-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ex3saUE6FjxYTpek1esp2KPBacDJ7rEDTW44QPWBQYbwdsYA+abZkmGTste5V4ph mgSlzDmBgJVr64Q6Bbh9Nw== 0000916641-97-000234.txt : 19970325 0000916641-97-000234.hdr.sgml : 19970325 ACCESSION NUMBER: 0000916641-97-000234 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970324 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MARKEL CORP CENTRAL INDEX KEY: 0000803509 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 540292420 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-15458 FILM NUMBER: 97561703 BUSINESS ADDRESS: STREET 1: 4551 COX RD CITY: GLEN ALLEN STATE: VA ZIP: 23060-3382 BUSINESS PHONE: 8047470136 MAIL ADDRESS: STREET 1: P O BOX 2009 CITY: GLEN ALLEN STATE: VA ZIP: 23058-2009 10-K 1 MARKEL CORPORATION 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [fee required] For the fiscal year ended December 31, 1996 Commission File Number 0-15458 MARKEL CORPORATION (Exact name of registrant as specified in its charter) A Virginia Corporation IRS Employer Identification No. 54-0292420 4551 Cox Road, Glen Allen, Virginia 23060-3382 (Address of principal executive offices) (Zip code) Telephone (804) 747-0136 (Registrant's telephone number including area code) Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, no par value 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy of information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K . [ ] The aggregate market value of the shares of the registrant's Common Stock held by non-affiliates as of January 31, 1997 was approximately $394,282,224. The number of shares of the registrant's Common Stock outstanding at January 31, 1997: 5,459,612. DOCUMENTS INCORPORATED BY REFERENCE The portions of the registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 13, 1997, referred to in Part III. INDEX AND CROSS REFERENCES - FORM 10-K ANNUAL REPORT ITEM NO. PART I PAGE 1. Business 12-23 1a.Executive Officers of the Registrant 63 2. Properties (note 5) 35-36 3. Legal Proceedings (note 13) 43 4. Submission of Matters to a Vote of Security Holders NONE PART II 5. Market for the Registrant's Common Equity and Related Stockholder Matters 62 6. Selected Financial Data 24-25 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 50-61 8. Financial Statements and Supplementary Data THE RESPONSE TO THIS ITEM IS SUBMITTED IN ITEM 14. 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures NONE PART III 10.Directors and Executive Officers of the Registrant* 11.Executive Compensation* 12.Security Ownership of Certain Beneficial Owners and Management* 13.Certain Relationships and Related Transactions* PART IV 14.Exhibits, Financial Statement Schedules, and Reports on Form 8-K a. Documents filed as part of this Form 10-K (1) Financial Statements Consolidated Balance Sheets at December 31, 1996 and 1995 26 Consolidated Statements of Income for the Years Ended December 31, 1996, 1995, and 1994 27 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995, and 1994 28 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995, and 1994 29 Notes to Consolidated Financial Statements for the Years Ended December 31, 1996, 1995, and 1994 30-47 (2) Schedules have been omitted since they either are not required or are not applicable, or the information called for is shown in the Consolidated Financial Statements. (3) Index to Exhibits b. Reports on Form 8-K. On November 13, 1996, the Company filed a report on Form 8-K, reporting under Item 2 the acquisition of Investors Insurance Holding Corp. and its subsidiaries c. See Index to Exhibits and Item 14a(3) d. See Index to Financial Statements and Item 14a(2) *Items Number 10, 11, 12, and 13 will be incorporated by reference from the Registrant's 1997 Proxy Statement pursuant to instructions G(1) and G(3) of the General Instructions to Form 10-K. INDEX TO EXHIBITS 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 long-term debt of the registrant and subsidiaries shown on the Consolidated Balance Sheet of registrant at December 31, 1996, and the respective Notes thereto, included in this Annual Report on Form 10-K. Management Contracts or Compensatory Plans required to be filed (Items 10.1 - - 10.7) 10.1 Markel Corporation 1986 Stock Option Plan as amended (4(d))c 10.2 Markel Corporation 1989 Non-Employee Directors Stock Option Plan (A)d 10.3 Markel Corporation 1993 Incentive Stock Plan (10.3)e 10.4 Executive Employment Agreement between Markel Corporation and Alan I. Kirshner dated as of October 1, 1991 (10.5)f 10.5 Executive Employment Agreement between Markel Corporation and Anthony F. Markel dated as of October 1, 1991 (10.6)f 10.6 Executive Employment Agreement between Markel Corporation and Steven A. Markel dated as of October 1, 1991 (10.7)f 10.7 Executive Employment Agreement between Markel Corporation and Darrell D. Martin dated as of March 1, 1992 (10.8)f 10.8(a) Lease Agreement dated July 21, 1995 between Prudential Insurance Company of America and Registrant related to premises located at 4551 Cox Road, Glen Allen, Virginia (10.9a) g 10.8(b) Lease Agreement dated July 21, 1995 between Prudential Insurance Company of America and Registrant related to premises located at 4600 Cox Road, Glen Allen, Virginia (10.9b)g 21 Subsidiaries of Markel Corporation 23 Consent of independent auditors to incorporation by reference of certain reports into the Registrant's Registration Statements on Form S-8 and S-4 27 Financial Data Schedule a. Incorporated by reference from the exhibit shown in parenthesis filed with the Commission in the Registrant's 1990 Form 10-K Annual Report b. Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant's 1992 Form 10-K Annual Report c. Incorporated by reference from the exhibit shown in the parenthesis filed with the Commission on May 25, 1989 in the Registrant's Registration Statement on Form S-8 (Registration No. 33-28921) d. Incorporated by reference from the exhibit 65 Markel Corporation & Subsidiaries Commission in the Registrant's Proxy Statement for the Annual Meeting of Shareholders held on May 15, 1989, as filed with the Commission e. Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant's 1994 Form 10-K Annual Report f. Incorporated by reference from the exhibit shown in the parentheses filed with the Commission in the Registrant's 1991 Form 10-K Annual Report g. Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant's 1995 Form 10-K Annual Report SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. MARKEL CORPORATION By: Steven A. Markel Vice Chairman March 24, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Title Alan I. Kirshner*, Chief Executive Officer and Chairman of the Board of Directors Anthony F. Markel*, President, Chief Operating Officer and Director Steven A. Markel*, Vice Chairman and Director Darrell D. Martin*, Executive Vice President,Chief Financial Officer and Director (Principal Accounting Officer) Leslie A. Grandis*, Director Stewart M. Kasen*, Director Gary L. Markel*, Director V. Prem Watsa*, Director *Signed as of March 24, 1997. 66 APPENDIX MARKEL CORPORATION Statement of Differences 1. The pages in the electronic filing do not correspond to the pages in the printed document because there is more material on each page of the printed document. The printed Annual Report and Form 10-K also contains numerous charts, graphs and pictures not incorporated into the electronic Form 10-K. 2. The information on pages 64 and 65 of the printed document, i.e. the 10-K cover sheet and index, have been repositioned on pages 1 and 2 of the electronic document for ease of reference. EX-13 2 EXHIBIT 13 THE CORPORATE PROFILE Markel Corporation markets and underwrites specialty insurance products and programs to a variety of niche markets. In each of these markets, we seek to provide quality products and excellent customer service so that we can be a market leader. Our financial goals are to earn consistent underwriting profits and superior investment returns to build shareholder value. THE MARKEL STYLE Markel has a Commitment to Success. We believe in hard work and a zealous pursuit of excellence while keeping a sense of humor. Our creed is honesty and fairness in all of our dealings. The Markel way is to seek to be a market leader in each of our pursuits. We seek to know our customers' needs and to provide our customers with quality products and service. Our pledge to our shareholders is that we will build the financial value of our Company. We respect our relationship with our suppliers and have a commitment to our communities. We are encouraged to look for a better way to do things...to challenge management. We have the ability to make decisions or alter a course quickly. The Markel approach is one of spontaneity and flexibility. This requires a respect for authority but a disdain of bureaucracy. At Markel, we hold the individual's right to self-determination in the highest light, providing an atmosphere in which people can reach their personal potential. Being results oriented, we are willing to put aside individual concerns in the spirit of teamwork to achieve success. Above all, we enjoy what we are doing. There is excitement at Markel, one that comes from innovating, creating, striving for a better way, sharing success with others...winning. HIGHLIGHTS
(IN MILLIONS, EXCEPT PER SHARE DATA) 1996 1995 1994 FINANCIAL HIGHLIGHTS Gross premium volume $ 414 $ 402 $ 349 Net written premiums 313 298 257 Earned premiums 307 285 243 Net income 47 34 19 GAAP combined ratio 100% 99% 97% - ------------------------------------------------------------------------ Total investments $ 1,131 $ 909 $ 612 Total assets 1,605 1,315 1,103 Long-term debt 115 107 101 Shareholders' equity 268 213 139 Debt to total capital 30% 33% 42% - ------------------------------------------------------------------------ PER SHARE DATA Common shares outstanding (IN THOUSANDS) 5,458 5,422 5,387 Net income $ 8.30 $ 6.15 $ 3.33 Total investments 207.18 167.57 113.55 Book value 49.16 39.37 25.71 Growth in book value 25% 53% (8%) - -------------------------------------------------------------------------
OPERATING HIGHLIGHTS (Bullet) Underwriting profits for the fifth consecutive year and the tenth year out of the past eleven (Bullet) Investment portfolio increases 24% to $1.1 billion, or $207 per share (Bullet) Book value per share increases to $49.16, a 25% increase for the year and a five year compound annual growth rate of 26% (Bullet) Investors Insurance Holding Corp. becomes our fifth underwriting division (Bullet) Committed capital resources increase by over $300 million Revenue (IN MILLIONS) (Revenue chart appears here. Plot points are below.) $450 400 350 367 300 250 200 223 150 100 50 25 0 1986 1991 1996 Net Income (IN MILLIONS) (Net Income chart appears here. Plot points are below.) $50 45 47 40 35 30 25 20 15 14 10 5 5 0 1986 1991 1996 Invested Assets (IN MILLIONS) (Invested Assets chart appears here. Plot points are below.) $1,300 1,200 1,131 1,100 1,000 900 800 700 600 500 400 415 300 200 100 30 0 1986 1991 1996 TO OUR BUSINESS PARTNERS We finished 1996 pleased with our achievements and long term success, yet challenged and committed to do even better in the future. Despite problems in a few products and storm losses from Hurricane Fran, we were able to achieve our primary objective of earning an underwriting profit. We closed 1996 with a combined ratio of slightly less than 100%, achieving our goal by a small margin. The extraordinary underwriting success of Essex Insurance Company saved the day. Despite our modest underwriting profit, 1996 proved quite successful financially. For the year, total operating revenues grew 7% to $366.7 million; core underwriting and investing results were $33.9 million, up 17% from the prior year; and net income was $46.7 million, or $8.30 per share, a Company record. Additionally, we enjoyed a significant increase in the value of our investment portfolio. Together, these items resulted in an increase in shareholders' equity per share of 25% to $49.16. In the ten years that we've been a public company, we've enjoyed consistent success in almost every financial measure. Revenues have increased at a 31% compound annual growth rate; we have earned underwriting profits in nine out of the ten years; our investment portfolio has grown at a 44% compound rate and now totals $1.1 billion 2 or $207 per share; and most importantly, book value has risen to $49.16 per share, a compound annual increase of 31% over the past 10 years. We attribute this success to a number of factors. Maybe the most important factor is a strong corporate culture which has enabled us to build a team focused on a common goal, building long-term shareholder value. Very much a part of this culture is the common sense business principle of operating and decision-making using what Ben Graham described as a margin of safety. Ben Graham is widely recognized as the founding father of modern security analysis. He developed and taught an investment decision-making framework based on sound business principles. His primary investment concept was to operate with a margin of safety. Graham's margin of safety, simply stated, is the attempt to build a safety net into investment and business decisions. The margin provides a cushion against errors and unfavorable results. This margin is achieved by acting on facts rather than emotions, conservatively forecasting outcomes, diversifying risk and erring on the side of safety when presented with options. Consistently applied, the concept is a powerful business tool. At Markel we attempt to apply Graham's concept to all our decisions. Regardless of whether we are dealing with accounting philosophy, loss reserving, underwriting, or investing, we seek to operate with a margin of safety. ACCOUNTING PHILOSOPHY At Markel we believe in conservatively stating our financial picture. Financial strength is an important component of our success. Our insurance clients are entitled to the greatest security we can offer, and our shareholders seek to increase the value of their investment. We believe the best way of achieving both of these goals is by building book value per share. 3 In the insurance business, earnings per share is not the best measure of financial performance. It is more important to establish adequate loss reserves and maintain a strong financial position. We value a strong balance sheet more than current earnings in any single year. Management is rewarded, as are shareholders, by building book value on a per share basis over long periods of time. Because we believe in the importance of conservative accounting, we often make choices which make economic sense but do not always enhance current earnings. For example, in 1990 we negotiated as part of the purchase price of Shand/Evanston a non-compete agreement that was amortized over four years rather than 40 years as goodwill. While this resulted in an annual charge against earnings of approximately $5.0 million rather than $0.5 million, it was beneficial in at least two ways. We received significant tax benefits and we built a stronger and more conservative balance sheet due to the accelerated amortization. Another recent example of this philosophy is the $18.4 million tax benefit recognized in the second quarter of this year. Over the past several years, we conservatively established our financial statement tax reserves. We determined that our estimated tax liabilities were actually less than previously accrued and adjusted the tax liability accordingly. Most recently, in order to reduce future expenses, we made the decision to sell our office building in Evanston, Illinois. This property was acquired as part of our purchase of Shand/Evanston. Over the years, the commercial office market in Evanston has declined. Because the expected proceeds will be significantly less than the carrying value of the building, we immediately recorded the after tax loss of $6.8 million in 1996. LOSS RESERVING Because it is the largest and most difficult to measure, the provision for unpaid losses and loss 4 adjustment expenses is the most important account on an insurance company's financial statement. This is certainly the case for Markel. This account also best represents our philosophy of conservative accounting and providing a margin of safety. As we have said many times, our goal is to establish loss reserves at a level that is more likely to prove redundant than deficient. This standard of setting loss reserves is somewhat different from other insurers. A.M. Best Co. recently estimated that the Property and Casualty industry is underreserved by $82.8 billion, or 23% of total reserves. We believe that much of this shortfall is related to companies' desire to report earnings. This illustrates why we do not stress current earnings. At Markel we seek to establish loss reserves at a level that anticipates the inevitable surprises that can and do occur, and to provide for an appropriate margin of safety. We constantly review our businesses and try to make sure the reserves we provide are adequate to meet future exposures. Getting the loss reserves right is critical to being able to make an underwriting profit. Current loss estimates not only affect financial results but also influence many pricing and risk selection decisions. Each year we try to make sure our margin of safety is as strong as it was in the prior year. In the insurance business, we sell the product before we know the actual cost. Claims often take many months or years before they are fully reported and settled. Obviously, as the underwriting years mature, we are better able to estimate the ultimate cost. Consequently, we regularly adjust loss reserves as more information is available. The best way to understand and analyze this process is to review the loss reserve development schedule shown in Management's Discussion and Analysis on page 55 of this report. From this schedule you can see that we have consistently 5 benefited from redundant loss reserves. For example, in December of 1991 we had loss reserve provisions of $557.6 million. This estimate was reduced in each of the following years as we became more confident that the actual results were better than originally provided. However, in each year we have attempted to maintain a margin of safety. Five years later we've recognized $56.5 million or 10% of the beginning estimate in redundancy. Looking at 1995 loss reserves you will see the same trend. During 1996 we realized approximately $24.1 million in redundancy from the prior year. This represents 4% of the original reserve amount. We continue to believe that the remaining reserves have a margin of safety and hope to see continuing positive development. The very nature of the insurance business makes it difficult to establish loss reserves with certainty. In fact it cannnot be done. But what we can do is make provisions with a view that to the extent we're wrong, we have erred on the side of safety. It is unfortunate that in the world of financial reporting and security analysis that current earnings receive more attention than the quality of loss reserves. That does not make it right. We would much prefer to be pessimistic when setting loss reserves than optimistic about current earnings. This philosophy benefits every aspect of our business. It supports our investment activity; and it helps build our margin of safety. UNDERWRITING Earned premiums in 1996 amounted to approximately $307.5 million, spread over more than 40 different product lines in our five operating divisions. In the past five years, we have enjoyed modest underwriting profits, reporting a combined ratio from 97% to slightly under 100%. Because this ratio has been relatively consistent, one might assume that each of our product lines produces 6 predictably consistent results. This is not the case. Our aggregate combined ratio is a result of many profitable lines of business balanced against some which are having difficulty. Each product line has unique characteristics and different profit objectives. New products often experience a higher than desired combined ratio because the costs associated with new product development are higher than after the product is fully established. Occasionally, expectations are not met and products simply develop more losses than we plan. Some products are exposed to weather events, and the results will vary accordingly. Fortunately, most of our businesses do in fact generate underwriting profits so that we enjoy a sufficient margin of safety to cover underwriting losses which inevitably occur. During the past few years, our specialty personal and commercial lines unit entered the mobile home insurance business. Over time, we expect this product to earn underwriting profits of 10% or more to achieve our return on equity goals. The business does not generate large amounts of investment income since claims are paid quickly. Additionally, the results from this line of business can be volatile because the insured structures are exposed to wind and hail losses. Unfortunately, 1996 was a bad year for this business as we absorbed approximately $1.7 million in losses from Hurricane Fran. While the impact was modest to Markel, this product line suffered an underwriting loss in 1996. In spite of these problems, we still expect to see combined ratios in the low 90's over time. Within the same unit, we also provide insurance for motorcycles and personal watercraft. These products have enjoyed steady growth and consistent underwriting profits over the past several years, and we expect they will continue to make a nice contribution to our results in the future. In 1996 we also experienced underwriting losses in our physicians' medical malpractice area. One problem involved a program providing 7 insurance for a large group of emergency room physicians. This particular program did not provide enough rate for the exposure. Unfortunately, we were unable to correct the problem, so we exited the line of business. In another segment, we found certain classes and territories which needed rate adjustments, and we acted accordingly. We are now comfortable with this business. The same division also has a variety of programs for other medical professions. These include coverage for exposures such as ambulance services, dialysis clinics, home health care agencies and outpatient centers. Also included is coverage for medical and allied health professionals, such as emergency medical technicians, x-ray technicians, paramedics and social workers. These segments of our medical malpractice business have proven to be consistently profitable over a number of years, and 1996 was no exception. In late 1993 we began a new property program, Markel Special Property, which provides large commercial coverage with some catastrophe exposure. Fortunately, the Northridge Earthquake in January 1994 occurred before we had written much business. While this event hurt our 1994 results, it actually was positive for us as it expanded our market opportunity as competitors exited the market. The lack of major catastrophes since then has contributed to our success. In 1996 we earned substantial underwriting profits in this line of business on increasing premium volume. Our most consistently profitable product line has been our small, commercial general liability business written on an excess and surplus lines basis by Essex Insurance Company. This product line includes a very broad list of categories including contractors, bars and taverns, offices and habitational risks, manufacturing and small products coverage. In this area we excel in providing customer service due to our expertise and responsiveness. As with most of our businesses, our success is the result of 8 the efforts of a group of highly talented, seasoned insurance professionals. INVESTING We believe it is important to manage our investment operation with the same thought, diligence and margin of safety as our underwriting operations. Excellent investment results combine with our underwriting profits to produce superior long-term growth in book value. Our investing philosophy is based on the goal of achieving the best after tax total return and protecting the integrity of our insurance operations. We focus on total return rather than current income. We seek to build value. We allocate our investment dollars by segregating our portfolio based on the source of the funds. Funds provided by our policyholders are invested in high quality, short duration, fixed income securities to assure the funds will be available to meet claims liabilities. Funds provided by shareholders are generally invested in common stocks of companies we believe will grow and build long-term value. We try to buy these companies at prices at or below our estimate of their intrinsic value. This method of allocation and investment approach helps build a margin of safety. Our fixed income portfolio is managed to minimize interest rate and credit risk. We therefore have a short duration and high quality portfolio. To maximize after tax total returns we own tax-exempt municipal securities. We also purchase bonds with unique "put" features to provide additional returns if interest rates fall. In our equity portfolio, we try to avoid undue risk of loss by knowing as much as possible about the companies we purchase. We do extensive research on the companies, and we visit and talk with their managements. Because of our knowledge and comfort with the insurance industry, we often buy other insurance stocks. We are long-term holders. 