2014, we became the owner of Abbey Protection Group Limited (trading as Abbey Legal Services). Abbey Legal Services employs approximately 80 lawyers who provide legal services to small and medium-sized enterprises in the United Kingdom and owns Lewis Hymanson Small Solicitors LLP (LHS), a full service commercial law firm in Manchester, England.
Both LHS and the legal services of Abbey Legal Services are authorized and regulated by the Solicitors Regulation Authority (SRA). The SRA is an independent regulatory body of the Law Society of England and Wales which regulates the conduct of solicitors and law firms to protect consumers and to support the rule of law and the administration of justice. The SRA works within a statutory framework for regulation provided by the Solicitors Act 1974, the Administration of Justice Act 1985 and, primarily, by the Legal Services Act 2007.
Ratings
Financial stability and strength are important purchase considerations of policyholders, cedents and insurance agents and brokers. Because an insurance premium paid today purchases coverage for losses that might not be paid for many years, the financial viability of the insurer is of critical concern. Various independent rating agencies provide information and assign ratings to assist buyers in their search for financially sound insurers. Rating agencies periodically re-evaluate assigned ratings based upon changes in the insurer's operating results, financial condition or other significant factors influencing the insurer's business. Changes in assigned ratings could have an adverse impact on an insurer's ability to write new business.
Best assigns financial strength ratings (FSRs) to property and casualty insurance companies based on quantitative criteria such as profitability, leverage and liquidity, as well as qualitative assessments such as the spread of risk, the adequacy and soundness of ceded reinsurance, the quality and estimated market value of assets, the adequacy of loss reserves and surplus and the competence, experience and integrity of management. Best's FSRs range from "A++" (superior) to "F" (in liquidation).
Fourteen of our fifteen insurance subsidiaries are rated by Best. Twelve of our insurance subsidiaries rated by Best have been assigned an FSR of "A" (excellent), one is rated "A-" (excellent) and one is rated "B++" (good). Our Lloyd's syndicate is part of a group rating for the Lloyd's overall market, which has been assigned an FSR of "A" (excellent) by Best.
Fourteen of our fifteen insurance subsidiaries are rated by S&P. All fourteen insurance subsidiaries rated by S&P have been assigned an FSR of "A" (strong). Our Lloyd's syndicate is part of a group rating for the Lloyd's overall market, which has been assigned an FSR of "A+" (strong) by S&P.
Thirteen of our fifteen insurance subsidiaries are rated by Fitch Ratings (Fitch). All thirteen of our insurance subsidiaries rated by Fitch have been assigned an FSR of "A" (strong). Our Lloyd's syndicate is part of a group rating for the Lloyd's overall market, which has been assigned an FSR of "AA-" (very strong) by Fitch.
Six of our fifteen insurance subsidiaries are rated by Moody's Corporation (Moody's). All six insurance subsidiaries rated by Moody's have been assigned an FSR of "A2" (good).
The various rating agencies typically charge companies fees for the rating and other services they provide. During 2014, we paid rating agencies, including Best, S&P, Fitch and Moody's, $1.5 million for their services.
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Risk Factors
A wide range of factors could materially affect our future prospects and performance. The matters addressed under "Safe Harbor and Cautionary Statements," "Critical Accounting Estimates" and "Market Risk Disclosures" in Management's Discussion and Analysis of Financial Condition and Results of Operations and other information included or incorporated in this report describe many of the significant risks that could affect our operations and financial results. We are also subject to the following risks.
We may experience losses from catastrophes. As a property and casualty insurance company, we may experience losses from man-made or natural catastrophes. Catastrophes may have a material adverse effect on operations. Catastrophes include, but are not limited to, windstorms, hurricanes, earthquakes, tornadoes, hail, severe winter weather and fires and may include events related to terrorism and political unrest. While we employ catastrophe modeling tools in our underwriting process, we cannot predict how severe a particular catastrophe will be before it occurs. The extent of losses from catastrophes is a function of the total amount of losses incurred, the number of insureds affected, the frequency and severity of the events, the effectiveness of our catastrophe risk management program and the adequacy of our reinsurance coverage. Most catastrophes occur over a small geographic area; however, some catastrophes may produce significant damage in large, heavily populated areas. If, as many forecast, climate change results in an increase in the frequency and severity of weather-related catastrophes, we may experience additional catastrophe-related losses, which may be material.
Our results may be affected because actual insured or reinsured losses differ from our loss reserves. Significant periods of time often elapse between the occurrence of an insured or reinsured loss, the reporting of the loss to us and our payment of that loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and the related loss adjustment expenses. The process of estimating loss reserves is a difficult and complex exercise involving many variables and subjective judgments. This process may become more difficult if we experience a period of rising inflation. As part of the reserving process, we review historical data and consider the impact of such factors as:
• | trends in claim frequency and severity, |
• | changes in operations, |
• | emerging economic and social trends, |
• | uncertainties relating to asbestos and environmental exposures, |
• | inflation or deflation, and |
• | changes in the regulatory and litigation environments. |
This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves, and actual results will differ from original estimates. As part of the reserving process, we regularly review our loss reserves and make adjustments as necessary. Future increases in loss reserves will result in additional charges to earnings, which may be material.
In addition, reinsurance reserves are subject to greater uncertainty than insurance reserves primarily because a reinsurer relies on the original underwriting decisions made by ceding companies. As a result, we are subject to the risk that our ceding companies may not have adequately evaluated the risks reinsured by us and the premiums ceded may not adequately compensate us for the risks we assume. In addition, reinsurance reserves may be less reliable than insurance reserves because there is generally a longer lapse of time from the occurrence of the event to the reporting of the loss or benefit to the reinsurer and ultimate resolution or settlement of the loss.
Changes in the assumptions and estimates used in establishing reserves for our life and annuity reinsurance book could result in material increases in our estimated loss reserves for such business. As part of the acquisition of Alterra, we acquired a life and annuity reinsurance book, which has been in run-off since 2010. The life and annuity reinsurance contracts expose us to mortality risk, which is the risk that the level of death claims may differ from that which we assumed in establishing the reserves for our life and annuity reinsurance contracts. Some of our life and annuity reinsurance contracts expose us to longevity risk, which is the risk that an insured person will live longer than expected when the reserves were established, or morbidity risk, which is the risk that an insured person will become critically ill or disabled. Our reserving process for the life and annuity reinsurance book is designed with the objective of establishing appropriate reserves for the risks we assumed. Among other things, these processes rely heavily on analysis of mortality, longevity and morbidity trends, lapse rates, interest rates and expenses. As of December 31, 2014, our reserves for life and annuity benefits totaled $1.3 billion.
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We expect mortality, morbidity, longevity, and lapse experience to fluctuate somewhat from period to period, but believe they should remain reasonably predictable over a period of many years. Mortality, longevity, morbidity or lapse experience that is less favorable than the mortality, longevity, morbidity or lapse rates that we used in establishing the reserves for a reinsurance agreement will negatively affect our net income because the reserves we originally set for the risks we assumed may not be sufficient to cover the future claims and expense payments. Furthermore, even if the total benefits paid over the life of the contract do not exceed the expected amount, unexpected increases in the incidence of deaths or illness can cause us to pay more benefits in a given reporting period than expected, adversely affecting our net income in any particular reporting period. Fluctuations in interest rates will impact the performance of our investments. If there are changes to any of the above factors to the point where a reserve deficiency exists, a charge to earnings will be recorded, which may have a material adverse impact on our results of operations and financial condition.
We are subject to regulation by insurance regulatory authorities that may affect our ability to implement and achieve our business objectives. Our insurance subsidiaries are subject to supervision and regulation by the insurance regulatory authorities in the various jurisdictions in which they conduct business. This regulation is intended for the benefit of policyholders rather than shareholders or holders of debt securities. Insurance regulatory authorities have broad regulatory, supervisory and administrative powers relating to solvency standards, licensing, coverage requirements, policy rates and forms and the form and content of financial reports. Regulatory and legislative authorities continue to implement enhanced or new regulatory requirements intended to prevent future financial crises or otherwise assure the stability of financial institutions. Regulatory authorities also may seek to exercise their supervisory or enforcement authority in new or more aggressive ways, such as imposing increased capital requirements. Any such actions, if they occur, could affect the competitive market and the way we conduct our business and manage our capital. As a result, such actions could materially affect our results of operations, financial condition and liquidity.
Our ability to make payments on debt or other obligations depends on the receipt of funds from our subsidiaries. We are a holding company, and substantially all of our insurance operations are conducted through our regulated insurance subsidiaries. As a result, our cash flow and our ability to service our debt are dependent upon the earnings of our subsidiaries and on the distribution of earnings, loans or other payments by our subsidiaries to us. In addition, payment of dividends by our insurance subsidiaries may require prior regulatory notice or approval.
