Credit Opinion: Markel Corporation

Transcription

1 Credit Opinion: Markel Corporation Global Credit Research - 05 Dec 2014 Glen Allen, Virginia, United States Ratings Category Rating Outlook Senior Unsecured Rated Intercompany Pool Members Rating Outlook Insurance Financial Strength Moody's Rating STA Baa2 STA A2 Contacts Analyst Phone Enrico Leo/New York City Pano Karambelas/New York City Robert Riegel/New York City Ji Liu/New York City Key Indicators Markel Corporation[1][2] As Reported (U.S. Dollar Millions) Total Assets 23,956 12,557 11,532 10,826 10,242 Shareholders' Equity 6,750 3,975 3,462 3,188 2,792 Net Income (Loss) Attributable to Common Shareholders Gross Premiums Written 3,920 2,514 2,291 1,982 1,906 Net Premiums Written 3,237 2,214 2,042 1,769 1,714 Moody's Adjusted Ratios High Risk Assets % Shareholders' Equity 48.7% 61.9% 55.3% 57.7% 53.9% Reinsurance Recoverable % Shareholders' Equity 35.1% 24.2% 27.3% 29.9% 36.8% Goodwill & Intangibles % Shareholders' Equity 26.9% 31.0% 31.4% 26.2% 23.8% Gross Underwriting Leverage 2.3x 2.2x 2.4x 2.5x 2.8x Return on Capital (1 yr) 3.8% 4.9% 3.2% 6.5% 5.9% Sharpe Ratio of ROC (5 yr avg) 350.5% 111.6% 102.0% NA NA Adv (Fav) Loss Dev % Beginning Reserves (1 yr) -9.0% -8.7% -7.7% -6.1% -5.3% Financial Leverage 26.9% 29.5% 29.5% 26.6% 28.0% Total Leverage 26.9% 29.5% 29.5% 26.6% 28.0% Earnings Coverage (1 yr) 3.9x 4.1x 3.0x 4.6x 4.3x Cash Flow Coverage (1 yr) 3.2x 2.1x 2.8x 2.9x 3.0x [1] Information based on US GAAP financial statements as of Fiscal YE December 31 [2] Certain items may have been relabeled and/or reclassified for global consistency Opinion SUMMARY RATING RATIONALE

2 The A2 insurance financial strength (IFS) ratings on Markel Corporation's (NYSE: MKL) lead insurance operating subsidiaries reflect the group's scale and market presence in the specialty and excess and surplus (E&S) property & casualty (P&C) markets, a diversified business mix, relatively good risk adjusted capitalization, and a prudent approach to reserving. Markel also maintains good holding company liquidity with $1.2 billion in investments, comprised of cash and short term investments and common stock as of September 30, These strengths are offset to a degree by its exposure to a number of volatile and long-tail lines of business, exposure to catastrophes, and an investment portfolio that contains a relatively large amount of equity exposure, creating potential earnings and capital volatility. The company's financial leverage was approximately 26% as of September 30, 2014, in line with Moody's expectations but above some peers. Markel's US-based insurance subsidiaries underwrite specialty property and casualty insurance programs through wholesale brokers as well as retail agents, competing primarily in the Excess & Surplus (E&S) and Specialty Admitted markets. Markel's London Insurance Market division underwrites through Markel Capital Limited and Markel International Insurance Company Limited (formerly Terra Nova Insurance Company). Markel Capital Limited is the corporate capital provider for its syndicate at Lloyd's (syndicate 3000), which is managed by Markel Syndicate Management Limited. Alterra Capital Holdings Limited, acquired by Markel in May 2013, is a Bermuda-based holding company whose subsidiaries underwrite specialty insurance and reinsurance products from hubs in Bermuda, Dublin, U.S., and Latin America, among others. Credit Strengths - Scale and presence in US specialty and excess and surplus lines markets - Well diversified mix of specialty insurance and reinsurance, and niche businesses - Solid historic underwriting results for North American E&S and Specialty divisions, and good performance in the London Market division - Consistent book value growth over time - High quality, liquid, fixed income investment portfolio Credit Challenges - Exposure to volatile and long-tail lines of business - Ongoing integration of Alterra - Exposure to natural and man-made catastrophes - High level of equity investments relative to surplus creates potential volatility Rating Outlook The outlook for Markel's ratings is stable. What to Watch For: - Ongoing integration efforts include: managing the competitive reinsurance market, aligning Alterra's reserves to be consistent with Markel's practices, and evaluating legal entity structure - Potential volatility in earnings from catastrophe losses - Volatility stemming from the company's large concentration of common stock investments What Could Change the Rating - Up - Strong and consistent earnings through the insurance cycle (return-on-capital consistently above 8%) - Maintain pre-tax interest coverage greater than 6x - Adjusted financial leverage of 20% or below What Could Change the Rating - Down

