Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.

com/

Markel (MKL) Breakfast in Omaha: Sunday, May 1st

Speakers:

Chief Investment Officer: Tom Gayner

Vice Chairman of the Board: Steve Markel

Tom Gayner: This is the 20th year that they have come to Omaha, had a function and had a chance to
talk about what is going on at MKL. He joined MKL in 1990 and soon realized that the people who would
understand MKL the best were people who owned shares of Berkshire Hathaway (BRK). So they decided
to come to Omaha and meet people as opposed to making them come to Richmond. They had only 6
people at the first meeting and now they pack an entire room.

MKL has now been public for 25 years has achieved a CAGR of book value—the best proxy of the value
of the company—of 14%, despite the tough last 5 years. The investment portfolio also has also gotten
much larger over that time period. They had $2M to manage in 1990 and now there is $3.5B in equity
capital. However, despite this larger amount of capital, in the last five years they have had achieved
better outperformance than during the first ten years.

This has been a heavy year in terms of activity in the investment portfolio. They are picking up steam
and momentum. Since they were in Omaha last year, they bought a company called Aspen whose
FirstComp division provides worker’s comp insurance to small businesses in 31 states. There are
interesting signs that the worker’s comp market is improving. FirstComp has a wonderful record of
underwriting profit and doing so in small towns. It is a very efficient and cost effective as well as being a
wonderful business. Owning Aspen offers cross-sell opportunities for MKL as well.

MKL opened new international offices in Hong Kong and Beijing and the international segments now
represent about a third of the business now. The other international offices are in the UK, Spain,
Canada, Singapore and Sweden. The ongoing maturation of One Markel is very positive. They have
integrated the whole message to everyone who does business with MKL. They have broken down silos
within the organization because they want it to be easier to do business with MKL. Everything is working
very well on the customer side. They just need to get the technology right-- this is the major challenge.

The non-insurance subsidiary, Markel Ventures, acquired Diamond Healthcare in December 2010. This
firm offers behavioral health programs in the US. In the same month, they added a company called
Retail Data, a company that provides retail intelligence services. AMF Bakery Systems also bought
Solbern, a pickle stuffing firm with 100% market share in pickle jar stuffing. Further, the Parkland mobile
home park business continues to grow at a very rapid rate. Finally, in January MKL entered into a
strategic venture called GoodHaven Capital Management, an investment firm that will have a value-
based strategy and focus on separately managed accounts for high net worth individuals and
institutions. Finally, Markel took a stake in a JV called Markel Eagle that looks to invest in distressed real
estate. With all of this activity, they estimate that MKL Ventures may be a $250M revenue run rate
business.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Regarding succession planning, they have taken some important steps. As an investor, Gayner said that
if he saw that a company had named 3 people to be the president of company, he would sell the stock.
But, MKL is different because this has been going on for 40 years in the sense that the guys have been
running the company as a triumvirate. The new three presidents will have authority over the areas that
are their expertise. Gayner handles the balance sheet and investment decisions and will make the sole
decisions in that arena.

Gayner started off his career as an accountant and one day he decided that he liked dollars more than
numbers, which are two very different things. He went to worker as broker and eventually met Steve
Markel, who twisted his arm to buy BRK shares with a price tag around $5500. Gayner was too much of
a value investor and he couldn’t believe that anything could cost that much if you couldn’t live in it. Now
he and Markel have been partners for 20 years and Gayner claims Steve is the best partner in the world.

Gayner said that they welcome questions about the insurance market. A lot of rain has fallen and a lot of
earth has moved so that may shift what is going on in the insurance industry.

Steve Markel: Said that that he likes it when Tom kisses up because it doesn’t happen very often. Tom
often proposes ideas and Steve tells him immediately how stupid the idea is. Then, when Steve finally
convinces Tom, Steve then turns around and takes the opposite position. In the end Tom does whatever
he wants to do.