Our investment results may be impacted by changes in interest rates, U.S. and international monetary and fiscal policies as well as broader economic conditions. We receive premiums from customers for insuring their risks. We invest these funds until they are needed to pay policyholder claims or until they are recognized as profits. Fluctuations in the value of our investment portfolio can occur as a result of changes in interest rates and U.S. and international monetary and fiscal policies as well as broader economic conditions (including, for example, equity market conditions and significant inflation or deflation). Our investment results may be materially impacted by one or more of these factors.
Competition in the insurance and reinsurance markets could reduce our underwriting margins. Insurance and reinsurance markets are highly competitive. We compete on an international and regional basis with major U.S., Bermuda, European, and other international insurers and reinsurers and with underwriting syndicates, some of which have greater financial, marketing, and management resources than we do. Recent industry consolidation, including business combinations among insurance and other financial services companies, has resulted in larger competitors with even greater financial resources. We also compete with new companies that continue to be formed to enter the insurance and reinsurance markets. In addition, capital market participants have created alternative products that are intended to compete with reinsurance products. Increased competition could result in fewer submissions, lower premium rates, and less favorable policy terms and conditions, which could reduce our underwriting margins and have a material adverse effect on our results of operations and financial condition.
The historical cyclicality in the property and casualty insurance industry could adversely affect our ability to improve or maintain underwriting margins or to grow or maintain premium volume. The insurance and reinsurance markets have historically been cyclical, characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity permitted more favorable rate levels. Among our competitive strengths have been our specialty product focus and our niche market strategy. These strengths also make us vulnerable in periods of intense competition to actions by other insurance companies who seek to write additional premiums without appropriate regard for underwriting profitability. During soft markets, it is very difficult for us to grow or maintain premium volume levels without sacrificing underwriting profits. If we are not successful in maintaining rates or achieving rate increases, it may be difficult for us to improve or maintain underwriting margins or to grow or maintain premium volume levels.
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We invest a significant portion of our invested assets in equity securities, which may result in significant variability in our investment results and may adversely impact shareholders' equity. Additionally, our equity investment portfolio is concentrated, and declines in the value of these significant investments could adversely affect our financial results. Equity securities were 54% and 49% of our shareholders' equity at December 31, 2014 and 2013, respectively. Equity securities have historically produced higher returns than fixed maturities; however, investing in equity securities may result in significant variability in investment returns from one period to the next. In volatile financial markets, we could experience significant declines in the fair value of our equity investment portfolio, which would result in a material decrease in shareholders' equity. Our equity portfolio is concentrated in particular issuers and industries and, as a result, a decline in the fair value of these concentrated investments also could result in a material decrease in shareholders' equity. A material decrease in shareholders' equity may adversely impact our ability to carry out our business plans.
Deterioration in financial markets could lead to investment losses and adverse effects on our business. In the event of a major financial crisis, similar to the downturn in the public debt and equity markets that began in 2008 (for example, a crisis precipitated by one or more of the following: the failure to adequately address U.S. government deficit spending and tax revenue generation, downgrades or defaults in U.S. or foreign sovereign debt obligations, the collapse of the Eurozone or material changes to the monetary policies of the U.S. Federal Reserve or the European Central Bank), we could incur substantial realized and unrealized investment losses in future periods, which would have an adverse impact on our results of operations, financial condition, debt and financial strength ratings, insurance subsidiaries' capital and ability to access capital markets.
We rely on the purchase of reinsurance and bear collection risk if the reinsurer fails to meet its obligations under the reinsurance agreement. We purchase reinsurance and retrocessional reinsurance to manage our net retention on individual risks and overall exposure to losses, while providing us with the ability to offer policies with sufficient limits to meet policyholder needs. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies. Reliance on reinsurance may create credit risk as a result of the reinsurer's inability or unwillingness to pay reinsurance claims when due. Deterioration in the credit quality of existing reinsurers or disputes over the terms of reinsurance could result in charges to earnings, which may have a material adverse impact on our results of operations and financial condition. The availability and cost of reinsurance are determined by market conditions beyond our control. There is no guarantee that our desired amounts of reinsurance or retrocessional reinsurance will be available in the marketplace in the future.
Our information technology systems could fail or suffer a security breach, which could adversely affect our business or reputation or result in the loss of sensitive information. Our businesses are dependent upon the successful functioning and security of our computer systems or the computer systems of third parties. Among other things, we rely on these systems to interact with producers, insureds, customers, clients, and other third parties, to perform actuarial and other modeling functions, to underwrite business, to prepare policies and process premiums, to process claims and make claims payments, to prepare internal and external financial statements and information, as well as to engage in a wide variety of other business activities. A significant failure of our computer systems, or those of third parties upon which we may rely, whether because of a breakdown, natural disaster or an attack on our systems, could compromise our personal, confidential and proprietary information as well as that of our customers and business partners, impede or interrupt our business operations and could result in other negative consequences, including remediation costs, loss of revenue, additional regulatory scrutiny and fines, litigation and monetary and reputational damages.
In addition, we are subject to numerous data privacy laws and regulations enacted in the jurisdictions in which we do business. A misuse or mishandling of confidential or proprietary information being sent to or received from a client, employee or third party could result in legal liability, regulatory action and reputational harm. Third parties to whom we outsource certain of our functions are also subject to these risks, and their failure to adhere to these laws and regulations could negatively impact us.
Further, we routinely transmit, receive and store personal, confidential and proprietary information by email and other electronic means. Although we attempt to protect this confidential and proprietary information, we may be unable to do so in all cases, especially with customers, business partners and other third parties who may not have or use appropriate controls to protect confidential information.
While we maintain cyber risk insurance providing first party and third party coverages, such insurance may not cover all costs associated with the consequences of personal and confidential and proprietary information being compromised. As a result, in the event of a material cyber security breach, our results of operations could be materially, adversely affected.
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We may not find suitable acquisition candidates or new insurance or non-insurance ventures and even if we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures. As part of our growth strategy, we continue to evaluate possible acquisition transactions on an ongoing basis, and at any given time we may be engaged in discussions with respect to possible acquisitions and new ventures. We may not be able to identify suitable acquisition targets or ventures, any such transactions may not be financed or completed on acceptable terms and our future acquisitions or ventures may not be successful.
The integration of acquired companies may not be as successful as we anticipate. We have recently engaged in a number of acquisitions in an effort to achieve profitable growth in our insurance operations and to create additional value on a diversified basis in our Markel Ventures operations. Acquisitions present operational, strategic and financial risks, as well as risks associated with liabilities arising from the previous operations of the acquired companies. All of these risks are magnified in the case of a large acquisition, such as the Alterra acquisition. Assimilation of the operations and personnel of acquired companies may prove more difficult than anticipated, which may result in failure to achieve financial objectives associated with the acquisition or diversion of management attention. In addition, integration of formerly privately-held companies into the management and internal control and financial reporting systems of a publicly-held company presents additional risks.
The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or on our results of operations. We seek to limit our loss exposure in a variety of ways, including adhering to maximum limitations on policies written in defined geographical zones, limiting program size for each client, establishing per risk and per occurrence limitations for each event, employing coverage restrictions and following prudent underwriting guidelines for each program written. We also seek to limit our loss exposure through geographic diversification. Underwriting is a matter of judgment, involving assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. One or more future events could result in claims that substantially exceed our expectations, which could have a material adverse effect on our financial condition and our results of operations, possibly to the extent of eliminating our shareholders' equity. In addition, we seek to limit loss exposures by policy terms, exclusion from coverage and choice of legal forum. Disputes relating to coverage and choice of legal forum also arise. As a result, various provisions of our policies, such as choice of forum, limitations or exclusions from coverage may not be enforceable in the manner we intend and some or all of our loss limitation methods may prove ineffective.
The effects of emerging claim and coverage issues on our business are uncertain. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either broadening coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance or reinsurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance or reinsurance contracts may not be known for many years after a contract is issued.
We could be adversely affected by the loss of one or more key executives or by an inability to attract and retain qualified personnel. Our success depends on our ability to retain the services of our existing key executives and to attract and retain additional qualified personnel in the future. The loss of the services of any of our key executives or the inability to hire and retain other highly qualified personnel in the future could adversely affect our ability to conduct or grow our business.
Our expanding international operations expose us to increased investment, political and economic risks, including foreign currency and credit risk. Our expanding international operations in the United Kingdom, Europe, Asia and South America expose us to increased investment, political and economic risks, including foreign currency and credit risk. Changes in the value of the U.S. dollar relative to other currencies could have an adverse effect on our results of operations and financial condition. Our investments in non-U.S. dollar-denominated securities are subject to fluctuations in non-U.S. securities and currency markets, and those markets can be volatile.
