Q: (from David Winters). Would you ever do anything that's dilutive. TG - Markel was a family business. Public offering process (1986) had a lot of layers around that issue. Ultimate goal to set up corp and biz that is more durable than any particular individual. Culture is more determinative of what they do than the comp structure (cash salary plus bonus 50/50 cash and stock). Try to hold onto stock as much as they can. SM - Priority of shareholder's interest over owner's interest. Make sure rewards of owning stock overwhelmed rewards of being an employee. Getting return for shareholders comes first. Want associates of company to become meaningful shareholders over time. Focus is also always on long- term returns. Building net worth takes priority over building net income. Q: If do pretty good job underwriting and pretty good job investing, you get a superior result. Explain. TG - Structure of insurance company lends itself to good results in right hands and with right people/approach. Insurance business that makes an underwriting profit - very difficult to accomplish. If you have that, it's better than cash on delivery. Instead, it's cash ahead of delivery. SM - Most insurance execs have grown up on underwriting side of biz and don't understand the investing side, so they outsource it. This leads to the wrong approach, as all you're trying to do is earn average returns and be rehired each year. Focus on short-term earnings is a penalty to earnings over long periods. Deferred tax on security gains is a penalty on earnings - if you sell. Supports the long-term approach. Q: Where do things stand in terms of the Alterra acquisition. TG - Good underwriting, good investments but different approach. Just make different choices. 99% of the transition is complete. Markel is heavier investor in equities (normally about 80%) than most other insurance companies. Allows for margin of safety and ability to endure bad days. Can absorb bad days that way. Coming out of financial crisis at 65-68%. At Alterra close were at about 40%. Rebuilding that back toward 80%. Now above 50%. Will move faster if they see the opportunities to do so.
Q: Knowing management teams of companies you invest in. Fruitful and fun, necessary, etc. SM - Results from Markel ventures are very much inline with expectations. TG - Jockey is key part of the process. Graham described visiting management as cheating. You should be able to do your work and analysis from the numbers. Talking to management violated rules of game. Many Graham and Dodd followers shy away from this. As investors, you can be seduced by charming CEO. Likes to know management as much as possible and likes to like them. It's critically essential to the success of the business. Having a charismatic CEO is an important part of leading the business well - it helps attract talented employees, customers, etc. Need to have people that like them. Companies run by difficult people where CEO accumulates enemies doesn't always end well. Q: Buying back stock given current P/B why not more aggressive (1.5-2.0 Book). SM - Trading at significant discount to that. Can reinvest in business, investment portfolio or share repurchase. The opportunity to repurchase shares are somewhat limited - few days after earnings release week or two to a month. Are limited to percentage of daily average trading volume (5k- 10k per day). Over long periods, have had much better opportunities to make investments. Will as much as possible offset dilution. If don't see opportunities, will be more aggressive. TG - Restricted stock - 5 years to earn, plus additional three, so it takes eight years. First priority with cash is to put it to work inside organization. Then make good investments. Then may repurchase if trading under intrinsic value. Even if stock looks cheap, will not buy back if options 1 and 2 provide better opportunity to increase Markel intrinsic value. Q: Use of debt by potential investments TG - Likes low debt. Prudent use is ok. Buying different businesses is risky. Avoiding businesses that use a lot of debt. If not debt, crooks are only stealing own money (don't want to do that). Having a lot of debt means there's a lot of other people's money in the game. Provides insight into the character of the people. Likes prudent use of debt. Where revenues highly uncertain, prudent level of debt is close to zero. Where revenues are more
assured and supported by assets, prudent use of debt can be higher. Bias though is on low debt. One of lessons learned from financial crisis is that there's much more leverage in the system than you realize. SM - Markel uses prudent amount of debt in its own port, so that extends to its investments. Q: View on financial equities. TG - Have done well with insurance. Haven't done as well with banks, so have very limited exposure Q: Which qualities of other insurance companies are so negative that you would you be short them. Which other two insurance companies in the industry do you admire most. TG - Admire underwriting profitability and reserve development. Travelers and Chubb are two competitors they think highly of. BRK is also their largest position. SM - Progressive and mindset of identifying and serving niche markets in personal auto space. Geico in terms of marketing. Power of renewals. What allows you to grow from 2%-10% is trying to manage EPS. Increasing marketing cost negatively