9 We like the idea of building large unrealized capital gains. To the extent that gains are not realized and taxes are deferred, we can continue to invest money that would have been used to pay taxes. At December 31, 1996, our unrealized gain on equity securities amounted to $60.8 million. For accounting purposes, taxes of $21.3 million have been provided on this unrealized gain. Among its other virtues, this also creates a margin of safety. When future markets cause lower stock prices than today, the book value impact will be cushioned by this tax provision. While we expect to continue to benefit from our investment flexibility, we are extremely aware that our ability to do so is dependent upon continuing to conservatively provide for our loss reserves and earning underwriting profits. OTHER EVENTS In October 1996 we completed the acquisition of Investors Insurance Holding Corp. While this company has had a difficult history, the former owners brought in a new management team and began to develop a sound business plan in 1995. We liked what we saw and had an opportunity to buy the company at an attractive price. This acquisition enables us to expand our product offerings in the excess and surplus lines market. In January 1997 we saw the opportunity to raise $150 million on terms that we felt were very attractive. Somehow it is always easier to raise capital when you don't need it. Believing that we would find a sound use for the funds in the not too distant future, we took advantage of the opportunity. The security we sold to raise the capital was a trust preferred stock at a cost of 8.71%. The security matures in 49 years, although we can redeem it in ten years. One unique feature of this security is that we can defer interest payments for five years. As a result of the long maturity, the interest deferral and the subordination provisions, this security has many of the benefits of equity, yet its cost is like debt. In the short run, we will lose money as a 10 result of this financing because the proceeds have been invested in short- term securities earning less than the 8.71% cost. Obviously, in the long run we think this financing will benefit our total capital structure. A LOOK TO THE FUTURE Every year we spend a lot of energy with each of our businesses reviewing the past and planning for the future. At the corporate level we also analyze our results and try to figure out how to best take advantage of the opportunities we face. We approach 1997 with a good plan and expect to achieve continued success. In spite of our plan, we will face both problems and opportunities that we have not anticipated. The insurance industry continues its evolution and reorganization. Markel is stronger and better prepared than ever before. We face our future with great optimism. Thank you for your loyal support and encouragement. /s/ Alan I. Kirshner Alan I. Kirshner CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER /s/ Anthony F. Markel Anthony F. Markel PRESIDENT AND CHIEF OPERATING OFFICER /s/ Steven A. Markel Steven A. Markel VICE CHAIRMAN /s/ Darrell D. Martin Darrell D. Martin EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 11 Markel Corporation & Subsidiaries BUSINESS OVERVIEW Markel Corporation (the Company), an insurance holding company, writes specialty insurance products and programs for a variety of niche markets through its insurance subsidiaries. The Company believes that its specialty product focus and niche market strategy enable it to develop expertise and specialized market knowledge. SPECIALTY INSURANCE The specialty insurance market differs from the standard market which focuses on coverages with relatively predictable exposures. In the standard market, insurance rates and forms are highly regulated by state insurance departments. Products and coverages are largely uniform, and companies tend to compete for customers primarily on the basis of price. In contrast, the specialty market provides coverage for risks that do not fit the underwriting criteria of the standard carriers. Competition tends to focus less on price and more on availability, service and other value-based considerations. While specialty market exposures may have higher insurance risks than their standard market counterparts, Markel manages these risks to achieve higher financial returns. To reach its financial and operational goals, the Company must have extensive knowledge and expertise in the specialty areas being marketed and underwritten. Most of the Company's risks are considered on an individual basis, and restricted limits, deductibles, exclusions and surcharges are employed in order to respond to distinctive risk characteristics. MARKETS The Company competes in two distinct areas of the specialty insurance market, the excess and surplus lines segment (E&S) and the specialty admitted segment. The E&S market focuses on hard to place risks and risks that admitted insurers specifically refuse to write. The most important function of the E&S market is this ability to provide insurance capacity. E&S eligibility allows the Company's insurance subsidiaries to underwrite nonstandard market risks with more flexible policy forms and unregulated premium rates. This typically results in coverages that are more restrictive and more expensive than the standard admitted market. In 1995 the E&S market represented approximately $9.2 billion or 3.4% of the entire $273.9 billion property and casualty (P&C) industry.* The Company is the fifth largest domestic E&S writer in the United States as measured by direct premium writings.* Three of the Company's underwriting units, Excess and Surplus Lines, Professional/Products Liability and Brokered Excess and Surplus Lines, write in the E&S market. In 1996, on a consolidated basis, the Company controlled $256.6 million of E&S business. The Company also writes business in the specialty admitted market. Most of these risks are unique or hard to place in the standard market, but for various reasons remain in this market. In 1995 the specialty admitted market represented $4.3 billion, or 1.5% of the entire P&C industry as measured by direct premium writings.* The specialty admitted market is subject to more state regulation than the E&S market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as guaranty funds and assigned risk plans. *According to the 1996 A.M. Best Company Special Report, SOLVENCY STUDY OF THE EXCESS AND SURPLUS LINES INDUSTRY. 12 Two of the Company's underwriting units, Specialty Program Insurance and Specialty Personal and Commercial Lines, write in the specialty admitted market. In 1996, on a consolidated basis, the Company controlled $157.0 million of specialty admitted business. COMPETITION The Company's underwriting operations compete with numerous insurance companies, including many which have significantly greater resources than the Company. The Company also competes with risk retention groups, insurance buying groups and alternative self-insurance mechanisms. Competition may take the form of lower prices, broader coverages, greater product flexibility, higher quality services or ratings by independent rating agencies. In all of its markets, the Company competes by developing specialty products to satisfy well-defined market needs and by maintaining relationships with brokers and insureds who rely on the Company's expertise. This expertise in offering and underwriting products that are not readily available is the Company's principal means of competition. The Company has over forty major product lines, each with its own distinct competitive environment. In all of its products, the Company competes with innovative ideas, appropriate pricing, expense control and quality service to policyholders, agents and brokers. Few barriers exist to prevent P&C insurers from entering into the Company's segments of the P&C industry, but many of the larger P&C insurance companies have historically been unwilling to write specialty coverages. The P&C industry is currently experiencing a soft market due to what is perceived by many as excessive amounts of capital in the industry. In an attempt to utilize their capital, many insurance companies often seek to write additional premium without regard for its ultimate profitability. Admitted standard companies are now writing programs that previously were written almost exclusively in the specialty admitted or E&S markets. This additional competition from the standard market has reduced rates and led to broader coverage being offered to many of the Company's customers. In response to this additional competition, the Company has maintained its underwriting standards at the expense of growth in premium volume. The Company does not expect the current soft market conditions to abate until more rational pricing and capital allocation takes place in the P&C industry. 13 Markel Corporation & Subsidiaries BUSINESS OVERVIEW (CONTINUED) UNDERWRITING PHILOSOPHY By focusing on market niches where it has underwriting expertise, the Company seeks to earn a consistent underwriting profit. Underwriting profits represent a key component of the Company's strategy because they demonstrate knowledge and expertise, commitment to superior customer service and the ability to manage insurance risk. The Company has earned an underwriting profit in each of the past five years and in ten of the past eleven years. The following graph shows Markel's GAAP combined ratio as compared to the P&C industry for the past five years: COMBINED RATIOS (Combined ratios chart appears here. Plot points are below.) 1992 1993 1994 1995 1996 Markel Corporation 97% 97% 97% 99% 100% Industry Average* 116% 107% 109% 107% 108% *Source: A.M. Best Co., Inc. Industry Average is estimated for 1996. THE UNDERWRITING UNITS The Company has five underwriting units focused on specific niches within the E&S and specialty admitted markets. Excess and Surplus Lines, Professional/Products Liability and Brokered Excess and Surplus Lines write business in the E&S market. The Brokered Excess and Surplus Lines unit was formed with the purchase of Investors Insurance Holding Corp. (Investors) in 1996. Specialty Program Insurance and Specialty Personal and Commercial Lines write business in the admitted specialty market. TOTAL GROSS PREMIUM VOLUME BY UNDERWRITING UNIT ($414 million) (Total gross premium volume chart appears here. Plot points are below.) 29% Professional/ 22% Specialty Products Program Liability Insurance 29% Excess and 16% Specialty Surplus Lines Personal and Commercial Lines 2% Other 2% Brokered Excess and Surplus Lines 14 EXCESS AND SURPLUS LINES The Excess and Surplus Lines unit (E&S unit) writes a variety of coverages, focusing on light-to-medium casualty exposures for businesses such as artisan contractors, habitational risks, restaurants and bars, child and adult care facilities, vacant properties, office buildings and light manufacturing operations. The E&S unit also writes property insurance on classes of business ranging from small, single location risks to large, multi-state, multi-location property schedules. Property coverages consist principally of fire and allied lines, such as windstorm, hail and water damage and more specialized property coverages. During 1993 the E&S unit began offering coverages for heavier property risks, including earthquake, through its Markel Special Property Division (MSP). These risks are typically larger in size and are of a low frequency/high severity nature. During 1995 the E&S unit established an excess and umbrella facility called Markel Excess and Umbrella (MEU). This division writes commercial umbrella and excess liability business on either an occurrence or claims made form. Most of the E&S unit's business is generated by approximately 130 professional surplus lines general agents who have limited quoting and binding authority. MSP and MEU produce business on a brokerage basis through wholesale brokers who specialize in the lines of business these divisions write. The E&S unit seeks to be a substantial underwriter for its producers in order to enhance the likelihood of receiving the most desirable underwriting opportunities. The E&S unit writes the majority of its business in Essex Insurance Company (Essex). Essex is admitted in Delaware and is eligible to write E&S insurance in 49 states and the District of Columbia. TOTAL GROSS PREMIUM VOLUME EXCESS AND SURPLUS LINES ($121 million) (Total gross premium volume chart appears here. Plot points are below.) 15% Property 33% Markel Special Property 4% Markel Excess 5% Other and Umbrella 43% Casualty 15 Markel Corporation & Subsidiaries BUSINESS OVERVIEW (CONTINUED) PROFESSIONAL/PRODUCTS LIABILITY The Professional/Products Liability unit underwrites and markets specialty professional liability coverages, including medical malpractice and specialized medical coverages, professional liability for lawyers, architects and engineers, agents and brokers and management consultants. In addition, directors' and officers' liability coverage and employment practices liability coverages are offered. Errors & omissions coverage is targeted to mutual fund advisors, investment advisors and insurance companies. The Professional/Products Liability unit also underwrites products liability insurance for manufacturers and distributors in its special risks division. Business is written nationwide and is developed primarily through approximately 350 wholesale brokers. The Professional/Products Liability unit writes the majority of its business in Evanston Insurance Company (EIC). EIC is admitted in Illinois and is eligible to write E&S insurance in 48 states and the District of Columbia. TOTAL GROSS PREMIUM VOLUME PROFESSIONAL/PRODUCTS LIABILITY ($119 million) (Total gross premium volume chart appears here. Plot points are below.) 19% Other 31% Medical Malpractice and Specified Medical 20% Special Risks 9% Directors' and Officers' 12% Financial 9% Specified Institutions Professions E&O BROKERED EXCESS AND SURPLUS LINES Brokered Excess and Surplus Lines (Brokered E&S) is the most recent addition to Markel. This unit was created with the purchase of Investors in the Fall of 1996. The Brokered E&S unit's area of expertise is hard to place, large general liability and products liability accounts. Products risks include sporting goods manufacturers, bicycle manufacturers, discontinued products, toy manufacturers and importers and automobile parts manufacturers. The unit also offers special events and other unique coverages and writes property coverages on mercantile and industrial sites. The unit operates through approximately 115 wholesale brokers. The Brokered E&S unit writes the majority of its business in Investors Insurance Company of America (IICA). IICA is eligible to write E&S insurance in 48 states and the Districtof Columbia and is admitted in New York and New Jersey. 16 SPECIALTY PROGRAM INSURANCE Specialty Program Insurance develops and underwrites insurance programs for individuals and groups of businesses whose insurance needs are not adequately met by the broader standard market. Children's summer camps and youth organizations (YM/YWCA's and Boys and Girls Clubs) comprise the main focus of the camp and youth recreation division. The child care division focuses on child care centers, nursery schools, Head Start programs and Montessori schools. The health and fitness division insures gymnastic schools, health clubs, martial arts schools, dance schools and studios, and family entertainment centers. The agriculture division provides horse mortality coverage, property and liability coverages for horse farms, and boarding, breeding and training facilities. The college student and special risk accident and health group primarily markets student health insurance plans to colleges and universities. In 1996 the new contract surety bond program began offering coverage for small contractors and transition contractors. Business is produced through approximately 6,000 retail insurance agents. Management does not grant underwriting authority to agents, and agency business is controlled through regular audits and pre-approvals. Specialty Program Insurance writes substantially all of its business in Markel Insurance Company (MIC). MIC is licensed to write P&C insurance in all 50 states, including the domicile state of Illinois, and the District of Columbia. TOTAL GROSS PREMIUM VOLUME SPECIALTY PROGRAM INSURANCE ($92 million) (Total gross premium volume chart appears here. Plot points are below.) 9% Child Care 15% Health and Fitness 24% Agriculture 12% Accident and Health 3% Other 37% Camp and Youth Recreation 17 Markel Corporation & Subsidiaries BUSINESS OVERVIEW (CONTINUED) SPECIALTY PERSONAL AND COMMERCIAL LINES Specialty Personal and Commercial Lines markets and underwrites its insurance products in niche markets that are overlooked by large admitted carriers. The recreational products division concentrates on watercraft and motorcycle coverages. The watercraft program provides personal insurance coverage for yachts and high performance boats, while small fishing ventures and rentals, such as jet skis, are the focus of the commercial marine department. The motorcycle program's target market is mature riders of high value bikes. The property division provides coverage for mobile homes and certain dwellings which do not qualify for standard homeowner's coverage. In addition, the Specialty Personal and Commercial Lines unit markets an automobile physical damage program in California and another automobile physical damage program for lenders. The special transportation division insures commercial vehicles and focuses primarily on taxi cab fleets. Specialty Personal and Commercial Lines products are characterized by high numbers of transactions, low average premiums and creative solutions for underserved and emerging markets. The unit distributes most of its products through wholesale brokers, retail agents and affinity groups. The motorcycle program is marketed directly to the consumer, using direct mail and telephone promotion as well as relationships with various motorcycle manufacturers, dealers and associations. The Specialty Personal and Commercial Lines unit writes the majority of its business in Markel American Insurance Company (MAIC). MAIC is licensed to write P&C business in 42 states, including its state of domicile, Virginia, and the District of Columbia and is in the process of applying for licenses in other states. TOTAL GROSS PREMIUM VOLUME SPECIALTY PERSONAL AND COMMERCIAL LINES ($65 million) (Total gross premium volume chart appears here. Plot points are below.) 28% Auto Physical 22% Property Damage 6% Special 12% Other Transportation 32% Recreational Products 18 REINSURANCE The Company enters into reinsurance agreements in order to reduce its liability on individual risks and enable it to underwrite policies with higher limits. During the past several years, Markel has reduced its reliance on reinsurance by steadily increasing retentions on its profitable current book of business and through commutations with pre-1987 reinsurers of Shand/Evanston. Markel strives to minimize credit exposure to reinsurers and maintains a margin of safety through adherence to its internal reinsurance guidelines. To become a reinsurance partner of Markel, prospective companies must: (i) maintain an A.M. Best rating of "A" (Excellent), (ii) maintain capital and surplus of $100 million and (iii) provide collateral for recoverables in excess of $10 million. In addition, foreign reinsurers must provide collateral equal to 100% of recoverables (with the exception of Lloyd's syndicates). The following table shows Markel's top ten active reinsurers at December 31, 1996. These ten reinsurers represent 68% of Markel's $222.1 million reinsurance recoverable.
