A Closer Look at Markel Ventures

Markel Ventures is a wholly owned subsidiary of Markel Corporation focusing on acquiring companies outside the insurance industry.  Starting with the $14 million acquisition of AMF Bakery Systems in 2005, Markel Ventures has grown into an operation that generated over $1 billion in revenue in 2015 which accounted for nearly 20 percent of Markel’s total revenue.  Although the vast majority of Markel Corporation’s value remains tied to its insurance subsidiaries, Markel Ventures has grown to be a more important part of the overall business.

We have covered Markel on a number of occasions in recent months starting with an overview of the company shortly after shares reached $800 in June 2015.  Although the Markel Ventures operation was discussed, the valuation estimate did not explicitly assign any value to the non-insurance subsidiaries, putting forth the following argument:

We choose to mostly disregard Ventures when assessing Markel’s current value and view the operations as providing additional upside potential in the future – perhaps significant upside potential.  In other words, it might be best to demand Markel Ventures for “free”, meaning that one could demand sufficient value from the insurance and investment operations to justify the price paid for the stock without giving consideration to the additional value potential of Ventures.

Shares have recently been climbing toward the $1,000 level which can be partially attributed to the company’s strong insurance results and book value growth in recent quarters.  However, the expansion of the company’s price-to-book ratio implies that market participants are starting to place more value on Markel as a “mini-Berkshire”.  Insisting on valuing Markel based on the insurance operations alone makes the current price appear to be increasingly stretched.  While changing valuation models in response to a run-up in a stock price is potentially hazardous, so is ignoring an important segment of a company and coming to the wrong conclusion regarding whether the shares continue to offer a reasonable value.  It is clearly past due to take a more serious look at the history and current composition of Markel Ventures.

History of Acquisitions

Although Markel Ventures began operations in 2005, the company took a conservative approach in terms of how quickly to build up its portfolio of non-insurance operations.  After the AMF Bakery Systems acquisition in 2005, the company waited until 2008 to add a second business and did not commit significant capital until the economy was in the midst of the severe economic downturn following the financial crisis of 2008.  Markel Ventures was first discussed in the company’s 2009 letter to shareholders.  Management argued that the criteria for acquisitions was essentially the same as the criteria for stock market investments:

Strategically we believe the ongoing development of Markel Ventures will create value for Markel. All of these companies fit our longstanding investment discipline. As is the case in what we seek in our portfolio of publicly traded businesses, these businesses are profitable, with good returns on capital, they are run by management teams with equal measures of talent and integrity, they will use their profits to either grow their existing business or return the cash to Markel and we acquired them at fair prices.

Ventures was expected to provide opportunities for reinvestment of capital within individual units or elsewhere within Markel.  Additionally, management found it attractive to have a source of earnings and cash flow independent from the insurance business which can provide additional flexibility to deploy cash at the holding company level without undue regulatory scrutiny during stock market downturns.

During the early years, Markel provided very limited data regarding the non-insurance subsidiaries.  Although significantly more detail has been provided over the past several years, some estimations were still required when coming up with a picture of the overall acquisition history.  The data in the following exhibit should be considered a good faith estimate rather than a precise accounting of the acquisition history of Markel Ventures (click on the image for full size):

MKL Ventures History

The bakery businesses have been consolidated into the Markel Food Group and links for the websites of the other subsidiaries can be found on Markel’s website.  Many of the businesses are quite interesting to read about but to keep this article to a reasonable length, we will refer the reader to Markel’s website for further information and proceed to a relatively high level look at the overall Markel Ventures operation based on consolidated information found in Markel’s financial statements.

Balance Sheet

Since 2012, Markel has provided a balance sheet for the Markel Ventures operations.  This is obviously useful for any evaluation of the unit’s overall economic performance and it also serves as a check on the imprecise accounting of the Ventures acquisitions presented above.  The following exhibit shows the balance sheet data for Markel Ventures for the past four years:

Ventures Balance Sheets

It is important to note that the balance sheets for Markel Ventures are fully consolidated into the balance sheets of Markel Corporation, with certain intra-company items eliminated in consolidation.  Although Markel Ventures utilizes debt, we should note that at December 31, 2015, $216.9 million of the $322.4 million of debt was due to other subsidiaries of Markel Corporation and eliminated in consolidation.  Markel Corporation has predominantly funded Markel Ventures using equity, thereby redeploying funds that it generated through the insurance operations over the years.

The non-controlling interests on the balance sheet arise from the fact that Markel Ventures often acquires a majority stake in a company that falls short of complete ownership.  In many cases, the remaining shares of the company are acquired subsequent to the initial transaction at prices that vary with the post-acquisition performance of the unit.  We can see that total capital employed of approximately $900 million is roughly in line with our estimate of the cash Markel Ventures has deployed over the past decade.  Earnings of ventures subsidiaries that are retained within the Markel Ventures organization would increase equity over time.  However, the balance sheets we have access to do not provide enough granularity to isolate changes in equity due to earnings retention versus new investment.

