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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2004

 

or

 

¨ Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from              to             

 

Commission File Number 001-15811

 


 

MARKEL CORPORATION

(Exact name of registrant as specified in its charter)

 


 

Virginia   54-1959284

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification number)

 

4521 Highwoods Parkway, Glen Allen, Virginia 23060-6148

(Address of principal executive offices)

(Zip code)

 

(804) 747-0136

(Registrant’s telephone number, including area code)

 

NONE

(Former name, former address and former fiscal year,

if changed since last report)

 


 

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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Number of shares of the registrant’s common stock outstanding at April 30, 2004: 9,850,887

 



Table of Contents

Markel Corporation

Form 10-Q

Index

 

     Page Number

PART I. FINANCIAL INFORMATION

    

Item 1. Financial Statements

    
     Consolidated Balance Sheets—
March 31, 2004 and December 31, 2003
   3
     Consolidated Statements of Operations and Comprehensive Income —
Three Months Ended March 31, 2004 and 2003
   4
     Consolidated Statements of Changes in Shareholders’ Equity —
Three Months Ended March 31, 2004 and 2003
   5
     Consolidated Statements of Cash Flows—
Three Months Ended March 31, 2004 and 2003
   6
     Notes to Consolidated Financial Statements —
March 31, 2004
   7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   13
     Critical Accounting Policies    13

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   18

Item 4. Controls and Procedures

   18

Safe Harbor and Cautionary Statement

   19

PART II. OTHER INFORMATION

    

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

   20

Item 6. Exhibits and Reports on Form 8-K

   20

Signatures

   21

Exhibit Index

   22

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

MARKEL CORPORATION AND SUBSIDIARIES

 

Consolidated Balance Sheets

 

    

March 31,

2004


   

December 31,

2003


 
     (dollars in thousands)  

ASSETS

                

Investments, available-for-sale, at estimated fair value

                

Fixed maturities (cost of $3,965,328 in 2004 and $3,840,339 in 2003)

   $ 4,096,252     $ 3,926,652  

Equity securities (cost of $687,810 in 2004 and $638,445 in 2003)

     1,055,145       968,777  

Short-term investments (estimated fair value approximates cost)

     74,222       82,012  
    


 


Total Investments, Available-For-Sale

     5,225,619       4,977,441  
    


 


Cash and cash equivalents

     265,522       372,511  

Receivables

     507,324       450,920  

Reinsurance recoverable on unpaid losses

     1,615,752       1,614,114  

Reinsurance recoverable on paid losses

     162,334       156,493  

Deferred policy acquisition costs

     207,221       200,284  

Prepaid reinsurance premiums

     204,333       213,403  

Intangible assets

     357,317       357,317  

Other assets

     208,307       189,750  
    


 


Total Assets

   $ 8,753,729     $ 8,532,233  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Unpaid losses and loss adjustment expenses

   $ 5,085,483     $ 4,929,713  

Unearned premiums

     1,087,772       1,060,188  

Payables to insurance companies

     144,828       150,159  

Convertible notes payable (estimated fair value of $106,000 in 2004 and $99,000 in 2003)

     91,750       90,601  

Senior long-term debt (estimated fair value of $574,000 in 2004 and $562,000 in 2003)

     521,983       521,510  

Junior Subordinated Deferrable Interest Debentures (estimated fair value of $162,000 in 2004 and $153,000 in 2003)

     150,000       150,000  

Other Liabilities

     197,212       247,783  
    


 


Total Liabilities

     7,279,028       7,149,954  
    


 


Shareholders’ equity

                

Common stock

     737,784       737,356  

Retained earnings

     415,049       375,041  

Accumulated other comprehensive income

                

Net unrealized holding gains on fixed maturities and equity securities, net of tax expense of $174,391 in 2004 and $145,826 in 2003

     323,868       270,819  

Cumulative translation adjustments, net of tax benefit of $1,077 in 2004 and $505 in 2003

     (2,000 )     (937 )
    


 


Total Shareholders’ Equity

     1,474,701       1,382,279  

Commitments and contingencies

                
    


 


Total Liabilities and Shareholders’ Equity

   $ 8,753,729     $ 8,532,233  
    


 


 

See accompanying notes to consolidated financial statements.

 

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MARKEL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Operations and Comprehensive Income

 

    

Three Months Ended

March 31,


 
     2004

    2003

 
    

(dollars in thousands,

except per share data)

 

OPERATING REVENUES

                

Earned premiums

   $ 505,392     $ 432,353  

Net investment income

     48,663       45,233  

Net realized gains from investment sales

     7,393       6,471  
    


 


Total Operating Revenues

     561,448       484,057  
    


 


OPERATING EXPENSES

                

Losses and loss adjustment expenses

     326,334       280,019  

Underwriting, acquisition and insurance expenses

     160,063       135,636  

Amortization of intangible assets

     —         2,629  
    


 


Total Operating Expenses

     486,397       418,284  
    


 


Operating Income

     75,051       65,773  

Interest expense

     12,881       11,395  
    


 


Income Before Income Taxes

     62,170       54,378  

Income tax expense

     19,894       17,945  
    


 


Net Income

   $ 42,276     $ 36,433  
    


 


OTHER COMPREHENSIVE INCOME (LOSS)

                

Unrealized gains (losses) on securities, net of taxes

                

Net holding gains (losses) arising during the period

   $ 57,854     $ (15,529 )

Less reclassification adjustments for gains included in net income

     (4,805 )     (4,206 )
    


 


Net unrealized gains (losses)

     53,049       (19,735 )

Currency translation adjustments, net of taxes

     (1,063 )     1,984  
    


 


Total Other Comprehensive Income (Loss)

     51,986       (17,751 )
    


 


Comprehensive Income

   $ 94,262     $ 18,682  
    


 


NET INCOME PER SHARE

                

Basic

   $ 4.29     $ 3.70  

Diluted

   $ 4.29     $ 3.70  
    


 


 

See accompanying notes to consolidated financial statements.