We are rated by Best, S&P, Fitch and Moody's, and a decline in these ratings could affect our standing in the insurance industry and cause our sales and earnings to decrease. Ratings are an important factor in establishing the competitive position of insurance and reinsurance companies. Certain of our insurance and reinsurance company subsidiaries are rated by Best, S&P, Fitch or Moody's. Our ratings are subject to periodic review, and we cannot be sure that we will be able to retain our current or any future ratings. If our ratings are reduced from their current levels by the rating agencies, our competitive position in our target markets within the insurance industry could suffer and it would be more difficult for us to market our products. A ratings downgrade could also adversely limit our access to capital markets, which may increase the cost of debt. A significant downgrade could result in a substantial loss of business as policyholders move to other companies with higher claims-paying and financial strength ratings.
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We depend on a few brokers for a large portion of our revenues and the loss of business provided by any one of them could adversely affect us. We market our insurance and reinsurance worldwide through insurance and reinsurance brokers. For the year ended December 31, 2014, our top three independent brokers represented approximately 28% of our gross premiums written. Loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our business.
Employee error and misconduct may be difficult to detect and prevent and may result in significant losses. There have been a number of cases involving misconduct by employees in a broad range of industries in recent years, and we run the risk that employee misconduct could occur. Instances of fraud, illegal acts, errors, failure to document transactions properly or to obtain proper internal authorization, or failure to comply with regulatory requirements or our internal policies may result in losses. It is not always possible to deter or prevent employee errors or misconduct, and the controls that we have in place to prevent and detect this activity may not be effective in all cases.
Our businesses and operations are subject to applicable laws and regulations relating to sanctions and foreign corrupt practices, the violation of which could adversely affect our operations. In our global businesses and operations we are required to comply with the economic sanctions and embargo programs administered by the United States Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) and similar multi-national bodies and governmental agencies worldwide, as well as applicable anti-corruption laws and regulations of the United States and other jurisdictions where we operate, including the United Kingdom and Europe. A violation of a sanction, embargo program, or anti-corruption law, could subject us, and individual employees, to a regulatory enforcement action as well as significant civil and criminal penalties. In addition, a violation could result in defaults under our outstanding indebtedness or credit facilities or damage our businesses and/or our reputation. Those penalties or defaults, or damage to our businesses and/or reputation, could have a material adverse effect on our results of operations and financial condition.
Compliance with the legal and regulatory requirements applicable to our businesses is extensive. Any failure to comply could have a material adverse effect on our businesses. Our businesses are highly dependent on our ability to engage on a daily basis in a large number of financial and operational activities, including among others insurance underwriting, claim processing and investment activities, many of which are highly complex. These activities often are subject to internal guidelines and policies, as well as legal and regulatory standards, including, among others, those related to privacy, anti-corruption, anti-bribery and global finance and insurance matters. Our continued expansion into new markets has brought about additional requirements. While we believe that we have adopted appropriate risk management and compliance programs, compliance risks will continue to exist, particularly as we adapt to new rules and regulations. Failure to comply with, or to obtain, appropriate authorizations and/or exemptions under any applicable laws and regulations could result in restrictions on our ability to do business or undertake activities that are regulated in one or more of the jurisdictions in which we conduct business and could subject us to fines, penalties, equitable relief and changes to our business practices. In addition, a failure to comply could result in defaults under our outstanding indebtedness or credit facilities or damage our businesses and/or our reputation. Compliance with applicable laws and regulations is time consuming and personnel-intensive, and changes in these laws and regulations may materially increase our direct and indirect compliance and other expenses of doing business, thus having a material adverse effect on our results of operations and financial condition.
Associates
At December 31, 2014, we had approximately 8,600 employees, of whom approximately 3,600 were employed within our insurance operations and approximately 5,000 were employed within our Markel Ventures operations.
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SELECTED FINANCIAL DATA (dollars in millions, except per share data) (1), (2)
2014 | 2013 | 2012 | |||||||||
Results of Operations | |||||||||||
Earned premiums | $ | 3,841 | $ | 3,232 | $ | 2,147 | |||||
Net investment income | 363 | 317 | 282 | ||||||||
Total operating revenues | 5,134 | 4,323 | 3,000 | ||||||||
Net income (loss) to shareholders | 321 | 281 | 253 | ||||||||
Comprehensive income (loss) to shareholders | 936 | 459 | 504 | ||||||||
Diluted net income (loss) per share | $ | 22.27 | $ | 22.48 | $ | 25.89 | |||||
Financial Position | |||||||||||
Total investments, cash and cash equivalents and restricted cash and cash equivalents (invested assets) | $ | 18,638 | $ | 17,612 | $ | 9,333 | |||||
Total assets | 25,200 | 23,956 | 12,557 | ||||||||
Unpaid losses and loss adjustment expenses | 10,404 | 10,262 | 5,371 | ||||||||
Senior long-term debt and other debt | 2,254 | 2,256 | 1,493 | ||||||||
Shareholders' equity | 7,595 | 6,674 | 3,889 | ||||||||
Common shares outstanding (at year end, in thousands) | 13,962 | 13,986 | 9,629 | ||||||||
OPERATING PERFORMANCE MEASURES (1, 2, 3) | |||||||||||
Operating Data | |||||||||||
Book value per common share outstanding | $ | 543.96 | $ | 477.16 | $ | 403.85 | |||||
Growth (decline) in book value per share | 14 | % | 18 | % | 15 | % | |||||
5-Year CAGR in book value per share (4) | 14 | % | 17 | % | 9 | % | |||||
Closing stock price | $ | 682.84 | $ | 580.35 | $ | 433.42 | |||||
Ratio Analysis | |||||||||||
U.S. GAAP combined ratio (5) | 95 | % | 97 | % | 97 | % | |||||
Investment yield (6) | 2 | % | 3 | % | 4 | % | |||||
Taxable equivalent total investment return (7) | 7 | % | 7 | % | 9 | % | |||||
Investment leverage (8) | 2.5 | 2.6 | 2.4 | ||||||||
Debt to capital | 23 | % | 25 | % | 28 | % | |||||
(1) | Reflects the acquisition of Alterra Capital Holdings Limited effective May 1, 2013, which included the issuance of equity totaling $2.3 billion. |
(2) | Effective January 1, 2012, we prospectively adopted Financial Accounting Standards Board Accounting Standards Update No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. |
(3) | Operating Performance Measures provide a basis for management to evaluate our performance. The method we use to compute these measures may differ from the methods used by other companies. See further discussion of management's evaluation of these measures in Management's Discussion & Analysis of Financial Condition and Results of Operations. |
(4) | CAGR—compound annual growth rate. |
