Markel Scores Big By Playing Small
The nation's fourth-largest excess and surplus lines insurer writes risk that others turn away from and does it with underwriting and investment discipline--plus a sense of humor.
Specialty insurer Markel Corp. is a study in paradoxes. Markel is a family-run company. It's a public company. Markel is based in Glen Allen, Va., a suburb of Richmond, at the foot of the Blue Ridge Mountains, yet it has an international presence and takes a piece of risk from many Fortune 500 companies. Markel is large--one of the top 75 property/casualty writers in the country as well as the fourth-largest excess and surplus lines writer. Yet Markel's niche is in small areas--not one of its 100 different products contributes more than 10% of its revenue, and the majority of its policies bring in just a few thousand dollars in premium annually.
Markel is brave, twice buying companies more than twice its size. Yet Markel is conservative, refusing to write business that isn't profitable, and not investing in companies that it doesn't understand.
While it has many dichotomies, Markel is consistent on its focus: long-term growth for the bottom line by writing profitable business and investing its surplus wisely. It may not always be successful reporting quarterly or annual profits, but the company has met its goal to double its net worth every five years since it went public in 1986. And while Markel the company is currently being led by a triumvirate of Markel relatives, it is the people who believe in Markel, but may not necessarily have Markel DNA, who are being groomed to one day take over the company.
"It's one of the rare situations where a family-run business has successfully transitioned into a company that adheres to the tenets of public ownership," said Elizabeth C. Malone, an equity analyst with Advest. "They like to project the image that they are soft-spoken, good old boys from Richmond, but in fact they have the business acumen of some of the most successful people in the marketplace. I think their management team is among the best in the property/casualty industry."
Markel's executives are plain spoken and outspoken, and emphasize that it's important to have a sense of humor. That's not to say they aren't serious about their business. They're quick to praise their colleagues for a job well done and to forgive mistakes--yet they take responsibility for their missteps. In 2001, when the company posted a net loss, the top four executives received no bonuses.
"From an underwriting standpoint, they have a long and successful history of underwriting both excess and surplus lines and specialty admitted business. They are a well-run company that sticks to their knitting and does it well," said David Blades, financial analyst with A.M. Best Co.
The company's business philosophy is deceptively simple: stay focused on the long-term. That means conservative underwriting, conservative reserving, conservative investments for the policyholders surplus, yet be a little more aggressive with shareholder money--not aggressive insofar as investing in high-risk equities, but by investing a greater portion of their assets compared with their peers.
Markel indoctrinates its employees in its corporate profile, which is even printed on coasters in its meeting rooms. It reads, in part: "Our financial goals are to earn consistent underwriting profits and superior investment returns to build shareholder value."
"They're very consistent in that strategy," Malone said. "They've always tried to break even on their property/casualty operations and make an excess return on investments, and on average, they've been able to achieve that. Their quarterly earnings are often volatile, but over time, they've been consistent in achieving growth in book value that exceeds 20% annually. That's a pretty good track record in an industry often challenged to grow its book value."
It's that business philosophy--and the company's continued focus on it--that's earning Markel comparisons to Warren Buffett and Berkshire Hathaway. Buffett is the master of maintaining an underwriting profit to leverage the "float" in value-oriented investments.
Markel hasn't "quite gotten to a size and scale where they can be a Berkshire Hathaway, but philosophically, there's a great deal of similarity," said David West, an equity analyst with Davenport & Co. "They look at the long-term. They want to be conservative in establishing reserves. They feel if they get the underwriting side right, and invest the policyholder side conservatively, then they can invest the shareholder money more aggressively. They tend to invest more in equities than other companies. They have an intense focus, and their long-term record bears out that it's not just words they whisper, not just hollow words in an annual report."
In 1986, the company had $24.5 million in revenue and a book value per share of $3.42. In 2001, 15 years later, Markel had revenue of $1.4 billion and a book value per share of $110.50, a 26.6% compound average growth rate. It's outperformed its peers inside and outside the insurance industry. For instance, $100 invested in Markel stock in 1996 grew to $200 in 2001, compared to just $166 if invested in the Standard & Poor's 500 or $156 if invested in the Dow Jones Property & Casualty Insurance index.
The Markel Model
Like the country's founding fathers, Markel has divided the "church and state" of the insurance world--underwriting and investing--by harnessing the individual strengths of the Markel family members. President and Chief Operating Officer Anthony F. Markel's forte is running the operating side, the underwriting and marketing. Vice Chairman Steven A. Markel, who worked as a banker before joining the family business, heads up the company's investments.