 

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MARKEL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Changes in Shareholders’ Equity

 

    

Three Months Ended

March 31,


 
     2004

    2003

 
     (dollars in thousands)  

Common Stock

                

Balance at beginning of period

   $ 737,356     $ 736,246  

Issuance of common stock and other equity transactions

     428       205  
    


 


Balance at end of period

   $ 737,784     $ 736,451  
    


 


Retained Earnings

                

Balance at beginning of period

   $ 375,041     $ 251,568  

Net income

     42,276       36,433  

Repurchase of common stock

     (2,268 )     (1 )
    


 


Balance at end of period

   $ 415,049     $ 288,000  
    


 


Accumulated Other Comprehensive Income

                

Unrealized gains

                

Balance at beginning of period

   $ 270,819     $ 179,170  

Net unrealized holding gains (losses) arising during the period, net of taxes

     53,049       (19,735 )
    


 


Balance at end of period

     323,868       159,435  

Cumulative translation adjustments

                

Balance at beginning of period

     (937 )     (7,873 )

Translation adjustments, net of taxes

     (1,063 )     1,984  
    


 


Balance at end of period

     (2,000 )     (5,889 )
    


 


Balance at end of period

   $ 321,868     $ 153,546  
    


 


Shareholders’ Equity at End of Period

   $ 1,474,701     $ 1,177,997  
    


 


 

See accompanying notes to consolidated financial statements.

 

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MARKEL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

 

    

Three Months Ended

March 31,


 
     2004

    2003

 
     (dollars in thousands)  

OPERATING ACTIVITIES

                

Net Income

   $ 42,276     $ 36,433  

Adjustments to reconcile net income to net cash provided by operating activities

     12,482       67,172  
    


 


Net Cash Provided By Operating Activities

     54,758       103,605  
    


 


INVESTING ACTIVITIES

                

Proceeds from sales of fixed maturities and equity securities

     854,101       880,426  

Proceeds from maturities, calls and prepayments of fixed maturities

     39,381       53,051  

Cost of fixed maturities and equity securities purchased

     (1,059,421 )     (1,233,462 )

Net change in short-term investments

     7,790       (25,532 )

Other

     (1,758 )     228  
    


 


Net Cash Used By Investing Activities

     (159,907 )     (325,289 )
    


 


FINANCING ACTIVITIES

                

Additions to senior long-term debt

     —         198,020  

Repayments and repurchases of senior long-term debt

     —         (175,000 )

Repurchase of common stock

     (2,268 )     (1 )

Other

     428       205  
    


 


Net Cash Provided (Used) By Financing Activities

     (1,840 )     23,224  
    


 


Decrease in cash and cash equivalents

     (106,989 )     (198,460 )

Cash and cash equivalents at beginning of period

     372,511       444,236  
    


 


Cash and Cash Equivalents at End of Period

   $ 265,522     $ 245,776  
    


 


 

See accompanying notes to consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - March 31, 2004

 

1. Principles of Consolidation

 

The consolidated balance sheet as of March 31, 2004 and the related consolidated statements of operations and comprehensive income, changes in shareholders’ equity and cash flows for the three months ended March 31, 2004 and 2003, are unaudited. In the opinion of management, all adjustments necessary for fair presentation of such consolidated financial statements have been included. Such adjustments consist only of normal recurring items. Interim results are not necessarily indicative of results of operations for the full year. The consolidated balance sheet as of December 31, 2003 was derived from the Company’s audited annual consolidated financial statements.

 

The consolidated financial statements and notes are presented as permitted by Form 10-Q, and do not contain certain information included in the Company’s annual consolidated financial statements and notes. Readers are urged to review the Company’s 2003 annual report on Form 10-K for a more complete description of the Company’s business and accounting policies.

 

Certain reclassifications of prior year’s amounts have been made to conform with 2004 presentations.

 

2. Net Income per share

 

Net income per share was determined by dividing net income by the applicable shares outstanding (in thousands):

 

    

Three Months Ended

March 31,


     2004

   2003

Net income, as reported (basic and diluted)

   $ 42,276    $ 36,433
    

  

Average common shares outstanding

     9,853      9,837

Dilutive potential common shares

     4      19
    

  

Average diluted shares outstanding

     9,857      9,856
    

  

 

3. Stock Compensation Plans

 

The Company applies the intrinsic value recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for stock based compensation plans. The Company has adopted the disclosure-only provisions of Statement No. 123, Accounting for Stock Based Compensation, as amended.