Operating Results

Over the past five years, revenue from Markel Ventures operations has increased rapidly due to the number of new acquisitions that have been made.  The company separates Markel Ventures revenue into manufacturing and non-manufacturing segments.  The exhibit below displays income statement data for the past five years:

Markel Ventures Income Statements

At a surface level, these results are not exactly inspiring to look at.  The overall operating margin has been in the mid-single digits over the past couple of years and net income has been modest relative to the investments made in Markel Ventures to date.  However, for a number of reasons, reported net income is not a particularly good measure of how the businesses have performed to date.  The reader should be very skeptical of this claim since specious “adjustments” to earnings have proliferated like wildfire in recent years.  EBITDA, Adjusted EBITDA, and even more creative measures are usually designed to obfuscate rather than enlighten.

Markel management does provide EBITDA information for Markel Ventures with the rationale explained in detail on pages six to eight of  the 2010 letter to shareholders.  Readers are encouraged to review this information and come to their own conclusions regarding the usefulness of EBITDA when it comes to evaluating Markel Ventures.  From our perspective, the primary use of EBITDA is to evaluate the performance of the business relative to capital employed in a manner that is independent of capital structure and tax policy.  The exhibit below shows the EBITDA information reported by Markel over the past seven years:

Markel Ventures EBITDA

The use of EBITDA, although warranted with the caveats explained by Markel’s management, seems a rather crude measure particularly because depreciation is a very real expense that must be taken into account.  Certain Markel Ventures subsidiaries are more capital intensive than others but we can see that depreciation has become a rather meaningful line item.

We prefer to look at Markel Ventures by starting with the net income line item and then making adjustments that seem appropriate in an effort to understand the true economic earnings of the group of businesses.  There are three major adjustments we have made:

  • Diamond Healthcare Goodwill Impairments.  Over the past two years, there have been goodwill impairments taken to write down the value of Diamond Healthcare.  Although these charges indicate that management may have made errors when deciding how much to pay for Diamond to begin with, they are non-cash charges that obscure the current earnings power of the group as a whole.
  • Cottrell Earn-Out Adjustment.  In 2015, there was a significant charge recorded to account for an increase in the expectation of “earn-outs” to be paid to the former owners of Cottrell.  At the time the Cottrell acquisition was made in 2014, a portion of the amount to be paid to the owners was based on the performance of the business in 2014 and 2015 subsequent to the close of the acquisition.  Markel’s management made an estimate of the amount of this “earn-out” based on their expectation of how Cottrell would perform.  It turned out that Cottrell performed better than anticipated.  As a result, the additional amount owed to the former owners was charged as an “expense” in 2015.  This charge is better looked at as an increase in the purchase price of Cottrell and should logically be attributed to a capital account rather than an expense account.
  • Amortization.  Accounting rules require management to amortize intangible assets over a period of time by recording charges against earnings.  In the 2010 letter to shareholders, management argues that this is not a real economic cost because the value of intangibles should actually be increasing over time rather than shrinking, assuming that intelligent acquisitions were being made and properly managed.  This viewpoint has merit but, in the interests of conservatism, we consider 20 percent of amortization charges to be “real” and 80 percent to be “non-economic”.  Warren Buffett has estimated the non-economic percentage of Berkshire Hathaway’s manufacturing, service, and retail amortization charge to be 80 percent.  While the mix of businesses are obviously different, using the 80 percent approach rather than assuming all amortization is non-economic seems like a conservative adjustment to make.

The exhibit below shows our estimate of “economic earnings” for Markel Ventures based on making the adjustments discussed above and accounting for tax effects.  Note that the tax effect line item may be overstated if amortization and/or goodwill impairments are not deductible for income tax purposes.  However, sufficient information does not appear to exist to make this determination so the adjustment is made in the interests of conservatism.

Markel Ventures Economic Earnings

If the estimate of economic earnings is in the ballpark and recent trends continue, it looks like the ventures operations, in aggregate, are earning around 10 percent on equity.  Obviously, this adjusted figure is far different from the return on equity one would calculate based on reported net income.  However, the adjustments seem quite defensible based on the arguments presented above.

Markel recently reported results for the first quarter of 2016.  Markel Ventures EBITDA was $41.1 million, up from $33.6 million in the first quarter of 2015.  Net income to shareholders was $14.1 million, up from $10.5 million.  Management reported that the increases were primarily due to higher earnings at certain manufacturing operations as well as due to the CapTech acquisition in December 2015.


The valuation approach presented in June 2015 explicitly did not account for any value associated with the Markel Ventures operations.  As noted earlier, the assumption was that any value that existed in the ventures operation would be an additional “margin of safety” for investors or could be viewed as a bonus.

