SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 September 30, 2001
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 (I.R.S. employer
incorporation or organization) 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 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 [_]
Number of shares of the registrant's common stock outstanding at October 30,
2001: 8,619,000
1
Markel Corporation
Form 10-Q
Index
PART I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Consolidated Balance Sheets--
September 30, 2001 and December 31, 2000 3
Consolidated Statements of Operations and Comprehensive Income (Loss)--
Quarters and Nine Months Ended September 30, 2001 and 2000 4
Consolidated Statements of Changes in Shareholders' Equity-- 5
Nine Months Ended September 30, 2001 and 2000
Consolidated Statements of Cash Flows--
Nine Months Ended September 30, 2001 and 2000 6
Notes to Consolidated Financial Statements-- 7
September 30, 2001
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 23
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MARKEL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
2001 2000
------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
ASSETS
Investments, available-for-sale, at estimated fair value
Fixed maturities (cost of $2,437,208 in 2001 and $2,322,616 in 2000) $ 2,555,732 $ 2,374,008
Equity securities (cost of $339,944 in 2001 and $291,385 in 2000) 475,327 431,126
Short-term investments (estimated fair value approximates cost) 68,446 80,710
------------------------------------------------------------------------------------------------------------------------
Total Investments, Available-For-Sale 3,099,505 2,885,844
------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 199,025 250,320
Receivables 228,503 223,114
Accrued premium income 148,453 160,048
Reinsurance recoverable on unpaid losses 1,410,350 989,470
Reinsurance recoverable on paid losses 183,698 114,963
Deferred policy acquisition costs 157,403 130,644
Prepaid reinsurance premiums 167,020 139,272
Intangible assets 379,715 402,999
Other assets 198,271 176,479
------------------------------------------------------------------------------------------------------------------------
Total Assets $ 6,171,943 $ 5,473,153
========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 3,602,076 $ 3,037,006
Unearned premiums 786,800 701,663
Payables to insurance companies 195,596 138,242
Convertible notes payable (estimated fair value of $117,555) 114,656 --
Long-term debt (estimated fair value of $274,548 in 2001 and $569,127 in 2000) 277,125 573,111
Other liabilities 135,025 120,759
Company-Obligated Mandatorily Redeemable Preferred Capital Securities of Subsidiary
Trust Holding Solely Junior Subordinated Deferrable Interest Debentures
of Markel Corporation (estimated fair value of $112,500 in 2001
and $130,742 in 2000) 150,000 150,000
------------------------------------------------------------------------------------------------------------------------
Total Liabilities 5,261,278 4,720,781
------------------------------------------------------------------------------------------------------------------------
Shareholders' equity
Common stock 525,777 325,914
Retained earnings 219,999 302,000
Accumulated other comprehensive income
Net unrealized holding gains on fixed maturities and equity securities,
net of taxes of $88,868 in 2001 and $66,897 in 2000 165,039 124,236
Cumulative translation adjustments, net of tax benefit of $81 in 2001
and tax expense of $120 in 2000 (150) 222
------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 910,665 752,372
------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 6,171,943 $ 5,473,153
========================================================================================================================
See accompanying notes to consolidated financial statements.
3
MARKEL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income (Loss)
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
OPERATING REVENUES
Earned premiums $ 327,522 $ 253,156 $ 866,856 $ 655,344
Net investment income 42,243 44,136 127,937 110,818
Net realized gains (losses) from investment sales 8,508 880 16,278 (3,462)
Other -- 47 -- 141
---------------------------------------------------------------------------------------------------------------------
Total Operating Revenues 378,273 298,219 1,011,071 762,841
---------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Losses and loss adjustment expenses 370,419 218,231 752,950 511,883
Underwriting, acquisition and insurance expenses 117,933 92,185 311,713 236,295
Amortization of intangible assets 7,712 7,202 23,096 15,979
---------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 496,064 317,618 1,087,759 764,157
---------------------------------------------------------------------------------------------------------------------
Operating Loss (117,791) (19,399) (76,688) (1,316)
Interest expense 11,782 14,978 37,811 37,235
---------------------------------------------------------------------------------------------------------------------
Loss Before Income Taxes (129,573) (34,377) (114,499) (38,551)
Income tax benefit (38,548) (18,728) (32,518) (19,180)
---------------------------------------------------------------------------------------------------------------------
Net Loss $ (91,025) $ (15,649) $ (81,981) $ (19,371)
=====================================================================================================================
OTHER COMPREHENSIVE INCOME
Unrealized gains on securities, net of taxes
Net holding gains arising during the period $ 21,920 $ 43,375 $ 51,384 $ 41,575
Less reclassification adjustments for gains (losses)
included in net loss (5,530) (572) (10,581) 2,251
---------------------------------------------------------------------------------------------------------------------
Net unrealized gains 16,390 42,803 40,803 43,826
Currency translation adjustments, net of taxes (656) (3,368) (372) (3,368)
=====================================================================================================================
Total Other Comprehensive Income 15,734 39,435 40,431 40,458
---------------------------------------------------------------------------------------------------------------------
Comprehensive Income (Loss) $ (75,291) $ 23,786 $ (41,550) $ 21,087
=====================================================================================================================
NET LOSS PER SHARE
Basic $ (10.58) $ (2.15) $ (9.85) $ (2.85)
Diluted $ (10.58) $ (2.15) $ (9.85) $ (2.85)
=====================================================================================================================
See accompanying notes to consolidated financial statements.
4
MARKEL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
Nine Months Ended
September 30,
----------------------------
2001 2000
----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Common Stock
Balance at beginning of period $ 325,914 $ 25,625
Issuance of common stock and other equity 199,863 299,088
----------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 525,777 $ 324,713
----------------------------------------------------------------------------------------------------------------------------
Retained Earnings
Balance at beginning of period $ 302,000 $ 342,426
Net loss (81,981) (19,371)
Repurchase of common stock and other (20) (12,830)
-----------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 219,999 $ 310,225
------------------------------------------------------------------------------------------------------------------------------
Accumulated Other Comprehensive Income
Unrealized gains
Balance at beginning of period $ 124,236 $ 15,368
Net unrealized holding gains arising during the period, net of taxes 40,803 43,826
----------------------------------------------------------------------------------------------------------------------------
Balance at end of period 165,039 59,194
Cumulative translation adjustment
Balance at beginning of period 222 --
Translation adjustments, net of taxes (372) (3,368)
-----------------------------------------------------------------------------------------------------------------------------
Balance at end of period (150) (3,368)
-----------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 164,889 $ 55,826
----------------------------------------------------------------------------------------------------------------------------
Shareholders' Equity at End of Period $ 910,665 $ 690,764
============================================================================================================================
See accompanying notes to consolidated financial statements.