Reinsurers A.M. Best Rating Reinsurance Recoverable - -------------------------------------------------------------------- TIG Reinsurance A $29,366 Munich American Reinsurance A+ 26,709 Trenwick America Reinsurance A+ 20,342 Zurich Reinsurance A 17,103 Constitution Reinsurance A+ 11,109 Underwriters Reinsurance A+ 10,476 Chartwell Reinsurance A 9,491 USF&G A 9,272 St. Paul Fire and Marine A+ 8,914 Signet Star Reinsurance A 8,371 Other reinsurers - 70,996 - ------------------------------------------------------------------- Total reinsurance recoverable on paid and unpaid losses $ 222,149 - -------------------------------------------------------------------
Reinsurance treaties are generally subject to cancellation by the Company or the reinsurers on the anniversary date upon 90 days prior written notice and are subject to renegotiation annually. The reinsurer remains responsible for all business produced prior to termination. Treaties also typically contain provisions concerning ceding commissions, required reports to the reinsurers, responsibility for taxes, arbitration in the event of a dispute and provisions allowing the Company to demand that a reinsurer post letters of credit or assets as security if a reinsurer becomes an "unauthorized" or "unapproved" reinsurer under applicable state laws and regulations. 19 Markel Corporation & Subsidiaries BUSINESS OVERVIEW (CONTINUED) INVESTMENTS The Company's business philosophy clearly recognizes the importance of both underwriting profits and superior investment returns to build shareholder value. The Company relies on sound underwriting practices to produce investable funds with minimum underwriting risk. Approximately three quarters of the Company's investable assets come from premiums paid by policyholders. Policyholder funds are invested predominately in high quality corporate, government and municipal bonds with relatively short durations. The balance, comprised of shareholder funds, is available to be invested in equity securities, which over the long run, have produced higher returns relative to fixed income investments. The Company seeks to invest in companies with the potential for appreciation and hold these investments over the long-term. Total investment returns include items which impact earnings, such as net investment income and realized gains and losses from the sales of investments, as well as items which do not impact earnings, such as unrealized gains and losses. The Company does not intend to lower the quality of its investment portfolio in order to enhance or maintain yields. Further, the Company's focus on long-term total investment returns may result in variability in the level of realized investment gains and losses from one period to the next. The ultimate success of the Company's investment strategy is evident from the review of total investment returns over several years. The following table presents taxable equivalent total returns for Markel's investment portfolio for the past five years: ANNUAL TAXABLE EQUIVALENT TOTAL RETURNS
5 Year 10 Year Weighted Weighted Years Ended December 31, Average Average -------------------------------------------- Annual Annual 1992 1993 1994 1995 1996 Return Return - -------------------------------------------------------------------------------------------- Equities 13.1% 28.7% (3.3%) 29.7% 26.9% 19.8% 18.0% Fixed maturities 7.8% 9.1% (0.2%) 13.9% 4.8% 7.3% 8.3% Total portfolio 8.2% 11.8% (1.1%) 15.7% 7.5% 8.8% 9.5% - -------------------------------------------------------------------------------------------- Ending portfolio balance (in millions) $ 434 $ 597 $ 612 $ 909 $ 1,131 - --------------------------------------------------------------------------------------------
The Company's investment performance also benefited from continued growth in the investment portfolio over the past ten years. The portfolio increased to $1.1 billion at December 31, 1996 from $43.1 million at December 31, 1987. The Company monitors its portfolio to ensure that credit risk does not exceed prudent levels. Standard and Poor's Corp. (S&P) and Moody's Investors Service provide corporate and municipal debt ratings based on assessments of the credit worthiness of an obligor with respect to a specific obligation. These debt ratings range from "AAA" (capacity to pay interest and repay principal is extremely strong) to "D" (debt is in payment default). Securities with ratings of "BBB" or higher are referred to as "investment grade" securities. Debt rated "BB" and below is regarded by the rating agencies as having predominately speculative characteristics with respect to capacity to pay interest and repay principal. It is the Company's policy to minimize its investments in fixed maturity securities that are unrated or rated below investment grade. 20 The Company's fixed maturity portfolio has an average rating of "AA", with 90% rated "A" or better by at least one nationally recognized rating organization. The following chart shows the Company's fixed maturity portfolio, at estimated fair value, by rating category at December 31, 1996: CREDIT QUALITY OF FIXED PORTFOLIO ($886 million) (Credit quality chart appears here. Plot points are below.) 56% AAA/AA 1% Other 9% BBB 34% A Approximately 70% of the investment portfolio is managed directly by officers of the Company, with the approval of the Boards of Directors of the insurance companies. Approximately 26% of the Company's cash and investments is managed by Hamblin Watsa Investment Counsel Ltd., a Canadian investment management firm which is controlled by V. Prem Watsa, a Director of the Company. The remainder of the portfolio is managed by other independent portfolio managers. 21 Markel Corporation & Subsidiaries BUSINESS OVERVIEW (CONTINUED) REGULATORY ENVIRONMENT 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. Such regulation is intended for the benefit of policyholders rather than shareholders. The insurance regulatory authorities have broad regulatory, supervisory and administrative powers. These powers relate to the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the approval of forms and policies used; the nature of, and limitations on, insurers' investments; the form and content of annual statements and other reports on the financial condition of such insurers; and the establishment of reserves for unearned premiums, losses or other purposes. The Company is also subject to state laws regulating insurance holding companies. Under these laws, the respective insurance departments may, at any time, examine the Company, require disclosure of material transactions by the holding company, require approval of certain "extraordinary" transactions, such as extraordinary dividends from an insurance subsidiary to the holding company, or require approval of changes in control of an insurer or an insurance holding company. The laws of the domicile states of the Company's insurance subsidiaries govern the amount of dividends which may be paid by such subsidiaries to the Company. Generally, statutes in the domicile states of the Company's insurance subsidiaries require prior approval for payment of "extraordinary" as opposed to "ordinary" dividends. At December 31, 1996, the Company's insurance subsidiaries may pay during the following twelve months up to $32.9 million under the ordinary dividend regulations without prior regulatory approval. RATINGS Financial stability and strength are important purchase considerations of policyholders and insurance agents and brokers. Because an insurance premium paid today purchases coverage for losses that might not be paid for many years, the financial viability of the insurer in such cases is of critical concern. Various rating agencies provide information to assist prospective buyers in their search for financially sound insurers. A.M. Best Co., Inc. (Best) publishes BEST'S INSURANCE REPORTS, PROPERTY- CASUALTY, and assigns ratings to P&C insurance companies based on quantitative criteria, such as profitability, leverage and liquidity as well as qualitative assessments, such as the spread of risk, the adequacy and soundness of reinsurance, the quality and estimated market value of assets, the adequacy of loss reserves and surplus and the competence, experience and integrity of management. Best's letter ratings range from "A++" (superior) to "F" (in liquidation). S&P and Duff & Phelps' Credit Rating Co. (Duff & Phelps) provide prospective policyholders with analytical and statistical information on the solvency and liquidity of major U.S. licensed insurance companies. These claims paying ability (CPA) ratings concern only the likelihood of timely payment of policyholder obligations and are not intended to refer to the ability of either the rated company, or its parent or subsidiary to pay non-policy obligations such as debt or commercial paper. The S&P CPA ratings range from "AAA" (superior financial security) to "R" (regulatory action). The Duff & Phelps CPA rating categories range from "AAA" (risk factors are negligible) to "DD" (under order of liquidation). 22 The following table sets forth the various ratings currently assigned to the Company's insurance subsidiaries: FINANCIAL RATINGS
A.M. BEST COMPANY RATING S&P DUFF & PHELPS - ------------------------------------------------------------------------------------------------------------------ Essex Insurance Company A (excellent) A (good financial security) A+ (high claims paying ability) Evanston Insurance Company A (excellent) A (good financial security) A+ (high claims paying ability) Investors Insurance Company of America A-(excellent) * * Markel Insurance Company A-(excellent) A (good financial security) A+ (high claims paying ability) Markel American Insurance Company A (excellent) A (good financial security) A+ (high claims paying ability) - ---------------------------------------------------------------------------------------------------------------------
* Investors did not apply for CPA ratings prior to Markel's ownership. ASSOCIATES At December 31, 1996, the Company and its consolidated subsidiaries employed 819 persons, four of whom were executive officers. The Company believes that, as a service organization, its continued profitability and growth are dependent upon the talent and enthusiasm its associates bring to their jobs. The Company has structured incentive compensation plans and stock purchase plans to encourage its associates to think and act like owners. Under Markel's incentive compensation plans, associates may earn a meaningful bonus based on individual performance and the Company's performance. Associates are also offered many opportunities to become shareholders. Stock may be acquired through a payroll deduction plan, and associates have been given the opportunity to purchase stock with low interest financing partially subsidized by the Company. Every associate eligible to participate in the Company's retirement program (a 401(k) plan) receives a portion of the Company's contribution in Markel stock and may purchase stock with their own contributions. At December 31, 1996, the Company estimated associates' ownership, including executive officers and directors, at approximately 32.4% of the Company. The Company believes that rewarding value- added performance and stock ownership aligns associates' interests with the interests of non-employee shareholders. 23 Markel Corporation & Subsidiaries SELECTED FINANCIAL DATA (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Years Ended December 31, ---------------------------- 1996 1995 1994 ------------------------------ RESULTS OF OPERATIONS (1) Earned premiums $ 307 $ 285 $ 243 Net investment income 51 43 29 Total operating revenues 367 344 280 Net income 47 34 19 - -------------------------------------------------------------------------- PRIMARY EARNINGS PER SHARE (2) - -------------------------------------------------------------------------- Core operations $ 6.03 $ 5.15 $ 3.77 Net realized gains 0.58 1.39 0.45 Nonrecurring items 2.05 - - Amortization expense (0.36) (0.39) (0.89) Net income $ 8.30 $ 6.15 $ 3.33 - -------------------------------------------------------------------------- FINANCIAL POSITION (1)(3)(4) - -------------------------------------------------------------------------- Total investments $ 1,131 $ 909 $ 612 Total assets 1,605 1,315 1,103 Unpaid losses and loss adjustment expenses 936 734 653 Long-term debt 115 107 101 Total shareholders' equity 268 213 139 - --------------------------------------------------------------------------- RATIO ANALYSIS - --------------------------------------------------------------------------- GAAP combined ratio 100% 99% 97% Investment yield (5) 5% 6% 5% Total return (6) 8% 15% (2%) Debt to total capital 30% 33% 42% Return on average shareholders' equity 19% 20% 13% - --------------------------------------------------------------------------- PER SHARE DATA (2) - --------------------------------------------------------------------------- Common shares outstanding (IN THOUSANDS) 5,458 5,422 5,387 Total investments $207.18 $167.57 $113.55 Book value $ 49.16 $ 39.37 $ 25.71 Growth in book value 25% 53% (8%) 5-Year CAGR in book value (7) 26% 31% 17% Closing stock price $ 90.00 $ 75.50 $ 41.50
(1) In December 1990 the Company acquired the remaining ownership interests of a previously unconsolidated subsidiary, Shand/Evanston Group, Inc. (Shand/Evanston). Assets and liabilities reflect the consolidation of Shand/Evanston beginning in 1990, and income reflects the consolidation of the revenues and expenses of Shand/Evanston in 1991 and subsequent years. (2) All per share amounts have been restated to reflect a 20% stock dividend in 1989. (3) The change in accounting for net unrealized gains (losses) on fixed maturities in accordance with provisions of Statement of Financial Accounting Standards No. 115 affects 1993 and subsequent years. 24
1993 1992 1991 1990 1989 1988 1987 10-YearCAGR(7) - -------------------------------------------------------------------------------------------- $ 193 $ 153 $ 152 $ 33 $ 24 $ 20 $ 13 42% 24 27 31 7 5 4 2 38% 235 206 223 73 48 37 28 31% 24 26 14 6 14 11 7 25% $ 3.31 $ 3.03 $ 2.61 $ 1.76 $ 1.33 $ 1.61 $ 0.86 20% 1.83 0.89 0.94 0.13 0.89 0.28 0.14 -- - 1.90 0.28 (0.41) 0.65 0.45 0.51 -- (0.91) (1.18) (1.15) (0.43) (0.25) (0.05) - -- $ 4.23 $ 4.64 $ 2.68 $ 1.05 $ 2.62 $ 2.29 $ 1.51 20% - --------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------- $ 597 $ 434 $ 415 $ 360 $ 66 $ 51 $ 43 44% 1,135 1,129 700 670 196 147 104 40% 688 733 346 302 31 27 22 -- 78 101 94 127 44 24 21 -- 151 109 83 55 60 45 20 34% - --------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------- 97% 97% 106% 81% 78% 84% 85% -- 5% 6% 7% 10% 8% 8% 8% -- 11% 7% 16% 8% 11% 11% 6% -- 34% 48% 53% 70% 42% 35% 52% -- 18% 27% 21% 10% 26% 33% 38% -- - --------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------- 5,414 5,403 5,332 5,323 5,401 5,220 4,320 -- $110.27 $ 80.27 $ 77.91 $ 67.59 $ 12.31 $ 9.71 $ 9.97 40% $ 27.83 $ 20.24 $ 15.59 $ 10.27 $ 11.69 $ 9.22 $ 4.66 31% 38% 30% 52% (12%) 27% 98% 36% -- 25% 34% 35% -- -- -- -- -- $ 39.38 $ 31.25 $ 22.00 $ 11.75 $ 22.50 $ 15.42 $ 11.46 --
(4) The gross reinsurance reporting provisions of Statement of Financial Accounting Standards No. 113 affect 1992 and subsequent years. (5) Investment yield reflects net investment income as a percent of average invested assets. (6) Total return includes net investment income, net realized investment gains and the change in market value during the period as a percent of average invested assets. (7) CAGR - compound annual growth rate. 25 Markel Corporation & Subsidiaries CONSOLIDATED BALANCE SHEETS
December 31, 1996 1995 ---------------------------- (DOLLARS IN THOUSANDS) - ---------------------------------------------------------------------------------------------------------------------- ASSETS Investments, available-for-sale, at estimated fair value Fixed maturities (cost of $879,401 in 1996 and $683,568 in 1995) $ 885,874 $ 706,055 Equity securities (cost of $132,558 in 1996 and $104,538 in 1995) 193,395 134,346 Short-term investments (estimated fair value approximates cost) 51,507 68,182 - ---------------------------------------------------------------------------------------------------------------------- TOTAL INVESTMENTS, AVAILABLE-FOR-SALE 1,130,776 908,583 - ---------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 11,054 18,315 Receivables 58,336 47,210 Reinsurance recoverable on unpaid losses 210,518 159,141 Reinsurance recoverable on paid losses 11,631 20,404 Deferred policy acquisition costs 37,979 32,024 Prepaid reinsurance premiums 44,881 39,728 Property and equipment 15,434 27,729 Intangible assets 39,297 41,657 Other assets 45,391 19,746 - ---------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 1,605,297 $ 1,314,537 - ---------------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Unpaid losses and loss adjustment expenses $ 935,582 $ 734,409 Unearned premiums 200,852 170,697 Payables to insurance companies 23,870 17,247 Long-term debt (estimated fair value of $115,191 in 1996 and $109,189 in 1995) 114,691 106,689 Other liabilities 61,967 72,053 - ---------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 1,336,962 1,101,095 - ---------------------------------------------------------------------------------------------------------------------- Shareholders' equity Common stock 24,347 23,118 Retained earnings 200,237 156,333 Net unrealized gains on fixed maturities and equity securities, net of taxes of $23,559 in 1996 and $18,304 in 1995 43,751 33,991 - ---------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 268,335 213,442 Commitments and contingencies - ---------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,605,297 $ 1,314,537 - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 26 CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, -------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) OPERATING REVENUES Earned premiums $307,453 $285,146 $ 243,067 Net investment income 51,168 42,981 29,110 Net realized gains from investment sales 5,013 11,952 3,870 Other 3,102 3,496 3,646 - ------------------------------------------------------------------------------------ TOTAL OPERATING REVENUES 366,736 343,575 279,693 - ------------------------------------------------------------------------------------ OPERATING EXPENSES Losses and loss adjustment expenses 202,378 186,655 156,169 Underwriting, acquisition and insurance expenses 105,032 96,113 80,681 Other 1,275 1,642 2,386 Loss on building 10,380 - - Amortization of intangible assets 2,655 2,778 7,051 - ------------------------------------------------------------------------------------ TOTAL OPERATING