And Chairman and Chief Executive Officer Alan I. Kirshner, the eldest of the three and a Markel by marriage, "is the highest paid referee in the country," Kirshner said, chuckling.
The company has succeeded "because we don't manage by committee," Tony Markel said. All facets remain focused on the company's goals: to be conservative at accounting, pricing, investing and reserving, and keeping its debt-to-capitalization ratio below 33%.
By breaking even on underwriting or better, and by maintaining a 4 to 1 investment-to-net-worth ratio, investments growing by 5% annually can produce a 20% return on equity over the long-term. Today the company has a 3 to 1 investment-to-net-worth ratio, and must make a 6.5% return--or make a bigger underwriting profit.
With 10-year Treasury bonds earning under 5% interest, a 5% after-tax return isn't a slam dunk, Steve Markel acknowledged. However, "in this environment we expect not to just break even, but to make an underwriting profit, which gives us more money to invest. So that matrix can move around. If the leverage is a little bit less, we need more underwriting profits," he said.
Steve Markel said he realizes a 20% ROE is a challenge. "It's an ambitious goal. I think the average company, not just insurance, but in all industries, averages 11% or 12% return on equity. Earning 20% really puts you in the league of super stars. We aren't going to make that every single year, but over time, we will do it. We have done it the last 15 years," he said.
The underwriting profit hasn't always been easy to reach either. Markel has posted higher-than-industry-average combined ratios after several major acquisitions, the most recent following the purchase of Terra Nova in 2000. Markel has a history, however, of turning such unprofitable companies around.
Holding the Line in Underwriting
After years of minimal, if any, increase in prices, and a loosening of terms and conditions, Markel is finding today's hard market a joy: double-digit increases, and more opportunity to write business than before. Markel hasn't changed its underwriting philosophy, however, and while more clients are knocking on its door, it hasn't accepted a higher percentage of business, said Stephen J. Vaccaro Jr., president and chief operating officer of Essex Insurance Co.
"Submissions are up 75%, but our hit ratio hasn't changed," Vaccaro said. The company still writes only 10% to 12% of submissions, he said. Casualty premium increases are up 20% to 25%, and the company is taking smaller amounts of program business.
For large property catastrophe risks, Markel is taking lower limits and raising prices. It won't accept 100% of the risk on any account, but will take $2.5 million in risk after the first $25 million. Of that $2.5 million risk, the maximum exposure that Markel has after reinsurance is $500,000. On any single catastrophic event, Markel's maximum U.S. exposure is $3 million. Its maximum global exposure is about $50 million--and that's for a Category 5 hurricane or a 7.0 magnitude earthquake.
"What will hurt a company is greed," said Vaccaro. "There's plenty of business out there for everyone. It's not having the most jelly beans in your jar; it's how many of them you keep."
Love the Small Stuff
In his annual meetings with company employees, Kirshner stresses the company's philosophy, including "Big is Good. Small is Good."
In part, Markel has grown by writing business that no one else wants--often entering small niches in the admitted or nonadmitted market, said Tony Markel.
In its attempt to consistently underwrite profitable business, Markel has gone into small lines of insurance, such as commercial garages, that the bigger players see as too small to bother with. For instance, Markel will write a class of business with only a couple of millions in annual premiums, as long as it can do so at a profit, Tony Markel said.
"We're reasonably below the large companies' radar screens," Tony Markel said. "Let them try to shoot the elephants out there."
Not only does Markel offer coverage that no one else wants to write, it also seeks out small face-value policies that the bigger players, such as American International Group, aren't interested in. "We don't compete with AIG," said Britton L. Glisson, president and chief operating officer of Markel Insurance Co.
"Other companies say they can't do it if it's under $15 million to $20 million. I'd love a $5 million line with a 80 combined [ratio]," Vaccaro said.
Many of the company's policies have annual premiums under $5,000. Most have limits under $1 million.
"We love little risks. A lot of people don't like them," Kirshner said. "We love the small stuff."
Entrepreneurial Spirit
"We trust our people," Kirshner said. "Our people feel that the business is as much theirs as it is ours. You have the permission to challenge the management here. We try to keep them informed."
The company will walk away from unprofitable business, and often did so in the recent soft market, Kirshner said. The company's profitable underwriting is so important, that it works to keep employees "with skin in the game," said Bruce A. Kay, vice president of investor relations.