5
MARKEL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
----------------------------
2001 2000
-----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
OPERATING ACTIVITIES
Net Loss $ (81,981) $ (19,371)
Adjustments to reconcile net loss to net cash provided by operating activities 169,421 46,142
-----------------------------------------------------------------------------------------------------------------------------
Net Cash Provided By Operating Activities 87,440 26,771
-----------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities and equity securities 616,654 688,922
Proceeds from maturities of fixed maturities 102,116 51,547
Cost of fixed maturities and equity securities purchased (874,611) (726,305)
Net change in short-term investments 12,264 13,800
Acquisition of insurance company, net of cash acquired -- (208,040)
Sale of insurance company shell, net of cash sold -- 12,482
Other (8,500) (10,774)
-----------------------------------------------------------------------------------------------------------------------------
Net Cash Used By Investing Activities (152,077) (178,368)
-----------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Additions to long-term debt and convertible notes payable 147,943 370,000
Repayments and repurchases of long-term debt (332,236) (126,488)
Issuance of common stock 197,991 --
Other (201) (9,224)
-----------------------------------------------------------------------------------------------------------------------------
Net Cash Provided By Financing Activities 13,497 234,288
-----------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (51,140) 82,691
Exchange on foreign currency cash balances (155) (799)
Cash and cash equivalents at beginning of period 250,320 129,055
-----------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 199,025 $ 210,947
=============================================================================================================================
See accompanying notes to consolidated financial statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - September 30, 2001
1. Principles of Consolidation
The consolidated balance sheet as of September 30, 2001, the related
consolidated statements of operations and comprehensive income (loss) for the
quarters and nine months ended September 30, 2001 and 2000, the consolidated
statements of changes in shareholders' equity and the consolidated statements of
cash flows for the nine months ended September 30, 2001 and 2000 are unaudited.
In the opinion of management, all adjustments necessary for a 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 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.
Certain reclassifications of prior year amounts have been made to conform with
2001 presentations.
2. World Trade Center and Other Events of September 11, 2001
The Company's 2001 third quarter and nine months results reflected $75.0 million
of estimated losses, net of approximately $250 million of reinsurance
recoverables, related to the terrorist attack on the World Trade Center and
other related events of September 11, 2001 (WTC). Markel International's, Markel
North America's and Discontinued Lines' WTC provisions were $70.8 million, $1.5
million and $2.7 million, respectively. The Company has used many loss
estimation techniques including detailed policy level reviews, the use of
catastrophe modeling software, direct contact with insureds and brokers and
sensitivity analysis to possible coverage scenarios in order to develop its
estimated WTC exposure. The Company has also completed a detailed review of its
reinsurance recoverables related to its potential WTC losses. Approximately 98%
of the estimated reinsurance recoverables are due from reinsurers rated "A-" or
better by A.M. Best or Standard and Poor's. The Company's gross and net WTC loss
estimates include a margin for underestimation of claims, reinsurance
reinstatement premiums and potentially uncollectable reinsurance. New
information concerning potential losses and coverage emerges daily. While the
Company believes that its WTC reserve is adequate, adverse development is
possible.
3. Net Loss per share
Net loss per share was determined by dividing net loss by the applicable shares
outstanding (in thousands):
Quarter Ended Nine Months Ended
September 30, September 30,
----------------------------- ----------------------------
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------------------
Net loss, as reported (basic and diluted) $ (91,025) $ (15,649) $ (81,981) $ (19,371)
===========================================================================================================================
Average basic common shares outstanding 8,605 7,288 8,327 6,793
Dilutive potential common shares -- -- -- --
---------------------------------------------------------------------------------------------------------------------------
Average diluted shares outstanding 8,605 7,288 8,327 6,793
===========================================================================================================================
Because the Company reported a net loss for the quarter and nine month periods
ended September 30, 2001 and
7
3. Net Loss per share (continued)
2000, dilutive potential common shares were not included in the calculation of
earnings per share.
4. Reinsurance
The table below summarizes the effect of reinsurance on premiums written and
earned (dollars in thousands):
Quarter Ended September 30,
------------------------------------------------------------------------------
2001 2000
------------------------------------------------------------------------------
Written Earned Written Earned
Direct $ 413,329 $ 418,321 $ 317,032 $ 299,833
Assumed 31,456 47,679 6,581 49,843
Ceded (138,674) (138,478) (81,110) (96,520)
------------------------------------------------------------------------------
Net premiums $ 306,111 $ 327,522 $ 242,503 $ 253,156
==============================================================================
Nine Months Ended September 30,
------------------------------------------------------------------------------
2001 2000
------------------------------------------------------------------------------
Written Earned Written Earned
Direct $ 1,147,044 $ 1,061,871 $ 773,910 $ 729,045
Assumed 132,027 123,375 44,663 124,585
Ceded (351,157) (318,390) (224,730) (198,286)
------------------------------------------------------------------------------
Net premiums $ 927,914 $ 866,856 $ 593,843 $ 655,344
==============================================================================
Incurred losses and loss adjustment expenses are net of reinsurance recoverables
of $420.2 million and $109.3 million for the quarters ended September 30, 2001
and 2000, respectively, and $732.8 million and $203.7 million for the nine
months ended September 30, 2001 and 2000, respectively. Reinsurance recoverables
for the third quarter and nine months ended September 30, 2001 include
approximately $250 million related to the WTC exposure discussed in Note 2.
5. Company Obligated Mandatorily Redeemable Preferred Securities (8.71%
Capital Securities)
On January 8, 1997, the Company arranged the sale of $150 million of 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 $154,640,000
aggregate principal amount of the Company's 8.71% Junior Subordinated Deferrable
Interest Debentures (the Debentures) due January 1, 2046, issued to the Trust
under an indenture dated January 13, 1997 (the Indenture). The Debentures are
the sole assets of the Trust. The Company has the right to defer interest
payments on the Debentures for up to five years. The 8.71% Capital Securities
and related 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.