 

Stock based compensation cost, net of taxes, included in net income under APB Opinion No. 25 was $0.5 million and $0.1 million for the quarters ended March 31, 2004 and 2003, respectively. Under the fair value method principles of Statement No. 123, pro forma stock based compensation cost, net of taxes, and pro forma net income would not have differed from reported amounts for the quarters ended March 31, 2004 and 2003. The pro forma impact of stock options issued after 1994 had no effect on basic or diluted net income per share in the periods presented.

 

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4. Reinsurance

 

The table below summarizes the effect of reinsurance on premiums written and earned (dollars in thousands) :

 

     Three Months Ended March 31,

 
     2004

    2003

 
       Written       Earned       Written       Earned  

Direct

   $ 570,114     $ 598,639     $ 571,896     $ 553,281  

Assumed

     94,741       56,069       72,840       35,320  

Ceded

     (126,274 )     (149,316 )     (169,773 )     (156,248 )
    


 


 


 


Net premiums

   $ 538,581     $ 505,392     $ 474,963     $ 432,353  
    


 


 


 


 

Incurred losses and loss adjustment expenses are net of reinsurance recoverables (ceded incurred losses and loss adjustment expenses) of $82.9 million and $45.3 million for the three months ended March 31, 2004 and 2003, respectively.

 

5. Junior Subordinated Deferrable Interest Debentures (8.71% Junior Subordinated Debentures)

 

On January 8, 1997, the Company arranged the sale of $150 million of Company-Obligated Mandatorily Redeemable Preferred Capital Securities (8.71% Capital Securities) issued under an Amended and Restated Declaration of Trust dated January 13, 1997 (the Declaration) by Markel Capital Trust I (the Trust), a statutory business trust sponsored and wholly-owned by the Company. Proceeds from the sale of the 8.71% Capital Securities were used to purchase the Company’s 8.71% Junior Subordinated Debentures due January 1, 2046, issued to the Trust under an indenture dated January 13, 1997 (the Indenture). The 8.71% Junior Subordinated Debentures are the sole assets of the Trust. The Company has the right to defer interest payments on the 8.71% Junior Subordinated Debentures for up to five years. The 8.71% Capital Securities and related 8.71% Junior Subordinated Debentures are redeemable by the Company on or after January 1, 2007. Taken together, the Company’s obligations under the Debentures, the Indenture, the Declaration and a guarantee made by the Company provide, in the aggregate, a full, irrevocable and unconditional guarantee of payments of distributions and other amounts due on the 8.71% Capital Securities. No other subsidiary of the Company guarantees the 8.71% Junior Subordinated Debentures or the 8.71% Capital Securities. In the event of default under the Indenture, the Trust may not make distributions on, or repurchases of, the Trust’s common securities. During a period in which the Company elects to defer interest payments or in the event of default under the Indenture, the Company may not make distributions on, or repurchases of, the Company’s capital stock or debt securities ranking equal or junior to the 8.71% Junior Subordinated Debentures.

 

6. Convertible Notes Payable

 

During 2001, the Company issued $408.0 million principal amount at maturity, $112.9 million net proceeds, of Liquid Yield Option Notes (LYONs). The LYONs are zero coupon senior notes convertible into the Company’s common shares under certain conditions, with an initial conversion price of $243.53 per common share. The issue price of $283.19 per LYON represented a yield to maturity of 4.25%. The LYONs mature on June 5, 2031. The Company uses the effective yield method to recognize the accretion of discount from the issue price to the face amount of the LYONs at maturity. The accretion of discount is included in interest expense.

 

On June 5, 2004, if the price of the Company’s common stock is at or below specified thresholds based on a

 

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measurement period prior to that date, contingent additional principal will accrue on the LYONs at a rate of either 0.50% or 1.00% per year for a period of two years, depending on the price of the Company’s common shares. No contingent additional principal will accrue after June 5, 2006.

 

The Company will pay contingent cash interest to the holders of the LYONs during the six-month period commencing June 5, 2006 and during any six-month period thereafter if the average market price of a LYON for a specified period equals or exceeds 120% of the sum of the issue price, accrued original issue discount and contingent additional principal, if any, for the LYON.

 

Each LYON will be convertible into 1.1629 shares of common stock upon the occurrence of any of the following events: if the closing price of the Company’s common shares on the New York Stock Exchange exceeds specified levels, if the credit rating of the LYONs is reduced below specified levels, if the Company calls the LYONs for redemption, or if the Company is party to certain mergers or consolidations.

 

LYONs holders have the right to require the Company to repurchase the LYONs on June 5th of 2004, 2006, 2011, 2016, 2021 and 2026 at their accreted value on these dates as follows:

 

June 5, 2004

   $ 321.27

June 5, 2006

   $ 349.46

June 5, 2011

   $ 431.24

June 5, 2016

   $ 532.16

June 5, 2021

   $ 656.69

June 5, 2026

   $ 810.36

 

The Company may choose to pay the purchase price for such repurchases in cash or common shares of the Company. The Company may redeem the LYONs for cash on or after June 5, 2006 at their accreted value.

 

7. Income Taxes

 

During the quarter ended March 31, 2004, the Internal Revenue Service (IRS) completed its review of the Company’s appeal of the previously issued assessment based upon alleged overstatement of loss reserves for tax returns filed for 1997, 1998 and 1999. The Company’s appeal was accepted and the assessment was withdrawn.