3 - Adjusted financial leverage consistently above 30% and/or interest coverage consistently below 4x - Gross underwriting leverage above 4x - Liquid assets at the holding company less than 3x annual interest expense - Decline in shareholders' equity by 10% or more as a result of losses - Reserve charges more than 3% of carried reserves Notching Considerations The spread between Markel's senior unsecured debt rating and the insurance financial strength ratings is three notches, which is consistent with Moody's typical notching practices for US property and casualty insurance holding company structures. The Baa2 senior debt rating for financing subsidiaries of Alterra Capital Holdings Limited is rated three notches below the A2 financial strength rating of its principal operating subsidiary, and at the same level as the Baa2 senior debt rating of ultimate parent Markel Corporation. This is wider notching than the customary two notches for Bermuda insurance holding company structures because more than half of Markel's consolidated group capital resides outside of Bermuda (principally the US) where regulatory dividend restrictions are tighter than those in Bermuda. During Q2 2014, Markel Corporation entered into agreements providing an unconditional guarantee of Alterra Finance LLC's $350 million senior unsecured notes due 2020 and Alterra USA Holdings Limited's $91 million of senior unsecured notes due Both sets of senior unsecured notes continue to be guaranteed by Alterra Capital Holdings Limited. DETAILED RATING CONSIDERATIONS Moody's rates Markel Corporation's property and casualty operating companies A2 for insurance financial strength, which is in line with the adjusted rating indicated by the Moody's insurance financial strength rating scorecard. Insurance Financial Strength Rating Key factors currently influencing the rating and outlook are: Market Position, Brand, and Distribution - A - STRONG E&S/SPECIALTY FRANCHISE, WITH ENHANCED SCALE Markel ranks among the top specialty commercial insurers in the US. The group offers products through three core segments: US Insurance, International Insurance, and Reinsurance. The US Insurance segment is the group's largest at 57% of 2013 gross written premiums and is an amalgamation of the former US E&S and Specialty Admitted segments, as well as E&S and specialty business acquired from Alterra. In this segment, Markel focuses on specialty insurance products in a number of niche areas. Its North American E&S operation is a mature and well-established business, and the company ranks as the fifth largest E&S carrier in the US, writing unique, hard-to-place risks, as well as commercial coverage for a number of specialized programs, specialty personal lines insurance, and workers' compensation. The International Insurance segment comprises 28% of the group's writings and consists of insurance business primarily in the UK, Continental Europe, South America, and Canada. This segment includes its participation in the London market, which includes the capital provider for its Lloyds syndicate (Markel Syndicate 3000) as well as the business formerly written through Alterra at Lloyd's (Syndicate 1400). Markel writes business on both a direct and subscription basis in the London market, which tends to be hard-to-place business due to size and complexity of the risks (larger limits and/or catastrophe risk). The company also targets to be lead underwriter when writing in the subscription market in order to control pricing and policy terms and conditions. Markel's Reinsurance segment includes all treaty reinsurance written across the group, and emanates primarily from Markel Bermuda Limited (formerly Alterra Bermuda Limited) and Alterra Reinsurance USA, focusing on both property and CAT-exposed lines as well as long-tail casualty lines such as professional liability. The acquisition of Alterra enhanced Markel's market presence, leading to size and scale advantages, potentially greater underwriting opportunities, and pricing leverage. It also added two platforms for Markel -- reinsurance and large account primary insurance. While the product portfolio is expanded and managed within Markel's underwriting and risk management guidelines, we note that these platforms contain higher-risk business line