6. Convertible Notes Payable
During the second quarter of 2001, the Company issued $408 million face amount,
$113 million net proceeds, of Liquid Yield Option Notes(TM) (LYONs). The LYONs
are zero coupon senior notes convertible into Markel
8
6. Convertible Notes Payable (continued)
common shares under certain conditions. The issue price of $283.19 per LYON
represented a yield to maturity of 4.25% per annum, with an initial conversion
price of $243.53 per Markel common share. The final maturity of the LYONs is
June 5, 2031. Contingent cash interest and contingent principal are payable to
the holders of the LYONs under certain circumstances.
Each $1,000 principal amount at maturity of the LYONs will be convertible into
1.1629 shares of Markel common stock upon the occurrence of any of the following
events: if the closing price of Markel common shares on the New York Stock
Exchange exceeds specified levels, if the credit rating of the LYON's is reduced
below specified levels, if the Company calls the LYON's for redemption, or if
the Company is party to certain mergers or consolidations.
Holders may require the Company to repurchase the LYONs on June 5th of 2002,
2004, 2006, 2011, 2016, 2021 and 2026 at their accreted value on these dates.
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.
During the second quarter of 2001, the Company used a portion of the LYON's net
proceeds to repay $100 million of balances outstanding under its revolving
credit facility.
7. Other Comprehensive Income
Other comprehensive income is composed of net holding gains on securities
arising during the period less reclassification adjustments for gains (losses)
included in net loss. Other comprehensive income also includes foreign currency
translation adjustments subsequent to the acquisition of Markel International in
March of 2000. The related tax expense on net holding gains on securities
arising during the period was $11.8 million and $27.7 million for the quarter
and nine months ended September 30, 2001 and $23.4 million and $22.4 million for
the same periods in 2000. The related tax expense (benefit) on the
reclassification adjustments for gains (losses) included in net loss was $3.0
million and $5.7 million, respectively, for the quarter and nine months ended
September 30, 2001 and $0.3 million and $(1.2) million, respectively, for the
same periods in 2000. The related tax benefit on the currency translation
adjustments was $0.4 million and $0.2 million, respectively, for the quarter and
nine months ended September 30, 2001 and $1.8 million for both periods of 2000.
8. Acquisition
On March 24, 2000, the Company became a holding company for Markel North
America, Inc. and completed its acquisition of Markel International. The Company
issued approximately 1.75 million Markel common shares and contingent value
rights (CVR) and paid approximately $325 million in cash to Markel International
shareholders in the transaction. Total consideration was approximately $658
million, including $31.2 million of Markel International shares purchased in the
open market prior to the acquisition date. Each former shareholder of Markel
North America, Inc. received for each Markel North America, Inc. share, one
common share of the Company. The acquisition was accounted for using the
purchase method of accounting. The excess of the purchase price over the fair
value of the net tangible and identifiable intangible assets acquired was
recorded as goodwill and is being amortized using the straight-line method over
20 years. The Company borrowed $245 million under its $400 million revolving
credit facility to fund a portion of the acquisition. In addition, $175
9
8. Acquisition (continued)
million of Markel International debt remained outstanding. The Company's results
include Markel International's results since the date of acquisition. Effective
as of March 31, 2001, Markel North America, Inc. was merged with and into the
Company.
Effective March 30, 2001 the CVRs issued in connection with the acquisition of
Markel International were extinguished pursuant to the terms of the Contingent
Value Rights Agreement (the Agreement). Under the Agreement the CVRs were
automatically extinguished when the Current Market Value, as defined by the
Agreement, of the Company's common stock, was greater than or equal to the
target price of $185 per share. The Current Market Value of the Company's common
stock exceeded $185 per share during the 20 consecutive trading day period ended
as of the close of trading on the New York Stock Exchange on March 30, 2001.
a) The following table summarizes, on a pro forma basis, the Company's unaudited
consolidated results of operations as if the purchase of Markel International
had taken place on January 1, 2000 after giving effect to certain adjustments,
including amortization of goodwill and other intangibles, increased interest
expense on debt related to the acquisition, lower investment income due to cash
used to fund a portion of the transaction, and related income tax effects.
Markel International's nonrecurring and transaction related expenses in the
first quarter of 2000, prior to the acquisition by the Company, were excluded
from the pro forma financial information. The pro forma financial information
does not necessarily reflect the results of operations that would have occurred
had the acquisition occurred on January 1, 2000 (dollars in thousands, except
per share amounts).
Nine months Ended
September 30,
-----------------
2000
--------------------------------------------------------------------------
Total operating revenues $ 922,635
Net loss (57,386)
==========================================================================
Net loss per share
Basic $ (7.87)
Diluted $ (7.87)
==========================================================================
b) The following summary reconciles cash paid for the acquisition of Markel
International (dollars in thousands).
Fair value of assets acquired, net of cash acquired $ 2,856,825
Fair value of liabilities assumed (2,353,303)
Common stock and other equity issued (295,482)
----------------------------------------------------------------------
Net cash paid for acquisition 208,040
Cash acquired in acquisition 154,883
----------------------------------------------------------------------
Cash paid for acquisition $ 362,923
======================================================================
9. Segment Reporting Disclosures
Markel North America includes the Excess and Surplus Lines and Specialty
Admitted segments. Markel International includes two operating segments: the
London Company Market and the Lloyd's Market. Markel
10
9. Segment Reporting Disclosures (continued)
International's results have been included in the Company's operating results
since the date of acquisition.
Prior year amounts have been reclassified to conform with 2001 presentations.
All investing activities are included in the Investing operating segment.
Discontinued programs and non-strategic insurance subsidiaries are included in
Other (Discontinued Lines) 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 the Markel North America and Markel International
operating divisions is measured by underwriting profit or loss. Segment profit
for the Investing operating segment is measured by net investment income and net
realized gains or losses.