EXPENSES 321,720 287,188 246,287 - ------------------------------------------------------------------------------------ OPERATING INCOME 45,016 56,387 33,406 - ------------------------------------------------------------------------------------ Interest expense 8,016 8,460 7,675 - ------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 37,000 47,927 25,731 Income tax expense (benefit) (9,672) 13,435 7,142 - ------------------------------------------------------------------------------------ NET INCOME $ 46,672 $ 34,492 $ 18,589 - ------------------------------------------------------------------------------------ Earnings per share Primary $ 8.30 $ 6.15 $ 3.33 Fully diluted $ 8.29 $ 6.12 $ 3.33 - ------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 27 Markel Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Common Common Retained Shares Stock Earnings Other Total - ---------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Balance at January 1, 1994 5,414 $ 22,805 $ 105,461 $ 22,412 $ 150,678 Net income -- -- 18,589 -- 18,589 Net unrealized depreciation of fixed maturities and equity securities, net of taxes -- -- -- (28,698) (28,698) Issuance of common stock 19 124 -- -- 124 Repurchase of common stock (46) -- (2,175) -- (2,175) Other -- -- (17) -- (17) - --------------------------------------------------------------------------------------------------------------- Balance at December 31, 1994 5,387 22,929 121,858 (6,286) 138,501 Net income -- -- 34,492 -- 34,492 Net unrealized appreciation of fixed maturities and equity securities, net of taxes -- -- -- 40,277 40,277 Issuance of common stock 35 189 -- -- 189 Other -- -- (17) -- (17) - --------------------------------------------------------------------------------------------------------------- Balance at December 31, 1995 5,422 23,118 156,333 33,991 213,442 Net income -- -- 46,672 -- 46,672 Net unrealized appreciation of fixed maturities and equity securities, net of taxes -- -- -- 9,760 9,760 Issuance of common stock 68 1,229 -- -- 1,229 Repurchase of common stock (32) -- (2,751) -- (2,751) Other -- -- (17) -- (17) - --------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 5,458 $ 24,347 $ 200,237 $ 43,751 $ 268,335 - ---------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 28 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------------ 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) OPERATING ACTIVITIES Net income $ 46,672 $ 34,492 $ 18,589 Adjustments to reconcile net income to net cash provided by operating activities Deferred income tax expense (benefit) (15,345) 1,374 4,328 Depreciation and amortization 10,934 11,088 15,361 Loss on building 10,380 - - Net realized gains from investment sales (5,013) (11,952) (3,870) Proceeds from reinsurer commutations and other settlements 6,544 82,637 31,818 Increase in receivables (5,208) (296) (10,261) Increase in deferred policy acquisition costs (1,044) (3,563) (2,513) Increase (decrease) in unpaid losses and loss adjustment expenses, net 40,819 43,133 (21,224) Increase in unearned premiums, net 6,009 12,393 14,014 Increase (decrease) in payables to insurance companies 2,581 (7,270) 13,782 Decrease in current income taxes (2,702) (894) (2,344) Other (275) 7,867 3,310 - --------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 94,352 169,009 60,990 - --------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Proceeds from sales of fixed maturities and equity securities 439,072 586,121 344,433 Proceeds from maturities of fixed maturities 66,512 35,993 15,983 Cost of fixed maturities and equity securities purchased (591,034) (793,058) (400,936) Net change in short-term investments 16,675 13,076 (17,099) Acquisitions of insurance companies, net of cash acquired (35,049) (21,747) -- Net proceeds from sale of buildings -- 19,068 -- Additions to property and equipment (3,952) (4,509) (7,025) Other (248) (1,989) 1,469 - --------------------------------------------------------------------------------------------------------- NET CASH USED BY INVESTING ACTIVITIES (108,024) (167,045) (63,175) - --------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Additions to long-term debt 40,500 27,500 29,280 Repayments of long-term debt (32,550) (21,550) (7,550) Retirement of capital lease -- -- (19,584) Other (1,539) 172 (2,118) - --------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 6,411 6,122 28 - --------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (7,261) 8,086 (2,157) Cash and cash equivalents at beginning of year 18,315 10,229 12,386 - --------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 11,054 $ 18,315 $ 10,229 - ---------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 29 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies The Company underwrites specialty insurance products and programs to niche markets. Significant areas of underwriting include excess and surplus lines, professional and products liability, specialty programs, specialty personal and commercial lines and brokered excess and surplus lines. A) PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS. Generally accepted accounting principles require management to make estimates and assumptions when preparing financial statements. Actual results could differ from those estimates. The consolidated financial statements include the accounts of Markel Corporation and all subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated in consolidation. B) INVESTMENTS. All investments are considered available-for-sale and are recorded at estimated fair value, generally based on quoted market prices. The net unrealized gains or losses on investments, net of deferred income taxes, are included as a separate component of shareholders' equity. A decline in the fair value of any investment below cost that is deemed other than temporary is charged to earnings, resulting in a new cost basis for the security. Premiums and discounts are amortized or accreted over the lives of the related fixed maturities as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the first in, first out method for determining the cost of securities sold. C) CASH EQUIVALENTS. The Company considers overnight deposits to be cash equivalents for purposes of the consolidated statements of cash flows. D) DEFERRED POLICY ACQUISITION COSTS. Costs directly related to the acquisition of insurance premiums, such as commissions to agents and brokers, are deferred and amortized over the related policy period, generally one year. If it is determined that future policy revenues on existing policies are not adequate to cover related costs and expenses, deferred policy acquisition costs are charged to earnings. E) PROPERTY AND EQUIPMENT. Owned property and equipment are stated at cost less accumulated depreciation. Depreciation and amortization of buildings and equipment are calculated using the straight-line method over the respective estimated service lives. F) INTANGIBLE ASSETS. Policy renewal rights represent the value attributable to renewal rights for lines of businesses acquired and are amortized using either the straight-line or accelerated methods over the estimated lives of the businesses acquired, generally seven to ten years. Goodwill is amortized using the straight-line method, generally over 40 years. The Company assesses the recoverability of goodwill by determining whether the amortization of the balance over its remaining life can be recovered through the undiscounted future operating cash flows of the acquired operations. G) REVENUE RECOGNITION. Insurance premiums are earned on a pro rata basis over the policy period, generally one year. Profit-sharing commissions from reinsurers are recognized when earned and are netted against policy acquisition costs. Reinsurance premiums ceded are netted against premiums written. H) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES. Unpaid losses and loss adjustment expenses are based on evaluations of reported claims and estimates for losses and loss adjustment expenses incurred but not reported. Estimates for losses and loss adjustment expenses incurred 30 1. Summary of Significant Accounting Policies (CONTINUED) but not reported are based on reserve development studies. The reserves recorded are estimates, and the ultimate liability may be greater than or less than the estimates; however, management believes the reserves are adequate. I) INCOME TAXES. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of the enactment date. J) EARNINGS PER SHARE. Primary earnings per share is computed by dividing net income, less required dividends on redeemable preferred stock, by the weighted average number of common shares outstanding during the year. The weighted average number of common shares outstanding includes the weighted average common equivalent shares attributable to dilutive stock options. Fully diluted earnings per share is computed using the weighted average common shares outstanding during the year, including the maximum dilutive effect of common equivalent shares. K) DERIVATIVE FINANCIAL INSTRUMENTS. The Company was not a party to any derivative financial instruments as defined by Statement of Financial Accounting Standards (SFAS) No. 119 at December 31, 1996. L) STOCK OPTION PLANS.Prior to January 1, 1996, the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Beginning January 1, 1996, SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant, or alternatively, allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected the latter method. M) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF. The Company adopted the provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, on January 1, 1996. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of an asset to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If an asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. N) RECLASSIFICATIONS. Certain reclassifications of prior years' amounts have been made to conform with 1996 presentations. 31 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. Investments A) Following is a summary of investments (DOLLARS IN THOUSANDS):
December 31, 1996 ------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------ Fixed maturities U.S. Treasury securities and obligations of U.S. government agencies $ 215,550 $ 1,634 $ (1,612) $ 215,572 Obligations of states, municipalities and political subdivisions 218,475 4,004 (692) 221,787 Public utilities 54,845 1,194 (1,004) 55,035 Convertibles and bonds with warrants 33,869 2,222 (553) 35,538 All other corporate bonds 356,193 4,402 (3,185) 357,410 Redeemable preferred stock 469 63 -- 532 - ------------------------------------------------------------------------------------------------------ Total fixed maturities 879,401 13,519 (7,046) 885,874 Equity securities Banks, trusts and insurance companies 46,095 23,537 (1,182) 68,450 Industrial, miscellaneous and all other 82,789 39,145 (349) 121,585 Nonredeemable preferred stock 3,674 21 (335) 3,360 Total equity securities 132,558 62,703 (1,866) 193,395 Short-term investments 51,507 -- -- 51,507 - ------------------------------------------------------------------------------------------------------ TOTAL $ 1,063,466 $ 76,222 $ (8,912) $1,130,776 - ------------------------------------------------------------------------------------------------------
December 31, 1995 ------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------ Fixed maturities U.S. Treasury securities and obligations of U.S. government agencies $ 211,779 $ 4,384 $ (212) $ 215,951 Obligations of states, municipalities and political subdivisions 109,314 3,674 (177) 112,811 Public utilities 48,542 3,205 -- 51,747 Convertibles and bonds with warrants 18,076 816 (1,052) 17,840 All other corporate bonds 293,852 11,948 (242) 305,558 Redeemable preferred stock 2,005 143 -- 2,148 - ------------------------------------------------------------------------------------------------------ Total fixed maturities 683,568 24,170 (1,683) 706,055 Equity securities Banks, trusts and insurance companies 32,202 11,554 (1,991) 41,765 Industrial, miscellaneous and all other 68,662 25,430 (5,085) 89,007 Nonredeemable preferred stock 3,674 37 (137) 3,574 - ------------------------------------------------------------------------------------------------------ Total equity securities 104,538 37,021 (7,213) 134,346 Short-term investments 68,182 -- -- 68,182 - ------------------------------------------------------------------------------------------------------ TOTAL $ 856,288 $ 61,191 $(8,896) $908,583 - ------------------------------------------------------------------------------------------------------
32 2. Investments (CONTINUED) B) The amortized cost and estimated fair value of fixed maturities at December 31, 1996 are shown below by contractual maturity (DOLLARS IN THOUSANDS):
Estimated Amortized Fair Cost Value - ------------------------------------------------------------- Due in one year or less $ 68,403 $ 68,408 Due after one year through five years 206,273 206,309 Due after five years through ten years 284,875 287,092 Due after ten years 319,850 324,065 - -------------------------------------------------------------- TOTAL $ 879,401 $ 885,874 - --------------------------------------------------------------
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, and the lenders may have the right to put the securities back to the borrower. Based on expected maturities, the estimated average duration of the fixed maturities was 4.3 years. C) Components of net investment income were as follows (DOLLARS IN THOUSANDS):
Years Ended December 31, ------------------------ 1996 1995 1994 - ---------------------------------------------------------------------- Interest Municipal bonds (tax-exempt) $ 8,824 $ 6,900 $ 7,784 Taxable bonds 36,823 31,042 18,299 Short-term investments, including overnight deposits 4,447 3,969 2,691 Dividends on equity securities 4,474 3,675 2,804 - ---------------------------------------------------------------------- 54,568 45,586 31,578 Less investment expenses 3,400 2,605 2,468 - ---------------------------------------------------------------------- NET INVESTMENT INCOME $ 51,168 $ 42,981 $ 29,110 - ----------------------------------------------------------------------
33 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. Investments (CONTINUED) D) The following table presents the Company's realized gains and losses from investment sales and the change in gross unrealized gains (losses) (DOLLARS IN THOUSANDS):
Years Ended December 31, --------------------------- 1996 1995 1994 - --------------------------------------------------------------------------------- Realized gains Fixed maturities $ 5,618 $ 13,861 $ 8,894 Equity securities 5,480 9,838 5,569 - --------------------------------------------------------------------------------- 11,098 23,699 14,463 - --------------------------------------------------------------------------------- Realized losses Fixed maturities (5,853) (9,281) (9,621) Equity securities (232) (2,466) (972) - --------------------------------------------------------------------------------- (6,085) (11,747) (10,593) - --------------------------------------------------------------------------------- NET REALIZED GAINS FROM INVESTMENT SALES $ 5,013 $ 11,952 $ 3,870 - --------------------------------------------------------------------------------- Change in gross unrealized gains (losses) Fixed maturities $ (16,014) $ 41,356 $ (31,029) Equity securities 31,029 20,610 (13,121) - --------------------------------------------------------------------------------- NET INCREASE(DECREASE) $ 15,015 $ 61,966 $ (44,150) - ---------------------------------------------------------------------------------
E) Investments with a carrying value of $41.9 million and $30.0 million were on deposit with regulatory authorities at December 31, 1996 and 1995, respectively. F) At December 31, 1996, there were no investments in any one issuer, other than U.S. Treasury securities and obligations of U.S. government agencies, that exceeded 10% of consolidated shareholders' equity. 3. Receivables Following are the components of receivables (DOLLARS IN THOUSANDS):
December 31, --------------- 1996 1995 - --------------------------------------------------------------------------- Agents' balances and premiums in course of collection $ 47,356 $ 39,326 Less allowance for doubtful receivables 2,694 2,201 - --------------------------------------------------------------------------- 44,662 37,125 Other 13,674 10,085 - --------------------------------------------------------------------------- RECEIVABLES $ 58,336 $ 47,210 - ---------------------------------------------------------------------------
34 4. Deferred Policy Acquisition Costs The following reflects the amounts of policy costs deferred and amortized (DOLLARS IN THOUSANDS):
Years Ended December 31, --------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------- Balance, beginning of year $ 32,024 $ 26,064 $ 23,551 Policy acquisition costs deferred 76,327 72,748 61,299 Amortization charged to expense (70,372) (66,788) (58,786) - ----------------------------------------------------------------------- DEFERRED POLICY ACQUISITION COSTS $ 37,979 $ 32,024 $ 26,064 - -----------------------------------------------------------------------
The following reflects the components of underwriting, acquisition and insurance expenses (DOLLARS IN THOUSANDS):
Years Ended December 31, ------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------- Amortization of policy acquisition costs $ 70,372 $ 66,788 $ 58,786 Other operating expenses 34,660 29,325 21,895 - ----------------------------------------------------------------------------- UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES $ 105,032 $ 96,113 $ 80,681 - -----------------------------------------------------------------------------
5. Property and Equipment Following are the components of property and equipment (DOLLARS IN THOUSANDS):
December 31, ---------------- 1996 1995 - ---------------------------------------------------------------------------------- Land $ 2,372 $ 2,372 Buildings and building equipment 14,015 24,221 Furniture and equipment 26,229 22,772 Other 94 130 - ---------------------------------------------------------------------------------- 42,710 49,495 Less accumulated depreciation and amortization 27,276 21,766 - ---------------------------------------------------------------------------------- PROPERTY AND EQUIPMENT $ 15,434 $ 27,729 - ----------------------------------------------------------------------------------