(5) | The U.S. GAAP combined ratio measures the relationship of incurred losses, loss adjustment expenses and underwriting, acquisition and insurance expenses to earned premiums. |
(6) | Investment yield reflects net investment income as a percentage of monthly average invested assets at amortized cost. |
(7) | See "Investing Results" in Management's Discussion & Analysis of Financial Condition and Results of Operations for detail regarding the calculation of taxable equivalent total investment return. |
(8) | Investment leverage represents total invested assets divided by shareholders' equity. |
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2011 | 2010 | 2009 | 2008 | 2007 | 2006 | 2005 | 5-Year CAGR (4) | 10-Year CAGR (4) | ||||||||||||||||||||||||
$ | 1,979 | $ | 1,731 | $ | 1,816 | $ | 2,022 | $ | 2,117 | $ | 2,184 | $ | 1,938 | 16 | % | 6 | % | |||||||||||||||
264 | 273 | 260 | 282 | 305 | 269 | 242 | 7 | % | 6 | % | ||||||||||||||||||||||
2,630 | 2,225 | 2,069 | 1,977 | 2,551 | 2,576 | 2,200 | 20 | % | 9 | % | ||||||||||||||||||||||
142 | 267 | 202 | (59 | ) | 406 | 393 | 148 | — | — | |||||||||||||||||||||||
252 | 431 | 591 | (403 | ) | 337 | 551 | 64 | — | — | |||||||||||||||||||||||
$ | 14.60 | $ | 27.27 | $ | 20.52 | $ | (5.95 | ) | $ | 40.64 | $ | 39.40 | $ | 14.80 | — | — | ||||||||||||||||
$ | 8,728 | $ | 8,224 | $ | 7,849 | $ | 6,893 | $ | 7,775 | $ | 7,524 | $ | 6,588 | 19 | % | 11 | % | |||||||||||||||
11,532 | 10,826 | 10,242 | 9,512 | 10,164 | 10,117 | 9,814 | 20 | % | 10 | % | ||||||||||||||||||||||
5,399 | 5,398 | 5,427 | 5,492 | 5,526 | 5,584 | 5,864 | 14 | % | 7 | % | ||||||||||||||||||||||
1,294 | 1,016 | 964 | 694 | 691 | 866 | 849 | — | — | ||||||||||||||||||||||||
3,388 | 3,172 | 2,774 | 2,181 | 2,641 | 2,296 | 1,705 | 22 | % | 16 | % | ||||||||||||||||||||||
9,621 | 9,718 | 9,819 | 9,814 | 9,957 | 9,994 | 9,799 | — | — | ||||||||||||||||||||||||
$ | 352.10 | $ | 326.36 | $ | 282.55 | $ | 222.20 | $ | 265.26 | $ | 229.78 | $ | 174.04 | 14 | % | 12 | % | |||||||||||||||
8 | % | 16 | % | 27 | % | (16 | )% | 15 | % | 32 | % | 3 | % | — | — | |||||||||||||||||
9 | % | 13 | % | 11 | % | 10 | % | 18 | % | 16 | % | 11 | % | — | — | |||||||||||||||||
$ | 414.67 | $ | 378.13 | $ | 340.00 | $ | 299.00 | $ | 491.10 | $ | 480.10 | $ | 317.05 | — | — | |||||||||||||||||
102 | % | 97 | % | 95 | % | 99 | % | 88 | % | 87 | % | 101 | % | — | — | |||||||||||||||||
4 | % | 4 | % | 4 | % | 4 | % | 4 | % | 4 | % | 4 | % | — | — | |||||||||||||||||
7 | % | 8 | % | 13 | % | (10 | )% | 5 | % | 11 | % | 2 | % | — | — | |||||||||||||||||
2.6 | 2.6 | 2.8 | 3.2 | 2.9 | 3.3 | 3.9 | — | — | ||||||||||||||||||||||||
28 | % | 24 | % | 26 | % | 24 | % | 21 | % | 27 | % | 33 | % | — | — | |||||||||||||||||
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MARKEL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, | |||||||
2014 | 2013 | ||||||
(dollars in thousands) | |||||||
ASSETS | |||||||
Investments, available-for-sale, at estimated fair value: | |||||||
Fixed maturities (amortized cost of $9,929,137 in 2014 and $10,129,141 in 2013) | $ | 10,422,882 | $ | 10,142,536 | |||
Equity securities (cost of $1,951,658 in 2014 and $1,566,553 in 2013) | 4,137,576 | 3,251,798 | |||||
Short-term investments (estimated fair value approximates cost) | 1,594,849 | 1,452,288 | |||||
Total Investments | 16,155,307 | 14,846,622 | |||||
Cash and cash equivalents | 1,960,169 | 1,978,526 | |||||
Restricted cash and cash equivalents | 522,225 | 786,926 | |||||
Receivables | 1,135,217 | 1,141,773 | |||||
Reinsurance recoverable on unpaid losses | 1,868,669 | 1,854,414 | |||||
Reinsurance recoverable on paid losses | 102,206 | 102,002 | |||||
Deferred policy acquisition costs | 353,410 | 260,967 | |||||
Prepaid reinsurance premiums | 365,458 | 383,559 | |||||
Goodwill | 1,049,115 | 967,717 | |||||
Intangible assets | 702,747 | 565,083 | |||||
Other assets | 985,834 | 1,067,922 | |||||
Total Assets | $ | 25,200,357 | $ | 23,955,511 | |||
LIABILITIES AND EQUITY | |||||||
Unpaid losses and loss adjustment expenses | $ | 10,404,152 | $ | 10,262,056 | |||
Life and annuity benefits | 1,305,818 | 1,486,574 | |||||
Unearned premiums | 2,245,690 | 2,127,115 | |||||
Payables to insurance and reinsurance companies | 276,122 | 295,496 | |||||
Senior long-term debt and other debt (estimated fair value of $2,493,000 in 2014 and $2,372,000 in 2013) | 2,253,594 | 2,256,227 | |||||
Other liabilities | 1,051,931 | 777,850 | |||||
Total Liabilities | 17,537,307 | 17,205,318 | |||||
Redeemable noncontrolling interests | 61,048 | 72,183 | |||||
Commitments and contingencies | |||||||
Shareholders' equity: | |||||||
Common stock | 3,308,395 | 3,288,863 | |||||
Retained earnings | 2,581,866 | 2,294,909 | |||||
Accumulated other comprehensive income | 1,704,557 | 1,089,805 | |||||
Total Shareholders' Equity | 7,594,818 | 6,673,577 | |||||
Noncontrolling interests | 7,184 | 4,433 | |||||
Total Equity | 7,602,002 | 6,678,010 | |||||
Total Liabilities and Equity | $ | 25,200,357 | $ | 23,955,511 | |||
See accompanying notes to consolidated financial statements.
29
MARKEL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Years Ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
(dollars in thousands, except per share data) | |||||||||||
OPERATING REVENUES | |||||||||||
Earned premiums | $ | 3,840,912 | $ | 3,231,616 | $ | 2,147,128 | |||||
Net investment income | 363,230 | 317,373 | 282,107 | ||||||||
Net realized investment gains: | |||||||||||
Other-than-temporary impairment losses | (4,784 | ) | (4,706 | ) | (12,078 | ) | |||||
Net realized investment gains, excluding other-than-temporary impairment losses | 50,784 | 67,858 | 43,671 | ||||||||
Net realized investment gains | 46,000 | 63,152 | 31,593 | ||||||||
Other revenues | 883,525 | 710,942 | 539,284 | ||||||||
Total Operating Revenues | 5,133,667 | 4,323,083 | 3,000,112 | ||||||||
OPERATING EXPENSES | |||||||||||
Losses and loss adjustment expenses | 2,202,467 | 1,816,273 | 1,154,068 | ||||||||
Underwriting, acquisition and insurance expenses | 1,460,882 | 1,312,312 | 929,472 | ||||||||
Amortization of intangible assets | 57,627 | 55,223 | 33,512 | ||||||||
Other expenses | 854,871 | 663,528 | 478,248 | ||||||||
Total Operating Expenses | 4,575,847 | 3,847,336 | 2,595,300 | ||||||||
Operating Income | 557,820 | 475,747 | 404,812 | ||||||||
Interest expense | 117,442 | 114,004 | 92,762 | ||||||||
Income Before Income Taxes | 440,378 | 361,743 | 312,050 | ||||||||
Income tax expense | 116,690 | 77,898 | 53,802 | ||||||||
Net Income | $ | 323,688 | $ | 283,845 | $ | 258,248 | |||||
Net income attributable to noncontrolling interests | 2,506 | 2,824 | 4,863 | ||||||||
Net Income to Shareholders | $ | 321,182 | $ | 281,021 | $ | 253,385 | |||||
OTHER COMPREHENSIVE INCOME | |||||||||||
Change in net unrealized gains on investments, net of taxes: | |||||||||||
Net holding gains arising during the period | $ | 687,735 | $ | 225,545 | $ | 266,425 | |||||
Change in unrealized other-than-temporary impairment losses on fixed maturities arising during the period | 173 | (141 | ) | (160 | ) | ||||||
Reclassification adjustments for net gains included in net income | (26,161 | ) | (40,830 | ) | (24,051 | ) | |||||
Change in net unrealized gains on investments, net of taxes | 661,747 | 184,574 | 242,214 | ||||||||
Change in foreign currency translation adjustments, net of taxes | (32,241 | ) | (10,143 | ) | 1,534 | ||||||
Change in net actuarial pension loss, net of taxes | (14,750 | ) | 4,065 | 6,664 | |||||||
Total Other Comprehensive Income | 614,756 | 178,496 | 250,412 | ||||||||
Comprehensive Income | $ | 938,444 | $ | 462,341 | $ | 508,660 | |||||
Comprehensive income attributable to noncontrolling interests | 2,510 | 2,852 | 4,858 | ||||||||
Comprehensive Income to Shareholders | $ | 935,934 | $ | 459,489 | $ | 503,802 | |||||
NET INCOME PER SHARE | |||||||||||
Basic | $ | 22.38 | $ | 22.57 | $ | 25.96 | |||||
Diluted | $ | 22.27 | $ | 22.48 | $ | 25.89 | |||||
See accompanying notes to consolidated financial statements.