Steve then made a comment that, in general, companies are really stuck in compliance matters.

MKL issued a release on Friday and is going to issue their 10-Q next week:

4 Highlights of Q1 2011:

1. Gross premium volume was up 21% over last year, not because the market has changed but
mainly as a result of FirstComp and Elliot Special Risks acquisitions. The only insurance areas in
which they are seeing any price improvement are the marine and energy divisions of MKL
International.
2. Earthquakes in Q1 were very meaningful and added 15 points to MKL’s combined ratio. As such,
the combined ratio will be 112 for Q. In spite of the catastrophe losses they are optimistic that
the results will be solid for the rest of the year and the company will have a good opportunity to
make an underwriting profit.
3. Book value per share was $329 in March, an increase from the prior period.
4. Additionally, the management team is focusing on continuity. MKL was founded by Samuel
Markel in 1930. In the mid-80s there was a transition between the 2 nd and 3rd generations.
Transitions can be highly risky and most businesses don’t make it from the 1 st generation to the
2nd. MKL raised $5M in its IPO and started its new life as public company. There are a few things
that began then that are still important today. They think of the company as a perpetual motion
machine and want the business to last forever. They didn’t want to just to raise $5M and cash
out. They just wanted to get liquidity for the cousins and others who had no interest in being in
the business.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Steve wants to continue to be engaged in the future but wants to make sure the business
thrives forever. They are creating a culture of accountability and an opportunity for people to
reach their goals. They are focused on sustainability. As mentioned by Gayner, early last year
they created the office of the presidency and split it between 3 people. Tony Allen and Steve
Markel have not gone away but they are letting out more rope to the 3 presidents.

Q&A Session

Question 1: David Winters of Wintergreen Funds- You have done such a good job in investing and
insurance and now you are moving into owning businesses. How do you not end up with a disparate
conglomerate?

Steve Markel: They have been in the R&D period in terms of private equity. They are building a model
that is not in place yet but they feel they are learning a lot. They believe this will be important for MKL
for the future.

Tom Gayner: Disparate conglomerates are not all bad. If there is no business focus and there is a market
manipulation aspect of the conglomerate’s business then that is bad. When people have different
agendas than running a great business then shareholders do not benefit. Buffett mentioned Teledyne at
the annual meeting and Gayner thinks that Teledyne is a good example of a conglomerate that worked.
Buffett learned a lot about running a business from Henry Singleton of Teledyne.

One of the things that you do get when you have control of business as opposed to owning shares is tax
efficiency. MKL does 100 things 1% better than other firms as opposed to doing 1 thing 100% better. The
cumulative effect of that is very profound over a long period of time. One thing that gives them an edge
is tax efficiency. When companies they own earn money they pay tax at that level but then it flows to
MKL with zero tax cost. That capital can then flow within MKL to wherever they want to put it without a
tax cost.

The way they have gone about selecting businesses is similar to the way they find stocks to buy. They
are looking for 4 things:

 Profitable business with high, unlevered returns on capital

 Capital discipline
 Selling for a fair place
 Run by honorable people

MKL acts as the board of directors and, in addition to tax efficiency, these are the added bonuses of
owning the entire company versus owning public equities. They helps determine capital spending and
that means there is not a hole in the board like there is in other companies-- where you see share
counts going up each year.

They are crawl, walk, run people. They have done the first 2 and are starting to trot now. There will be a
lot of opportunities going forward.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

The dredging business is a good example of the type of businesses they like. When Buffett bought Acme
brick he said that 10 years from now this will still be the latest thing in bricks. The Ellicott Dredge
company built the dredge that built the Panama Canal. Dredges last 30 to 40 years and there is not a lot
of new technology in the space. There is no app for dredging; you actually have to do it. 24 hours a day,
7 days a week, Mother Nature gives the company inventory to use. This company does not build ocean
going vessels that do huge jobs. The guy runs who Ellicott is in his mid-50s. He is an undergrad from Yale
and is a Harvard MBA. Before he ran the company, his father ran it. What happens to his business really
matters to him. This is why MKL is an interesting option for him to sell to. MKL provided permanent
capital and he got to know where the business would go and how it would be run in the future.