 

8. Comprehensive Income

 

Other comprehensive income (loss) is composed of net holding gains (losses) on securities arising during the period less reclassification adjustments for gains included in net income. Other comprehensive income (loss) also includes foreign currency translation adjustments. The related tax expense (benefit) on net holding gains (losses) on securities arising during the period was $31.2 million and $(8.4) million for the quarters ended March 31, 2004 and 2003, respectively. The related tax expense on the reclassification adjustments for gains included in net income was $2.6 million and $2.3 million for the quarters ended March 31, 2004 and 2003, respectively. The related tax expense (benefit) on foreign currency translation adjustments was $(0.6) million and $1.1 million for the quarters ended March 31, 2004 and 2003, respectively.

 

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9. Segment Reporting Disclosures

 

The Company operates in three segments of the specialty insurance marketplace: the Excess and Surplus Lines, the Specialty Admitted and the London markets.

 

All investing activities are included in the Investing segment. Discontinued programs and non-strategic insurance subsidiaries are included in Other for purposes of segment reporting.

 

The Company considers many factors, including the nature of the underwriting units’ insurance products, production sources, distribution strategies and regulatory environment in determining how to aggregate operating segments.

 

Segment profit or (loss) for each of the Company’s operating segments is measured by underwriting profit or (loss). The property and casualty insurance industry commonly defines underwriting profit or (loss) as earned premiums net of losses and loss adjustment expenses and underwriting, acquisition and insurance expenses. Underwriting profit or (loss) does not replace operating income (loss) or net income (loss) computed in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) as a measure of profitability. Underwriting profit or (loss) provides a basis for management to evaluate the Company’s underwriting performance. Segment profit for the Investing segment is measured by net investment income and net realized gains or losses.

 

The Company does not allocate assets to the Excess and Surplus Lines, Specialty Admitted and London Insurance Market operating segments for management reporting purposes. The total investment portfolio, cash and cash equivalents are allocated to the Investing segment. The Company does not allocate capital expenditures for long-lived assets to any of its operating segments for management reporting purposes.

 

a) Following is a summary of segment disclosures (dollars in thousands):

 

     Quarter Ended March 31, 2004

 
    

Excess and

Surplus Lines


   

Specialty

Admitted


   

London

Insurance

Market


    Investing

   Other

    Consolidated

 

Gross premium volume

   $ 362,269     $ 61,738     $ 211,046     $ —      $ 29,802     $ 664,855  

Net premiums written

     278,001       58,341       177,682       —        24,557       538,581  

Earned premiums

   $ 275,454     $ 62,745     $ 160,007     $ —      $ 7,186     $ 505,392  

Losses and loss adjustment expenses

     150,089       35,830       134,678       —        5,737       326,334  

Underwriting, acquisition and insurance expenses

     78,306       21,738       56,264       —        3,755       160,063  
    


 


 


 

  


 


Underwriting profit (loss)

     47,059       5,177       (30,935 )     —        (2,306 )     18,995  
    


 


 


 

  


 


Net investment income

     —         —         —         48,663      —         48,663  

Net realized gains from investment sales

     —         —         —         7,393      —         7,393  
    


 


 


 

  


 


Segment profit (loss)

   $ 47,059     $ 5,177     $ (30,935 )   $ 56,056    $ (2,306 )   $ 75,051  
    


 


 


 

  


 


Interest expense

                                            12,881  
                                           


Income before income taxes

                                          $ 62,170  
                                           


U.S. GAAP combined ratio*

     83 %     92 %     119 %     —        132 %     96 %

 

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     Quarter Ended March 31, 2003

 
    

Excess and

Surplus Lines


   

Specialty

Admitted


   

London

Insurance

Market


    Investing

   Other

    Consolidated

 

Gross premium volume

   $ 365,609     $ 57,738     $ 199,690     $ —      $ 21,699     $ 644,736  

Net premiums written

     255,695       53,467       147,720       —        18,081       474,963  

Earned premiums

   $ 236,674     $ 54,658     $ 134,238     $ —      $ 6,783     $ 432,353  

Losses and loss adjustment expenses

     146,221       33,715       88,763       —        11,320       280,019  

Underwriting, acquisition and insurance expenses

     62,650       19,954       49,231       —        3,801       135,636  
    


 


 


 

  


 


Underwriting profit (loss)

     27,803       989       (3,756 )     —        (8,338 )     16,698  
    


 


 


 

  


 


Net investment income

     —         —         —         45,233      —         45,233  

Net realized gains from investment sales

     —         —         —         6,471      —         6,471  
    


 


 


 

  


 


Segment profit (loss)

   $ 27,803     $ 989     $ (3,756 )   $ 51,704    $ (8,338 )   $ 68,402  
    


 


 


 

  


 


Amortization of intangible assets

                                            2,629  

Interest expense

                                            11,395  
                                           


Income before income taxes

                                          $ 54,378  
                                           


U.S. GAAP combined ratio*

     88 %     98 %     103 %     —        223 %     96 %

* The U.S. GAAP 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.