The Company does not allocate assets to the Markel North America or the Markel
International operating divisions for management reporting purposes. The total
investment portfolio, cash and cash equivalents are allocated to the Investing
operating 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:
Segment Revenues
Quarter Ended September 30, Nine Months Ended September 30,
-------------------------------------------------------------------------------------------------------
2001 2000 (dollars in thousands) 2001 2000
----------------------------------------------------------------------------------------------------------
$ 130,189 $ 91,089 Excess and Surplus Lines $ 358,158 $ 250,563
35,345 30,336 Specialty Admitted 99,591 87,272
33,576 34,075 London Company Market 91,869 91,150
102,102 74,170 Lloyd's Market 242,210 134,492
50,751 45,016 Investing 144,215 107,356
26,310 23,486 Other (Discontinued Lines) 75,028 91,867
----------------------------------------------------------------------------------------------------------
$ 378,273 $ 298,172 Total $1,011,071 $ 762,700
==========================================================================================================
Segment Profit (Loss)
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------------------------------------------------------------------
2001 2000 (dollars in thousands) 2001 2000
----------------------------------------------------------------------------------------------------------
$ (25,625) $ (1,132) Excess and Surplus Lines $ (17,193) $ 2,730
338 3,262 Specialty Admitted (59) 6,736
(31,049) (6,245) London Company Market (39,683) (15,227)
(57,549) (10,666) Lloyd's Market (75,885) (24,350)
50,751 45,016 Investing 144,215 107,356
(46,945) (42,479) Other (Discontinued Lines) (64,987) (62,723)
----------------------------------------------------------------------------------------------------------
$ (110,079) $ (12,244) Total $ (53,592) $ 14,522
==========================================================================================================
11
9. Segment Reporting Disclosures (continued)
Combined Ratios
Quarter Ended September 30, Nine Months Ended September 30,
-------------------------------------------------------------------------------------------------
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------
120% 101% Excess and Surplus Lines 105% 99%
99% 89% Specialty Admitted 100% 92%
193% 118% London Company Market 143% 117%
156% 114% Lloyd's Market 131% 118%
278% 281% Other (Discontinued Lines) 187% 168%
-------------------------------------------------------------------------------------------------
149% 123% Consolidated 123% 114%
=================================================================================================
Segment Assets (dollars in thousands)
September 30,
-----------------------------
2001 2000
------------------------------------------------------------------
Investing $ 3,298,530 $ 2,973,809
Other 2,873,413 2,305,430
------------------------------------------------------------------
Total $ 6,171,943 $ 5,279,239
==================================================================
b) The following summary reconciles significant segment items to the Company's
consolidated financial statements (dollars in thousands):
Quarter Ended Nine Months Ended
September 30, September 30,
---------------------------- ------------------------------
2001 2000 2001 2000
------------------------------------------------------------------------------------------------------------------
Operating Revenues
Segment revenues $ 378,273 $ 298,172 $ 1,011,071 $ 762,700
Other -- 47 -- 141
------------------------------------------------------------------------------------------------------------------
Total Operating Revenues $ 378,273 $ 298,219 $ 1,011,071 $ 762,841
==================================================================================================================
------------------------------------------------------------------------------------------------------------------
Loss before income taxes
Segment profit (loss) $ (110,079) $ (12,244) $ (53,592) $ 14,522
Unallocated amounts
Amortization expense (7,712) (7,202) (23,096) (15,979)
Interest expense (11,782) (14,978) (37,811) (37,235)
Other -- 47 -- 141
------------------------------------------------------------------------------------------------------------------
Loss Before Income Taxes $ (129,573) $ (34,377) $ (114,499) $ (38,551)
==================================================================================================================
10. Derivative Financial Instruments
The Company adopted Financial Accounting Standards Board Statement of Financial
Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended by SFAS No. 137 and 138, effective January 1,
2001. The standard requires that all derivatives be recorded as an asset or
liability, at estimated fair value, regardless of the purpose or intent for
holding the derivative. If a derivative does not qualify as a hedge under SFAS
No. 133, all gains or losses from the change in the derivative's estimated fair
12
10. Derivative Financial Instruments (continued)
value are recognized in earnings. The gains or losses from the change in
estimated fair value of derivatives that qualify as hedges under SFAS No. 133
are recognized in earnings or other comprehensive income depending on the type
of hedge relationship.
The Company has entered into forward foreign exchange contracts which have been
designated as hedges of net investments in foreign operations. The contracts are
recorded at fair value, with the change in fair value recorded in cumulative
translation adjustments (CTA) to the extent the change is equal to or less than
the offsetting adjustment recorded in CTA that arose by translating the hedged
foreign operation's financial statements to the Company's reporting currency.
To the extent the change in the fair value of the forward contracts is greater
than the adjustment of the net investment, it is included in earnings.
At September 30, 2001, the Company held positions in forward foreign exchange
contracts with an aggregate notional amount of $55.3 million to buy United
Kingdom Sterling. Contracts mature in June of 2002. The fair value of the
unsettled forward contracts was a cumulative gain of $0.3 million at September
30, 2001 and was included on the accompanying consolidated balance sheets. The
gain (loss) on the forward contracts for the quarter and the nine month period
ended September 30, 2001 was $2.3 million and $(2.7) million, respectively. Net
loss for the quarter and nine month period ended September 30, 2001 included a
gain of $2.2 million and $0.3 million, respectively, for the forward contracts.
CTA included a gain of $0.1 million and a loss of $3.0 million, respectively,
for the quarter and nine months ended September 30, 2001.
The Company held $220.3 million and $ 242.0 million of corporate bonds with
embedded put options as of September 30, 2001 and December 31, 2000,
respectively. These embedded derivatives are clearly and closely related to the
host contracts and therefore are not accounted for separately under SFAS No. 133
as amended.
In March 2001 the Company entered into a $50 million notional amount interest
rate swap to hedge interest rate risk associated with a portion of its variable
rate revolving credit facility. Under the interest rate swap agreement, the
Company pays 4.70% fixed interest and receives three month LIBOR. The swap
expires March 26, 2002. During the second quarter of 2001, the hedged debt was
repaid. Accordingly the swap was recorded at fair value with subsequent changes
in fair value recognized in earnings. The fair value of the swap at September
30, 2001 was a liability of $0.5 million. Included in interest expense for the
quarter and nine month period ended September 30, 2001 was a loss of $0.4
million and $0.6 million, respectively.
The contingent cash interest and contingent principal features of the LYON's are
embedded derivatives required to be accounted for separately under SFAS No. 133
as amended. The fair value of the contingent cash interest and the contingent
principal features at September 30, 2001 was a liability of $0.6 million all of
which was recognized in interest expense during the third quarter of 2001.
11. Contingencies
On January 31, 2001, the Company received notice of a lawsuit filed in the
United States District Court for 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. The Company believes it has
numerous defenses to these claims, including the defense that the alleged
reinsurance agreements were not valid. The Company intends
13
11. Contingencies (continued)
to vigorously defend this matter; however, it cannot predict the outcome at this
time.