Question 2: Steve made some comments about compliance. Given that Berkshire Hathaway (BRK) is
your largest position, will you please make some comments about the meeting yesterday and how the
Sokol affair was handled?

Tom Gayner: BRK is their largest holding so this is important. He is not concerned about the future of
BRK in this instance. He had dinner with some senior BRK managers and they said that some good will
come of the Sokol affair. Buffett will never be the same in his relationship with Sokol—this was a
personal tragedy. However, all BRK managers will see this experience as a warning sign. People now see
that they have to be accountable.

He thinks Buffet explained it the best he could. It is still a moving story and information continues to pop
up. This is a valuable learning experience for Berkshire. One of the books he read this past year was
actually not a business book. In fact, he recommends (with hesitation) Keith Richard’s biography. Two-
thirds of the way into the book, there came a point when the Rolling Stones separated. Richards wrote
about his emotional state and described how he had started to resent Mick Jagger. After starting his
own band and being the front man, he soon realized what Mick’s job was. He developed empathy for
Mick and they were able to mend their relationship. He realized that he needed partners in the band if
he was going to be successful. Businesses have episodes like these all the time. There are differentials in
talent and people need to know what their roles are. The Stones are still with us and BRK will be with us
—with different members of the band—for a long time.

Steve Markel: The relationship with Sokol evolved over 20 years and managing that change is very
tough. How to manage that change and turn it into growth is very important.

Question 3: Questioner said that they need to improve disclosures in MKL Ventures. Also, will you talk
about the integration of the acquisitions? How do you instill the MKL culture?

Steve Markel: The integration of Aspen has been one of the smoothest they have ever experienced. The
cooperation between the people is going very well. MKL has a different philosophy when it comes to
reserving so they select a loss reserve number that is closer to an 80/20 pick than a 50/50 pick. This
philosophical difference can be contentious when people look at the glass with a different perspective.
But, the Aspen people understand that MKL is more conservative. The people at Aspen understand that
the pricing environment is very tough and you can’t grow premium revenues at a clip that everyone
would like. But, he believes that the margin play in the future should be positive.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Tom Gayner: MKL bought a lot of troubled companies when it first started in private equity. This is
because they had very little money. They knew the difference between good and bad companies; they
just couldn’t afford to buy the good ones. Aspen was a good company before MKL got there.

In terms of disclosure, companies have crossed the threshold of materiality and now MKL will be
reporting EBITDA for these companies. In terms of capital investment, these are very low capital
expenditure businesses. But, he said he is willing to break out CAPEX a little more in the statements.

Question 4: What is the state of pricing in the property and casualty (P&C) business? Have the recent
events changed the environment?

Steve Markel: He continues to be somber about the pricing. But he continues to hopeful. They are trying
to balance the two. They don’t want to be too optimistic before a change actually happens. There are a
lot of reasons why things should be better—capturing the risk of inflation is one of them. Why would
anyone want to write a ten year contract with an implicit 1% inflation rate? In reality, he believes that
prices should go up by double digits. But, that has not happened in the last 30 days. Broadly speaking,
they are not going to be doing backflips about the current market.

Tom Gayner: This is also an AIG shareholder meeting—as taxpayers we are shareholders. There is not a
lot of accountability there. Their job is to survive in the long run. (Author’s note: I believe this was a
reference to AIG being an irrational player in the market right now)

Question 5: In the last 5-6 years there has been $1B in reserve releases. It was a harder market when
the corresponding policies were written. Is the margin go safety tighter now because it is a very soft
market? Are there likely to be the kind of reserve releases going forward, given that they are writing
insurance in a softer market?