To motivate employees to think like owners, Markel has implemented a system that ties employees' compensation to the company's performance. Each employee's bonus is based on how the employee meets his or her goals and how the company as a whole meets its goals. The more an employee's duties are related to the company's performance, the greater the percentage of compensation that is tied to the company's performance. For instance, underwriters receive a bonus based on how profitable the business they write is. They may choose to write $5 million in premium with a combined ratio of 80, or $10 million in business with a combined ratio of 90. It's the profit, not the premium, that counts.
"We're not held accountable for the top line here. Everything here is bottom line," said Vaccaro of Essex Insurance. That's true from the file clerks on up to Kirshner, Tony and Steve Markel, and other top officers.
"If you talk the talk, you got to walk the walk," Kirshner said. "Thinking like an owner is vital."
For senior executive officers, no bonus is given if the company's five-year average compound growth in adjusted book value per share is under 15%. A 15% ROE nets the top executives a bonus equal to 25% of their base salaries; 16% ROE nets a 40% bonus and the percentage increases to 100% of their salaries if the 20% ROE is met. Exceed a 20% ROE and the bonus continues to increase, up to 175% of an executive's salary at 25% ROE. Manage a return greater than 25%, and the bonus is "discretionary."
Yet the company eschews stock options, a common way companies try to make employees feel like owners.
"We don't think that stock options create an aura of ownership. Most employees treat it as a gift," Tony Markel said. The company encourages employees to buy Markel stock, however, and offers a low-interest loan program to give them a boost.
"There's no comparison in attitude between an employee who has borrowed money, albeit at favorable interest rates, and signed on the dotted line [to buy stock] to those who are just handed stock options," Tony Markel said.
Stock options are intended to serve as long-term incentive plans while creating additional income for employees, but do not effectively serve either goal, Steve Markel said.
"Some people really don't want the ownership aspect, just the income aspect. As soon as they could, they'll sell the stock to buy a boat, because that's what they really wanted anyway," Steve Markel said. "We decided we'd have cash incentive plans to reward people who create underwriting profits and stock ownership plans to encourage those people who had an interest in building equity in the company."
The company does offer a loan program, so employees can borrow a minimum of $10,000 up to four times their annual salary to buy stock, with Markel subsidizing the interest on the loan. Employees can also opt into a payroll deduction plan to buy stock, which includes an annual 10% bonus purchase of stock, and can invest in Markel stock through their 401(k)s.
"Most stock option plans are for the top 5% of employees. This plan is for everyone, every employee," Steve Markel said.
All directors and officers of Markel collectively own about 15.2% of Markel's stock as of Feb. 15. Tony Markel owned 3.8% and Steve Markel owned 5.7%. Gary L. Markel, a board member who runs his own brokerage in Florida (and is Tony Markel's brother), owned 3.6%.
While the company does not offer stock options, it agreed with the current movement to force companies to include stock options as an expense on their balance sheet. "Companies have treated stock options like a costless incentive. They are not costless," Tony Markel said.
Value Investing
Markel loves to be compared to Berkshire Hathaway, especially when it comes to investing. "From your lips to God's ears," said Thomas S. Gayner, chief investment officer.
Like Berkshire Hathaway, Markel believes in value-oriented investing and dollar-cost averaging or continuing to commit funds to buy stocks regardless of how the market is performing at a given time.
The company has tended to have about 21% to 22% of its investment portfolio in equity stocks, but pulled back to 14% or 15% in the 1990s "when the market went crazy," Gayner said. "Being value-oriented, we didn't know what to make of it."
Malone, the Advest equity analyst, said the company stuck with its value investing platform even during the 1990s when value investing wasn't a high return business.
Markel "is one of the few companies that employs that strategy in the insurance industry. Their consistency and determination not to be dissuaded by short-term market conditions has served them well," Malone said.
Gayner explained Markel invests in companies that have the following characteristics:
-- a profitable business;
-- talented and honest management;
-- reinvest in the company to grow; and
-- fairly priced stock.
Markel's search for value-oriented stocks, instead of growth stocks, kept it from investing in technology stocks and in companies like WorldCom and Enron. It also maintained its philosophy throughout its acquisitions.
The acquisition of Terra Nova doubled the company's investment portfolio, but Markel sold all of the holdings "in about 20 minutes the day after we bought the company" because they didn't match Markel's investment philosophy, Steve Markel said. "We avoided pretty significant junk that they'd bought," he added.