On May 29, 2001 Reliance Insurance Company was placed in rehabilitation by
Pennsylvania Insurance Department. During the third quarter of 2001, the
Pennsylvania Insurance Department removed Reliance Insurance Company from
rehabilitation and placed it into liquidation. Reliance Insurance Company and
its affiliates owed the Company approximately $25.9 million and $33.4 million in
reinsurance recoverables for paid and unpaid losses at September 30, 2001 and
December 31, 2000, respectively. These balances were considered in the normal
course of assessing the collectability of reinsurance recoverables.
The Company has other contingencies that arise in the normal conduct of its
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.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Quarter and Nine Months ended September 30, 2001 compared to Quarter and Nine
Months ended September 30, 2000
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.
On March 24, 2000, the Company completed its acquisition of Terra Nova (Bermuda)
Holdings Ltd. As a result the Company realigned its operations with Terra Nova
(Bermuda) Holdings Ltd. becoming the Company's international division, Markel
International, and the Company's existing domestic operations becoming Markel
North America. The acquisition was accounted for as a purchase transaction and
accordingly, Markel International has been included in the Company's operating
results since the date of acquisition.
Markel North America includes the Excess and Surplus Lines segment which is
comprised of four underwriting units and the Specialty Admitted segment which
consists of two underwriting units. The Excess and Surplus Lines segment writes
property and casualty insurance for nonstandard 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. These underwriting units
write specialty program insurance for well-defined niche markets and personal
and commercial property and liability coverages.
Markel International includes two segments: the London Company Market and the
Lloyd's Market. The London Company Market consists of the operations of Terra
Nova Insurance Company Limited. The Lloyd's Market includes Markel Capital
Limited, which is the corporate capital provider for four Lloyd's syndicates
managed by Markel Syndicate Management Limited. Markel International's operating
units write specialty property, casualty, marine and aviation insurance and
reinsurance on a worldwide basis. The majority of Markel International's
business comes from the United Kingdom and United States.
14
Discontinued lines of business and non-strategic insurance subsidiaries are
included in Other (Discontinued Lines) for segment reporting purposes.
Following is a comparison of gross premium volume by significant underwriting
area:
Gross Premium Volume
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------------------------------------------------------------------
2001 2000 (dollars in thousands) 2001 2000
----------------------------------------------------------------------------------------------------------
$ 205,245 $ 151,657 Excess and Surplus Lines $ 581,659 $ 414,213
53,489 44,541 Specialty Admitted 128,427 106,040
42,590 12,380 London Company Market 127,852 55,006
126,956 110,906 Lloyd's Market 408,038 197,912
16,505 4,129 Other (Discontinued Lines) 33,095 45,402
----------------------------------------------------------------------------------------------------------
$ 444,785 $ 323,613 Total $ 1,279,071 $ 818,573
==========================================================================================================
Gross premium volume was $444.8 million for the third quarter and $1.3 billion
for the nine month period in 2001 compared to $323.6 million and $818.6 million,
respectively, for the same periods of 2000. Gross premium volume for 2000
included Markel International since its acquisition on March 24, 2000.
Discontinued Lines consisted primarily of discontinued Markel International
programs.
Markel North America gross written premiums for the third quarter and nine month
period increased 32% and 36%, respectively, due to increased submission activity
and price increases across all business units. Excess and Surplus Lines gross
premium volume increased 35% to $205.2 million in the third quarter of 2001 from
$151.7 million a year ago. For the nine month period, gross premium volume
increased 40% to $581.7 million in 2001 from $414.2 million in 2000. The growth
in both periods was due to increased submission activity in most programs, price
increases and new programs.
Specialty Admitted Lines gross premium volume in the third quarter of 2001
increased 20% to $53.5 million compared to $44.5 million in 2000. For the nine
month period of 2001, gross premium volume increased 21% to $128.4 million in
2001 from $106.0 million in the prior year. The increase in both periods was
primarily due to higher submissions, new programs and price increases.
In the third quarter of 2001, Markel International's gross premium volume
increased 38% to $169.5 million from $123.3 million in 2000. Gross premium
volume for the nine months ended September 30, 2001 was $535.9 million compared
to $252.9 million for the same period of 2000. The London Company Market gross
premium volume for the third quarter of 2001 increased to $42.6 million from
$12.4 million in 2000 primarily due to prior years' premium increases related to
casualty swing-rated policies and due to higher actual premium writings than
previously estimated on prior years' property reinsurance treaties. The Lloyd's
Market third quarter 2001 gross premium volume increased to $127.0 million from
$110.9 million in 2000 primarily due to increased professional liability
writings partially offset by lower motor writings. The increase in gross written
premium for the nine month period of 2001 was primarily due the inclusion of
Markel International for the entire period of 2001.
Discontinued Lines third quarter 2001 gross premium volume increased to $16.5
million from $4.1 million in the prior year. The increase was due to additional
premiums on prior years' swing-rated policies and additional premiums on the
discontinued satellite program. The Company had previously purchased reinsurance
protection for the satellite program and has no additional loss exposure.
Discontinued Lines gross premium volume decreased to $33.1 million for the nine
month period ended September 30, 2001 from $45.4 million in the prior year due
to its continued runoff.
Beginning in late 1999, signs of market hardening, that is stricter coverage
terms and higher prices, began to emerge in the United States. Markel North
America's submissions and premium writings have increased substantially during
2001. In many product lines, prices are increasing for the first time in many
years. The Company anticipates that the North American and London insurance
markets will continue to tighten and provide a favorable environment for growth
in its operations. The Company is currently obtaining significant
15
rate increases across most programs. Markel International remained on target to
produce approximately $650 million of gross premium volume in 2001. Premium
volume may vary significantly with the Company's decision to alter its product
concentration to maintain or improve underwriting profitability.
The Company enters into reinsurance agreements in order to reduce its liability
on individual risks and enable it to underwrite policies with higher limits. The
Company's net retention of gross premium volume decreased to 69% in the third
quarter of 2001 compared to 75% in 2000. Net retention of gross premium volume
for the nine month period was 73% in 2001 and 2000. The decrease in the
retention rate for the third quarter of 2001 was primarily due to lower
retentions for Markel International compared to the third quarter of 2000 as a
result of net reinsurance reinstatement premiums of approximately $15.0 million
on WTC exposures.
Total operating revenues for the third quarter of 2001 were $378.3 million
compared to $298.2 million in the prior year. For the nine month period,
operating revenues rose to $1.0 billion from $762.8 million in 2000. The
increase in operating revenues for the third quarter was primarily attributed to
higher earned premiums for Markel North America due to higher gross premium
volume and higher earned premiums for Markel International due primarily to
prior years' premium increases and higher gross premium volume. The increase for
the nine month period was primarily due to the inclusion of Markel International
results for the entire nine month period of 2001 and higher earned premiums for
Markel North America.