Depreciation and amortization expense of property and equipment was $6.0 million, $6.0 million and $5.0 million for the years ended December 31, 1996, 1995, 1994 respectively. Total rental expense for the years ended December 31, 1996, 1995 and 1994 was approximately $2.7 million, $1.9 million and $1.0 million, respectively. As part of the purchase of Shand/Evanston in 1987, the Company acquired Shand's headquarters building in Evanston, Illinois. The estimated fair value of the building has fallen significantly since 1987 due to escalating property taxes and reduced demand for office space in Evanston. In response to a purchase offer, the Company decided to dispose of the building and immediately recognized a $10.4 million ($6.8 million after tax) loss in 1996. The building's estimated fair value was approximated using the purchase offer. 35 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. Property and Equipment (CONTINUED) During 1995 the Company entered into sale-leaseback agreements related to its home office facilities in Richmond, Virginia. The Company sold the properties which house its corporate offices and Richmond-based underwriting units for approximately $19.1 million after expenses and concurrently entered into ten to twelve year lease agreements with the buyers. The Company realized a $4.9 million gain on the sale of the properties which is being deferred and amortized over the terms of the operating leases. In addition, the Company has other office facilities, furniture and equipment under operating leases with remaining terms ranging from 22 months to 46 months. Minimum annual rental commitments for noncancelable operating leases at December 31, 1996 are as follows (DOLLARS IN THOUSANDS): Years Ending December 31, - ---------------------------------------------- 1997 $ 2,924 1998 2,969 1999 2,899 2000 2,932 2001 2,651 2002 and thereafter 10,549 - ----------------------------------------------- Total $ 24,924 - ----------------------------------------------- 6. Intangible Assets Following are the components of intangible assets (DOLLARS IN THOUSANDS): December 31, ------------ 1996 1995 - ------------------------------------------ Goodwill $ 36,035 $ 36,628 Policy renewal rights 3,262 5,029 - ------------------------------------------ INTANGIBLE ASSETS $ 39,297 $ 41,657 - ------------------------------------------ Accumulated amortization related to intangible assets was $17.6 million and $14.9 million at December 31, 1996 and 1995, respectively. 7. Income Taxes Income tax expense (benefit) on income before income taxes, substantially all of which was federal tax expense, consists of (DOLLARS IN THOUSANDS): Current Deferred Total - -------------------------------------------- 1996 $ 5,673 $ (15,345) $ (9,672) 1995 $ 12,061 $ 1,374 $ 13,435 1994 $ 2,814 $ 4,328 $ 7,142 The Company made income tax payments of $8.4 million in 1996, $13.0 million in 1995 and $5.2 million in 1994. Current income taxes recoverable were $3.4 million at December 31, 1996. At December 31, 1995, current income taxes payable were $0.2 million. 36 7. Income Taxes (CONTINUED) Reconciliations of the U.S. corporate income tax rate and the effective tax rate on income before income taxes are as follows: Years Ended December 31, ------------------------ 1996 1995 1994 - ---------------------------------------------------------------------- U.S. corporate tax rate 35% 35% 35% Tax-exempt investment income (9) (6) (11) Amortization of intangibles 1 1 2 Difference between financial reporting and tax bases of assets acquired (53) -- - Other - (2) 2 - ---------------------------------------------------------------------- EFFECTIVE TAX RATE (26%) 28% 28% - ---------------------------------------------------------------------- The components of the net deferred tax asset (liability) are as follows (DOLLARS IN THOUSANDS): December 31, -------------- 1996 1995 - ---------------------------------------------------------------------------- Assets Income reported in different periods for financial reporting and tax purposes $ 11,793 $ 10,409 Unpaid losses and loss adjustment expenses, nondeductible portion for income tax purposes 51,765 42,558 Unearned premiums, adjustment for income tax purposes 10,918 9,168 Other 717 815 - ---------------------------------------------------------------------------- Total gross deferred tax assets 75,193 62,950 - ---------------------------------------------------------------------------- Liabilities Property and equipment, depreciation 1,123 3,069 Deferred policy acquisition costs 13,293 11,208 Investments, net unrealized gains 23,559 18,304 Differences between financial reporting and tax bases of assets acquired 13,837 33,073 Other 1,267 1,169 - ---------------------------------------------------------------------------- Total gross deferred tax liabilities 53,079 66,823 - ---------------------------------------------------------------------------- DEFERRED TAX ASSET (LIABILITY), NET $ 22,114 $ (3,873) - ---------------------------------------------------------------------------- The Company believes that a valuation allowance with respect to the realization of the total gross deferred tax assets is not necessary. The Company expects to realize substantially all of its gross deferred tax assets existing at December 31, 1996 through the reversal of existing temporary differences and the application of the carryback provisions of the Internal Revenue Code. The Company expects to generate future taxable income, excluding the effect of future originating temporary differences,to realize the remaining gross deferred tax assets. The Internal Revenue Service completed an examination of the 1994 and prior federal tax returns and made no material adjustments. 37 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Unpaid Losses And Loss Adjustment Expenses The following table sets forth a reconciliation of beginning and ending reserves for losses and loss adjustment expenses (DOLLARS IN THOUSANDS):
Years Ended December 31, ------------------------ 1996 1995 1994 - -------------------------------------------------------------------------------------- NET RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES, BEGINNING OF YEAR $ 575,268 $ 471,996 $ 426,796 Commutations and other settlements 6,544 54,637 59,818 Reserves for losses and loss adjustment expenses of acquired insurance companies 117,499 35,233 -- - -------------------------------------------------------------------------------------- RESTATED NET RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES, BEGINNING OF YEAR $ 699,311 $ 561,866 $ 486,614 - -------------------------------------------------------------------------------------- Incurred losses and loss adjustment expenses Current year 226,495 195,448 159,730 Prior years (24,117) (8,793) (3,561) - -------------------------------------------------------------------------------------- TOTAL INCURRED LOSSES AND LOSS ADJUSTMENT EXPENSES 202,378 186,655 156,169 - -------------------------------------------------------------------------------------- Payments Current year 52,158 42,002 27,456 Prior years 124,467 131,251 144,376 - -------------------------------------------------------------------------------------- TOTAL PAYMENTS 176,625 173,253 171,832 - -------------------------------------------------------------------------------------- Other - - 1,045 - -------------------------------------------------------------------------------------- NET RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES, END OF YEAR 725,064 575,268 471,996 - -------------------------------------------------------------------------------------- Reinsurance recoverable on unpaid losses 210,518 159,141 180,934 - -------------------------------------------------------------------------------------- GROSS RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES, END OF YEAR $ 935,582 $ 734,409 $ 652,930 - --------------------------------------------------------------------------------------
The provision for prior years decreased in 1996, 1995 and 1994. Inherent in the Company's reserving practices is the desire to have reserves more likely to prove to be redundant than deficient. Furthermore, the Company's philosophy is to price its insurance products to make an underwriting profit, not to increase written premiums. 38 8. Unpaid Losses And Loss Adjustment Expenses (CONTINUED) Management continually attempts to improve its loss estimation process by refining its ability to analyze loss development patterns, claims payments and other information, but there remain many reasons for potential adverse development of estimated ultimate liabilities. For example, the uncertainties inherent in the loss estimation process have become increasingly subject to changes in social and legal trends. In recent years, these trends have expanded the liability of insureds, established new liabilities and reinterpreted contracts to provide unanticipated coverage long after the related policies were written. Such changes from past experience significantly affect the ability of insurers to estimate reserves for unpaid losses and related expenses. Management recognizes the higher variability associated with certain exposures and books of business and considers this factor when establishing loss reserves. Management currently believes the Company's gross and net reserves, including the reserves for environmental impairment liability and toxic tort exposures, are adequate. The Company has shown redundancies in 1987 and subsequent years. The net reserves for losses and loss adjustment expenses maintained by the Company's insurance subsidiaries are equal under both statutory and generally accepted accounting principles. However, certain reserves for claim handling expenses are maintained by the Company's underwriting management subsidiaries, in accordance with the contractual obligations of these subsidiaries. As a result, the consolidated net reserves for losses and loss adjustment expenses will be different from the statutory net reserves for losses and loss adjustment expenses. 9. Long-Term Debt Long-term debt consists of the following (DOLLARS IN THOUSANDS):
December 31, ------------ 1996 1995 - --------------------------------------------------------------------------------- 7.25% notes, due November 1, 2003, interest payable semi-annually , net of unamortized discount of $359 in 1996 and $411 in 1995 $ 99,641 $ 99,589 6.06% borrowings under $150 million revolving credit facility 15,000 - 6.63% borrowings under $40 million revolving credit facility, due June 30, 1997 - 7,000 Other 50 100 - --------------------------------------------------------------------------------- LONG-TERM DEBT $ 114,691 $106,689 - ---------------------------------------------------------------------------------
The notes due November 1, 2003 are not redeemable or subject to any sinking fund requirements and have an effective cost of approximately 7.54%. The estimated fair value of the Company's long-term debt is based on quoted market prices at the reporting date. In December 1996 the Company arranged a syndicated revolving credit facility which provides up to $150.0 million for working capital and other general corporate purposes. The Company may select from various interest rate options for balances outstanding under the facility. The Company pays a commitment fee of .15% on the unused portion of the facility. The facility is a revolving credit facility until October 1, 1998. Any outstanding balances at that date are converted to a four year term loan. This facility replaced the Company's $40.0 million credit facility. 39 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. Long-Term Debt (CONTINUED) Following is a schedule of future principal payments due on long-term debt as of December 31, 1996 (DOLLARS IN THOUSANDS): Years Ending December 31, - ------------------------------------- 1997 $ 50 1998 15,000 1999 -- 2000 -- 2001 -- 2002 and thereafter 99,641 - ------------------------------------- Total $ 114,691 - ------------------------------------- The Company paid $7.7 million, $8.4 million and $7.4 million in interest during the years ended December 31, 1996, 1995 and 1994, respectively. 10. Shareholders' Equity A) The Company has 15,000,000 shares of no par value common stock authorized, of which 5,458,077 and 5,421,988 shares were outstanding at December 31, 1996 and 1995, respectively. The Company is authorized to issue up to 2,069,200 shares of preferred stock, $1.00 par value per share, in one or more series and to fix the powers, designations, preferences and rights of each series. There were 11,269 shares of Series A redeemable preferred stock outstanding at December 31, 1996 and 1995. These shares were included in other liabilities at a redemption value of $28.50 per share and carry a cumulative dividend of $1.50 per share, payable semi-annually. B) The Company has three stock option or stock award plans for employees and directors; the 1986 Stock Option Plan which expired on November 3, 1996, the 1989 Non-employee Director Stock Option Plan and the 1993 Incentive Stock Plan. At December 31, 1996, there were 240,250 shares, 60,000 shares and 100,000 shares reserved for issuance under the 1986 plan, the 1989 plan and the 1993 plan, respectively. The 1986 and 1993 plans are administered by the Compensation Committee of the Company's Board of Directors. The 1993 plan provides for the award of incentive stock options, stock appreciation rights or incentive stock awards to employees of the Company. The 1989 plan is administered by the Company's Board of Directors and provides for the award of non-statutory stock options to the non-employee directors. Options are granted at a price not less than market price on the date of the grant and are exercisable within a period established by the Committee or the Board at the time of the grant, but not earlier than six months from the date of grant. Options expire either five or ten years from the date of grant. At December 31, 1996, the Company had 36,000 options available for grant under the 1989 plan and 100,000 options, stock appreciation rights or incentive stock awards were available for grant under the 1993 plan. 40 10. Shareholders' Equity (CONTINUED) Stock option transactions are summarized below:
Years Ended December 31, -------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise 1996 Price 1995 Price 1994 Price - --------------------------------------------------------------------------------------------------- Options outstanding at January 1 339,582 $ 23.85 382,421 $ 22.67 383,566 $ 19.51 Granted 5,000 87.00 -- -- 46,000 44.03 Exercised (75,332) 22.18 (40,919) 12.38 (44,850) 18.11 Canceled (5,000) 21.55 (1,920) 32.16 (2,295) 11.77 - --------------------------------------------------------------------------------------------------- Options outstanding at December 31 264,250 $ 25.55 339,582 $ 23.85 382,421 $ 22.67 - --------------------------------------------------------------------------------------------------- Options exercisable at December 31 210,735 255,274 273,935 Options available for grant at December 31 136,000 151,215 149,295 - ---------------------------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at December 31, 1996:
Options Outstanding Options Exercisable --------------------------------- -------------------- Weighted Weighted Weighted Range of Average Average Average Exercise Number Remaining Exercise Number Exercise Prices Outstanding Contractual Life Price Exercisable Price - --------------------------------------------------------------------------- $10 to 15 77,209 2.3 years $ 12.35 77,209 $ 12.35 16 to 22 87,851 2.8 18.82 85,676 18.80 23 to 33 10,540 0.4 27.76 8,740 28.07 34 to 47 83,650 4.8 40.86 39,110 40.66 87 5,000 9.8 87.00 -- -- - --------------------------------------------------------------------------- $10 to 87 264,250 3.3 years $ 25.55 210,735 $ 20.88 - ---------------------------------------------------------------------------
The pro forma impact of stock options granted in 1996 was not material to the Company's results of operations. 41 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. Shareholders' Equity (CONTINUED) C) Earnings per share is determined by dividing net income, as adjusted below, by the applicable shares outstanding (IN THOUSANDS):
Years Ended December 31, --------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------- Net income as reported $ 46,672 $ 34,492 $ 18,589 Dividends on redeemable preferred stock (17) (17) (17) - ------------------------------------------------------------------------------- Primary and fully diluted income $ 46,655 $ 34,475 $ 18,572 - ------------------------------------------------------------------------------- Average common shares outstanding 5,438 5,405 5,395 Shares applicable to common stock equivalents 185 200 174 - ------------------------------------------------------------------------------- Average primary shares outstanding 5,623 5,605 5,569 Additional dilution attributable to common stock equivalents 4 28 -- - ------------------------------------------------------------------------------- Average fully diluted shares outstanding 5,627 5,633 5,569 - -------------------------------------------------------------------------------
Average primary and fully diluted shares include common and common equivalent shares attributable to stock options. Common stock market prices which produce the maximum dilutive effect are used to calculate fully diluted shares attributable to stock options. 11. Employee Benefit Plans The Company maintains a defined contribution plan, the Markel Corporation Retirement Savings Plan, in accordance with Section 401(k) of the Internal Revenue Code. The plan requires the Company to contribute, on an annual basis, 6% of each participating employee's compensation plus a matching contribution of 100% of the first 2% and 50% of the next 2% of each participating employee's contribution. Annual expenses relating to this plan were $2.2 million, $1.9 million and $1.9 million in 1996, 1995 and 1994, respectively. 12. Reinsurance The Company enters into reinsurance agreements in order to reduce its liability on individual risks and enable it to underwrite policies with higher limits. In a reinsurance transaction, an insurance company transfers, or cedes, all or part of its exposure in return for a portion of the premium. The ceding of the insurance does not legally discharge the ceding company from its primary liability for the full amount of the policies, and the ceding company is required to pay the loss and bear collection risk if the reinsurer fails to meet its obligations under the reinsurance agreement. The table below summarizes the effect of reinsurance on premiums written and earned (DOLLARS IN THOUSANDS):