Steve Markel: If you can increase your prices 15-20%, it is easier to set a larger margin of safety than if
prices have gone down each year. Psychologically, most companies make reserves stronger when prices
are going up and give it back when prices are going down. Also, it is hard to watch your market share
declining and feel like you are not keeping up with inflation. MKL wants to be consistent with their loss
reserves each year. They want a consistent margin of safety. In a declining market when prices and
volume are going down they are not writing much new business. Accordingly, a smaller part of the
business is new, risky new business. Right now they are seeing much more renewal business. In any
case, they are very consciously setting up conservative reserves. They are trying to rebuild the
redundancies in their books.

Tom Gayner: They want to be here 5-10 years from now talking about redundant reserves.

Question 6: Can Steve talk about the rope he is letting out? Meaning, how is he ceding control to the
presidents?

Steve Markel: When it comes to investment decisions, he never tells Tom not to buy anything. But he
also never withholds his opinion. Tom is OK with disagreement and he does what he feels is right. The 3
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

guys are running about 80% of the operations within their expertise. He knows what is going on but he
wants to become unnecessary even If he is around.

Tom Gayner: Tom hears Steve’s voice in his head even if Steve is out of the office and that is never going
to go away. He can anticipate what Steve will think. His greatest business teacher was his father. He died
30 years ago but Tom can remember what he told him every day. That will never go away.

Question 7: Can he talk about the state of the municipal bond market?

Tom Gayner: They have a lot of dollars of municipal bonds in their portfolio. If he had complete
discretion he would not own them. But, practically they have to own a fixed income portfolio to match
their liabilities. They just have to figure out how to minimize risk. Their fixed income portfolio is
becoming 50% munis and 50% sovereigns. They have about $3B in munis and that amount is about the
same as MKL’s total equity. They have positions limits of 10% in each state-- each state can only
represent 10% of total equity. They also don’t have $30M in bonds that say Illinois—they say Chicago or
O’Hare. They don’t finance sports stadiums or anything like that. They want to be in the least risky
securities.

In 1990, he was worried about the time after Drexel went into bankruptcy. He knew nothing about junk
bonds other than that the market for junk bonds was falling apart. Knowing nothing, he still wanted to
buy something because he knew that the market was so dislocated. So, he bought RJR-Nabisco zero
coupon bonds that had a 10% reset in 1994. The bond was trading at $.30 at the time. There was also a
tax cash cost whether it got paid or not because of new tax laws. While he was working as a broker he
called Steve Markel about these bonds. Steve and Tony had borrowed money to buy their parents out.
As such, Steve had an interest bill larger than his income. But Tom recommended these bonds because
they were so attractive. Within a short period those bonds traded at par.

The lesson is that sometimes they own bonds because they look like stocks and have equity-like returns
— they are like stocks in drag. They also have a globally diversified book of bonds.

Question 8: Tom Russo of Gardner Russo & Gardner- Has there been any change in Tom’s connection
with the insurance part of the business?

Tom Gayner: He has always been connected to the insurance side. He really likes this role and this is
why MKL is different. He was the director of unsolicited opinion before he ran the bond portfolio. He
now occupies a similar role within the insurance division and help his colleagues think about risk and
reward.

Steve Markel: Tom’s role before the transition had always been in understanding where we are in the
insurance cycle and the potential for premium growth going forward. He has to manage the portfolio
with an eye on what is going on in insurance. He needs to make decisions about bond and stock
weighting based on the insurance cycle. More capital will be devoted to P&C business when prices
eventually go up. As prices go up, risk should be going down.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Question 9: Marcelo Lima—Lots of P&C stocks have been trading below book value recently. One
should assume that acquirer could pay a slight premium and actually purchase these companies. Are
there challenges to consolidation?

Steve Markel: The first thing you have to figure out is whether their loss reserves are properly stated.
Concerns over the reserves are a major reason why some companies are trading below book value. Do
they have a book of business that gives them a competitive advantage and allows them achieve
profitable underwriting?