Although the vast majority of Markel’s intrinsic value still resides in the insurance business, Markel Ventures has been growing to the point where it should be explicitly considered in the valuation process.  There are a number of approaches that could be used to incorporate Markel Ventures.  The methodology we have chosen, which clearly is not the only “valid” approach, is to segment the insurance and ventures operations as if they were two separate companies.  We estimate the value of each unit and then come up with a sum of the parts to arrive at the total valuation for Markel Corporation.

The valuation of the insurance business is essentially identical to the approach presented in June 2015, except that we have deducted equity attributable to the ventures operations from the estimate of insurance equity.  We assume that Markel posts a 100 percent combined ratio over the next five years and deploys its investments at various rates of return.  We then come up with a terminal price-to-book value for the insurance business only to estimate the market’s assessment of the business in five years.  This valuation is then discounted to estimate today’s present value of the insurance subsidiaries.

The Markel Ventures valuation model simply estimates 2016 “economic earnings” and applies an earnings multiple ranging from 16 to 20 to arrive at an estimate of current intrinsic value.  One can debate both the estimate of economic earnings and the multiple selected but a good “reality check” is that the estimated valuation falls within a plausible range given the cash that Markel has invested into these businesses over the past decade.

The exhibit below presents the valuation exercise for Markel Corporation as described above:

Markel Valuation

The overall valuation of Markel Corporation is simply the sum of the parts divided by shares outstanding at March 31, 2016.  Taking the base case estimate, we arrive at a valuation of $909 per share, with $825 per share attributed to insurance operations and $84 per share attributed to Markel Ventures.  Although this baseline estimate is materially higher than what we would estimate if Markel Ventures were totally ignored, it is still substantially below where Markel has traded recently.

Markel has a very strong track record, as we have pointed out in past articles, and the current share price might very well prove to be justified based on future events.  Nevertheless, it is always prudent to estimate the value of a business based on sound principles that are not subject to changes designed to “justify” a recent price advance.  At the same time, valuation methodologies cannot remain so fixed as to fail to respond to material changes in the underlying business. Markel Ventures has clearly reached the point where shareholders must estimate its value in some manner.  The method above is one of many ways to do so.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Markel Corporation.

Company Profile: Alleghany Corporation

“More people should copy us [Berkshire Hathaway]. It’s not difficult, but it looks difficult because it’s unconventional — it isn’t the way things are normally done.”  — Charlie Munger, 2000 Wesco Financial annual meeting

Alleghany Corporation is a holding company founded in 1929 with a long history of success operating in a variety of industries.  The company’s objective is to create value through its property and casualty insurance and reinsurance operations as well as through ownership and management of non-insurance operating subsidiaries and investments.  Alleghany has been led by President and Chief Executive Office Weston Hicks since 2004.  Shareholders’ equity was $7.8 billion and book value per share was $503.43 as of March 31, 2016 compared to a recent market quotation of $515 per share.

The company is managed by a small headquarters staff responsible for capital allocation and overall strategic direction while operational responsibility is delegated to subsidiaries that operate in a “quasi-autonomous” environment.  At least at a surface level, Alleghany’s management approach and corporate structure appears to take several pages from the well known Berkshire Hathaway playbook.  It is worth taking a look at the company to see whether it represents a “mini Berkshire”, particularly given the modest valuation in terms of price-to-book value.


Alleghany’s stated objective is to compound book value per share at seven to ten percent over long periods of time.  While this objective seems modest, management believes that it can be achieved at relatively low risk.  Over the past decade, book value has indeed progressed at a rate that is roughly in line with management’s current goal.  For the ten year period that ended on December 31, 2015, book value per share grew at a compounded annual rate of 8.6 percent which compares favorably to the 7.3 percent annual return of the S&P 500.  However, Alleghany’s performance compares unfavorably to Berkshire Hathaway and Markel with ten year growth rates of 10.1 percent and 12.4 percent, respectively.

The following exhibit, taken from a recent company presentation (pdf) shows that long term annualized returns have been quite consistent over the past fifteen years:

Alleghany GrowthIn his annual letter to shareholders (pdf), CEO Weston Hicks notes that he is satisfied with Alleghany’s relatively modest 4.4 percent gain in book value per share for 2015 given the low levels of returns available elsewhere in the capital markets.  He also notes that over the past decade, Alleghany’s stock price has only compounded at 6.6 percent annually because the price-to-book ratio has compressed over time.  Alleghany shareholder letters are very detailed and worth reviewing.  It is quite clear that Mr. Hicks is trying to emulate Warren Buffett’s style when it comes to annual communications with shareholders.