Years Ended December 31, - ------------------------------------------------------------------------------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------------- Written Earned Written Earned Written Earned Direct $ 398,412 $ 391,942 $ 366,739 $ 349,417 $ 310,748 $ 291,816 Assumed 8,058 11,062 23,879 26,158 29,121 30,618 Ceded (93,011) (95,551) (93,079) (90,429) (82,847) (79,367) - ------------------------------------------------------------------------------------------------------- Net Premiums $ 313,459 $ 307,453 $ 297,539 $ 285,146 $ 257,022 $ 243,067 - -------------------------------------------------------------------------------------------------------
42 12. Reinsurance (CONTINUED) Incurred losses and loss adjustment expenses are net of reinsurance recoveries of $51.2 million, $63.9 million and $67.1 million for the years ended December 31, 1996, 1995 and 1994, respectively. Since 1993 the Company has pursued the commutation, or termination, of contracts with certain reinsurers of Shand/Evanston's 1987 and prior books of business. The objectives of the commutations were to reduce credit risks and eliminate administrative expenses associated with the run-off of reinsurance placed with certain inactive reinsurers. Primarily as a result of the commutation program, during 1996 the Company reassumed exposures for ceded unpaid losses and loss adjustment expenses in exchange for $6.5 million. In 1995 and 1994 reinsurer commutations and other settlements totaled $54.6 million and $59.8 million, respectively. In all years, pricing for commutations was based on ceded unpaid losses and loss adjustment expenses at the date of commutation plus other factors deemed appropriate by management. The recording of commutations had no effect on the Company's results of operations in 1996, 1995 and 1994. The percentage of assumed earned premiums to net earned premiums for the years ended December 31, 1996, 1995 and 1994 was approximately 4%, 9% and 13%, respectively. 13. Contingencies The Company has 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. 14. Related Party Transactions The Company purchases investment counseling services from Hamblin Watsa Investment Counsel Ltd., a company in which a Director of the Company has a significant interest. The cost of such services was $674,000, $618,000 and $512,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company pays commissions to Gary Markel & Associates, Inc. and Gary Markel Surplus Lines Brokerage, Inc., entities owned by a Director of the Company. The commissions paid were $467,000, $424,000 and $344,000 for the years ended December 31, 1996, 1995 and 1994, respectively. 15. Statutory Financial Information The following table includes selected information for the Company's wholly-owned insurance subsidiaries as filed with insurance regulatory authorities (DOLLARS IN THOUSANDS): Years Ended December 31, ----------------------- 1996 1995 1994 - -------------------------------------------------------------------- Net income $ 27,424 $ 42,181 $ 26,816 - -------------------------------------------------------------------- Statutory capital and surplus $ 282,774 $ 224,833 $ 164,650 - -------------------------------------------------------------------- 1996 amounts include Investors Insurance Holding Corp.'s statutory net loss and capital and surplus of $6.6 million and $28.7 million, respectively. 43 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. Statutory Financial Information (CONTINUED) The Company's insurance subsidiaries are subject to certain regulatory restrictions on the payment of dividends or advances to the Company. As of December 31, 1996, $249.9 million of the insurance subsidiaries' statutory surplus was so restricted. In converting from statutory accounting principles to generally accepted accounting principles, typical adjustments include deferral of policy acquisition costs, a provision for deferred federal income taxes and the inclusion of net unrealized gains or losses in shareholders' equity relating to fixed maturities. 16. Acquisitions A) On October 31, 1996, the Company acquired Investors Insurance Holding Corp. and its subsidiaries (Investors). The acquisition was accounted for using the purchase method of accounting. Total consideration paid to the shareholders of Investors was $38.1 million which approximated the fair value of the net assets acquired. The Company funded the transaction with available cash and borrowings of approximately $15.0 million under existing lines of credit. Investors had gross premium volume of $56.9 million in 1996. However, following the acquisition, the Company expects Investors' gross premium volume to decline as Investors focuses on its core general liability and property lines of business. The acquisition's effect on the Company's current earnings was not significant in 1996. The table below summarizes, on a pro forma basis, the Company's consolidated results of operations as if the purchase of Investors had taken place as of January 1, 1995 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS): Years Ended December 31, ----------------------- 1996 1995 - ------------------------------------------------------------- Total operating revenues $ 405,899 $ 389,397 Net income 39,469 29,508 - ------------------------------------------------------------- Earnings per share Primary $ 7.02 $ 5.26 Fully diluted $ 7.01 $ 5.24 - ------------------------------------------------------------- Investors' results had a dilutive effect on the Company's pro forma results of operations in 1996 and 1995 due to significant loss reserve strengthening at Investors. The Company does not expect that Investors' loss reserves will require additional strengthening in future years. B) On May 30, 1995, the Company acquired the stock of Lincoln Insurance Company (LIC), an excess and surplus lines company. The acquisition was accounted for using the purchase method of accounting. The terms of the transaction provided for the Company to pay total consideration of $24.3 million which approximated the fair value of the net assets acquired. Additionally, the seller will provide indemnification against adverse development of reserves for losses and loss adjustment expenses and uncollectible reinsurance, if any, in an amount up to the purchase price. The Company funded the transaction with available cash and borrowings of approximately $17.0 million under existing lines of credit. After the acquisition, LIC ceased writing business as soon as practical. However, certain portions of the business were renewed in Essex Insurance Company, a subsidiary of the Company. The acquisition's effect on current earnings, which consists primarily of investment income from LIC's investment portfolio, was not significant in 1995. 44 17. Subsequent Events In January 1997 the Company arranged the sale of $150 million of 8.71% Capital Securities (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 Markel Corporation. Proceeds from the sale of the Capital Securities were used to purchase the Company's 8.71% Junior Subordinated 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 Capital Securities and related Debentures are redeemable by the Company on or after January 1, 2007. Payments of distributions and other amounts due on the Capital Securities (to the extent the Trust has funds on hand legally available for the payment of such distributions) are irrevocably guaranteed by the Company (the Guarantee). Taken together, the Company's obligations under the Debentures, the Indenture, the Declaration and the Guarantee provide, in the aggregate, a full, irrevocable and unconditional guarantee of payments of distributions and other amounts due on the Capital Securities. 18. Markel Corporation (Parent Company Only) Financial Information CONDENSED BALANCE SHEETS
December 31, ---------------------- 1996 1995 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) ASSETS Investments in consolidated subsidiaries $ 336,301 $ 282,732 Short-term investments at estimated fair value (estimated fair value approximates cost) 17,618 13,740 Cash and cash equivalents 1,562 812 Notes receivable from subsidiaries 49,694 45,224 Other assets 10,757 14,598 - ------------------------------------------------------------------------------ TOTAL ASSETS $ 415,932 $ 357,106 - ------------------------------------------------------------------------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current income taxes payable $ 281 $ -- Deferred income taxes 13,070 10,954 Long-term debt 114,641 106,589 Other liabilities 19,605 26,121 - ------------------------------------------------------------------------------ TOTAL LIABILITIES 147,597 143,664 - ------------------------------------------------------------------------------ Shareholders' equity 268,335 213,442 - ------------------------------------------------------------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 415,932 $ 357,106 - ------------------------------------------------------------------------------
45 Markel Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. Markel Corporation (Parent Company Only) Financial Information (CONTINUED) CONDENSED STATEMENTS OF INCOME
Years Ended December 31, ------------------------ 1996 1995 1994 - --------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) REVENUES Net investment income $ 2,585 $ 3,879 $ 3,434 Cash dividends on common stock of consolidated subsidiaries 31,841 35,459 15,380 Other 1,471 129 452 - --------------------------------------------------------------------------------- TOTAL REVENUES 35,897 39,467 19,266 - --------------------------------------------------------------------------------- EXPENSES Interest 8,016 8,460 7,675 Other 205 3,144 2,064 - --------------------------------------------------------------------------------- TOTAL EXPENSES 8,221 11,604 9,739 - --------------------------------------------------------------------------------- INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS OF CONSOLIDATED SUBSIDIARIES AND INCOME TAXES 27,676 27,863 9,527 Equity in undistributed earnings of consolidated subsidiaries 15,655 5,139 11,423 Income tax expense (benefit) (3,341) (1,490) 2,361 - --------------------------------------------------------------------------------- NET INCOME $ 46,672 $ 34,492 $ 18,589 - ---------------------------------------------------------------------------------
46 18. Markel Corporation (Parent Company Only) Financial Information (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------ 1996 1995 1994 - ------------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) OPERATING ACTIVITIES Net income $ 46,672 $ 34,492 $ 18,589 Adjustments to reconcile net income to net cash provided by operating activities (3,608) (3,181) 725 - ------------------------------------------------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 43,064 31,311 19,314 - ------------------------------------------------------------------------------------ INVESTING ACTIVITIES Cost of investments purchased (4,030) (4,626) (20,802) Proceeds from sales of investments 3,996 4,663 34,525 Net change in short-term investments (3,878) 1,562 (6,650) Increase in notes receivable from subsidiaries (4,470) (4,005) (18,092) Capital contribution to subsidiaries -- (9,500) (27,000) Acquisitions of insurance companies (38,050) (24,281) -- Other (1,263) (96) (31) - ------------------------------------------------------------------------------------ NET CASH USED BY INVESTING ACTIVITIES (47,695) (36,283) (38,050) - ------------------------------------------------------------------------------------ FINANCING ACTIVITIES Dividends to subsidiaries (1,080) (1,080) (1,080) Additions to long-term debt 40,500 27,500 29,280 Repayments of long-term debt (32,500) (21,500) (7,500) Other (1,539) 172 (2,118) - ------------------------------------------------------------------------------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 5,381 5,092 18,582 - ------------------------------------------------------------------------------------ Increase (decrease) in cash and cash equivalents 750 120 (154) Cash and cash equivalents at beginning of year 812 692 846 - ------------------------------------------------------------------------------------ Cash and cash equivalents at end of year $ 1,562 $ 812 $ 692 - ------------------------------------------------------------------------------------
47 Markel Corporation & Subsidiaries INDEPENDENT AUDITORS' REPORT (KPMG Peat Marwick LLP logo appears here.) The Board of Directors and Shareholders Markel Corporation: We have audited the accompanying consolidated balance sheets of Markel Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Markel Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. As described in Note 1, in 1996 the Company adopted the provisions of Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. /s/ KPMG PEAT MARWICK LLP Richmond, Virginia February 4, 1997 48 QUARTERLY INFORMATION The following table presents the quarterly results of consolidated operations for 1996, 1995 and 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS):
Mar. 31 June 30 Sept. 30 Dec. 31 - ------------------------------------------------------------------------------------- 1996 Operating revenues $ 92,990 $ 83,672 $90,367 $ 99,707 Income before income taxes 10,554 10,117 11,144 5,185 Net income 7,810 26,090 8,469 4,303 Earnings per share Primary $ 1.38 $ 4.61 $ 1.50 $ 0.76 Fully diluted 1.38 4.60 1.50 0.76 Common stock price ranges High $ 91 $ 94 1/2 $ 93 $ 92 Low 72 1/2 78 85 83 1995 Operating revenues $ 76,525 $ 82,565 $91,543 $ 92,942 Income before income taxes 8,838 11,286 12,835 14,968 Net income 6,540 8,352 8,984 10,616 Earnings per share Primary $ 1.17 $ 1.49 $ 1.59 $ 1.88 Fully diluted 1.17 1.49 1.59 1.88 Common stock price ranges High $ 48 1/4 $ 57 $75 1/2 $ 75 1/2 Low 40 3/4 47 1/4 56 1/4 67 1/2 1994 Operating revenues $ 65,468 $ 66,398 $72,414 $ 75,413 Income before income taxes 7,236 6,388 5,858 6,249 Net income 5,210 4,599 4,218 4,562 Earnings per share Primary $ 0.93 $ 0.83 $ 0.76 $ 0.82 Fully diluted 0.93 0.83 0.76 0.82 Common stock price ranges High $ 44 1/2 $ 42 1/2 $ 44 $ 42 1/4 Low 38 1/2 37 1/2 39 40 1/4
49 Markel Corporation & Subsidiaries MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS In 1996 gross premium volume totaled $413.6 million compared to $402.1 million in 1995 and $349.3 in 1994. Following is a comparison of gross premium volume by significant underwriting unit (DOLLARS IN THOUSANDS):
Years Ended December 31, ----------------------------------------- GROSS PREMIUM VOLUME 1996 1995 1994 - ----------------------------------------------------------------------------------- Excess and Surplus Lines $ 121,356 $ 104,841 $ 90,211 Professional/Products Liability 118,891 127,245 128,876 Specialty Program Insurance 92,333 102,336 94,637 Specialty Personal and Commercial Lines 64,706 44,456 13,924 Brokered Excess and Surplus Lines 6,809 -- -- Other 9,511 23,212 21,636 - ----------------------------------------------------------------------------------- Total $ 413,606 $ 402,090 $ 349,284 - -----------------------------------------------------------------------------------
(Premiums chart appears here. Plot points are below.) PREMIUMS (in millions) 1994 1995 1996 gross premium volume $349 $402 $414 net premium volume $257 $298 $313 Excess and Surplus Lines premiums grew 16% in 1996 to $121.4 million and 16% in 1995 to $104.8 million from $90.2 million in 1994. Growth was achieved despite significant competition in the E&S market. The increases in 1996 and 1995 were primarily the result of growth in the Markel Special Property program (MSP). MSP premiums amounted to $39.9 million in 1996 compared to $34.2 million in 1995 and $21.6 million in 1994. 1996 also benefited from growth in casualty premiums, due to a new garage program and the selective renewal of portions of the Lincoln Insurance Company (LIC) book of business, a new excess and umbrella program and growth in the E&S property unit. Growth in 1995 production from E&S product lines, other than MSP, was moderate due to increased competition during the year. Premiums from Professional/Products Liability insurance totaled $118.9 million in 1996 compared to $127.2 million in 1995 and $128.9 million in 1994. In 1996 growth in the employment practices and directors' and officers' product lines was more than offset by lower production from other lines due to continued aggressive competition in the professional liability markets. Medical malpractice and special risk programs production also declined in 1996 due to changes in risk selection. In 1995 the Company reported growth in the medical malpractice and specified medical professions product lines. However, 1995 production was adversely affected by increasing competition from the standard markets, especially in the insurance companies, lawyers and architects and engineers programs, which more than offset the growth in the medical malpractice and specified medical professions lines. Premiums from Specialty Program Insurance totaled $92.3 million in 1996 compared to $102.3 million in 1995 and $94.6 million in 1994. 1996 premiums were adversely affected by intense competition and the nonrenewal of certain underperforming lines of business. Higher production in 1995 was prompted by policy processing improvements and other operating efficiencies. Growth in the child care program also contributed to the 1995 increase. 50 Specialty Personal and Commercial Lines premiums rose to $64.7 million in 1996, a 46% increase over prior year premiums of $44.5 million which was a 219% increase over 1994's premiums of $13.9 million. Due to the loss of a key auto products agent, the Company does not expect premium growth of this magnitude in 1997. New programs added over the past three years, including several auto related products and property coverage for mobile homes and dwellings contributed $43.2 million and $28.5 million to 1996 and 1995 production, respectively. Also in both years, an improved economy helped increase production in the recreational products division. Premiums from Brokered Excess and Surplus Lines totaled $6.8 million in 1996. This new underwriting unit was the result of the purchase of Investors Insurance Holding Corp. (Investors) on October 31, 1996. Other gross premium volume was $9.5 million in 1996 compared to $23.2 million in 1995 and $21.6 million in 1994. Other gross premium volume included facultative reinsurance placed by the Professional/Products Liability unit, run- off business related to LIC and premiums from the Company's brokerage operation. The decrease in 1996 was due to the run-off of LIC business and the sale of the Company's wholesale brokerage operation in September 1996. While certain of the Company's products may be adversely affected by the increased competition and lower rates which characterize a "soft" insurance market, the Company does not intend to relax underwriting standards or rates in order to sustain premium volume. Further, the volume of premiums written may vary significantly with the Company's decision to alter its product concentration to maintain or improve underwriting profitability. Total operating revenues increased 7% to $366.7 million in 1996 from $343.6 million in 1995. Operating revenues in 1995 were 23% above the $279.7 million reported in 1994. In 1996 moderate growth in earned premiums and higher net investment income more than offset lower realized gains from the sales of investments. In 1995 growth in earned premiums and substantially higher net investment income and realized gains accounted for the increase in revenues. Earned premiums advanced 8% to $307.5 million in 1996 and 17% to $285.1 million in 1995 from $243.1 million in 1994. Following is a comparison of earned premiums by significant underwriting unit (DOLLARS IN THOUSANDS):