The company also believes in dollar-cost averaging, "because there are two kinds of people. Those who don't know what the stock market will do and those who don't know that they don't know," Gayner said.
Sugar, Dirt, Money
Gayner joked that Markel invests in three types of industries: sugar, dirt and money.
Sugar means companies such as Anheuser-Busch. Dirt means real estate and companies such as gravel pits, and the professional cleaning company ServiceMaster. And money refers to financial services and insurance companies, such as Berkshire Hathaway. In fact, about 10% of Markel's equity portfolio of $550 million in invested in Warren Buffett's company.
"They represent durable business," Gayner said. "They have been around a long time, they've been profitable for a long time. No one thinks they are going to shoot out like lightning, but neither do they collapse."
Taking another lesson from the Berkshire Hathaway playbook, Markel does not believe in splitting stock. Except for a stock split shortly after the company went public--which was necessary to maintain the company's standing then on the NASDAQ--the company hasn't taken that action.
"There's no benefit to splitting stock," Steve Markel said. "The idea is stocks aren't just pieces of paper to be traded, but are a partnership interest in business. You should treat your shareholders as partners who will be with you for the long-term. When companies split the stock, it tends to do the exact opposite. It encourages people to sell, to lose sight of what really happened, and to think of pieces of paper as the quote behind it, and not as a share of the business."
Steve Markel said if you think about a company like a pizza, "you wouldn't pay more or less for it because you were going to cut it in six to 12 slices."
Darrell D. Martin, executive vice president and chief financial officer, said the only good reason he can think of to split stock is to make it affordable for employees. Markel tries to do that, however, by offering a payroll deduction plan and a low-interest loan program.
In for the Long Haul
Markel has unusual views about its shareholders: it wants people who are committed to the company and will stay for the long-haul, not bail if Markel reports disappointing quarterly results. If a growth-oriented fund approaches Markel with interest in buying stock, Markel will try to dissuade the fund from buying in, Kay said. "I tell them we're really not right for them," he said.
Markel doesn't do investor "road shows" like other companies who look for investors or aim to win Wall Street analysts' affections. Markel will open its doors to significant private investors, however, and spend time to teach them about the company and its philosophy.
To capture those attractive shareholders, Markel's leaders embark on an annual pilgrimage to the Mecca of Berkshire Hathaway, where they host their own private party on the heels of Warren Buffett's annual shareholder meeting.
"We figured the people most likely to understand our values were people who already owned Berkshire Hathaway stock," Steve Markel said.
In 1991, Steve Markel and Gayner traveled to Nebraska and invited four Markel shareholders also attending Buffett's annual shareholder fest for dinner. Over the years, mostly by word of mouth, attendance at the Markel meeting--now held as a brunch--has grown to 80 people.
The once small, little-known company is growing not just in size, but in stature, and has cultivated quite a few fans.
Malone, the equity analyst, said Markel has a mystique about it. "They are very genuine people. They consider their shareholders and employees part of one big family. It really makes you wish you could be adopted. I think they really enjoy each other, and what they do, and it makes you a little envious."
Markel Business Production--2001
Here's a listing of insurance products that Markel markets broken down by the percentage of total net premiums written and each line's corresponding pure loss ratio for 2001.
($ Thousands)
% of Pure
Total Loss
Product Line Direct Net NPW Ratio
Other Liability Occurrence $239,987 $198,094 24.7 75.1
Other Liability Claims-Made 137,884 110,917 13.8 54.4
Commercial MultiPeril 116,424 93,591 11.7 37.8
Medical Malpractice Claims-Made 83,754 71,092 8.9 65.0
Inland Marine 124,689 67,422 8.4 39.3
Ocean Marine 32,164 32,161 4.0 56.3
Other Accident & Health 30,738 31,999 4.0 60.6
Product Liability Occurrence 35,307 30,108 3.7 62.2
Fire 51,185 27,790 3.5 33.3
Product Liability Claims-Made 29,807 27,323 3.4 42.5
International ... 25,015 3.1 94.2
Allied Lines 46,333 20,571 2.6 58.5
Auto Physical 12,677 19,345 2.4 62.8
Homeowners 16,611 16,100 2.0 26.3
All Other 37,110 31,701 3.9 45.0
Totals $994,673 $803,229 100.0 56.5
Source: A.M. Best Co.
see "Markel Corporation Group at a Glance"
see "A Niche Company"
see "Top 5 Surplus Lines Groups--2001"
by Meg Green