30
MARKEL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(in thousands) | Common Shares | Common Stock | Retained Earnings | Accumulated Other Comprehensive Income | Total Shareholders' Equity | Noncontrolling Interests | Total Equity | Redeemable Noncontrolling Interests | ||||||||||||||||||||||
December 31, 2011 | 9,621 | $ | 891,507 | $ | 1,835,086 | $ | 660,920 | $ | 3,387,513 | $ | 602 | $ | 3,388,115 | $ | 74,231 | |||||||||||||||
Net income (loss) | 253,385 | — | 253,385 | (262 | ) | 253,123 | 5,125 | |||||||||||||||||||||||
Other comprehensive income (loss) | — | 250,417 | 250,417 | — | 250,417 | (5 | ) | |||||||||||||||||||||||
Comprehensive Income (Loss) | 503,802 | (262 | ) | 503,540 | 5,120 | |||||||||||||||||||||||||
Issuance of common stock | 47 | 9,145 | — | — | 9,145 | — | 9,145 | — | ||||||||||||||||||||||
Repurchase of common stock | (39 | ) | — | (16,873 | ) | — | (16,873 | ) | — | (16,873 | ) | — | ||||||||||||||||||
Restricted stock awards expensed | — | 6,462 | — | — | 6,462 | — | 6,462 | — | ||||||||||||||||||||||
Acquisitions | — | — | — | — | — | — | — | 15,055 | ||||||||||||||||||||||
Adjustment of redeemable noncontrolling interests | — | — | (3,101 | ) | — | (3,101 | ) | — | (3,101 | ) | 3,101 | |||||||||||||||||||
Purchase of noncontrolling interest | — | 1,430 | — | — | 1,430 | — | 1,430 | (3,573 | ) | |||||||||||||||||||||
Other | — | 436 | (157 | ) | — | 279 | 20 | 299 | (7,709 | ) | ||||||||||||||||||||
December 31, 2012 | 9,629 | 908,980 | 2,068,340 | 911,337 | 3,888,657 | 360 | 3,889,017 | 86,225 | ||||||||||||||||||||||
Net income (loss) | 281,021 | — | 281,021 | (958 | ) | 280,063 | 3,782 | |||||||||||||||||||||||
Other comprehensive income | — | 178,468 | 178,468 | — | 178,468 | 28 | ||||||||||||||||||||||||
Comprehensive Income (Loss) | 459,489 | (958 | ) | 458,531 | 3,810 | |||||||||||||||||||||||||
Issuance of common stock | 71 | 24,518 | — | — | 24,518 | — | 24,518 | — | ||||||||||||||||||||||
Repurchase of common stock | (109 | ) | — | (57,388 | ) | — | (57,388 | ) | — | (57,388 | ) | — | ||||||||||||||||||
Restricted stock awards expensed | (3 | ) | 25,239 | — | — | 25,239 | — | 25,239 | — | |||||||||||||||||||||
Acquisition of Alterra | 4,398 | 2,330,199 | — | — | 2,330,199 | — | 2,330,199 | — | ||||||||||||||||||||||
Adjustment of redeemable noncontrolling interests | — | — | 1,963 | — | 1,963 | — | 1,963 | (1,963 | ) | |||||||||||||||||||||
Purchase of noncontrolling interest | — | (136 | ) | — | — | (136 | ) | — | (136 | ) | (11,716 | ) | ||||||||||||||||||
Other | — | 63 | 973 | — | 1,036 | 5,031 | 6,067 | (4,173 | ) | |||||||||||||||||||||
December 31, 2013 | 13,986 | 3,288,863 | 2,294,909 | 1,089,805 | 6,673,577 | 4,433 | 6,678,010 | 72,183 | ||||||||||||||||||||||
Net income (loss) | 321,182 | — | 321,182 | (1,981 | ) | 319,201 | 4,487 | |||||||||||||||||||||||
Other comprehensive income | — | 614,752 | 614,752 | — | 614,752 | 4 | ||||||||||||||||||||||||
Comprehensive Income (Loss) | 935,934 | (1,981 | ) | 933,953 | 4,491 | |||||||||||||||||||||||||
Issuance of common stock | 19 | 5,691 | — | — | 5,691 | — | 5,691 | — | ||||||||||||||||||||||
Repurchase of common stock | (43 | ) | — | (26,053 | ) | — | (26,053 | ) | — | (26,053 | ) | — | ||||||||||||||||||
Restricted stock awards expensed | — | 22,935 | — | — | 22,935 | — | 22,935 | — | ||||||||||||||||||||||
Adjustment of redeemable noncontrolling interests | — | — | (8,186 | ) | — | (8,186 | ) | — | (8,186 | ) | 8,186 | |||||||||||||||||||
Purchase of noncontrolling interest | — | (10,257 | ) | — | — | (10,257 | ) | 905 | (9,352 | ) | (18,566 | ) | ||||||||||||||||||
Other | — | 1,163 | 14 | — | 1,177 | 3,827 | 5,004 | (5,246 | ) | |||||||||||||||||||||
December 31, 2014 | 13,962 | $ | 3,308,395 | $ | 2,581,866 | $ | 1,704,557 | $ | 7,594,818 | $ | 7,184 | $ | 7,602,002 | $ | 61,048 | |||||||||||||||
See accompanying notes to consolidated financial statements.
31
MARKEL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
(dollars in thousands) | |||||||||||
OPERATING ACTIVITIES | |||||||||||
Net income | $ | 323,688 | $ | 283,845 | $ | 258,248 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Deferred income tax expense | 84,543 | 4,050 | 37,648 | ||||||||
Depreciation and amortization | 203,580 | 190,066 | 87,326 | ||||||||
Net realized investment gains | (46,000 | ) | (63,152 | ) | (31,593 | ) | |||||
Decrease (increase) in receivables | 21,148 | 142,065 | (36,590 | ) | |||||||
Decrease (increase) in deferred policy acquisition costs | (99,387 | ) | (103,704 | ) | 37,209 | ||||||
Increase (decrease) in unpaid losses and loss adjustment expenses, net | 249,873 | 290,130 | (28,052 | ) | |||||||
Decrease in life and annuity benefits | (62,883 | ) | (40,235 | ) | — | ||||||
Increase in unearned premiums, net | 147,840 | 97,249 | 71,073 | ||||||||
Increase (decrease) in payables to insurance and reinsurance companies | (45,204 | ) | (150,764 | ) | 19,190 | ||||||
Increase (decrease) in income taxes payable | (46,576 | ) | 81,995 | (9,909 | ) | ||||||
Other | (13,830 | ) | 13,976 | (12,017 | ) | ||||||
Net Cash Provided By Operating Activities | 716,792 | 745,521 | 392,533 | ||||||||
INVESTING ACTIVITIES | |||||||||||
Proceeds from sales of fixed maturities and equity securities | 1,286,871 | 879,564 | 336,548 | ||||||||
Proceeds from maturities, calls and prepayments of fixed maturities | 1,420,817 | 1,475,938 | 510,697 | ||||||||
Cost of fixed maturities and equity securities purchased | (3,153,055 | ) | (1,651,397 | ) | (426,439 | ) | |||||
Net change in short-term investments | (129,164 | ) | (470,423 | ) | (428,292 | ) | |||||
Proceeds from sales of equity method investments | 107,292 | 313,557 | — | ||||||||
Cost of equity method investments | (16,081 | ) | (38,018 | ) | (40,650 | ) | |||||
Change in restricted cash and cash equivalents | 264,701 | (263,014 | ) | (37,642 | ) | ||||||
Additions to property and equipment | (82,132 | ) | (47,725 | ) | (45,519 | ) | |||||
Acquisitions, net of cash acquired | (319,086 | ) | (12,198 | ) | (243,675 | ) | |||||
Other | (2,368 | ) | 1,103 | (2,158 | ) | ||||||
Net Cash Provided (Used) By Investing Activities | (622,205 | ) | 187,387 | (377,130 | ) | ||||||
FINANCING ACTIVITIES | |||||||||||
Additions to senior long-term debt and other debt | 89,480 | 547,214 | 492,792 | ||||||||
Repayment and retirement of senior long-term debt and other debt | (83,722 | ) | (321,978 | ) | (313,790 | ) | |||||
Repurchases of common stock | (26,053 | ) | (57,388 | ) | (16,873 | ) | |||||
Issuance of common stock | 5,691 | 24,518 | 9,145 | ||||||||
Purchase of redeemable noncontrolling interests | (25,918 | ) | (11,852 | ) | (2,143 | ) | |||||
Distributions to noncontrolling interests | (5,245 | ) | (5,124 | ) | (7,684 | ) | |||||
Other | (21,357 | ) | (23 | ) | (19,485 | ) | |||||
Net Cash Provided (Used) By Financing Activities | (67,124 | ) | 175,367 | 141,962 | |||||||
Effect of foreign currency rate changes on cash and cash equivalents | (45,820 | ) | 6,485 | 3,142 | |||||||
Increase (decrease) in cash and cash equivalents | (18,357 | ) | 1,114,760 | 160,507 | |||||||
Cash and cash equivalents at beginning of year | 1,978,526 | 863,766 | 703,259 | ||||||||
CASH AND CASH EQUIVALENTS AT END OF YEAR | $ | 1,960,169 | $ | 1,978,526 | $ | 863,766 | |||||
See accompanying notes to consolidated financial statements.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Markel Corporation is a diverse financial holding company serving a variety of niche markets. Markel Corporation's principal business markets and underwrites specialty insurance products. Through its wholly-owned subsidiary, Markel Ventures, Inc. (Markel Ventures), Markel Corporation also owns interests in various industrial and service businesses that operate outside of the specialty insurance marketplace.