 

     As of

    

March 31,

2004


  

December 31,

2003


Segment Assets

             

Investing

   $ 5,491,141    $ 5,349,952

Other

     3,262,588      3,182,281
    

  

Total Assets

   $ 8,753,729    $ 8,532,233

 

10. Goodwill and Other Intangible Assets

 

As required by Financial Accounting Standards Board Statement No. 142, Goodwill and Other Intangible Assets, goodwill is tested at least annually for impairment. The Company completes its annual test during the fourth quarter of each year based upon the results of operations through September 30. There was no indication of goodwill impairment as of March 31, 2004 or December 31, 2003.

 

Intangible assets (other than goodwill) were fully amortized as of June 30, 2003. The amortization expense for intangible assets was $2.6 million for the quarter ended March 31, 2003.

 

The carrying amounts of goodwill by reporting unit at both March 31, 2004 and 2003 were as follows: Excess and Surplus Lines, $81.8 million, and London Insurance Market, $275.5 million.

 

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11. Contingencies

 

On January 31, 2001, the Company received notice of a lawsuit filed in the United States District Court of the Southern District of New York against Terra Nova Insurance Company Limited by Palladium Insurance Limited and Bank of America, N.A. seeking approximately $27 million plus exemplary damages in connection with alleged reinsurance agreements. This matter is still in the discovery phase and is not expected to be ready for trial before late 2004 or 2005. The Company believes it has numerous defenses to this claim, including the defense that the alleged reinsurance agreements and insurance policies were not valid. The Company intends to vigorously defend this matter.

 

This and other contingencies arise in the normal conduct of the Company’s operations. In the opinion of management, the resolutions of these contingencies are not expected to have a material impact on the Company’s financial condition or results of operations. However, adverse outcomes are possible and could negatively impact the Company’s financial condition or results of operations.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The accompanying Consolidated Financial Statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and include the accounts of Markel Corporation and all subsidiaries (the Company).

 

Critical Accounting Policies

 

Critical accounting policies are defined as those that are both important to the portrayal of the Company’s financial condition and results of operations and require management to exercise significant judgment. 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 and liabilities and disclosure of material contingent assets and liabilities, including litigation contingencies, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates, by necessity, are based on assumptions about numerous factors.

 

Management reviews its estimates and assumptions quarterly, including the adequacy of reserves for unpaid losses and loss adjustment expenses, reinsurance allowance for doubtful accounts, as well as, the recoverability of deferred tax assets and intangible assets and the evaluation of the investment portfolio for other than temporary declines in value. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.

 

Readers are urged to review the Company’s 2003 annual report on Form 10-K for a more complete description of the Company’s Critical Accounting Policies.

 

The Company

 

The Company markets and underwrites specialty insurance products and programs to a variety of niche markets. In each of these markets, the Company seeks to be a market leader. The financial goals of the Company are to earn consistent underwriting profits and superior investment returns to build shareholder value.

 

The Company competes in three segments of the specialty insurance marketplace: the Excess & Surplus Lines, the Specialty Admitted and the London markets. The Excess and Surplus Lines segment is comprised of five underwriting units, the Specialty Admitted segment consists of two underwriting units and the London Insurance Market segment is comprised of the ongoing operations of Markel International.

 

The Excess and Surplus Lines segment writes property and casualty insurance for non-standard and hard-to-place risks including catastrophe-exposed property, professional liability, products liability, general liability, commercial umbrella and other coverages tailored for unique exposures.

 

The Specialty Admitted segment writes risks that are unique and hard-to-place in the standard market but must remain with an admitted insurance company for marketing and regulatory reasons. The underwriting units in this segment write specialty program insurance for well-defined niche markets and personal and commercial property and liability coverages.

 

The Company participates in the London market through Markel Capital Limited and Markel International

 

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Insurance Company Limited, two wholly-owned subsidiaries. Markel Capital Limited is the corporate capital provider for Markel Syndicate 3000 at Lloyd’s. Markel Syndicate Management Limited, a wholly-owned subsidiary, manages the Company’s Lloyd’s operations. The London Insurance Market segment writes specialty property, casualty, marine and aviation insurance and reinsurance.

 

Discontinued lines of business and non-strategic insurance subsidiaries are included in Other for segment reporting purposes. Other consisted primarily of discontinued Markel International programs and Corifrance, a wholly-owned subsidiary, for both quarters ended March 31, 2004 and 2003.

 

Results of Operations

 

Three Months ended March 31, 2004 compared to Three Months ended March 31, 2003

 

Underwriting Results

 

Following is a comparison of selected data from the Company’s operations (dollars in thousands):

 

    

Three Months Ended

March 31,


 
     2004

    2003

 

Gross premium volume

   $ 664,855     $ 644,736  

Net premiums written

   $ 538,581     $ 474,963  

Net retention

     81 %     74 %

Earned premiums

   $ 505,392     $ 432,353  

Losses and loss adjustment expenses

   $ 326,334     $ 280,019  

Underwriting, acquisition and insurance expenses

   $ 160,063     $ 135,636  

Underwriting profit*

   $ 18,995     $ 16,698  

U.S. GAAP Combined Ratios

                

Excess and Surplus Lines

     83 %     88 %

Specialty Admitted

     92 %     98 %

London Insurance Market

     119 %     103 %

Other

     132 %     223 %

Markel Corporation (Consolidated)

     96 %     96 %

* See note 9 of the notes to consolidated financial statements for a discussion of underwriting profit or (loss) and a reconciliation of this amount to income (loss) before income taxes. The property and casualty insurance industry commonly defines underwriting profit or (loss) as earned premiums net of losses and loss adjustment expenses and underwriting, acquisition and insurance expenses. Underwriting profit or (loss) does not replace operating income (loss) or net income (loss) computed in accordance with U.S. GAAP as a measure of profitability.