Years Ended December 31, ------------------------------------------- EARNED PREMIUMS 1996 1995 1994 - ------------------------------------------------------------------------------------ Excess and Surplus Lines $ 76,089 $ 70,160 $ 62,236 Professional/Products Liability 110,154 112,988 107,735 Specialty Program Insurance 68,906 64,582 56,002 Specialty Personal and Commercial Lines 45,102 25,181 11,180 Brokered Excess and Surplus Lines 4,957 -- -- Other 2,245 12,235 5,914 - ------------------------------------------------------------------------------------ Total $ 307,453 $ 285,146 $ 243,067 - ------------------------------------------------------------------------------------
51 Markel Corporation & Subsidiaries MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Excess and Surplus Lines earned premiums rose 8% in 1996 to $76.1 million and 13% in 1995 to $70.2 million from $62.2 million in 1994. Higher gross premium volume over the past several years accounted for the increases. Premiums earned from Professional/Products Liability insurance decreased 3% in 1996 to $110.2 million while increasing 5% in 1995 to $113.0 million from $107.7 million in 1994. The 1996 decline resulted from lower gross premium volume over the past two years as a result of the extremely competitive professional liability market. Specialty Program Insurance earned premiums increased 7% to $68.9 million in 1996 and 15% to $64.6 million in 1995 from $56.0 million in 1994. The growth was caused by increased retentions of gross premium volume over the past three years and growth in gross premiums in 1995. Specialty Personal and Commercial Lines earned premiums rose 79% in 1996 to $45.1 million and 125% in 1995 to $25.2 million from $11.2 million in 1994. The increase was due to significant growth in gross premium volume from new programs as well as established programs over the past two years. Investment Earnings (Investment Earnings chart appears here. Plot points are below.) INVESTMENT EARNINGS (in millions) 1994 1995 1996 ---- ---- ---- Net realized gains $ 4 $12 $ 5 Net investment income 29 43 51 ---- ---- ---- $33 $55 $56 Net investment income increased 19% in 1996 to $51.2 million and 48% in 1995 to $43.0 million from $29.1 million in 1994. The increase in 1996 reflected the impact of a larger investment portfolio. Higher yields during 1995 enhanced the impact of the Company's significantly larger investment portfolio. Invested assets grew 24% in 1996 to $1.1 billion and 49% in 1995 to $908.6 million from $611.7 million in 1994. Net realized gains from the sales of investments totaled $5.0 million in 1996 compared to $12.0 million in 1995 and $3.9 million in 1994. Over the past three years, the Company has experienced variability in its realized and unrealized investment gains. The fluctuations are primarily the result of interest rate volatility which influences the market values of fixed maturity and equity investments. The Company's investment strategy seeks to maximize total investment returns over a long-term period. The Company's focus on long- term total investment returns may result in variability in the level of realized investment gains and losses from one period to the next. Total operating expenses, which included losses and loss adjustment expenses, underwriting, acquisition and insurance expenses, other operating expenses, amortization of intangible assets and a nonrecurring item in 1996, were $321.7 million in 1996 compared to $287.2 million in 1995 and $246.3 million in 1994. Higher variable expenses associated with higher earned premiums accounted for the majority of the increase in 1996 and 1995. As part of the purchase of Shand/Evanston in 1987, the Company acquired Shand's headquarters building in Evanston, Illinois. The estimated fair value of the building has fallen significantly since 1987 due to escalating property taxes and reduced demand for office space in Evanston. In response to a purchase offer, the Company decided to dispose of the building and immediately recognized a $10.4 million, nonrecurring, non-cash loss. While Shand/Evanston will remain in the building in the short-term, the transaction is expected to reduce future operating expenses at this unit by approximately $1.5 million per year. 52 The following is a comparison of selected data from the Company's operations (DOLLARS IN THOUSANDS):
Years Ended December 31, ------------------------------------- 1996 1995 1994 - --------------------------------------------------------------------------------------------- Gross premium volume $ 413,606 $ 402,090 $ 349,284 Net premiums written $ 313,459 $ 297,539 $ 257,022 Net retention 76% 74% 74% Earned premiums $ 307,453 $ 285,146 $ 243,067 Losses and loss adjustment expenses $ 202,378 $ 186,655 $ 156,169 Underwriting, acquisition and insurance expenses $ 105,032 $ 96,113 $ 80,681 GAAP RATIOS Loss ratio 66% 65% 64% Expense ratio 34% 34% 33% - --------------------------------------------------------------------------------------------- COMBINED RATIO 100% 99% 97% - ---------------------------------------------------------------------------------------------
The combined ratio measures the relationship of incurred losses, loss adjustment expenses and underwriting, acquisition and insurance expenses to earned premiums. The loss ratio for 1996 increased to 66% from 65% in 1995 and from 64% in 1994. Losses in the medical malpractice book of business and property losses from winter storms and Hurricane Fran prompted the 1996 increase. In 1995 the loss ratio rose as increased competition and continued soft market conditions prompted the Company to establish loss reserves for current business at higher levels relative to the prior years. The expense ratio was 34% in 1996 and 1995 compared to 33% in 1994. The 1996 expense ratio benefited from the recognition of contingent profit commissions which offset higher acquisition costs in several of the Company's recently added lines of business. The increase in 1995 is largely the result of investments in new programs which carry nonrecurring start-up costs, as well as higher commission expenses. Non-cash expenses related to the amortization of intangible assets were $2.7 million in 1996 compared to $2.8 million in 1995 and $7.1 million in 1994. The decrease in 1995 reflected the expiration of certain noncompete agreements in December 1994. Interest expense amounted to $8.0 million in 1996 compared to $8.5 million in 1995 and $7.7 million in 1994. The 1996 decrease was due to the repayment, late in 1995, of the majority of the debt incurred for the purchase of LIC. Interest expense in 1995 increased as a result of the borrowings for the LIC purchase. 53 Markel Corporation & Subsidiaries MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Earnings from Core Operations (Earnings from Core Operartions chart appears here. Plot points are below.) Earnings from Core Operations ($ per primary share) 1994 1995 1996 $3.77 $5.15 $6.03 In evaluating its operating performance, the Company focuses on core underwriting and investing results before consideration of realized gains or losses from the sales of investments, expenses related to the amortization of intangible assets and any nonrecurring items. Management believes this is a better indicator of the Company's performance because it reduces the variability in results associated with realized gains or losses and also eliminates the impact of accounting transactions which do not reflect current operating costs. Income from core underwriting and investing operations advanced to $33.9 million in 1996 which represented a 17% increase over 1995. In 1995 income from core operations rose 38% to $28.9 million from $21.0 million in 1994. The 1996 and 1995 increases were due to continued underwriting profitability and higher net investment income, resulting primarily from larger investment portfolios. Net income was $46.7 million in 1996 compared to $34.5 million in 1995 and $18.6 million in 1994. In 1996 growth in net investment income was partially offset by a decrease in realized investment gains. Also during the year, the Company recognized an $18.4 million nonrecurring tax benefit which was partially offset by the recognition of the building loss of $6.8 million, net of taxes. The increase in 1995 was due to substantial growth in net investment income, realized investment gains and continued underwriting profits. CLAIMS AND RESERVES The Company maintains reserves for specific claims incurred and reported, reserves for claims incurred but not reported (IBNR) and reserves for uncollectible reinsurance. Reserves for reported claims are based primarily on case-by-case evaluations of the claims and their potential for adverse development. Reserves for reported claims consider the Company's estimate of the ultimate cost to settle the claims, including investigation and defense of lawsuits resulting from the claims, and may be subject to adjustment for differences between costs originally estimated and costs subsequently re- estimated or incurred. Generally accepted accounting principles require that reserves for claims incurred but not reported be based on the estimated ultimate cost of settling claims (including the effects of inflation and other social and economic factors), using past experience adjusted for current trends and any other factors that would modify past experience. The Company also evaluates and adjusts reserves for uncollectible reinsurance in accordance with its collection experience and the development of the gross reserves. Ultimate liability may be greater or less than current reserves. In the insurance industry there is always the risk that reserves may prove inadequate. Reserves are continually monitored by the Company using new information on reported claims and a variety of statistical techniques. Anticipated inflation is reflected implicitly in the reserving process through analysis of cost trends and the review of historical development. The Company does not discount its reserves for losses and loss adjustment expenses to reflect estimated present value. 54 The following table represents the development of the Company's balance sheet reserves for the period 1986 through 1996 (IN THOUSANDS):
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 - --------------------------------------------------------------------------------------------------------------------------- NET RESERVES RESTATED FOR COMMUTATIONS, ACQUISITIONS AND OTHER $ 397,906 486,015 487,263 508,335 511,004 557,554 569,769 598,499 619,594 671,447 725,064 - --------------------------------------------------------------------------------------------------------------------------- Paid (cumulative) as of: One year later 47,547 79,318 54,180 65,810 52,545 83,720 95,084 150,078 135,947 124,467 Two years later 81,915 111,929 89,973 116,418 107,209 156,256 215,845 253,418 219,133 Three years later 104,641 140,161 131,899 154,798 160,808 252,089 297,034 307,831 Four years later 121,961 176,442 160,942 194,199 241,335 318,298 331,709 Five years later 145,136 195,152 199,982 257,077 297,914 346,009 Six years later 158,735 230,109 259,850 310,448 320,766 Seven years later 190,000 283,961 312,210 331,842 Eight years later 241,026 335,971 332,622 Nine years later 291,473 355,460 Ten years later 310,669 Reserves re-estimated as of: One year later 424,357 498,442 497,207 502,869 506,626 547,965 563,530 594,938 610,801 647,330 Two years later 421,488 495,708 477,865 500,780 494,748 542,903 551,858 582,563 585,667 Three years later 420,751 477,814 474,989 493,433 490,751 528,365 537,944 564,401 Four years later 411,844 486,440 480,153 486,623 478,416 513,983 521,724 Five years later 429,947 494,924 477,324 474,099 464,129 501,083 Six years later 445,738 491,895 465,399 459,082 452,772 Seven years later 438,150 481,822 449,548 448,569 Eight years later 428,465 465,655 441,116 Nine years later 412,989 457,697 Ten years later 407,492 CUMULATIVE REDUNDANCY (DEFICIENCY) $ (9,586) 28,318 46,147 59,766 58,232 56,471 48,045 34,098 33,927 24,117 - --------------------------------------------------------------------------------------------------------------------------- Cumulative % (2%) 6% 9% 12% 11% 10% 8% 6% 5% 4% Gross liability, end of year, restated for acquisitions and other 824,044 935,582 Reinsurance recoverable, restated for commutations, acquisitions and other 152,597 210,518 - --------------------------------------------------------------------------------------------------------------------------- NET LIABILITY, END OF YEAR, RESTATED FOR COMMUTATIONS, ACQUISITIONS AND OTHER 671,447 725,064 - --------------------------------------------------------------------------------------------------------------------------- Gross re-estimated liability-latest 798,491 Re-estimated recoverable-latest 151,161 - --------------------------------------------------------------------------------------------------------------------------- Net re-estimated liability-latest 647,330 Gross cumulative redundancy 25,553 - ---------------------------------------------------------------------------------------------------------------------------
55 Markel Corporation & Subsidiaries MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The first line of the table shows net reserves for losses and loss adjustment expenses restated for reinsurer commutations, acquisitions and other items, and is the result of adding the reserves for losses and loss adjustment expenses as originally estimated at the end of each year and all prior years to reserves reassumed through commutations and other activities, including acquisitions, completed in recent years. The upper portion of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The lower portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year, including cumulative payments made since the end of the respective year. For example, the 1991 liability for losses and loss adjustment expenses at the end of 1991 for 1991 and all prior years, adjusted for commutations, acquisitions and other, was originally estimated to be $557.6 million. Five years later (as of December 31, 1996), this amount was re- estimated to be $501.1 million, of which $346.0 million had been paid, leaving a reserve of $155.1 million for losses and loss adjustment expenses for 1991 and prior years remaining unpaid as of December 31, 1996. "Cumulative redundancy (deficiency)" represents the change in the estimate from the original balance sheet date to the date of the current estimate. For example, the 1991 liability for losses and loss adjustment expenses developed a $56.5 million redundancy from December 31, 1991 to December 31, 1996 (five years later). Conditions and trends that have affected the development of liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on the table. The gross cumulative redundancy for 1995 and prior is presented before deductions for reinsurance. Gross deficiencies and redundancies may be significantly more or less than net deficiencies and redundancies depending on the nature and extent of applicable reinsurance. The deficiencies in net reserves for losses and loss adjustment expenses in the 1986 and prior years is related primarily to Shand/Evanston's experience prior to the Company's ownership. From 1987 to 1991, Shand/Evanston increased reserves for its pre-1987 book of business by approximately $97 million. These increases were made in response to adverse development related to professional liability policies with optional extension provisions, environmental impairment liability (EIL) and toxic tort exposures and potentially uncollectible reinsurance recoverables. A significant portion of the reserve increases (approximately $51 million) was ultimately offset by reductions in deferred purchase price obligations owed to the former owners of Shand/Evanston and therefore did not affect operating results. ENVIRONMENTAL MATTERS From 1980 to 1985, Shand/Evanston offered EIL insurance to large companies which generated or transported toxic wastes. The EIL coverage was designed to fill gaps in an insured's general liability coverage to the extent a gap would have existed and was offered as a primary policy with an "Other Insurance" clause. To the extent that other insurance was not valid and collectible, Shand/Evanston's EIL policy was intended to perform as primary coverage provided that all other terms and conditions of the policy were met. To the extent that other insurance was valid and collectible, the policy was intended to perform as excess coverage. All EIL policies 56 were underwritten on a claims made basis, and in almost all instances, with policy limits that included the costs of defense and related expenses. This book of business was reinsured with numerous reinsurers, and Shand/Evanston's original retentions were less than 5% of policy limits. Policy limits ranged from $1 million per impairment with $2 million in the aggregate to $30 million per impairment with $60 million in the aggregate. Shand/Evanston's defenses in EIL claims have generally been policy specific and have included defenses of non-disclosure and misrepresentation on policy applications, policy exclusions including site limitations, late assertion of claims and the existence of other valid and collectible insurance. Following is an analysis of the Company's net outstanding reserves for Shand/Evanston's EIL exposures. Commutations include reinsurer commutations completed in 1996 as well as changes in reserves related to reinsurer commutations occurring in earlier years (DOLLARS IN THOUSANDS).
