When Markel (NYSE: MKL) first revealed last December that government authorities had contacted it with inquiries into late 2017 and early 2018 loss reserves at its CATCo subsidiary -- a 25-employee investment-management business it acquired in late 2015 -- it raised more than a few eyebrows among shareholders in the specialty insurance and financial holding company.
Still, Markel not only insisted it would cooperate with the authorities' investigations, but it also retained outside counsel to conduct its own internal review of the situation.
With little fanfare on Sunday evening, Markel announced its review has been completed and "found no evidence that CATCo personnel acted in bad faith in exercising business judgment in the setting of reserves and making related disclosures" for the periods in question.
Consequences of a challenging year
That's good news, of course. At the very least, Markel shareholders can remove willful deception from the list of problems that caused this debacle at CATCo.
But that also raises the question: What exactly happened at CATCo to draw this unwanted attention? Incidentally, Markel management offered some hints to that end during their fourth-quarter 2018 conference call with analysts in February.
According to Markel co-CEO Rich Whitt:
In a recent Aon publication, they stated that 2017 and 2018 were the costliest back-to-back catastrophe years on record with insured losses approaching $240 billion. This level of loss activity was an extreme challenge for the ILS [insurance-linked securities] market in general, and for Markel CATCo in particular. Not only did Markel CATCo funds incur significant losses in 2017 and 2018, but their initial estimates for 2017 losses were too low.
Shareholders should also keep in mind there have been other direct consequences leading up to the conclusion of Markel's internal review.
On Jan. 18, for one, Markel announced that CATCo's co-CEOs were no longer with the company, effective immediately -- but not as a direct results of the loss-reserves issue. Rather, during the course of the review, Markel discovered the two executives had violated company policies relating to an undisclosed personal relationship, for which "prompt action was taken."
What's more, when Markel released fourth-quarter 2018 results a few weeks later, the company determined that in light of the ongoing government inquiries, the aforementioned executive departures, and its subsequent decision to offer special term redemption rates to investors in the ILS funds managed by CATCo, it was necessary to reduce the carrying value of goodwill and intangible assets for CATCo to zero. The end result of that decision was a $179 million asset-impairment charge taken during the quarter.
Finally, we should remember that Markel isn't in the clear just yet. The governmental authorities' inquiries have yet to conclude, and Markel cautioned that it can't "predict the duration, scope, or result" of those investigations.
But Markel still believes in the promise of the ILS market.
"We expect to learn from the 'cat' events from 2017 and '18, and we've planned to adapt our Markel CATCo strategy accordingly," Whitt said during the call. "We remain confident in the future of ILS, and we believe ILS will be a valuable, important component to Markel's overall strategy in the future."
That's all well and good. But before Markel can realize the fruits of that strategy, investors would do well to keep an eye peeled for the results of the governments' investigations.
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