When Wall Street doesn’t have a clear picture about what’s going on with a company’s finances, it can assume the worst. So when Markel (MKL) made public last week that U.S. and Bermuda regulators were looking into some loss reserves at one of its units, it naturally led to share prices taking a dive. It also led a MarketFoolery listener to ask for the Fools’ views on the situation.
In this segment of the MarketFoolery podcast, host Chris Hill and senior analyst Jason Moser — who, full disclosure, added to his Markel position on the drop — explain why the concerns, which strictly relate to the small Markel CATCo business, can largely be discounted.
Why Markel’s Regulator Worries Are Probably Minor
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Speaking of Markel question from Jason McClary who writes What are your thoughts on the recent announcement of a regulatory inquiry into Markel which may have driven some of those out. Yes Jason writes The stock has traded down a little less than 10 percent since the announcement. Just wondering where things go from here. Thanks. Thank you for the question Jason. Yeah it was a week ago. Markel announced that it is hiring an outside counsel for an internal review after it was notified by unnamed regulators. And. Right off the bat it's the unnamed part of that sentence that makes some investors go oh wait a minute is this a paperwork thing or is this just a rounding error or is the FCC kicking in your door.
Yeah I mean that's fair to be a little bit knee jerk whenever you see investigations. I mean that doesn't exactly instill a lot of confidence but you know it's one where you have to dig in a little bit and try to understand exactly what's going on here. So we look at the AK that Markel actually released and they were saying that after having been contacted on November 30th they are cooperating with inquiries by U.S. and Bermuda authorities into loss reserves that were recorded in late 2017 early 2018 in the Markel CATCo investment management business. Okay. And it's not in the way it rolls off the tongue. But my point in reading that in that CATCo part there is that it is limited just to that catastrophe. Part of the business the reinsurance CATCo business that they have and they acquired not all that long ago. It does not have anything to do with any other part of Markel whatsoever. So Markel Ventures not the Markel insurance. This is limited to just one little wing of the business that they acquired for about 210 million dollars the little while back.
So in terms of Markel's overall revenue streams roughly what percentage is CATCo contributing.
I'm glad you asked that because it's not a lot OK to be very clear as to what this CATCo business is involved in what's called retrocession. And again rolls right out the top.
I mean insurance is exciting anything that insurance. Retrocession is essentially like reinsurers its reinsurance for the reinsurers it's a way that reinsurers spread that risk to other reinsurers and it's just part and parcel of the insurance business. So when we talk about the actual exposure to Markels overall business well it's not a whole heck of a lot because if you look at the total revenues that were attributed to this Markel CATCo side of the business and in 2017 for the full year it was only 27 twenty eight point seven million dollars in Markel's trailing 12 month revenue is about seven and a half billion dollars. Okay so it is just a drop in the bucket. So I think that was a little bit of a knee jerk reaction. The stock wasn't necessarily cheap before the sell off. It's not I wouldn't argue that it's cheap now either it's still trading at about one and a half times book value. But my litmus test there is ultimately like what if you just completely eliminated this cat business from Markel's business model. What ultimately happens when they lose a little bit on the assets and are management side. But it doesn't really impair the business at all. In another encouraging thing I think is that the original management team with this Caco business is still on. So these are the guys that knew the business from the very start. It's very difficult to come up with the reserves for these reinsurance businesses. It's not just set in stone process it's a bit nebulous. You have to make some assumptions and we've had some pretty severe natural disasters here the past couple of years. California wildfires are going to be contributing to that as well. So it's understandable in the near term to be a little bit worried perhaps of what this might mean.