Following is a comparison of earned premiums by significant underwriting area:
Earned Premiums
Quarter Ended September 30, Nine Months Ended September 30,
-----------------------------------------------------------------------------------------------------
2001 2000 (dollars in thousands) 2001 2000
-----------------------------------------------------------------------------------------------------
$ 130,189 $ 91,089 Excess and Surplus Lines $ 358,158 $ 250,563
35,345 30,336 Specialty Admitted 99,591 87,272
33,576 34,075 London Company Market 91,869 91,150
102,102 74,170 Lloyd's Market 242,210 134,492
26,310 23,486 Other (Discontinued Lines) 75,028 91,867
-----------------------------------------------------------------------------------------------------
$ 327,522 $ 253,156 Total $ 866,856 $ 655,344
=====================================================================================================
Third quarter earned premiums were $327.5 million compared to $253.2 million in
2000. Nine month earned premiums were $866.9 million compared to $655.3 million
in 2000. Earned premiums for Markel North America rose 36% and 35%,
respectively, in the third quarter and nine month period of 2001 compared to the
same periods of 2000. The increase in both periods was primarily due to growth
in Excess and Surplus Lines earned premiums due to increased gross premium
volume. Markel International's earned premiums increased 25% and 48%,
respectively, for the third quarter and nine months ended September 30, 2001.
The increase for the third quarter of 2001 was primarily due to higher earned
premiums primarily due to prior years' premium increases and higher gross
premium volume. The increase in earned premiums for the nine month period of
2001 was primarily due to the inclusion of Markel International for the entire
period of 2001. Discontinued Lines earned premiums for the third quarter of 2001
increased 12% to $26.3 million from $23.5 million in 2000 primarily due to prior
years' premium increases and increased Corifrance earned premiums partially
offset by the run off of other discontinued lines at Markel International.
Discontinued Lines earned premiums decreased 18% to $75.0 million from $91.9
million for the nine months ended September 30, 2000. The decrease for the nine
month period was due to the run off of discontinued programs at Markel
International.
Third quarter 2001 net investment income was $42.2 million compared to $44.1
million in the prior year. The decrease was due to lower investment yields
partially offset by a larger investment portfolio. Net investment
16
income for the nine month period rose to $127.9 million from $110.8 million in
2000. The increase was due to the acquisition of Markel International.
In the third quarter, the Company recognized $8.5 million of net realized gains
compared to $0.9 million of net realized gains in 2000. For the nine month
period of 2001, net realized investment gains were $16.3 million compared to net
losses of $3.5 million for the same period last year. Variability in the timing
of realized and unrealized investment gains and losses is to be expected.
Total operating expenses for the third quarter were $496.1 million compared to
$317.6 million in 2000. Total operating expenses for the nine month period were
$1.1 billion compared to $764.2 million a year ago. The increase in operating
expenses in the third quarter of 2001 was primarily due to $75.0 million of
estimated losses associated with the WTC and prior years' reserve strengthening
of approximately $68.0 million. Prior years' loss reserves were strengthened due
to $39.0 million of loss development in Markel International's discontinued
lines and approximately $29 million of development in New York contractors
business which the Brokered Excess and Surplus Lines unit stopped writing in
January 2000. The increase for the nine month period was primarily due to the
acquisition of Markel International which occurred March 24, 2000, WTC losses
and reserve strengthening.
Following is a comparison of selected data from the Company's operations
(dollars in thousands):
Quarter Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------------
Gross premium volume $ 444,785 $ 323,613 $ 1,279,071 $ 818,573
Net premiums written $ 306,111 $ 242,503 $ 927,914 $ 593,843
Net retention 69% 75% 73% 73%
Earned premiums $ 327,522 $ 253,156 $ 866,856 $ 655,344
Losses and loss adjustment expenses $ 370,419 $ 218,231 $ 752,950 $ 511,883
Underwriting, acquisition and insurance expenses $ 117,933 $ 92,185 $ 311,713 $ 236,295
Underwriting loss $ (160,830) $ (57,260) $ (197,807) $ (92,834)
U.S. GAAP ratios
Loss ratio 113% 86% 87% 78%
Expense ratio 36% 37% 36% 36%
---------------------------------------------------------------------------------------------------------------------
Combined ratio 149% 123% 123% 114%
=====================================================================================================================
Underwriting performance is measured by the combined ratio of losses and
expenses to earned premiums. The Company reported a combined ratio of 149% in
the third quarter of 2001 compared to a combined ratio of 123% in the third
quarter of 2000. For the nine month period of 2001, the Company reported a
combined ratio of 123% compared to 114% for the same period of 2000. The
increase in the combined ratios for both periods of 2001 was primarily due to
$75.0 million of estimated WTC losses and strengthening of prior years' loss
reserves by $68.0 million in the third quarter of 2001. Excluding these items,
the Company's 2001 third quarter and nine month period combined ratio was 105%
and 106%, respectively.
Markel North America reported a combined ratio of 115% and 104%, respectively,
for the third quarter and nine month period of 2001 compared to 98% and 97%,
respectively, for the same periods of 2000.
17
Markel North America's 2001 third quarter and nine month period underwriting
loss was the result of approximately $29 million of adverse loss development on
New York contractors business discontinued by the Brokered Excess and Surplus
Lines unit in January 2000 and due to $2.5 million of WTC and Hurricane Allison
losses. Excluding these items, Markel North America continued to produce solid
underwriting profits with a combined ratio of 96% and 97%, respectively, for the
third quarter and nine months ended September 30, 2001. The Company plans to
reduce brokerage commissions in certain programs in 2002 to further improve the
Markel North America expense ratio.
The combined ratio for Excess and Surplus Lines increased to 120% and 105%,
respectively, for the third quarter and nine month period of 2001 from 101% and
99%, respectively, for the same periods of 2000. The increase in the combined
ratio for both periods of 2001 was primarily attributed to unfavorable reserve
development on the New York contractors program partially offset by an improved
expense ratio due to higher volume.
Since discontinuing the New York contractors program, the Company has
experienced adverse development in the program and as a result initiated a
project to reevaluate its potential ultimate exposure. Issues involving
application of statutes of limitations and the evolving and complex judicial and
legislative environment in New York made the process difficult. In addition the
Company brought in new claims management at the unit. New claims management with
legal and actuarial assistance completed a review of this program during the
quarter. As a result of this review, the Company determined that reserves
required strengthening.