On May 1, 2013 (the Acquisition Date), Markel Corporation completed the acquisition of 100% of the issued and outstanding common stock of Alterra Capital Holdings Limited (Alterra).
a)Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and include the accounts of Markel Corporation and its subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements include the results of operations and cash flows of Alterra from the Acquisition Date to December 31, 2014 and not in any prior periods, except with respect to the Supplemental Pro Forma Information included in note 2. The Company consolidates the results of its Markel Ventures subsidiaries on a one-month lag. Certain prior year amounts have been reclassified to conform to the current presentation.
b)Use of Estimates. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Management periodically reviews its estimates and assumptions. Quarterly reviews include evaluating the adequacy of reserves for unpaid losses and loss adjustment expenses, life and annuity reinsurance benefit reserves, litigation contingencies, the reinsurance allowance for doubtful accounts and income tax liabilities, as well as analyzing the recoverability of deferred tax assets, estimating reinsurance premiums written and earned and evaluating the investment portfolio for other-than-temporary declines in estimated fair value. Estimates and assumptions for goodwill and intangible assets are reviewed in conjunction with an acquisition, and goodwill and indefinite-lived intangible assets are reassessed at least annually for impairment. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.
c)Investments. Available-for-sale investments are recorded at estimated fair value. Unrealized gains and losses on investments, net of deferred income taxes, are included in accumulated other comprehensive income in shareholders' equity. The Company completes a detailed analysis each quarter to assess whether the decline in the fair value of any investment below its cost basis is deemed other-than-temporary.
Premiums and discounts are amortized or accreted over the lives of the related fixed maturities as an adjustment to the yield using the effective interest method. Dividend and interest income are recognized when earned. Realized investment gains or losses are included in earnings. Realized gains or losses from sales of investments are derived using the first-in, first-out method.
Investments accounted for under the equity method of accounting are recorded at cost within other assets on the consolidated balance sheets and subsequently increased or decreased by the Company's proportionate share of the net income or loss of the investee. The Company records its proportionate share of net income or loss of the investee in net investment income. The Company records its proportionate share of other comprehensive income or loss of the investee as a component of other comprehensive income. Dividends or other equity distributions are recorded as a reduction of the investment. The Company reviews equity method investments for impairment when events or circumstances indicate that a decline in the fair value of the investment below its carrying value is other-than-temporary.
d)Cash and Cash Equivalents. The Company considers all investments with original maturities of 90 days or less to be cash equivalents. The carrying value of the Company's cash and cash equivalents and restricted cash and cash equivalents approximates fair value.
33
e)Receivables. Receivables include amounts receivable from agents, brokers and insureds, which represent premiums that are both currently due and amounts not yet due on insurance and reinsurance policies. Premiums for insurance policies are generally due at inception. Premiums for reinsurance policies generally become due over the period of coverage based on the policy terms. The Company monitors the credit risk associated with premiums receivable, taking into consideration the fact that in certain instances credit risk may be reduced by the Company's right to offset loss obligations or unearned premiums against premiums receivable. Amounts deemed uncollectible are charged to net income in the period they are determined. Changes in the estimate of reinsurance premiums written will result in an adjustment to premiums receivable in the period they are determined.
f)Reinsurance Recoverables. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. Allowances are established for amounts deemed uncollectible and reinsurance recoverables are recorded net of these allowances. The Company evaluates the financial condition of its reinsurers and monitors concentration risk to minimize its exposure to significant losses from individual reinsurers.
g)Deferred Policy Acquisition Costs. Costs directly related to the acquisition of insurance premiums are deferred and amortized over the related policy period, generally one year. Concurrent with the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, effective January 1, 2012, the Company only defers acquisition costs incurred that are related directly to the successful acquisition of new or renewal insurance contracts, including commissions to agents and brokers and premium taxes. Commissions received related to reinsurance premiums ceded are netted against broker commissions in determining acquisition costs eligible for deferral. To the extent that future policy revenues on existing policies are not adequate to cover related costs and expenses, deferred policy acquisition costs are charged to earnings. The Company does not consider anticipated investment income in determining whether a premium deficiency exists.
h)Goodwill and Intangible Assets. Goodwill and intangible assets are recorded as a result of business acquisitions. Goodwill represents the excess of the amount paid to acquire a business over the net fair value of assets acquired and liabilities assumed at the date of acquisition. Indefinite-lived and other intangible assets are recorded at fair value as of the acquisition date. The determination of the fair value of certain assets acquired and liabilities assumed involves significant judgment and the use of valuation models and other estimates, which require assumptions that are inherently subjective. Goodwill and indefinite-lived intangible assets are tested for impairment at least annually. The Company completes an annual test during the fourth quarter of each year based upon the results of operations through September 30. Intangible assets with definite lives are amortized using the straight-line method over their estimated useful lives, generally five to 20 years, and are reviewed for impairment when events or circumstances indicate that their carrying value may not be recoverable.
i)Property and Equipment. Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of property and equipment are calculated using the straight-line method over the estimated useful lives (generally, the life of the lease for leasehold improvements, ten to 40 years for buildings, seven to 40 years for land improvements, three to ten years for furniture and equipment and three to 25 years for other property and equipment).
j)Redeemable Noncontrolling Interests. The Company owns controlling interests in various companies through its Markel Ventures operations. In some cases, the Company has the option to acquire the remaining equity interests, and the remaining equity interests have the option to sell their interests to the Company, in the future. The redemption value of the remaining equity interests is generally based on the respective company's earnings in specified periods preceding the redemption date. The redeemable noncontrolling interests generally become redeemable through 2018.
The Company recognizes changes in the redemption value that exceed the carrying value of redeemable noncontrolling interests to retained earnings as if the balance sheet date were also the redemption date. Changes in the redemption value also result in an adjustment to net income to shareholders in the calculation of basic and diluted net income per share. The adjustment recorded to retained earnings during 2014, 2013 and 2012 was an increase of $8.2 million, a decrease of $2.0 million, and an increase of $3.1 million, respectively.
34
k)Income Taxes. The Company records deferred income taxes to reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. Deferred tax assets are reduced by a valuation allowance when management believes it is more likely than not that some, or all, of the deferred tax assets will not be realized. The Company recognizes the tax benefit from an uncertain tax position taken or expected to be taken in income tax returns only if it is more likely than not that the tax position will be sustained upon examination by tax authorities, based on the technical merits of the position. Tax positions that meet the more likely than not threshold are then measured using a probability weighted approach, whereby the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement is recognized. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.
l)Unpaid Losses and Loss Adjustment Expenses. Unpaid losses and loss adjustment expenses on our property and casualty insurance business are based on evaluations of reported claims and estimates for losses and loss adjustment expenses incurred but not reported. Estimates for losses and loss adjustment expenses incurred but not reported are based on reserve development studies, among other things. The Company does not discount reserves for losses and loss adjustment expenses to reflect estimated present value, except for reserves assumed in connection with an acquisition, which are recorded at fair value at the acquisition date. Recorded reserves are estimates, and the ultimate liability may be greater or less than the estimates.
m)Life and Annuity Benefits. Prior to its acquisition by the Company, Alterra entered into long duration reinsurance contracts for life and annuity benefits which subject the Company to mortality, longevity and morbidity risks. The assumptions used to determine policy benefit reserves were determined at the Acquisition Date and are generally locked-in for the life of the contract unless an unlocking event occurs. To the extent existing policy reserves, together with the present value of future gross premiums and expected investment income earned thereon, are not adequate to cover the present value of future benefits, settlement and maintenance costs, the locked-in assumptions are revised to current best estimate assumptions and a charge to earnings for life and annuity benefits is recognized at that time. Because of the assumptions and estimates used in establishing reserves for life and annuity benefit obligations and the long-term nature of these reinsurance contracts, the ultimate liability may be greater or less than the estimates.