The following slide from the investor presentation illustrates that Alleghany stock has typically sold at a discount to book value in the years since the financial crisis.  We can see that book value growth has been fairly consistent with only one down year in 2008.  However, the stock price, even when observed with only one price point per year, is clearly more volatile.

Y Stock Price

Although the exhibit shown below from a company presentation is slightly out of date, it is a good high level illustration of how management is allocating capital between the insurance subsidiaries, non-insurance activities, and investments.  These specific business lines will be discussed in more detail later in this article.  At this point, we would simply note that the vast majority of capital has been allocated toward insurance operations, and specifically toward reinsurance activities at TransRe.  In contrast to Berkshire and Markel, Alleghany is clearly much more weighted toward reinsurance.

Alleghany Capital Allocation

Insurance and Reinsurance Overview

Alleghany posted $4.2 billion in earned premiums in 2015 which was down slightly over four percent compared to 2014.  The company reports results in two segments:  Insurance and Reinsurance.  Within the insurance segment, results are broken down into three operating units:  RSUI, Cap Specialty, and Pacific Comp.  Within reinsurance, results are broken down into property and casualty lines.  2015 underwriting profit was $467 million and the combined ratio was 89 percent.  The charts below show the composition of earned premiums and underwriting profit for 2015.


Alleghany has posted underwriting profits on a consistent basis in recent years.  The exhibit below shows the overall loss, expense, and combined ratio for all of the company’s insurance segments over the past decade.  In addition, a breakdown of earned premiums as a percentage of total by segment is provided along with combined ratios on a segment basis.


As we drill into the positive overall record, we can see that the TransRe acquisition in 2012 was transformative in terms of the overall size of Alleghany’s insurance operations.  It is also apparent that certain insurance operations have posted less than stellar results, although these units account for a relatively minor percentage of premium volume.  Several of these observations warrant further explanation.

Transatlantic Re

Alleghany acquired Transatlantic Re in March 2012 for approximately $3.5 billion consisting of cash consideration of $816 million and 8,360,959 shares of Alleghany common stock.  Total consideration was approximately $61.14 per TransRe share.  The merger was announced on November 21, 2011.  Earlier in 2011, a number of companies, including Berkshire Hathaway, were reportedly interested in acquiring TransRe.  Berkshire made an offer of $52 per share for TransRe in August 2011.  This is notable given the fact that Warren Buffett and Ajit Jain would have been unlikely to overpay.

Although Alleghany had to offer more than Berkshire in order to close the deal, it was still at a discount to TransRe’s book value and immediately accretive to Alleghany’s book value per share.  At the time of the merger, Alleghany hired Joe Brandon, who previously ran Berkshire’s General Re operations in the 2000s, to oversee all of Alleghany’s insurance operations.  Readers interested in additional merger details can refer to The Brooklyn Investor website which published a good summary of the merger event.

A summary of TransRe’s results since 2012 are shown in the exhibit below:

TransRe Results

It is clear that the TransRe merger transformed Alleghany’s operations and made the company much more focused on reinsurance.  Since the merger, TransRe has posted overall underwriting profits in all years with property lines performing at a lower combined ratio than casualty lines.  Prior to the acquisition, TransRe had posted several consecutive years of underwriting profits.  There are always concerns regarding reserve adequacy when an insurance company is acquired.  Based on a review of Alleghany’s loss triangle in the 2015 annual report, it looks like reserving has been conservative so far.

Mr. Hicks makes a number of comments regarding the merger in his annual letter.  He notes that TransRe’s book value has grown approximately $1.6 billion since March 2012 which is a compound annual growth rate of 9.5 percent.  Considering the gain on bargain purchase (due to TransRe being acquired at less than book value) at the time of the merger, TransRe has contributed almost $2.1 billion to the growth of Alleghany’s book value.  Alleghany’s book value per share is about 10 percent higher than it would have been had TransRe not been purchased.  Although four years isn’t a very long time, initial results of the merger seem promising.  Reinsurance pricing has been soft recently, as Warren Buffett and many others have noted, so it will be interesting to see how TransRe performs over the next several years.


RSUI underwrites specialty insurance coverages in the property, umbrella/excess liability, general liability, directors’ and officers’ liability, and professional liability lines of business.  Specialty coverage is required for difficult to place risks and is less regulated than standard markets.  RSUI has a number of operating subsidiaries and conducts business through 125 independent brokers and 29 managing agents.  RSUI was acquired in 2003 and has been focused on underwriting profits over multiple industry cycles.  As a result, management has been willing to shrink premium volume when pricing is inadequate.

The exhibit below shows RSUI’s results over the past decade:

RSUI 2006-2015

We can see that RSUI has been willing to shrink premium volume when necessary but it has been growing again in recent years.  The combined ratio has been below 100 percent for each of the past ten years reflecting underwriting profitability.