4 characteristics in both short-tail property catastrophe and long-tail, casualty lines compared with its traditional US and specialty business. With respect to business integration, given the overlap in some US specialty and E&S lines of business, the group's organization and business structure could change over time as Alterra's US business is merged with Markel. Due to group's strong US E&S and specialty market presence, and growing international operations, this factor is more in line with A-rated insurers, compared to the Baa calculated scorecard metric (which only takes into account premiums generated from the US). Much of the company's distribution is through wholesale brokers, and expense ratios are higher than average due to the specialty focus and the resultant need to dedicate greater resources to underwriting. We expect incremental improvement in the expense ratio, driven by economies of scale and a lower proportion of total business written through the wholesale channel which tends to carry higher commission. Product Risk and Diversification - A - GOOD PRODUCT LINE AND GEOGRAPHIC DIVERSIFICATION, WITH SOME HIGHER-RISK PRODUCTS Markel has good geographic and line of business diversification with 75% of its business spread across 50 US states and 25% of its business written on risks outside of the US based on gross written premium. The group has generated growth organically, by hiring teams of experience underwriters, and by acquiring companies. A sizeable portion of Markel's US premiums is in its Excess and Surplus (E&S) division, which is free from rate and form regulation, and allows the flexibility to set more restrictive terms and higher prices. In the US, business written on both an admitted and non-admitted basis is concentrated in higher risk, predominantly casualty-based, exposures that standard insurance underwriters have typically avoided, such as specialized errors and omissions and other hard to place risks that are less prone to commoditization. Markel's international exposures includes a portfolio of products, written either through Markel Bermuda Limited, Markel's international insurance companies or Markel Syndicate The company's international business is focused on higher risk, higher limit commercial liability and commercial property, which exposes the franchise to large catastrophe losses. Markel's catastrophe exposure, which the company actively manages through a combination of reinsurance protection, control over policy limits exposure, strict price requirements, and overall risk selection, will remain a significant risk given the group's new business mix. Some lines of business, such as excess liability, reinsurance and large account insurance are subject to significant price competition and are more distinct from Markel's traditional E&S and niche specialty products. These products are also long tail in nature and subject to material pricing and reserving risk. However, we expect Markel to manage these products within its historical underwriting discipline and willingness to reduce business in markets in which pricing no longer provides adequate compensation for risk. Asset Quality - A - HIGH QUALITY FIXED INCOME PORTFOLIO, ABOVE AVERAGE EQUITY ALLOCATION ADDS VOLATILITY The group maintains a high quality, liquid fixed income investment portfolio (about 97% rated A or higher as of September 30, 2014), with policyholder funds invested in high quality instruments with short to intermediate durations. The company's investment portfolio has a relatively high exposure to common stock investments, bringing with it volatility risk. Markel's long term target common stock allocation is about 70% to 80% of shareholders' equity though this has been lower in recent years. We expect Markel will align Alterra's asset allocation with its own, likely increasing exposure to public equities. Approximately 30% (based on fair value) of the company's equity portfolio is invested in financial institutions common stocks (property and casualty insurance companies, banks and trusts, which includes the company's equity investments in Berkshire Hathaway). Sovereign holdings and non-sovereign financial institution holdings for Portugal, Ireland, Italy, Greece and Spain amount to less than 0.5% of the fixed income portfolio. Total European (sovereign, financial institutions and non-sovereign) holdings are approximately 21% of the fixed income portfolio, higher than some similarly-rated peers. In recent years, Markel has also expanded its equity investments in private companies (typically non-insurance related, majority-owned by Markel and through Markel Ventures). Revenues and earnings from non-insurance operations were $608 million and $53 million respectively for the first nine months of 2014, representing over 16% of consolidated revenues and 8% of net earnings, respectively. EBITDA for Markel Ventures was approximately $66 million for the first nine months of These investments are held outside of the insurance operating subsidiaries and at an intermediate holding company, Markel Ventures Inc., which add incremental unregulated cash flows to the parent. Given the company's relatively high common stock exposure and private investments through Markel Ventures, we view this factor more in-line with A-rated insurers rather than the Aa calculated