Results attributable to the run-off of life and annuity reinsurance business are included in other revenues and other expenses in the Company's consolidated statements of income and comprehensive income and as part of the Company's Other Insurance (Discontinued Lines) segment.
n)Revenue Recognition.
Property and Casualty Premiums
Insurance premiums are generally earned on a pro rata basis over the policy period, typically one year. The cost of reinsurance ceded is initially recorded as prepaid reinsurance premiums and is amortized over the reinsurance contract period in proportion to the amount of insurance protection provided. Premiums ceded are netted against premiums written.
Assumed reinsurance premiums are recorded at the inception of each contract based upon contract terms and information received from cedents and brokers and are earned on a pro rata basis over the coverage period, or for multi-year contracts, in proportion with the underlying risk exposure to the extent there is variability in the exposure through the coverage period. Changes in reinsurance premium estimates are expected and may result in significant adjustments in any period. These estimates change over time as additional information regarding changes in underlying exposures is obtained. Any subsequent differences arising on such estimates are recorded as premiums written in the period they are determined. The Company uses the periodic method to account for assumed reinsurance from foreign reinsurers. The Company's foreign reinsurers provide sufficient information to record foreign assumed business in the same manner as the Company records assumed business from United States reinsurers.
Certain contracts that the Company writes provide for reinstatement of coverage. Reinstatement premiums are the premiums for the restoration of the insurance or reinsurance limit of a contract to its full amount after a loss occurrence by the insured or reinsured. The Company accrues for reinstatement premiums resulting from losses recorded. Such accruals are based upon contractual terms and management judgment is involved with respect to the amount of losses recorded. Changes in estimates of losses recorded on contracts with reinstatement premium features will result in changes in reinstatement premiums based on contractual terms. Reinstatement premiums are recognized at the time losses are recorded and are earned on a pro-rata basis over the coverage period.
35
Other Revenues
Other revenues primarily relate to the Company's Markel Ventures operations and consist of revenues from the sale of manufactured products and service revenues. Revenues from manufactured products are generally recognized at the time title transfers to the customer, which typically occurs at the point of shipment or delivery to the customer, depending on the terms of the sales arrangement. Revenues from services are generally recognized as the services are performed. Services provided pursuant to a contract are recognized either over the contract period or upon completion of the elements specified in the contract, depending on the terms of the contract.
o)Stock-based Compensation. Stock-based compensation expense is recognized as part of underwriting, acquisition and insurance expenses over the requisite service period. Stock-based compensation expense, net of taxes, was $18.7 million in 2014, $18.4 million in 2013 and $4.4 million in 2012. See note 12.
p)Foreign Currency Translation. The functional currencies of the Company's foreign operations are the currencies in which the majority of their business is transacted. Assets and liabilities of foreign operations are translated into the United States Dollar using the exchange rates in effect at the balance sheet date. Revenues and expenses of foreign operations are translated using the average exchange rate for the period. Gains or losses from translating the financial statements of foreign operations are included, net of taxes, in shareholders' equity as a component of accumulated other comprehensive income. Gains and losses arising from transactions denominated in a foreign currency, other than a functional currency, are included in net income.
The Company manages its exposure to foreign currency risk primarily by matching assets, other than goodwill and intangible assets, and liabilities denominated in the same currency. To the extent that assets and liabilities in foreign currencies are not matched, the Company is exposed to foreign currency risk. For functional currencies, the related exchange rate fluctuations are reflected in other comprehensive income. The cumulative foreign currency translation adjustment, net of taxes, was a loss of $43.5 million and $11.2 million at December 31, 2014 and 2013, respectively.
q)Derivative Financial Instruments. Derivative instruments, including derivative instruments resulting from hedging activities, are measured at fair value and recognized as either assets or liabilities on the consolidated balance sheets. The changes in fair value of derivatives are recognized in earnings unless the derivative is designated as a hedge and qualifies for hedge accounting.
The Company's foreign currency forward contracts are generally designated and qualify as hedges of a net investment in a foreign operation. The effective portion of the change in fair value resulting from these hedges is reported in currency translation adjustments as part of other comprehensive income. The ineffective portion of the change in fair value is recognized in earnings.
r)Comprehensive Income. Comprehensive income represents all changes in equity that result from recognized transactions and other economic events during the period. Other comprehensive income refers to revenues, expenses, gains and losses that under U.S. GAAP are included in comprehensive income but excluded from net income, such as unrealized gains or losses on investments, foreign currency translation adjustments and changes in net actuarial pension loss.
s)Net Income Per Share. Basic net income per share is computed by dividing adjusted net income to shareholders by the weighted average number of common shares outstanding during the year. Diluted net income per share is computed by dividing adjusted net income to shareholders by the weighted average number of common shares and dilutive potential common shares outstanding during the year. See note 12(b).
t)Recent Accounting Pronouncements. Effective January 1, 2014, the Company adopted FASB ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU No. 2013-11 requires that a liability related to an unrecognized tax benefit be offset against a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In that case, the liability associated with the unrecognized tax benefit is presented in the financial statements as a reduction to the related deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward. Otherwise, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The adoption of this guidance did not have an impact on the Company's financial position, results of operations or cash flows.
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In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which creates a new comprehensive revenue recognition standard that will serve as a single source of revenue guidance for all companies in all industries. The guidance applies to all companies that either enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards, such as insurance contracts. ASU No. 2014-09's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU No. 2014-09 becomes effective for the Company during the first quarter of 2017 and may be applied retrospectively or under a modified retrospective method where the cumulative effect is recognized at the date of initial application. Early application is not permitted. The Company is currently evaluating ASU No. 2014-09 to determine the potential impact that adopting this standard will have on its consolidated financial statements.
2. Acquisitions
Acquisition of Alterra
a)Overview. On May 1, 2013, the Company completed the acquisition of 100% of the the issued and outstanding common stock of Alterra pursuant to an agreement dated December 18, 2012 (the Merger Agreement) which provided for the merger of Alterra with one of the Company's subsidiaries. Alterra was a Bermuda-headquartered global enterprise providing diversified specialty property and casualty insurance and reinsurance products to corporations, public entities and other property and casualty insurers. Results attributable to Alterra's property and casualty insurance and reinsurance business are included in each of the Company's underwriting segments, which were redefined during the first quarter of 2014. Previously, Alterra also offered life and annuity reinsurance products. In 2010, Alterra ceased writing life and annuity reinsurance contracts and placed this business into run-off. Results attributable to the run-off of Alterra's life and annuity reinsurance business are included in the Company's Other Insurance (Discontinued Lines) segment. See note 19 for further discussion of the Company's reportable segments.
Pursuant to the terms of the Merger Agreement, on the Acquisition Date, equity holders of Alterra received, in exchange for each share of Alterra common stock held (other than restricted shares that did not vest in connection with the transaction), (1) 0.04315 shares of the Company's common stock and (2) $10.00 in cash. Equity holders of Alterra received total consideration of $3.3 billion, consisting of cash consideration of $964.3 million and stock consideration of 4.3 million shares of the Company's common stock.
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b)Purchase Price. The Company's total purchase price for Alterra as of the Acquisition Date was calculated as follows:
(in thousands, except per share amounts) | |||
Shares of Alterra common stock outstanding as of the Acquisition Date | 96,433 | ||
Exchange ratio per the Merger Agreement | 0.04315 | ||
Markel share issuance to Alterra shareholders | 4,161 | ||
Shares of Alterra restricted stock outstanding as of the Acquisition Date | 2,239 | ||
Incentive award ratio per the Merger Agreement | 0.06252 | ||
Markel restricted stock issuance to Alterra restricted stock holders | 140 | ||
Multiplied by Markel's weighted average stock price on April 30, 2013 (1) | $ | 529.59 | |
Markel share and restricted stock issuance consideration, net of taxes | $ | 2,267,648 | |
Alterra common shares outstanding as of the Acquisition Date that received cash consideration | 96,433 | ||
Multiplied by cash price per share component per the Merger Agreement | $ | 10.00 | |
Markel cash consideration | $ | 964,330 | |
Fair value of Markel warrant issuance to Alterra warrant holders as of the Acquisition Date | $ | 73,685 | |
Fair value of Markel stock option issuance to Alterra stock option holders as of the Acquisition Date, net of taxes | $ | 12,335 | |
Fair value of partially vested Markel restricted stock unit issuance as of the Acquisition Date, net of taxes | $ | 6,867 | |
Unrecognized compensation on unvested restricted stock and restricted stock units | $ | (20,572 | ) |
Total acquisition consideration | $ | 3,304,293 | |
(1) | The fair value of the shares issued by the Company was calculated as the weighted average price of the Company's stock on April 30, 2013, the day preceding the Acquisition Date. |
As part of the consideration, the Company issued replacement warrants, options and restricted stock awards to holders of Alterra warrants, options and restricted stock awards. The acquisition consideration related to the options, restricted stock and restricted stock units issued was net of income taxes of $1.9 million, $10.1 million and $0.7 million, respectively. See note 12 for additional information about the equity awards issued in connection with the acquisition.
c)Fair Value of Net Assets Acquired and Liabilities Assumed. The purchase price was allocated to the acquired assets and liabilities of Alterra based on estimated fair values at the Acquisition Date. The Company recognized goodwill of $295.7 million, which is primarily attributable to Alterra's assembled workforce and synergies that are expected to result upon integration of Alterra into the Company's insurance operations and investing activities. See note 7 for goodwill recorded by reportable segment. None of the goodwill that was recorded is deductible for income tax purposes. The Company also recognized indefinite lived intangible assets of $37.5 million and other intangible assets of $170.0 million, which will be amortized over a weighted average period of 17 years.