 

Underwriting profits are a key component of the Company’s strategy to grow book value per share. The Company believes that the ability to achieve consistent underwriting profits demonstrates knowledge and expertise, commitment to superior customer service and the ability to manage insurance risk. The Company uses underwriting profit or (loss) as a basis of evaluating its underwriting performance.

 

The U.S. GAAP 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 of less than 100% indicates an underwriting profit, while a combined ratio of greater than 100% reflects an underwriting loss.

 

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While the combined ratio was 96% in both quarters ended March 31, 2004 and 2003, the Company’s underwriting profit increased 14% to $19.0 million in 2004 from $16.7 million in 2003 as a result of higher earned premium in 2004. The continued improvement in underwriting performance for the Excess and Surplus Lines and Specialty Admitted segments was partially offset by loss development in the London Insurance Market segment during the quarter ended March 31, 2004.

 

The combined ratio for the Excess and Surplus Lines segment improved for the quarter ended March 31, 2004 primarily due to favorable development of prior years’ loss reserves and strong pricing.

 

The Specialty Admitted segment produced improved underwriting results for the quarter ended March 31, 2004 compared to the same period of 2003 primarily due to lower current year losses.

 

The underwriting loss for the London Insurance Market segment for the quarter ended March 31, 2004 was $30.9 million compared to $3.8 million for the same period of 2003. The first quarter of 2004 included $30.0 million of loss reserve increases for adverse development from 1997 to 2001 on U.S. casualty reinsurance, financial institution risks and general and professional liability exposures, most of which are no longer written.

 

The Other underwriting loss for the quarter ended March 31, 2004 was $2.3 million compared to $8.3 million for the same period of 2003. The underwriting loss for the first quarter of 2003 included a $5.0 million allowance for potentially uncollectible reinsurance related to the Company’s discontinued operations.

 

Premiums

 

While most of the Company’s insurance operations continue to achieve rate increases compared to the prior year, rate increases have begun to slow and, in certain lines of business, rates have declined. Lines of business which have experienced rate declines include large direct and reinsurance property accounts, aviation, energy and marine war accounts. Despite these rate reductions, the Company believes that the rates being obtained on these books of business are still at levels that support underwriting profit targets. The Company is committed to maintaining adequate pricing and will not sacrifice its goal of underwriting profitability in order to maintain premium growth. As a result, premium volume may vary when the Company alters its product offerings to maintain or improve underwriting profitability.

 

Following is a comparison of gross premium volume and earned premiums by significant underwriting segment:

 

Gross Premium Volume

                  Earned Premiums

Three Months Ended March 31,

                  Three Months Ended March 31,

2004

   2003

       

(dollars in thousands)


        2004

   2003

$362,269    $ 365,609         Excess and Surplus Lines         $ 275,454    $ 236,674
61,738      57,738         Specialty Admitted           62,745      54,658
211,046      199,690         London Insurance Market           160,007      134,238
29,802      21,699         Other           7,186      6,783

  

                 

  

$664,855    $ 644,736         Total         $ 505,392    $ 432,353

  

                 

  

 

Gross written premium for the quarter ended March 31, 2004 increased 3%, slightly below the Company’s anticipated 2004 gross premium growth of 5% to 10%. In total, gross written premium for the Excess and

 

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Surplus Lines and Specialty Admitted segments for the quarter ended March 31, 2004 was flat compared to the same period of 2003. Gross written premium on property business decreased $20 million due to increased market competition. Gross written premium on the casualty book of business at the Investors Brokered Excess and Surplus Lines unit decreased $15 million due to the Company’s decision to re-underwrite and re-price this business in response to prior years’ loss reserve development during 2003. These decreases were offset by new programs and growth in other casualty business in these two segments. The increase in gross written premium for the London Insurance Market segment was primarily due to movement in foreign currency rates since 2003. Other gross written premiums consisted primarily of Corifrance’s writings in 2004 and 2003.

 

Earned premium for the first quarter of 2004 increased 17% compared to the same period of 2003. This increase is due to higher gross premium volume and higher retentions over the past year in all segments.

 

Net Retention

 

The Company purchases reinsurance in order to reduce its retention on individual risks and enable it to write policies with sufficient limits to meet policyholder needs. The Company’s underwriting philosophy seeks to offer products with limits that do not require significant amounts of reinsurance. The Company’s net retention of gross premium volume increased to 81% in the first quarter of 2004 compared to 74% in the prior year. The increase was primarily due to changes in the mix of premium writings and purchasing lower amounts of reinsurance in both the Excess and Surplus Lines and the London Insurance Market segments during 2004 compared to 2003.

 

Investment Results

 

Net investment income for the first quarter of 2004 was $48.7 million compared to $45.2 million in the prior year. In the first quarter of 2004, a larger investment portfolio offset lower investment yields. During the first quarter of 2004, the Company added approximately $49 million on a cost basis to the equity investment portfolio.