Mr. Hicks reports that RSUI achieved modest renewal rate increases in all of its product lines except for property in 2015.  He also notes that since Alleghany acquired RSUI for $628 million in 2003, RSUI has paid dividends to the holding company of $774 million.  RSUI has generated over $1.5 billion of underwriting profits since the acquisition and its stockholders equity has compounded at 11.1 percent adjusted for dividends and capital contributions.  RSUI is clearly a very good insurance operation and dominated Alleghany’s overall financial results until TransRe was acquired in 2012.


CapSpecialty writes property and casualty insurance and surety products such as commercial and contract surety bonds through 137 agents and 69 general agents primarily serving small and mid-sized businesses in the United States.  The company was acquired by Alleghany in 2002 for $242 million.

Representing only 5 percent of Alleghany’s overall earned premiums, CapSpecialty is not very material to overall results.  Mr. Hicks notes in the annual letter that management has been taking steps intended to return the company to underwriting profitability.  However, we can see from the exhibit below that CapSpecialty has posted underwriting losses for the past five years.  On an cumulative basis, the company has posted an underwriting loss over the past decade.

Cap Specialty 2006-2015

Pacific Comp

Alleghany acquired Pacific Comp’s predecessor company in 2007.  Prior to 2009, the company’s main business was workers’ compensation insurance.  In 2009, management determined that rates were inadequate due to the state of the California workers’ compensation market and stopped writing new and renewal business.  In 2011, the company began writing a modest amount of coverage and the business has increased since that time.  Pacific Comp currently does business in California and six additional states.

As one might expect based on its history, the results of Pacific Comp in recent years leaves much to be desired as we can see from the exhibit below:

PacificComp 2006-2015

With premium volume tumbling to very low levels after 2009, the combined ratio predictably shot through the roof.  As business has increased again over the past few years, the combined ratio has declined but the overall operation is still unprofitable from an underwriting perspective.  In his annual letter to shareholders, Mr. Hicks expresses some optimism regarding Pacific Comp’s prospects for restoring underwriting profitability.  Time will tell whether this will be the case.  However, at only 2 percent of overall earned premiums, Pacific Comp is not a major factor driving the overall performance of Alleghany’s insurance operations.

Alleghany Capital Corporation

As we noted earlier, Alleghany is seen by many observers as a “mini-Berkshire Hathaway” because it owns interests in a number of non-insurance operations and has a decentralized management philosophy that offers significant autonomy to subsidiaries.  Alleghany Capital oversees the company’s private capital investments in non-insurance businesses.  The strategy is to invest in closely held businesses where owners and managers are seeking a long term home to support growth.

The following exhibit from a recent investor presentation provides a high level overview of Alleghany Capital:

Alleghany Capital

What is the value proposition that Alleghany Capital provides to potential sellers?  Again, we can see the influence of the Berkshire Hathaway model when we take a look at a slide from a company presentation (pdf):

Alleghany Capital Slide

The Berkshire Hathaway comparison is not perfect.  Subsequent slides in the presentation illustrate that the acquisition process is more involved and not the kind of “hand shake deal” that Warren Buffett is famous for.  However, it is clear that Alleghany is promising many of the same benefits to sellers including preservation of their company’s culture and legacy as well as continued operational control.  The entire presentation is worth reviewing since it contains more details regarding the rationale for past acquisitions including the companies listed below:

