Markel Group

Markel continued to show progress in improving its underwriting results in the second quarter as the ongoing bull market in equities created a tailwind.

Why it matters: Markel has been a negative industry outlier in terms of underwriting margins over the past couple of years but the second quarter showed that the company is continuing to improve. The company's reported combined ratio came in 92.9% compared with 96.9% last year. Markel has returned to its typically large levels of favorable reserve development this year, with the company's reserve development equating to 6.9% of net earned premiums through the first six months of the year. We think Markel has now brought its underwriting margins roughly back in line with peers. Additionally, gross written premium growth (adjusted for one-time events) of 10% suggests increasing confidence on the part of management.

The bottom line: We will maintain our $1,880 per share fair value estimate for the no-moat company and see the shares as being about fairly valued. Markel saw $1.2 billion in investment gains in the second quarter from its equity portfolio, more than reversing the $730 million loss it saw in the first quarter. While the company has proven to be an adept equity investor, this year highlights the potential volatility its investment approach can create. One negative in the quarter was a $205 million write-off on reinsurance recoverables due from a bankrupt carrier. While this highlights a potential risk within the State National business, at this point we see it as a one-off event.

We are increasing our fair value estimate to $1,960 per share from $1,880 due mainly to time value of money since our last update and an adjustment to our cost of equity assumption. Our fair value estimate is equivalent to 1.3 times 2025 year-end book value and 1.7 times year-end book value excluding intangibles and accumulated other comprehensive income.

We assume premiums rise at a 3% compound annual rate over the next five years. We think the need to pull back a bit and restore underwriting margins will limit growth in the near term. Longer term, we expect only limited growth, since we expect a weaker industry pricing environment.

Our assumptions result in an average combined ratio of 97%, a bit worse than the 94% average the company has posted over the past five years. We expect underwriting profits in the industry to narrow over the course of our projection period as we expect normalization of industry returns and higher interest rates to lead to lower underwriting profitability for the industry.

On the investment side, we assume improved fixed-income results as interest rates have risen. We project the company's noninsurance operations to grow organically at a mid-single-digit rate over the next five years and maintain recent margin levels. Our projections do not include any unannounced acquisitions.

We use a cost of equity of 8.9% in our valuation.

In general, insurers do not benefit from favorable competitive positions. Industry competition is fierce, and the products are essentially commodities. Furthermore, most participants do not know their cost of goods sold for a number of years, allowing them to underprice policies without knowing it. Firms have a large incentive to chase growth without regard for profitability, a cycle that repeats itself as competitors are forced to match artificially low prices or risk losing business. That said, we do believe the space contains some moaty franchises.

While Markel has generated a reputation as a mini-Berkshire, we do not believe it benefits from a moat. In terms of underwriting, the company falls a bit short of the level we think is necessary to award a narrow moat. Markel does tend to focus on specialty, noncommodified lines, and we believe focusing on specialty lines is the most common path to a moat for property-casualty insurers. Outside of excess and surplus lines, the company operates in a number of areas that fit our definition of specialty lines, ranging from executive liability to commercial equine insurance. As a result, the company historically has produced very attractive loss ratios. However, its elevated expense ratio has limited underwriting income over time. Expense ratios in specialty lines are typically higher than in other lines, but Markel's expense ratios are high even relative to other specialty insurers. The company's relative inefficiency on this score is one of the main obstacles to developing a moat, in our view.

We believe the company's perceived ability to generate alpha on the investment side is the primary attraction for many investors. CEO Gayner has an impressive record, as he has beaten the S&P 500 by almost 2 percentage points on average over the past 10 years. We like his investing approach, as it closely mirrors our methodology. However, we think the company's asset allocation decisions (and the bull market) have been a much bigger factor in driving book value growth in recent years. We estimate that even if Gayner is able to replicate the alpha he has generated historically, this would add only about 1 percentage point to annual book value growth, suggesting that his investment skill is not enough to significantly affect our view of the company's long-term prospects. Further, the company acquires noninsurance operations as part of its investment strategy. While Markel believes these companies can grow over time to justify the prices paid, we think a skeptical view of potential value creation in this area is warranted.

Markel's focus on specialty lines creates the potential for a moat.

Gayner has outperformed the S&P 500 by almost 2 percentage points on average over the past 10 years, and his philosophy of opportunistically investing in high-quality equities should be a long-term winner.

Markel is conservative in setting initial reserve estimates and generally benefits from sizable favorable reserve development.

Markel's relatively large exposure to equities makes the company much more vulnerable than peers to a bear market and reduces the upside from higher interest rates.

Due to Markel's recent underwriting missteps, the company has largely missed out on the hard market its peers are enjoying.

In terms of relative performance, the low-interest-rate environment and bull equity market we saw in the decade following the financial crisis formed an ideal backdrop for Markel, but capital market conditions have now changed.