 

In the first quarter of 2004, the Company recognized $7.4 million of net realized gains compared to $6.5 million of net realized gains in 2003. Variability in the timing of realized and unrealized investment gains and losses is to be expected.

 

Other Expenses

 

Interest expense for the first quarter of 2004 was $12.9 million compared to $11.4 million for the same period of 2003. The increase was primarily due to the 2003 issuance of $250 million of unsecured senior notes.

 

For the quarter ended March 31, 2004, the Company’s effective tax rate was 32% compared to 33% for the quarter ended March 31, 2003.

 

Comprehensive Income

 

Comprehensive income was $94.3 million for the first quarter of 2004 compared to $18.7 million for the same period of 2003. The improvement was primarily due to a significant increase in the market value of the Company’s investment portfolio during the first quarter of 2004 compared to a decline in market value during

 

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the same period of 2003. Comprehensive income for the first quarter of 2004 includes $1.1 million of losses from currency translation adjustments, net of taxes, compared to gains of $2.0 million for the same period of 2003. The Company attempts to match assets and liabilities in original currencies to mitigate the impact of currency volatility.

 

Financial Condition as of March 31, 2004

 

At March 31, 2004, the Company’s investment portfolio increased 3% to $5.5 billion from $5.3 billion at December 31, 2003. The Company reported net unrealized gains, net of taxes, on its fixed maturity and equity investments of $323.9 million at March 31, 2004 compared to $270.8 million at December 31, 2003. Equity securities were $1.1 billion, or 19% of the total investment portfolio, at March 31, 2004 compared to $1.0 billion, or 18%, at December 31, 2003.

 

For the three month period ended March 31, 2004, the Company reported net cash provided by operating activities of $54.8 million, compared to $103.6 million for the same period in 2003. The decrease was primarily due to larger incentive compensation and contingent commission payments in the first quarter of 2004 compared to the same period last year as a result of the strong underwriting performance for the year ended December 31, 2003.

 

For the three month period ended March 31, 2004, the Company reported net cash used by investing activities of $159.9 million compared to $325.3 million in 2003. The decreased use of cash for investing activities during 2004 was primarily due to decreased operating cash flows.

 

For the three month period ended March 31, 2004, the Company reported net cash used by financing activities of $1.8 million compared to net cash provided by financing activities of $23.2 million in 2003. The net cash used by financing activities during the first quarter of 2004 was primarily due to the repurchase of 8,200 shares of the Company’s common stock. These repurchases were made in anticipation of the future issuance of the Company’s common stock to satisfy grants of Restricted Stock Units made to directors and officers under the Markel Corporation Omnibus Incentive Plan. The net cash provided by financing activities during the three month period ended March 31, 2003 was primarily the result of the debt issuance during the first quarter of 2003 partially offset by the repayment of the outstanding balance under the Company’s revolving credit facility.

 

During the second quarter of 2004, holders may require the Company to repurchase some or all of its convertible notes payable. See note 6 of the notes to the consolidated financial statements for further discussion of the Company’s convertible notes payable. The Company also expects to reallocate capital and liabilities from certain of its wholly-owned Bermuda subsidiaries to Markel International by means of commutation and reinsurance agreements between the subsidiaries. Additionally, the Company will be required to fund losses at Lloyd’s related to closed years of account for syndicates now in run-off. The Company anticipates these transactions may require up to $200 million of cash during 2004.

 

The Company has access to various liquidity sources including dividends from its insurance subsidiaries, holding company investments and cash, undrawn capacity under its revolving credit facility and access to the debt and equity capital markets. Management believes that the Company has sufficient liquidity to meet its needs.

 

Shareholders’ equity at March 31, 2004 was $1,474.7 million compared to $1,382.3 million at December 31, 2003. Book value increased 7% to $149.70 per share primarily as a result of $42.3 million of net income and a $53.0 million increase in net unrealized investment gains, net of taxes, for the quarter ended March 31, 2004.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company’s consolidated balance sheets include assets and liabilities with estimated fair values which are subject to market risk. The primary market risks to the Company are equity price risk associated with investments in equity securities, interest rate risk associated with investments in fixed maturities and foreign exchange risk for its international operations. The Company has no material commodity risk.

 

The Company primarily manages foreign exchange risk by matching assets and liabilities in each foreign currency as closely as possible. Significant estimations and assumptions are required when establishing insurance balances such as reinsurance recoverables and reserves for unpaid losses and loss adjustment expenses. As a result, matching of assets and liabilities by currency is subject to change as actual results emerge.

 

The Company’s market risks at March 31, 2004 have not materially changed from those identified at December 31, 2003.

 

Item 4. Controls and Procedures

 

As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chairman and Chief Executive Officer (CEO) and the Executive Vice President and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15 (Disclosure Controls).