  • Stranded Oil Resources Corporation.  The company was formed in June 2011 and Alleghany has invested $243.9 million.  Stranded Oil seeks to acquire legacy oil fields and apply innovative enhanced oil recovery techniques.  The company commenced drilling operations in 2015 but delays were encountered and production is now expected to begin in 2016.  Alleghany owns approximately 80 percent of the company.  The company is not yet profitable with negative EBITDA of $19.7 million in 2015 according to Alleghany’s annual letter.  It is unclear whether Stranded Oil has a profitable business model in light of current low energy prices and only limited disclosure exists in Alleghany’s financial statements.
  • ORX Exploration.  ORX is a Louisiana based oil and gas exploration company.  Alleghany owns a 40 percent interest.  The company has developed a number of regional resource opportunities known collectively as the “Louisiana Heritage Play”.  According to Alleghany’s annual letter, the decline in oil and gas prices has had a negative impact and the ORX investment has been written down to zero.  According to the 2015 10-K, there was a $25.8 million realized capital loss related to a non-cash impairment charge required to write off the ORX investment.  Presumably a recovery in oil and gas prices will be required to realize value from this investment.
  • Bourn & Koch.  Alleghany acquired an 80 percent interest in Bourn & Koch in 2012 and increased its position to 88 percent at the end of 2015.  The company is a manufacturer and retrofitter of precision machine tools and a supplier of replacement parts.  According to the Bourn & Koch website, the company specializes in machine tools for gear manufacturing, surface grinding, boring and vertical tuning with all production taking place in Rockford, Illinois.  The company was founded in 1975.  At the end of 2015, Alleghany had received cumulative cash distributions of $24.8 million in comparison to a gross investment of $55 million.  The company produced EBITDA of $5.9 million in 2015 compared to $6.4 million in 2014.
  • Kentucky Trailer.  Alleghany owns an 80 percent equity interest in Kentucky Trailer as well as a preferred equity interest.  The company’s website shows a large variety of custom trailers and truck bodies along with replacement parts.  The company has roots going back to the establishment of the Kentucky Wagon Manufacturing Company in 1879.  In October 2015, Kentucky Trailer made its third acquisition since Alleghany made its initial investment in Kentucky Trailer in 2013.  This indicates that Kentucky Trailer may be a platform that can be used to allocate additional capital in the future.  Alleghany has a cumulative gross investment of $42.6 million in Kentucky Trailer.  In 2015, Kentucky Trailer generated EBITDA of $12.3 million compared to $8.3 million in 2014.
  • Jazwares.  Alleghany owns a 30 percent interest in Jazwares which is a Florida based toy company.  Alleghany acquired its interest in Jazwares in July 2014 for $60.3 million and has received $13.4 million in cash distributions since the initial investment.  Jazwares produced EBITDA of $35.8 million in 2015 compared to $41.3 million in 2014.
  • Integrated Project Services (IPS).  Alleghany acquired 84 percent of IPS in October 2015 for $89.9 million.  IPS is a technical service provider focused on the global pharmaceutical and biotechnology industries.  IPS generated EBITDA of $16.5 million in 2015.  Alleghany’s share of 2015 EBITDA during its period of ownership was $1.3 million.  According to the 2015 annual letter, IPS entered 2016 with a significantly larger backlog than at the start of 2015 which could presumably indicate higher earnings for 2016.

In addition to the businesses listed above, Alleghany owns and manages properties in the Sacramento, California region through Alleghany Properties, a wholly owned subsidiary.  Alleghany properties owns improved and unimproved commercial land as well as residential lots.  Total land holdings was approximately 317 acres at the end of 2015.  According to the 2015 annual letter, Alleghany properties completed its first property sale in late 2015 since the 2008 financial crisis and a small profit was reported for 2015.

Alleghany’s financial supplement (pdf) for the first quarter of 2016 contains new disclosures for Alleghany Capital that do not exist in prior supplements.  The results for Alleghany Capital are broken down into “manufacturing and services” and “oil and gas”.  Although we do not have granular quarterly results for each of the businesses listed above, it is evident that the manufacturing and services group is profitable while the oil and gas sector is not.  This is unsurprising given the current energy pricing environment.

It is difficult to come to any firm conclusions regarding Alleghany’s venture into non-insurance operations.  These acquisitions have been relatively recent and the energy related companies skew the overall results negatively.  Alleghany Capital represents a very small percentage of the total company’s capital at this point so the results here are not terribly material.  Nevertheless, these ventures should be scrutinized over the coming years since much of the “mini Berkshire” narrative is based on diversification into controlled or wholly owned subsidiaries outside insurance.

Roundwood Asset Management

Alleghany’s public equity investments, including assets held by insurance subsidiaries, are managed primarily through Roundwood Asset Management which is a wholly owned subsidiary.  These investments are funded both with shareholders’ equity as well as policyholder float.  As of March 31, 2016, Alleghany’s investment portfolio was slightly over $17 billion with 17 percent invested in equities, 80 percent invested in fixed income securities, and the remainder invested in short term investments.  The exhibit below shows the allocation of the investment portfolio:

Alleghany Investments 3/31/16

The effective duration of the fixed income portfolio was 4.6 years as of March 31, 2016 with the majority rated AAA or AA.  Alleghany’s stated investment strategy is to preserve principal and liquidity while maximizing risk adjusted after-tax rate of return.  Although equity investments represent a small percentage of total investments, management characterizes the approach as “research intensive” and focused on finding companies that can reliably grow revenues, earnings, and dividends over time.  The following exhibit taken from the 2015 annual letter shows the composition of the equity portfolio as of December 31, 2015.

Alleghany Equity Portfolio - 12/31/15

The approach is quite concentrated with the top seven positions accounting for more than half of the portfolio’s value.  At $2.8 billion, the equity portfolio size is small enough to invest meaningful sums in companies with relatively small market caps so it is interesting to note that most of the top positions are very large capitalization companies.  According to a recent invest presentation, the equity portfolio provided a 10.6 percent compounded annual return for the three years ended September 30, 2015.