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The following table summarizes the fair values of the assets acquired and liabilities assumed at the Acquisition Date.
(dollars in thousands) | |||
ASSETS | |||
Investments | $ | 6,407,841 | |
Cash and cash equivalents | 1,036,274 | ||
Restricted cash and cash equivalents | 414,497 | ||
Receivables | 866,388 | ||
Reinsurance recoverable on unpaid losses | 1,169,084 | ||
Reinsurance recoverable on paid losses | 80,672 | ||
Prepaid reinsurance premiums | 317,445 | ||
Other assets | 859,884 | ||
LIABILITIES | |||
Unpaid losses and loss adjustment expenses | 4,719,461 | ||
Life and annuity benefits | 1,477,482 | ||
Unearned premiums | 1,075,610 | ||
Payables to insurance and reinsurance companies | 342,858 | ||
Senior long-term debt | 512,463 | ||
Other liabilities | 223,108 | ||
Net assets | 2,801,103 | ||
Goodwill | 295,690 | ||
Intangible assets | 207,500 | ||
Acquisition date fair value | $ | 3,304,293 | |
An explanation of the significant adjustments for fair value and the related impact on amortization is as follows:
• | Investments - Fixed maturity investments acquired include a net increase of $223.1 million to adjust the historical carrying amount of Alterra's investments to their estimated fair value as of the Acquisition Date. The difference in the historical amortized cost of the fixed maturity investments acquired and their estimated fair value as of the Acquisition Date, $495.5 million, represents incremental premium that will be amortized to net investment income over the term of the underlying securities. The amount of the unamortized incremental premium as of December 31, 2014 and 2013 was $281.1 million and $398.1 million, respectively. The decrease in the unamortized incremental premium is due to amortization expense of $59.3 million and $58.3 million for the years ended December 31, 2014 and 2013, respectively, and sales of securities. |
• | Intangible assets - Establish the estimated fair value of intangible assets related to Alterra (see below for further detail). |
• | Unearned Premiums - Unearned premiums acquired include a decrease of $176.3 million to adjust the carrying value of Alterra's historical unearned premiums to fair value as of the Acquisition Date. The adjustment consists of the present value of the expected underwriting profit within the unearned premiums liability less costs to service the related policies and a risk premium. This adjustment was amortized to underwriting, acquisition and insurance expenses over a weighted average period of approximately one year, as the contracts for business in-force as of the Acquisition Date expired. As of December 31, 2014, this adjustment was fully amortized. |
• | Unpaid losses and loss adjustment expenses - Unpaid losses and loss adjustment expenses acquired include an increase of $120.8 million to adjust the carrying value of Alterra's historical unpaid losses and loss adjustment expenses, net of related reinsurance recoverable, to fair value as of the Acquisition Date. The estimated fair value consists of the present value of the expected net loss and loss adjustment expense payments plus a risk premium. This adjustment, plus the $26.5 million unamortized fair value adjustment included in Alterra's historical unpaid losses and loss adjustment expenses, will be amortized to losses and loss adjustment expenses over a weighted average period of approximately five years, based on the estimated payout pattern of net reserves as of the Acquisition Date. The amount of the unamortized fair value adjustment included in unpaid losses and loss adjustment expenses as of December 31, 2014 and 2013 was $114.6 million and $136.5 million, respectively. |
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• | Life and Annuity Benefits - Life and annuity benefits acquired include an increase of $329.6 million to adjust the carrying value of Alterra's historical life and annuity benefits to fair value as of the Acquisition Date. The estimated fair value consists of the present value of the expected net life and annuity benefit payments plus a risk premium. See note 10 for detail regarding accounting for life and annuity benefits. |
• | Senior long-term debt - Senior long-term debt acquired includes an increase of $71.9 million to adjust the carrying value of Alterra's senior long-term debt to its estimated fair value based on prevailing interest rates and other factors as of the Acquisition Date. This adjustment will be amortized to interest expense over the term of the notes. See note 11. The amount of the unamortized premium on the acquired senior long-term debt as of December 31, 2014 and 2013 was $56.7 million and $66.1 million, respectively. |
The following table summarizes the intangible assets recorded in connection with the acquisition.
(dollars in thousands) | Amount | Economic Useful Life | |||
Customer relationships | $ | 132,000 | 18 years | ||
Broker relationships | 19,000 | 18 years | |||
Technology | 18,000 | Ten years | |||
Trade names | 1,000 | One year | |||
Lloyd's syndicate capacity | 12,000 | Indefinite | |||
Insurance licenses | 25,500 | Indefinite | |||
Intangible assets as of the Acquisition Date | $ | 207,500 | |||
Customer relationships represent policyholder relationships and the network of insurance companies through which Alterra conducted its operations. The fair value of customer relationships and broker relationships was estimated using the income approach. Critical inputs into the valuation model for customer relationships and broker relationships include estimates of expected premium and attrition rates, and discounting at a weighted average cost of capital. Technology represents the intangible asset related to Alterra's internally developed software and was valued using the income approach.
The fair value of Lloyd's syndicate capacity and insurance licenses was estimated using the market approach. Lloyd's syndicate capacity represents Alterra's authorized premium income limit to write insurance business in the Lloyd's of London (Lloyd's) insurance market. The Lloyd's capacity is renewed annually at no cost to the Company or may be freely purchased or sold, subject to Lloyd's approval. The ability to write insurance business within the syndicate capacity is indefinite with the premium income limit being set annually by the Company, subject to Lloyd's approval.
d)Income Taxes. As a result of the acquisition, Alterra and its non-U.S. subsidiaries became controlled foreign corporations subject to U.S. income tax at a statutory rate of 35%. The acquisition was taxable to U.S. shareholders of Alterra, and Markel has elected to treat it as an asset acquisition under section 338(g) of the U.S. Internal Revenue Code of 1986 (IRC), as amended.
Effective May 1, 2013, the Company made an IRC section 953(d) election with respect to Markel Bermuda Limited (Markel Bermuda, formerly known as Alterra Bermuda Limited), a wholly-owned subsidiary of Alterra. As a result of the 953(d) election, Markel Bermuda is treated as a domestic corporation for U.S. tax purposes and, accordingly, is required to record deferred taxes at the 35% statutory U.S. rate.
As part of the allocation of the purchase price, the Company recorded net deferred tax assets of $310.1 million. Of this amount, $343.9 million represents deferred tax assets related to accrued losses and loss adjustment expenses and life and annuity benefits, which were partially offset by deferred tax liabilities of $64.6 million related to the estimated fair value of the intangible assets recorded. Other net deferred tax assets recorded primarily relate to differences between financial reporting and tax bases of the acquired assets and liabilities as of the Acquisition Date. As of the Acquisition Date, earnings of Alterra's foreign subsidiaries are considered reinvested indefinitely, consistent with the Company's other foreign subsidiaries, and no provision for deferred U.S. income tax was recorded.
e)Transaction and Acquisition-Related Costs. The following table summarizes transaction and acquisition-related costs incurred by the Company in connection with the acquisition, all of which were included in underwriting, acquisition and insurance expenses in the consolidated statements of income and comprehensive income.
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(dollars in thousands) | Year Ended December 31, 2013 | ||
Transaction costs | $ | 15,981 | |
Acquisition-related costs: | |||
Severance costs | 31,734 | ||
Stay bonuses | 14,804 | ||
Acceleration of Alterra long-term incentive compensation awards and restricted stock awards | 12,621 | ||
Total transaction and acquisition-related costs | $ | 75,140 | |
Transaction costs primarily consist of due diligence, legal and investment banking costs. Per the terms of the Merger Agreement, transaction costs attributable to Alterra were recorded and paid by Alterra prior to the Acquisition Date ($23.0 million) and are not included within the Company's consolidated statements of income and comprehensive income.