 

The Company’s management, including the CEO and CFO, does not expect that its Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based upon the Company’s controls evaluation, the CEO and CFO have concluded that the Company’s Disclosure Controls provide reasonable assurance that the information required to be disclosed by the Company in its periodic reports is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

There were no changes in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Safe Harbor and Cautionary Statement

 

This is a “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995. It also contains general cautionary statements regarding the Company’s business, estimates and management assumptions. Future actual results may materially differ from those described in this report because of many factors. Among other things:

 

  The impact of the events of September 11, 2001 will depend on the number of insureds and reinsureds affected by the events, the amount and timing of losses incurred and reported and questions of how coverage applies;

 

  The occurrence of additional terrorist activities could have a material impact on the Company and the insurance industry;

 

  The Company’s anticipated premium growth is based on current knowledge and assumes no significant man-made or natural catastrophes, no significant changes in products or personnel and no adverse changes in market conditions;

 

  The Company is legally required to offer terrorism insurance and has attempted to manage its exposure, however, in the event of a covered terrorist attack, the Company could sustain material losses;

 

  Changing legal and social trends and inherent uncertainties (including but not limited to those uncertainties associated with the Company’s asbestos and environmental reserves) in the loss estimation process can adversely impact the adequacy of loss reserves and the allowance for reinsurance recoverables;

 

  Industry and economic conditions can affect the ability and/or willingness of reinsurers to pay balances due;

 

  The Company recently completed a review of claims processes at the Investors Brokered Excess and Surplus Line unit. The Company continues to closely monitor this unit and discontinued lines and related reinsurance programs and exposures. Adverse experience in these areas could lead to additional charges;

 

  Regulatory actions can impede the Company’s ability to charge adequate rates and efficiently allocate capital; and

 

  Economic conditions, interest rates and foreign exchange rate volatility can have a significant impact on the market value of fixed maturity and equity investments as well as the carrying value of other assets and liabilities.

 

The Company’s premium growth, underwriting and investment results have been and will continue to be potentially materially affected by these factors. Additional factors, which could affect the Company, are discussed in the Company’s reports on Forms 8-K, 10-Q and 10-K. By making these forward looking statements, the Company is not intending to become obligated to publicly update or revise any forward looking statements whether as a result of new information, future events or other changes. Readers are cautioned not to place undue reliance on any forward looking statements, which speak only as at their dates.

 

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PART II. OTHER INFORMATION

 

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

The following table summarizes the Company’s common stock repurchases for the quarter ended March 31, 2004:

 

Issuer Purchases of Equity Securities¹

 

     (a)

   (b)

   (c)

   (d)

Period


  

Total

Number
of

Shares

(or Units)

Purchased


  

Average

Price

Paid per

Share

(or Units)


  

Total

Number of

Shares

(or Units)

Purchased as

Part

Of Publicly

Announced

Plans

Or
Programs


  

Maximum

Number (or

Approximate

Dollar

Value) of

Shares

(or Units)

that

May Yet Be

Purchased
Under

The Plans or

Programs


                       

01/01/2004-01/31/2004

   —        —      —      —  
                       

02/01/2004-02/29/2004

   —        —      —      —  
                       

03/01/2004-03/31/2004

   8,200    $ 276.31    0    —  
                       
    
  

  
  

Total

   8,200    $ 276.31    0    —  
    
  

  
  

¹ All purchases were made via open-market transactions. Such purchases were made in anticipation of the future issuance of common stock to satisfy grants of Restricted Stock Units made to directors and officers under the Markel Corporation Omnibus Incentive Plan. The Company does not have any publicly announced plans or programs to repurchase its common stock.

 

Item 6. Exhibits and Reports on Form 8-K

 

(a) Exhibits.

 

The Exhibits to this Report are listed in the Exhibit Index.

 

(b) On January 29, 2004, the Company filed a report on Form 8-K furnishing under Item 7 and Item 12 a copy of the Company’s press release announcing fourth quarter and year-end 2003 financial results.

 

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, this 5th day of May, 2004.

 

The Company

By

 

/s/ Alan I. Kirshner


    Alan I. Kirshner
    Chairman and Chief Executive Officer
    (Principal Executive Officer)

By

 

/s/ Anthony F. Markel


    Anthony F. Markel
    President
    (Principal Operating Officer)

By

 

/s/ Steven A. Markel


    Steven A. Markel
    Vice Chairman

By

 

/s/ Darrell D. Martin


    Darrell D. Martin
   

Executive Vice President and

Chief Financial Officer

(Principal Financial Officer and

Principal Accounting Officer)

 

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Exhibit Index

 

Number

  

Description


3(i)    Amended and Restated Articles of Incorporation, as amended (3(i))a
3(ii)    Bylaws, as amended (4.2)b
4    Credit Agreement dated September 30, 2003, among Markel Corporation, the lenders named therein and SunTrust Bank, as Administrative Agent (4)c
     The registrant hereby agrees to furnish to the Securities and Exchange Commission a copy of all instruments defining the rights of holders of convertible notes payable and long-term debt of the registrant and subsidiaries shown on the Consolidated Balance Sheet of the registrant at March 31, 2004 and the respective Notes thereto, included in the Quarterly Report on Form 10-Q.
31.1    Certification of Principal Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)*
31.2    Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)*
32.1    Certification of Principal Executive Officer furnished Pursuant to 18 U.S.C. Section 1350*
32.2    Certification of Principal Financial Officer furnished Pursuant to 18 U.S.C. Section 1350*

 

a. Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant’s report on Form 10-Q for the quarter ended March 31, 2000.

 

b. Incorporated by reference from Exhibit 4.2 to S-8 Registration Statement No. 333-107661, dated August 5, 2003.

 

c. Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant’s report on Form 10-Q for the quarter ended September 30, 2003.

* Filed with this report.

 

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