The combined ratio for Specialty Admitted was 99% and 100%, respectively, for
the third quarter and nine month period of 2001 compared to a combined ratio of
89% and 92% for the same periods of 2000. The increase in both periods of 2001
was the result of lower favorable loss reserve development partially offset by
an improved expense ratio due to higher volume.
The Company's total estimated exposure to WTC losses is $75.0 million, net of
estimated reinsurance recoverables of approximately $250 million. Markel
International's, Markel North America's and Discontinued Lines' WTC provisions
were $70.8 million, $1.5 million and $2.7 million, respectively. The Lloyd's and
London Company Markets included $47.5 million and $23.3 million, respectively,
of WTC losses. The Company has used many loss estimation techniques including
detailed policy level reviews, the use of catastrophe modeling software, direct
contact with insureds and brokers and sensitivity analysis to possible coverage
scenarios in order to develop its estimated WTC exposure. Approximately 87% of
the Company's net estimated WTC exposure is related to property and business
interruption exposures. The Company has also completed a detailed review of its
reinsurance recoverables related to its potential WTC losses. Approximately 98%
of the estimated reinsurance recoverables are due from reinsurers rated "A-" or
better by A.M. Best or Standard and Poor's. The Company's gross and net WTC loss
estimates include a margin for underestimation of claims, reinsurance
reinstatement premiums and potentially uncollectable reinsurance. New
information concerning potential losses and coverage emerges daily. While the
Company believes that its WTC reserve is adequate, adverse development is
possible.
Markel International reported a combined ratio of 165% and 135%, respectively,
for the third quarter and the nine month period of 2001 compared to 116% and
118%, respectively, for the same periods of 2000. Markel International's 2001
third quarter and nine month period results included $70.8 million of WTC
losses.
18
Excluding the impact of WTC losses, Markel International's combined ratio for
the quarter and nine month period of 2001 was 112% and 113%, respectively.
Markel International's expense reductions have not kept pace with planned
premium reductions. The Company will continue working to align Markel
International's expenses with its premium writings. Expense reduction
initiatives include the consolidation of Markel International's four syndicates
at Lloyd's into one syndicate for 2002 and planned reductions of brokerage
commissions. In addition the Company has reduced its maximum limits to a range
of $5 to $10 million depending on the program. These reductions will reduce
future reinsurance costs and collection risks. The pricing environment continues
to improve in the London Market.
For the third quarter of 2001, the combined ratio for the London Company and
Lloyd's Markets was 193% and 156%, respectively, compared to 118% and 114%,
respectively, for the same period of 2000. The combined ratio for the London
Company and Lloyd's Markets was 143% and 131%, respectively, for the nine months
of 2001 compared to 117% and 118%, respectively, for the same period of 2000.
The increase in the combined ratio in both segments for both periods of 2001 was
primarily due to estimated WTC losses.
The underwriting loss from Discontinued Lines increased in the third quarter and
nine month periods of 2001 to $46.9 million and $65.0 million, respectively,
compared to $42.5 million and $62.7 million, respectively, in 2000. The increase
in the Discontinued Lines underwriting loss in both periods of 2001 was due to
$39.0 million of reserve strengthening primarily in Markel International's
discontinued worldwide motor program and WTC losses. The Company discontinued
the worldwide motor book of business shortly after the purchase of Markel
International due to the program's poor administrative controls, including
delegation of underwriting and claims authority to brokers around the world, and
due to inadequate pricing. During the third quarter of 2001, the Company
obtained information from brokers and performed broker audits in order to
reassess its potential exposure. Upon completion of this work, the Company
determined that reserve strengthening was required.
Management continues to monitor claims and reinsurance experience on
pre-acquisition books of business and Discontinued Lines. The Company also
continues to closely monitor recent unfavorable development at its Brokered
Excess and Surplus Lines unit. The Company believes that its reserves are
adequate; however adverse experience is possible and could result in reserve
increases in the future.
Amortization of intangible assets was $7.7 million in the third quarter of 2001
compared to $7.2 million last year. For the nine month period ended September
30, 2001, amortization of intangible assets was $23.1 million compared to $16.0
million in 2000. The increase for the nine month period was due to the
amortization of goodwill and other intangibles from the Markel International
acquisition.
Interest expense was $11.8 million in the third quarter of 2001 compared to
$15.0 million in 2000. The decrease for the third quarter of 2001 was due to a
reduction in the Company's long-term debt. During the first quarter of 2001, the
Company used the proceeds of its February 2001 common stock offering and other
cash from operations to repay $227 million of long-term debt. Interest expense
was $37.8 million for the nine month period of 2001 compared to $37.2 million
last year.
The Company reported tax benefits of 30% and 28%, respectively, for the third
quarter and nine month period of 2001 compared to tax benefits of 54% and 50% in
2000. In the third quarter of 2000, the Company recognized a nonrecurring
benefit of $8.0 million related to the realization of tax benefits attributable
to certain differences between financial reporting and tax bases of assets
acquired in a prior period. Prior to considering this nonrecurring benefit in
2000, the tax benefits would have been 31% and 29%, respectively, for the third
quarter and nine months ended September 30, 2000.
In evaluating its operating performance, the Company focuses on core
underwriting and investing results before consideration of net realized gains or
losses from the sales of investments and expenses related to the amortization of
intangible assets and any nonrecurring items (earnings for core operations).
Although earnings from core operations does not replace operating income or net
income computed in accordance with accounting principles generally accepted in
the United States as a measure of profitability, management focuses on this
19
performance measure because it reduces the variability in results associated
with net realized investment gains or losses and eliminates the impact of
accounting conventions which do not reflect current operating costs. Third
quarter loss from core operations was $10.44 per share compared to a loss from
core operations of $2.46 per share in 2000. For the nine months of 2001, loss
from core operations was $8.71 per share compared to a loss from core operations
of $1.61 per share in the prior year. The higher losses for both periods of 2001
were due to $75.0 million of estimated WTC losses and $68.0 million of prior
years' loss development in the third quarter of 2001.
Comprehensive loss was $8.75 per share for the third quarter of 2001 compared to
comprehensive income of $3.26 per share in 2000. For the nine month period ended
September 30, 2001, comprehensive loss was $4.99 per share compared to
comprehensive income of $3.10 per share in 2000. The comprehensive losses in
both periods of 2001 were primarily due to lower net income due to WTC losses
and reserve strengthening partially offset by the increased market value of the
Company's investment portfolio.