Years Ended December 31, -------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------------------- Case reserves $ 665 $ 579 $ 1,130 IBNR reserves -- -- 49 Case and IBNR reserves reassumed through commutations 14,730 13,125 14,008 - -------------------------------------------------------------------------------------- TOTAL $ 15,395 $ 13,704 $ 15,187 - -------------------------------------------------------------------------------------- Net paid losses and loss adjustment expenses $ 3,616 $ 14,894 $ 60,755 - --------------------------------------------------------------------------------------
Shand/Evanston carried net EIL case and IBNR reserves for losses and loss adjustment expenses of $15.4 million at December 31, 1996 compared to $13.7 million at December 31, 1995 and $15.2 million at December 31, 1994. The Company's goal is to close EIL claims as aggressively as reasonably possible. The increase in 1996 reserves was due to development on existing claims as well as limited new claim activity. The decrease in net EIL reserves in 1995 was due primarily to claims closing efforts. In some cases, the Company may be entitled to subrogation against other primary insurers. No specific provision for these potential recoveries is made when establishing loss and loss adjustment expense reserves for EIL. As of December 31, 1996, Shand/Evanston's net retention of case and IBNR reserves related to EIL was approximately 79% of gross EIL case and IBNR reserves. Inception to date net paid losses and loss adjustment expenses for EIL related exposures totaled $115.0 million at December 31, 1996, of which approximately $9.3 million was litigation related expense. There were 10 active site exposures related to EIL at December 31, 1996 compared to 9 active site exposures at December 31, 1995 and 11 active site exposures at December 31, 1994. The 10 active site exposures at December 31, 1996 represent 10 insureds. Management believes future exposure to valid claims is limited because coverage was afforded on a claims made basis. 57 Markel Corporation & Subsidiaries MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Shand/Evanston's exposure to toxic tort related claims originated from umbrella, excess and commercial general liability (CGL) insurance it underwrote on an occurrence basis from the late 1970's to mid-1980's. The majority of the policies attach over a self-insured retention, deductible, or other insurance. This book of business was reinsured with numerous reinsurers, and Shand/Evanston's original retention was less than 5% of policy limits. Policy limits ranged from $125,000 to $30 million. Toxic tort claims include property damage and clean-up related to pollution, as well as personal injury allegedly arising from exposure to hazardous materials. After 1986 Shand/Evanston underwrote CGL coverage using a claims made form which included a pollution exclusion that significantly reduced its exposure to toxic tort claims. Insurance coverage issues and other uncertainties have made the estimation of reserves for toxic tort exposures difficult. The outcome of legal actions to determine general liability coverages related to toxic tort issues has been inconsistent among the states with respect to whether insurance coverage exists at all; what policies provide the coverage; when and if an insurer has a duty to defend; whether the release of contaminants is one or more "occurrence" for purposes of determining applicable policy limits; how pollution exclusions in policies should be applied; and whether clean-up costs constitute property damage. Regulatory requirements regarding environmental matters are also inconsistent and change frequently. Following is an analysis of the Company's net outstanding reserves for Shand/Evanston's toxic tort exposures. Commutations include reinsurer commutations completed in 1996 as well as changes in reserves related to reinsurer commutations occurring in earlier years (DOLLARS IN THOUSANDS).
Years Ended December 31, ------------------------- 1996 1995 1994 - ---------------------------------------------------------------------------------- Case reserves $ 1,782 $ 2,197 $ 2,089 IBNR reserves 1,354 1,589 1,032 Case and IBNR reserves reassumed through commutations 37,751 44,636 24,887 - ---------------------------------------------------------------------------------- TOTAL $ 40,887 $ 48,422 $ 28,008 - ---------------------------------------------------------------------------------- Net paid losses and loss adjustment expenses $ 10,849 $ 1,504 $ 3,721 - ----------------------------------------------------------------------------------
Shand/Evanston carried net toxic tort case and IBNR reserves for losses and loss adjustment expenses of $40.9 million at December 31, 1996 compared to $48.4 million at December 31, 1995 and $28.0 million at December 31, 1994. The decrease in net toxic tort reserves in 1996 was due to claims payments partially offset by increases due to commutations with reinsurers and adverse development in the underlying exposures. The net toxic tort reserves increased from 1994 to 1995 due to commutations with reinsurers, adverse development in the underlying exposures and reserve strengthening by management. As of December 31, 1996, Shand/Evanston's net retention of case and IBNR reserves related to toxic torts was approximately 87% of gross toxic tort case and IBNR reserves. Inception to date net paid losses and loss adjustment expenses for toxic tort related exposures totaled $19.3 million, of which approximately $1.7 million was litigation related expense. 58 During 1996 toxic tort net paid losses increased compared to prior years due to the payment of $7.4 million of breast implant product liability claims. The exposure had been fully reserved in prior years. At December 31, 1996, the Company has either paid or fully reserved all of its breast implant product liability exposure. There were 210 open claims related to toxic torts at December 31, 1996 compared to 249 at December 31, 1995 and 307 at December 31, 1994. Of the toxic tort claims open at December 31, 1996, less than 10% were products liability asbestos or related claims. Furthermore, the average severity of toxic tort claims is substantially lower than the average severity of EIL claims. The Company's reserves for losses and loss adjustment expenses related to EIL and toxic tort exposures represent management's best estimate of ultimate settlement values. These reserves are continually monitored by management, and the Company's statistical analysis of these reserves is reviewed by independent consulting actuaries. In addition, the Company continues to maintain unallocated IBNR reserves to further mitigate the impact of adverse development, if any, in these and other reserves. At December 31, 1996, LIC held case and IBNR reserves for toxic tort claims of $6.1 million. The sellers of LIC have indemnified the Company against adverse development of losses and loss adjustment expenses and uncollectible reinsurance, if any, in an amount up to the purchase price of approximately $24.3 million. This indemnification covers all of LIC's reserves, including environmental matters. Exposures of these types are generally subject to significant uncertainty due to potential severity and an uncertain legal climate. Reserves for these types of claims could be subject to increases in the future; however, these reserves have been established in accordance with the Company's desire to have reserves of all types that are more likely to prove to be redundant than deficient. LIQUIDITY AND CAPITAL RESOURCES The Company seeks to maintain prudent levels of liquidity and financial leverage for the protection of its policyholders, shareholders and creditors. The Company's targeted capital structure is approximately one-third debt to two- thirds equity. At December 31, 1996, the Company's debt to total capital ratio was 30%. From time to time, the Company's debt to total capital ratio may increase due to business opportunities that may be financed in the short term with debt. In order to maintain strong liquidity, the Company seeks to maintain cash and short-term investments at least equal to approximately two times annual interest expense at its holding company (Markel Corporation). At December 31, 1996, $19.2 million of cash and short-term investments were held at Markel Corporation which approximated 2.4 times annual interest expense. The Company's insurance subsidiaries collect premiums and pay current claims, reinsurance costs and operating expenses. Premiums collected and positive cash flow from the insurance operations are invested primarily in short-term investments and long-term bonds. 59 Markel Corporation & Subsidiaries MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Short-term investments held by the Company's insurance subsidiaries provide liquidity for projected claims, reinsurance costs and operating expenses. As a holding company, the Company receives cash from its subsidiaries as reimbursement for operating and other administrative expenses it incurs. The reimbursements are executed within the guidelines of various management agreements between the holding company and its subsidiaries. The holding company has historically relied upon dividends from its subsidiaries to meet debt service obligations. Under the insurance laws of the various states in which the Company's insurance subsidiaries are incorporated, an insurer is restricted in the amount of dividends it may pay without prior approval of regulatory authorities. Pursuant to such laws, at December 31, 1996, the Company's insurance subsidiaries could pay dividends of $32.9 million without prior regulatory approval. Invested Assets (Invested Assets chart appears here. Plot points are below.) 1,200 1,131 909 612 1994 1995 1996 $ in millions The Company's invested assets increased to $1.1 billion at December 31, 1996 from $908.6 million at December 31, 1995. The increase in invested assets was largely due to the purchase of Investors, operating cash flows, and an increase in the market value of the Company's fixed maturity and equity investments. Long-term debt increased to $114.7 million at December 31, 1996 from $106.7 million at December 31, 1995. In 1996 the Company arranged a revolving credit facility which provides up to $150.0 million of funds for working capital and other general corporate purposes. This facility replaced a similar $40.0 million facility. As of December 31, 1996, $15.0 million was outstanding under the revolving credit facility. In January 1997 the Company arranged the sale of $150.0 million of 8.71% Capital Securities issued by Markel Capital Trust I, a statutory business trust sponsored by Markel Corporation. Proceeds from the sale of the Capital Securities were used to purchase the Company's 8.71% Junior Subordinated Debentures due January 1, 2046. The Capital Securities and related Debentures are redeemable by the Company on or after January 1, 2007. The Company plans to use the proceeds of the offering to reduce indebtedness and for general corporate purposes. The insurance companies require capital to support premium writings. The National Association of Insurance Commissioners (NAIC) developed a model law and risk-based capital (RBC) formula designed to help regulators identify P&C insurers that may be inadequately capitalized. Under the NAIC's requirements, an insurer must maintain total capital and surplus above a calculated threshold or face varying levels of regulatory action. The capital and surplus at December 31, 1996 of each of the Company's insurance subsidiaries, with the exception of Investors, was above the calculated minimum regulatory threshold. In 1996 Investors' RBC level fell to the "Company Action Level", requiring Investors to file a corrective action plan with its state of domicile. The Company believes that through normal operations the RBC level of Investors can be raised above the regulatory threshold within two years. The Company believes that all of its insurance subsidiaries have sufficient capital to support their expected near-term writings. 60 IMPACT OF INFLATION Property and casualty insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such expenses, is known. Consequently, in establishing premiums, the Company attempts to anticipate the potential impact of inflation. Inflation is also considered by the Company in the determination and review of reserves for losses and loss adjustment expenses since portions of these reserves are expected to be paid over extended periods of time. The importance of continually reviewing reserves is even more pronounced in periods of extreme inflation. IMPACT OF ACCOUNTING STANDARDS In June 1996 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125 (SFAS 125), ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES. SFAS 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and is to be applied prospectively. This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. The Company expects that the adoption will have no material impact on the Company's consolidated financial position or results of operations. 61 Markel Corporation & Subsidiaries MARKET AND DIVIDEND INFORMATION The Company's common stock is traded in the NASDAQ stock market under the symbol MAKL. The number of shareholders of record as of January 31, 1997 was 492. The total number of shareholders, including those holding shares in "street name" or in brokerage accounts is estimated to be in excess of 2,400. The Company's current strategy is to retain earnings, permitting the Company to take advantage of expansion and acquisition opportunities. Consequently, the Company has never paid a cash dividend on its common stock. NASDAQ quotations during 1996 reflect a high sales price of $94.50 and a low sales price of $72.50. See "Quarterly Information" on page 49 for additional quarterly sales price information. SHAREHOLDER RELATIONS, FORM 10-K This document represents Markel Corporation's Annual Report and Form 10-K which is filed with the Securities and Exchange Commission. Information about Markel Corporation, including exhibits filed as part of this Form 10-K, may be obtained by writing Mr. Bruce Kay, Vice President- Investor Relations, at the corporate offices, or by calling (800) 446-6671. ANNUAL SHAREHOLDERS' MEETING Shareholders of Markel Corporation are invited to attend the Annual Meeting to be held at The Jefferson Hotel, Franklin and Adams Streets, Richmond, Virginia at 4:30 p.m., May 13, 1997. TRANSFER AGENT First Union National Bank Shareholder Services Group 230 South Tryon Street 10th Floor Charlotte, North Carolina 28288-1154 (800) 829-8432 CORPORATE OFFICES Markel Corporation 4551 Cox Road Glen Allen, Virginia 23060 (804) 747-0136 (800) 446-6671 62 DIRECTORS AND EXECUTIVE OFFICERS DIRECTORS Alan I. Kirshner CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER Leslie A. Grandis PARTNER MCGUIRE WOODS BATTLE & BOOTHE, LLP Stewart M. Kasen PRIVATE INVESTOR Anthony F. Markel PRESIDENT AND CHIEF OPERATING OFFICER Gary L. Markel PRESIDENT GARY MARKEL & ASSOCIATES, INC. Steven A. Markel VICE CHAIRMAN Darrell D. Martin EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER V. Prem Watsa PRINCIPAL HAMBLIN WATSA INVESTMENT COUNSEL LTD. EXECUTIVE OFFICERS Alan I. Kirshner CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER SINCE 1986. HE HAS ALSO SERVED AS PRESIDENT FROM 1979 UNTIL MARCH OF 1992 AND HAS BEEN A DIRECTOR OF THE COMPANY SINCE 1978. AGE 61. Anthony F. Markel PRESIDENT AND CHIEF OPERATING OFFICER SINCE MARCH OF 1992. HE SERVED AS EXECUTIVE VICE PRESIDENT FROM 1979 UNTIL MARCH OF 1992 AND HAS BEEN A DIRECTOR OF THE COMPANY SINCE 1978. AGE 55. Steven A. Markel VICE CHAIRMAN SINCE MARCH OF 1992. HE SERVED AS TREASURER FROM 1986 TO AUGUST OF 1993, AND EXECUTIVE VICE PRESIDENT FROM 1986 TO MARCH OF 1992 AND HAS BEEN A DIRECTOR OF THE COMPANY SINCE 1978. AGE 48. Darrell D. Martin EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER SINCE MARCH OF 1992. HE SERVED AS CHIEF FINANCIAL OFFICER FROM 1988 TO MARCH OF 1992 AND HAS BEEN A DIRECTOR OF THE COMPANY SINCE JANUARY 1991. AGE 48. 63 EX-21 3 EXHIBIT 21 EXHIBIT 21 CERTAIN SUBSIDIARIES OF MARKEL CORPORATION State or Other Jurisdiction of Incorporation or Subsidiary Organization - ---------- ---------------- Essex Insurance Company Delaware Markel Insurance Company Illinois Shand/Evanston Group, Inc. Virginia Evanston Insurance Company Illinois Investors Insurance Holding Corporation New Jersey Investors Insurance Company of America New Jersey EX-23 4 EXHIBIT 23 Exhibit 23 Consent of Independent Auditors The Board of Directors Markel Corporation We consent to incorporation by reference in Registration Statements No. 33-28921, No. 33-46706 and No. 33-61598 on Form S-8 and No. 333-21633 on Form S-4 of Markel Corporation of our report dated February 4, 1997, relating to the consolidated balance sheets of Markel Corporation and subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996, which report appears in the Company's 1996 annual report on Form 10-K. Our report refers to the Company's adoption of Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF. KPMG PEAT MARWICK LLP Richmond, Virginia March 24, 1997 EX-27 5 EXHIBIT 27
7 This schedule contains summary financial information extracted from the consolidated financial statements contained in the Form 10-K for the year ended December 31, 1996 for Markel Corporation and is qualified in its entirety by reference to such financial statements. 12-MOS DEC-31-1996 DEC-31-1996 885,874 0 0 193,395 0 0 1,130,776 11,054 11,631 37,979 1,605,297 935,582 200,852 0 0 114,691 0 0 24,347 243,988 1,605,297 307,453 51,168 5,013 3,102 202,378 70,372 34,660 37,000 (9,672) 46,672 0 0 0 46,672 8.30 8.29 699,311 226,495 (24,117) 52,158 124,467 725,064 (24,117)
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