5 scorecard metric. Markel's level of reinsurance recoverables to shareholders' equity is reasonable at approximately 34% as of September 30, 2014, and the credit quality of most of the company's largest reinsurers is relatively strong. Markel has a sizeable amount of goodwill and intangibles on its balance sheet (about 30% of shareholders' equity as of September 30, 2014) but not out of line with its peers. Capital Adequacy - A - GOOD RISK ADJUSTED CAPITALIZATION, BUT WITH SIGNIFICANT CATASTROPHE RISK Markel's capital adequacy is good with gross underwriting leverage averaging about 2.3x over the past two years in line with similarly rated insurance companies. Tempering our view of Markel's capital adequacy is the company's meaningful volume of catastrophe-exposed property business and volatility associated with its equity portfolio. We do not expect gross underwriting leverage to change dramatically from current levels; however, the potential for greater capital volatility is likely given increases in catastrophe-exposed and higher limit business lines (e.g., property reinsurance, primary property insurance written through Lloyds, and large account casualty). We therefore view this factor more appropriately positioned in the A category rather than Aa scorecard calculation. Markel continues to manage its catastrophe risk closely through a combination of reinsurance protection, control over policy limits exposure, strict price requirements, and overall risk selection. We expect that with business acquired from Alterra, Markel will manage its combined catastrophe exposure in line with current enterprise risk tolerance levels. Profitability - A - GOOD EARNINGS, THOUGH POTENTIAL FOR GREATER VOLATILITY Markel has historically been a strong underwriter, having produced underwriting profits in eight out of the last ten years. In the first nine months of 2014, the group reported a combined ratio of 97%. The combined ratio for Markel historically has been higher than some peers, driven by a higher expense ratio due to various infrastructure initiatives and higher commission payments to wholesalers. However, the expense ratio for the first nine months of 2014 improved to 37% due to higher earned premiums. Going forward, we expect Markel's expense ratio to improve due to greater economies of scale and expense efficiencies. The new business lines acquired through Alterra can carry significant margins but they also come with higher-risk characteristics in the form of property catastrophe reinsurance and excess casualty insurance. The increase in both short-tail property catastrophe and long-tail, casualty lines raises the prospect for potentially greater earnings and capital volatility than has historically been the case. While more distinct from Markel's historical offerings, the new business lines acquired through Alterra still align with its overall strategy of providing coverage for complex, hard-to-place risks through the US and international specialty insurance markets. The group's underwriting expertise and intimate knowledge of markets has led to solid underwriting margins over the long-term. However, the influx of alternative capital is creating significant competition and pricing deterioration in the property catastrophe reinsurance market and is expected to pressure profit margins for this business. We expect Markel will manage the challenges associated with earnings volatility through a balanced business mix, adequate underwriting controls, and active portfolio/cat risk management. Reserve Adequacy - A - STRONG TRACK RECORD, HIGHER RISK OF RESERVE UNCERTAINTY IN LONG-TAIL LINES AND REINSURANCE Markel's historical reserves have been conservatively positioned as the company generally sets its reserves at a level higher than the mid-point estimate. The company experienced approximately $260 million of favorable reserve development in the first three quarters of 2014, largely attributed to casualty E&S lines and professional and financial risks divisions within Markel International, partially offset by reserve strengthening in A&E ($27 million) and architect and engineers product lines. While Markel experienced favorable reserve development, it was lower than the prior year period ($280 million for 9M 2013). Markel writes small-account workers' compensation insurance; however, the nature of the accounts tends to be less price-sensitive than larger accounts. Despite its strong track record, the company has exposure to long-tail lines which inherently leads to higher risk of reserve uncertainty. Therefore we view this factor more in-line with A-rated insurers rather than the Aaa calculated scorecard metric. Alterra has also reported favorable reserve development in each year since An important variable is the adequacy of legacy-harbor Point (acquired by Alterra in 2010) reserves, particularly for exposures vulnerable to D&O/E&O claims from the financial crisis. Given the relative size of reserves, any reserve deterioration from legacy-harbor Point's professional liability reinsurance business is unlikely to be a substantial swing factor. We