Financial Condition as of September 30, 2001
The Company's insurance operations collect premiums and pay current claims,
reinsurance commissions and operating expenses. Premiums collected and positive
cash flows from the insurance operations are invested primarily in short-term
investments and long-term bonds. Short-term investments held by the Company's
insurance subsidiaries provide liquidity for projected claims, reinsurance costs
and operating expenses.
The Company's insurance subsidiaries are subject to regulation and supervision
by the insurance regulatory authorities of the various jurisdictions in which
they conduct business. The Company's ability to meets its debt obligations is
dependent upon the earnings and cash flows of its insurance subsidiaries and
their ability to pay dividends or to advance or repay funds to the Company.
The Company's invested assets and cash and cash equivalents were $3.3 billion at
September 30, 2001 compared to $3.1 billion at December 31, 2000.
For the nine month period ended September 30, 2001, the Company reported net
cash provided by operating activities of $87.4 million, compared to $26.8
million for the same period in 2000. The increase in cash provided by operations
was primarily due to a $81.7 million improvement in operating cash flow provided
by Markel North America operations due to higher gross premium volume and a $3.1
million improvement in cash used by Markel International operations partially
offset by an additional $24.2 million of cash outflows for Gryphon's
discontinued programs.
Reinsurance recoverables on unpaid losses increased to $1.4 billion at September
30, 2001 from $1.0 billion at December 31, 2000. The increase was due to
approximately $250 million of ceded losses related to WTC and due to adverse
development at Markel International for which a portion was ceded to reinsurers.
Reinsurance recoverables on paid losses increased to $183.7 million at September
30, 2001 from $115.0 million at December 31, 2000. The increase was due to
increased loss activity, slow payment and payment disputes at Markel
International. The Company is working aggressively to pursue collection of
reinsurance recoverables and assesses all collection situations when
establishing its allowance for uncollectable reinsurance.
For the nine month period ended September 30, 2001, the Company reported net
cash provided by financing activities of $13.5 million compared to $234.3
million in 2000. On February 27, 2001, the Company issued
20
1,288,940 shares of common stock and received net proceeds of approximately $198
million. The common stock was sold pursuant to the Company's shelf registration
statement covering the issuance from time to time of approximately $400 million
of various securities by the Company. Net proceeds from the offering along with
other cash from operations were used to repay and retire outstanding debt of
approximately $227 million during the first quarter of 2001. During the second
quarter of 2001, the Company issued $408 million face amount, $113 million net
proceeds, of Liquid Yield Option Notes(TM) (LYONs). The LYONs are zero coupon
senior notes convertible into the Company's common stock under certain
conditions. Contingent cash interest and contingent principal may be payable in
certain circumstances and the LYON's holders may require the Company to
repurchase the LYONs at specified anniversary dates. During the second quarter,
the Company used a portion of the LYON's net proceeds to repay $100 million of
balances outstanding under its revolving credit facility. During the nine months
of 2000, the net cash provided by financing activities was primarily due to
borrowings under the Company's revolving credit facility used to fund a portion
of the Markel International acquisition.
Shareholders' equity at September 30, 2001 was $910.7 million compared to $752.4
million at December 31, 2000. Book value per common share was $105.66 at
September 30, 2001, compared to $102.63 at December 31, 2000. The increase was
primarily due to the February 2001 completion of a 1,288,940 share common stock
offering with net proceeds of approximately $198 million and higher unrealized
gains, partially offset by a net loss for the nine months of 2001.
Impact of Recently Issued Accounting Standards
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (Statement) No. 141, Business Combinations, and
Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill. Statement 142 will
require that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in
accordance with the provisions of Statement 142. Statement 142 will also require
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The Company is required to adopt the provisions of Statement 141 immediately and
Statement 142 effective January 1, 2002. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.
In connection with the transitional goodwill impairment evaluation, Statement
142 will require the Company
21
to perform an assessment of whether there is an indication that goodwill is
impaired as of the date of adoption. Any transitional impairment loss will be
recognized as the cumulative effect of a change in accounting principle in the
Company's statement of operations.
As of the date of adoption, the Company expects to have unamortized goodwill in
the amount of $357.3 million and unamortized identifiable intangible assets in
the amount of $14.8 million, all of which will be subject to the transition
provisions of Statements 141 and 142. Amortization expense related to goodwill
was $15.7 million and $14.4 million for the year ended December 31, 2000 and the
nine months ended September 30, 2001, respectively. Because of the extensive
effort needed to comply with adopting Statements 141 and 142, it is not
practicable to reasonably estimate the impact of adopting these Statements on
the Company's financial statements at the date of this report, including whether
any transitional impairment losses will be required to be recognized as the
cumulative effect of a change in accounting principle.
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 whose
estimated fair values 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 at Markel International. The Company has no material
commodity risk.
The Company's market risks at September 30, 2001 have not materially changed
from those identified at December 31, 2000.
Safe Harbor Statement
This is a "Safe Harbor" statement under the Private Securities Litigation Reform
Act of 1995. Certain statements contained herein are forward-looking statements
that involve risks and uncertainties. Future actual results may materially
differ from those in these statements 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
Company's anticipated premium and profitability growth are based on current
knowledge and assume no man-made or natural catastrophes, no significant changes
in products or personnel and no adverse changes in market conditions. Changing
legal and social trends and inherent uncertainties in the loss estimation
process can adversely impact the adequacy of loss reserves. The Company
continues to closely monitor reinsurance programs and exposures. Adverse
experience in these programs could lead to additional charges. Regulatory
actions can impede the Company's ability to charge adequate rates and
efficiently allocate capital. Economic conditions and interest rate volatility
can have significant impact on the market value of fixed maturity and equity
investments and foreign currency exchange rates. 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
22
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
date.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
The Exhibits to this Report are listed in the Exhibit Index.
(b) No reports on Form 8-K were filed during the quarter ended September 30,
2001.
23
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 2nd day of November, 2001.
The Company
By /s/ Alan I. Kirshner
-----------------------------------
Alan I. Kirshner
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 (3.1)a
3(ii) Bylaws, as amended (3.2)b
4 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 June 30, 2001 and the respective Notes
thereto, included in the Quarterly Report on Form 10-Q.
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-4 Registration Statement
No. 333-88609, dated October 7, 1999
25