impacts combined ratio. But, if you keep a client for 10 years, you get a much better return on that investment. Retention of business is really important element of building insurance company, particularly property and casualty. Progressive also were hawks an making sure insurance reserves were more than necessary. P&C insurance companies 25, 10 and five years ago. There have been very few long-term success stories. Q: What are you seeing in underwriting markets today. SM - Trend not great. Relative pricing in 2013 was good. Rate increases quarter after quarter for last 2-3 years. Cumulative impact over time is quite good. Level of pricing pretty strong overall throughout industry. Toward end of last year, into 1Q, particularly in property (especially casualty) that is starting to change. Hard at this point to judge magnitude. Have let some business go away because they're not willing to compete at that pricing. If peers want to cut prices and have underwriting losses, then Markel won't try
and compete and won't lose sleep over it. In general, more recently, pricing is moving in the wrong direction in casualty. TG - Companies that produce underwriting profit are liked by Markel. That's rational business practice. Q: What's your opinion about stock today. TG - Short answer is I don't know. When it comes to general market conditions and what will happen in market, there are those that don't know and those that don't know they don't know. In long run (next 10, 20, and more years) is wildly optimistic. There are billions of people around the world that are becoming more and more interconnected. Winnows out the bad things and improves the environment. Q: What was rationale for acquiring Alterra last year. SM - Combination of factors. Expanding lines of business and expanding insurance skills was driving force. Brought Markel into reinsurance world in much more important way. Brought company more meaningfully into large account world as well. Alterra had division doing business with Fortune 1000 companies that had higher coverage. This was well above where Markel played (typically up to $1 mm vs up to $50 mm).. In existing businesses that Markel was very good at, the scope was broadened. Thought the purchase was at a very fair price and economics will be quite attractive over time. Plus, from investment perspective, the size of the opportunity set increased due to having more capital to invest. Q: Expense ratio. At what level are you running as efficiently as possible. Commercial insurance business for AIG - formidable competitor or not. SM - Ideal expense ratio is as low as possible. Function of business mix and how you structure your reinsurance business. Writing smaller policies makes acquisition costs higher. When buy reinsurance, the way that it's structured can impact the expense ratio. Commissions can exceed actual costs. You can manipulate that to make it look better. Markel looks to do as little reinsurance business as possible. New entrants in specialty arena. Hard to judge how relevant they are. When they want business and offer right prices, they can get the business. Disruptive but not worried about it.
Q: How do you think about ratio of investments to equity. Book value growth. How you view adjustments to book value in regards to float. Even with long-term deferred taxes on capital gains for long-term positions. How do they think about that. SM - Investment leverage. Port was about 4x shareholders equity at one time. Those days are gone forever. Having runoff business embedded in an acquisition also impacted this. Dropped below 3:1 and below. About 2.8 today. Normal level, depending on how fast they can grow equity. Have to assume it's about where it's going to be. When they can earn 6-7% on US Governments, high returns on equity are much easier with modest underwriting profits. In today's environment, underwriting profits have to be much stronger. How do you value float and deferred tax assets and liabilities. Do not go through any specific analysis in this regard. If you can make underwriting profits in perpetuity, float is equivalent to 100% equity. Common stocks should earn 10% or more. But, it's very subjective. It's all about your opportunity cost. What's your choice. How does it compare to others. TG - Investment leverage is just one factor. Trying to make the value of the business grow. Car Max has been very successful investment. Has financial operation embedded in the retail operation. Respects skills of management and ways in which it executes those levers. Q: How did they get comfortable with Alterra book of business. SM - Underlying companies in Alterra (one was Max RE) new start-up 10 years ago. Wrote very low risk, finite reinsurance. Short tail. Known policy limits. All had happened in fairly near term. Also did merger in which they bought Sun insurance operations (originally from Chubb). Also, had short operating history and short tail risk. Much smaller and easier to analyze/assess. Alterra people also had very little loyalty to brand as it hadn't been around that long. Also, over last 5-6 years, reorg in Markel IT were largely complete, making transition much easier. Alterra also had strong IT. TG - Alterra was well run company. Good due diligence team. Familiarity. Companies were in similar lines of business. Q: What are the signals that lead to decision to buy another insurance business.