This article has provided a fairly high level overview of Alleghany Corporation primarily intended to examine whether the company might be considered a “mini Berkshire” in terms of its overall operating strategy.  Alleghany is a company with a very long track record as well as long serving and experienced management.  The company has clearly shifted its strategy numerous times over the years in an opportunistic manner and has posted a compelling track record of book value growth.  Book value growth has exceeded the S&P 500 over the past decade while trailing the performance of Berkshire Hathaway itself as well as Markel which is often thought of as a “mini Berkshire”.

Although Alleghany has many positive attributes, it is important to note that reinsurance is currently its dominant business and will be the primary driver of overall results.  The insurance business, in aggregate, has been very good for Alleghany with combined ratios under 100 percent over the past decade.  As a result, policyholder float in excess of $10 billion has been cost free and available to invest for the benefit of shareholders.  However, many industry observers, including Warren Buffett, have noted that reinsurance pricing is currently inadequate.  A reinsurance focused insurer like Alleghany will have to decide whether to reduce its premium volume (and float) or accept the risk of underwriting losses.  Therefore, we cannot really view the $10 billion of float as a reliable cost-free source of funding for investments going forward.

It is probably too soon to evaluate the success of Alleghany Capital’s venture into non-insurance businesses.  The companies that are not involved in oil and gas exploration seem to be profitable based on the limited data provided by Alleghany.  But we simply do not have enough of a track record to evaluate the long term returns on capital invested in this area.

Market participants seem to be viewing Alleghany with some caution given the stock’s modest premium to book value.  In recent years, shares have typically traded at a discount to book value and, at certain times, the discount has been quite large.  Markel trades at a significant premium to book value (about 1.55x) so the market is viewing it as more of a “mini Berkshire” candidate at the moment.  However, Markel has a much more diversified insurance business with less emphasis on reinsurance.

Alleghany appears to offer a reasonable value for risk averse investors seeking a conservative management team that is hoping to compound book value per share at a 7 to 10 percent annual rate.  Purchasing a business of this quality at book value is probably going to work out reasonably well over time.  More opportunistic investors might prefer to stay on the sidelines and wait for a meaningful discount to book value before buying shares.

Disclosure:  No position in Alleghany.  Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway and Markel Corporation.

Markel CATCo Investment Management

Markel CATCo Markel CATCo is a leading insurance linked securities investment fund manager and reinsurance manager based in Bermuda.  Markel completed the acquisition of CATCo Investment Management and CATCo Reinsurance Ltd. in December 2015 for total consideration of $205.7 million paid in cash.  Retention payments and performance bonuses based on the results of the business through 2018 is estimated to cost an additional $100 million.

The Rational Walk has covered Markel in the past and we have followed the CATCo acquisition with interest over the past few months.  Markel released results for the first quarter of 2016 on May 3 which included some additional details regarding the acquisition.  In this article, we take a brief look at the insurance linked securities market as well as Markel’s increased involvement in this market due to the CATCo acquisition.

Insurance Linked Securities

The market for insurance linked securities (ILS) has grown rapidly over the past five years as capital market participants search for securities offering higher yields in the midst of a historically low interest rate environment.  Catastrophe bonds represent the largest segment of the ILS market.  Cat bonds are structured to pay interest and principal based on a catastrophe event that exceeds a certain magnitude or causes aggregate losses in excess of a specified amount.

Property/casualty insurers and reinsurers can utilize cat bonds to transfer risk from their books to capital market investors which reduces overall risk and frees up capital that would otherwise remain tied up.  For a more detailed write-up on the basic characteristics of the ILS market, readers may refer to Insurance-Linked Securities:  Catastrophe Bonds, Sidecars, and Life Insurance Securitization published by the National Association of Insurance Commissioners.  Artemis, a website focusing on ILS, provides a listing of the latest catastrophe bonds and ILS offerings which illustrates the wide variety of insured risks and bond terms.

The size of the cat bond and ILS market has grown significantly in recent years although issuance declined in the aftermath of the financial crisis.  The following exhibit from the Artemis website shows that the overall market size has been approximately $25 billion over the past few years:

ILS Market Size

Artemis has published a useful article describing the overall structure and mechanics of cat bonds.  Typically, an insurer or special purpose vehicle is set up, enters into a reinsurance transaction with a counter-party, and receives a premium in exchange for providing the coverage.  Securities are issued to investors and the principal is invested into a collateral account.  Investor coupon payments are comprised of interest payments from the collateral account and the premium.  Assuming that the triggering event does not occur, investors receive principal at the end of the term from funds in the collateral account.  The exhibit below, sourced from Moody’s and included in the Artemis article, is a good illustration of the mechanics of a catastrophe bond:

Cat Bond Mechanics

In addition to providing attractive yields in a low interest rate environment, cat bonds are not typically correlated with other financial markets.  In other words, a triggering event that results in the loss of part of all of the principal of a cat bond is unlikely to also result in commensurate losses in other financial instruments.  There could be certain exceptions such as the chain reaction of events associated with the 2011 Fukushima Daiichi nuclear disaster in Japan.  The disaster was caused by a tsunami triggered by an earthquake and was severe enough to cause serious regional economic damage and a stock market slump.  However, an event such as a major hurricane in the United States is unlikely to be highly correlated with the overall stock market given the magnitude of such an event in the context of the overall economy.