6 expect that Markel will align Alterra's reserves with its own reserving practices. Financial Flexibility - A - SIGNIFICANT FINANCIAL LEVERAGE; STRONG HOLDING COMPANY LIQUIDITY Adjusted financial leverage was approximately 26% as of September 30, 2014, in line with our expectations, though higher than some similarly-rated peers. Markel's target capital structure includes approximately 30% debt to capital on an unadjusted basis. Markel's earnings coverage has been good, though on average is below peer levels. Markel does not pay a stockholder dividend, which we view as strengthening the company's financial flexibility. On August 1, 2014, Markel entered into a revolving credit facility that provides $300 million of capacity for future acquisitions, investments, repurchases of capital stock and for general corporate purposes, of which $200 million may be used for secured letters of credit. In addition, the company maintains a $650 million secured credit facility, which expires in December The credit facilities contain financial covenants around leverage and net worth. Markel implemented a new share repurchase program of $300 million in November 2013, which the company has historically used opportunistically. During the first nine months of 2014, the company repurchased $21 million of its common shares with $279 million remaining under the current authorization. Liquidity Profile: For 2014, Markel has approximately $300 million in unencumbered dividend capacity available from its domestic insurance subsidiaries, which provides coverage of interest of about 3x, as well as $376 million in available dividends from its Bermuda subsidiary. As of September 30, 2014, invested assets held at the parent company were $1.2 billion, in line with historical levels. Markel's holding company liquidity is available to support growth initiatives at its operating subsidiaries, complete acquisitions, and capital management activity including repurchasing shares and retiring debt. Furthermore, through Markel Ventures Inc., the group owns interests in various non-insurance operations, mainly industrial and service companies. During the first nine months of 2014, these non-insurance operations reported EBITDA of $66 million. While the amount of earnings is relatively small currently, it is expected that these operations will provide unregulated cash flows to the parent company over time. Rating Factors Markel Corporation[1][2] Financial Strength Rating Scorecard Aaa Aa A Baa Ba B Caa Score Adjusted Score Business Profile Baa A Market Position and Brand (25%) Baa A - Relative Market Share Ratio X - Underwriting Expense Ratio % Net 40.6% Premiums Written Product Focus and Diversification (10%) A A - Product Risk X - P&C Insurance Product Diversification X - Geographic Diversification X Financial Profile Aa A Asset Quality (10%) Aa A - High Risk Assets % Shareholders' Equity 48.7% - Reinsurance Recoverable % Shareholders' 35.1% Equity - Goodwill & Intangibles % Shareholders' Equity 26.9%

7 Capital Adequacy (15%) Aa A - Gross Underwriting Leverage 2.3x Profitability (15%) A A - Return on Capital (5 yr avg) 4.9% - Sharpe Ratio of ROC (5 yr avg) 350.5% Reserve Adequacy (10%) Aaa A - Adv (Fav) Loss Dev % Beginning Reserves -8.0% (5 yr. wtd avg) Financial Flexibility (15%) A A - Financial Leverage 26.9% - Total Leverage 26.9% - Earnings Coverage (5 yr avg) 4.0x - Cash Flow Coverage (5 yr avg) 2.8x Operating Environment Aaa - A Aggregate Profile A1 A2 Aaa - A [1] Information based on US GAAP financial statements as of Fiscal YE December 31 [2] The Scorecard rating is an important component of the company's published rating, reflecting the stand-alone financial strength before other considerations (discussed above) are incorporated into the analysis This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATION") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY'S ANALYTICS, INC. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR

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