Tom Gayner's Wrestling Match

A keen-eyed friend told me my question to Tom Gayner at this year’s Markel Brunch was captured on video. I had forgotten just how good his answer was, and think it’s excellent advice for anyone analysing a financial services business.

Graham Rhodes:

Hi, everyone. My name is Graham Rhodes. I’m from Hong Kong.

I think my question is gonna riff off the last one: investing in a financial services company like yours is always a bit tricky because you report earnings today but have these commitments long into the future, which could be called and create liabilities.

So my question is, what are the risks or the events that could torpedo Markel, and how do you either manage them or avoid them? And secondly, what should I look for in your 10Qs and your 10Ks to keep track of how you’re doing that? Thank you.

Tom Gayner:

Well, sure. That’s an outstanding question. And believe me, that occupies the front lobe of our mind all of the time. Managing risks is what we do; that’s the very definition of what an insurance-based operation does.

So, we look at and think about and try to monitor everything that we think could be coming at us. We’ve tried to allow for possibilities of things we can’t think of coming at us. We try to structure each and every decision we have so that if we’re utterly wrong and completely taken by surprise - as we have been from time to time - we live to fight another day. And, you know, the company’s been in business 90-some years facing those risks. So I would suggest that the process by which we try to manage that is robust and it is time-tested.

To the second part about sort of what the earnings really are. I think there’s a wonderful tell that if you’re a financial analyst, you should look at, and that is… We make the statement - you hear it from us regularly - we want our reserves to be more likely to be redundant than deficient. So every year, there’s loss development tables which show that eight years ago… We made a loss pick as of December 31 eight years ago, what we thought the ultimate losses would be. We report to you how that develops and then what actually happened in the passage of time.

And every single insurance company - I’m speaking just for insurance right now, but really in all financial institutions, banks and whatnot. At any given point in time, every quarterly report that they give to you is a wrestling match, a fight between the income statement and the balance sheet. And if you have managers of the company who have sort of a mindset of being an agent, as opposed to a principal, those fights would tend to lean towards the supremacy of the income statement.

That’s not the case at Markel. Our bias is to think as principals rather than agents and as such, of the three financial statements, the one that kind of wins the tie… that predominates in that fight, is the balance sheet. We want to get the balance sheet right and the balance sheet conservative. And once we do that, the income statement falls out of the balance sheet. And so the earnings are the residual from sort of the changes of the balance sheet accounts.

And I think you have a pretty good tool in your hands as an outsider. So looking at year after year after year after year… and you can’t make the judgement after any one quarter. But when you see that pattern year after year after year after year. One way or the other. I think you are not looking at something that’s accidental. The management team has told you by their actions what matters to them the most.