TG - Red flag issues revolve around integrity. How conservative are the decisions. In terms of valuation, lower combined ratio, higher ROE and persistence. What you look at relates to the past. What you're buying relates to the future. Be careful of being overprecise. It is an iterative process. SM - Broadly looking for specialty property and casualty coverages. How they're priced, how claims are handled. How sustainable. What are their moats? Q: Impact of QE on process. TG - Think about inflation, rates of inflation or deflation and impact on the operations of their investments. SM - It will change some day but try not to worry too much about when it will happen. Q: What is attraction to bakery industry. Social vs. Business brain. TG - Both Social and Business brain can benefit business success. Culture of long-term stewardship. Wish to pay reasonable salaries for roles and responsibilities people have. Want people with ability to do extraordinarily well. SM - important part of value system is really want people to be very community minded where they operate. Very strong obligation to support community. Get involved in local non-profits and activities that will help build their communities. TG - Like food businesses and agricultural things in terms of rising standard of living. Leads to eating better. Don't expect that to change. Q: What is max transaction size Markel ventures looks at. TG - Pledge they will act rationally. Do what's best for Markel over time. Harder to buy businesses as you grow. Sometimes there is the possibility to write as much business as you can at a good price. In other cases, overall size opportunity may not be as large, just write as much as you can that will allow for requisite profitability. Not aggressively pursuing deals today. Too much leverage in system and prices aren't attractive. Not scared of paying a premium if the deal is below intrinsic value Q: Preferred economics of insurance industry
SM - Nice to be able to collect money a year ahead of time. Not many other industries like that. Q: Abbey Protection acquisition in UK SM - Specialist insurance company writing legal protection insurance in UK against audit on your tax returns. Working very well to date. High volume of small transactions. Policy limits on each transaction are very small. Often sold through association membership. Also a servicing industry that provides very nice margins. Opens door for Markel into a lot of other retail businesses - selling other insurance into UK small business market. TG - Brought to Markel by Markel international people that have been with company for 10 years. Akin to BRK See's deal. They bring expertise that others within Markel don't see. Q: Status of pension funding ratios and accounting implications. TG - Has gotten meaningfully better over last year. Not solved but getting better day-by-day right now. Q: Culture. What are some threats to it as make more acquisitions. SM - Have to emphasize important elements every day and work on incorporating them. Repetitive process. Bringing it into the discussion regularly. Principles of shareholder value, shareholders come first. Pay for performance not for showing up. Culture in Lloyd's 10 years ago was very different. Now Markel International is very similar to Markel US. Repetitive process. Talking it and living it day after day. Understanding long- versus short-term rewards. TG - It's fun. Not a negative activity but a positive one. Q: Corporate governance thoughts. TG - Relatively decentralized organization. Give people a long leash. Better organization and people than if they'd micromanaged. Cost of it not working is very explicit. Benefits of having everyone do the right thing every day are implicit. Hard to quantify the value, but despite specific costly failures of being decentralized it works well. SM - Part of having systems work is making sure everything is transparency. Be open and honest about everything. This makes you more likely to not
have a problem. That is a cultural thing that's important. Allows people to talk to one another.