Cat bonds, and ILS generally, represent additional capital flowing into the reinsurance market and could be expected to contribute to overall soft pricing for risks.  Berkshire Hathaway Chairman and CEO Warren Buffett and other industry participants have recently commented on how pricing in reinsurance is inadequate to ensure acceptable underwriting profitability in the long run.  One could view the growth of ILS to be a contributing factor and a warning sign.  However, a recent article argues that the ILS market has taken Mr. Buffett’s warnings into consideration, especially with respect to pricing.  As an outside observer, it is difficult to know whether this is the case and we may need to go through a full reinsurance pricing cycle before evaluating the results.

Markel’s Increases ILS Involvement via CATCo

Markel’s acquisition of CATCo included CATCo Reinsurance Ltd. and CATCo Investment Management.  Markel CATCo Reinsurance is a Bermuda licensed reinsurance company that provides clients with custom programs to meet their reinsurance needs.  Markel CATCo Investment Management offers funds to investors that provide diversified portfolios made up of risks accessed through the reinsurance operation.  As of March 31, 2016, the investment management business had total assets under management of $3.2 billion.

Markel is participating in the ILS market as both a fund manager through Markel CATCo Investment Management as well as through an investment in one of the funds offered by the manager.  The investment management operation began receiving management fees for investment and insurance management services on January 1, 2016.  In addition, performance fees may be earned based on annual performance of the investment funds under management.  According to management’s comments in the first quarter conference call held on May 4, the revenue associated with management fees is expected to vary from quarter to quarter with a higher figure expected in the fourth quarter assuming performance targets are attained.  The investment management business posted a $2.8 million loss in the first quarter which was attributed to acquisition and integration costs as well as the impact of bonuses that are not expected to be recurring.

Markel has also made investments in funds offered by Markel CATCo Investment Management and, as a result, will participate in the performance of the funds along with other investors.  In October 2015, Markel made a $25 million investment in one of the CATCo funds prior to closing of the acquisition.  This investment, along with an additional $175 million investment made in January 2016, are now invested in the Markel CATCo Diversified Fund.

The investment is far from risk free, as President Michael Crowley’s comments in the conference call illustrate:

In terms of the $200 million investment we’ve made in CATCo, the potential is – there need to be multiple events, but the potential is we could lose the entire $200 million. And that is the same for virtually any other investor in CATCo. There is a slight complication to that. We have multiple funds. And in some of the funds we actually do go out and hedge some of the risks for the investors in those funds, so their results could be slightly different as a result of that.

But in a multi-event – large event scenario, Markel could lose the entire investment. That is highly unlikely. In a one event, sort of large event loss we can lose as much as approximately $50 million of the $200 million. CATCo’s product is – not to get into great detail, but CATCo’s product is little different than most other cat products out there as opposed to a single shot retro sort of product. It is a multi-pillar product and you can have up to four losses against the product and the entire limit does not erode unless you have up to those four losses.

The majority of Markel’s investment in the CATCo funds are classified as Level 3 equity investments indicating that the net asset value of the fund is calculated using both observable and unobservable inputs.  Markel may redeem the investment on January 1st of each calendar year.


As an outside observer, it is difficult to evaluate Markel’s acquisition of CATCo in terms of its long term potential.  Markel has the ability to profit from management fees generated by the $3.2 billion of assets under management and also is a participant in the funds through its $200 million investment.

Catastrophe bonds and insurance linked securities serve an important role by bringing capital provided by market participants into the insurance and reinsurance industries.  However, at least at a superficial level, it is difficult to not view this additional inflow of capital with some degree of suspicion given the soft pricing conditions in reinsurance that Warren Buffett and others have been warning about for several years.

Market participants who purchase ILS and mutual funds comprised of ILS are looking for yield in an environment where yield is exceedingly difficult to come by.  At least some percentage of these investors are probably lulled into a false sense of security due to the lack of recent mega-catastrophes.  When (not if) a major mega-catastrophe occurs, we can expect plenty of cat bonds to be wiped out.  At that time, the overall market could very well shrink reducing the assets under management of firms such as Markel CATCo.

Markel’s management is obviously well aware of the soft pricing environment in reinsurance and elected to go forward with the acquisition in spite of these conditions.  In addition, the $200 million investment in the Markel CATCo Diversified Fund is a vote of confidence in the market.  Ultimately, we will have to wait for a full reinsurance cycle to occur before we will know the results of the ILS market in general and the impact on Markel CATCo.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Markel Corporation.