You would have expected that there would have been more consolidation. But, a number of companies
have a lot of private equity money in them. So, if they are offered a price below book value per share,
the PE firms are unlikely to sell because of the loss they would realize on the sale and the loss of their
management fee. So, these companies have not been sold. And they will. It just may be while.

Question 10: Victor Liu of Causeway Funds- If you don’t like bonds, why should investors buy MKL,
which owns so many bonds?

Tom Gayner: Every insurance company owns a lot of bonds because it needs liquidity. There is an
inherent flaw in that logic and a contradiction—just like how Buffett likes receiving dividends but does
not like to pay them. At MKL, they have used the discretion they have to invest in long-term securities
and that has created a lot of value at the company—just like the how insurance company has helped
BRK so much.

Steve Markel: They have higher inflation expectations than does the market. The coupon on the 10 year
Treasury is so low that it makes bonds look like a bad investment.

Tom Gayner: The Parkland business is a forever user of leverage. They borrow to buy mobile homes at
60% LTV. Over the last few years it would have looked like a better idea to use short-term financing.
Instead, they take out 10 year financing with fixed rates to be conservative. They don’t want to be at the
mercy of interest rate shocks or refinancing risks. They like higher, but certain costs.

Question 11: Are they seeing the excess and surplus (E&S) insurance business going back into the
standard market?

Steve Markel: Yes, and this is why the business is so soft. In the standard market place, there is a
specialization in writing restaurant business. But, they are not writing a lot of bar and tavern business.
Eventually the rest of the players in the market will realize that they are losing money on their
restaurant business because they are actually underwriting bars and taverns and calling them
restaurants. Ultimately, this will change and these policies will be reclassified.

Question 12: How do they earn a high return on capital with such low interest rates?

Steve Markel: Suggested that they have to try to achieve a much lower combined ratio. If you can’t
make the money on your investments, you have to do it in underwriting. This can be very challenging at
times. They are trying to allocate money to equity markets because they can get higher dividends from
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

stocks than 2 to 3 year Treasuries. As such, allocation of capital can trend toward equities. But, if they
can make good returns on the P&C business, they do not need to be there as much. They will benefit in
the long-term as the underwriting environment improves.

Tom Gayner: Why are interest rates low? First, because of anemic business activity and the fact that
demand for money and loans is weak. There is some element of that but there is another force in the
market—excess supply of money. These are different reasons for low interest rates than normal and
thus the normal behaviors get inverted and the appetite for risk gets skewed. Eventually this will all
revert and a normal relationship will return. Right now there is too much capital in the insurance
business for the demand. Eventually, this will change. Interest rates are low and the demand for
business is low. Business activity and demand for insurance will grow, interest rates will go up and it will
be doubly good for MKL.

Question 13: Warren Buffett has been buying more foreign government bonds. Is MKL doing that?

Tom Gayner: When they write insurance in a specific country, they buy bonds in that currency and run a
matched book. They will not run an un-matched book. But, they do not think they are not smart enough
to know which bonds will do best.

Question 14: How do you open up and staff all of the new offices?

Tom Gayner: They are opening up offices in new locals because they think they know how to. They
didn’t think so 20 years ago. The Terra Nova acquisition has taught them a lot about how to grow
internationally. The London office is spearheading the drive to open up in new markets. MKL’s goal is to
have an underwriting profit and that formula translates all around the world. The company has skills
today it did not have previously.

Question 15: What types of hedges do they have on?

Tom Gayner: Every once in while they have a small number of hedges on. For example, if they write a
big piece of business in Australian dollars, they might just do a currency swap to keep the book balanced
if they don’t find bonds they like. However, these hedges represent a very small amount of money. They
are not a user of hedges in general. They do not think they can predict anything well enough to make a
directional bet. He recently had a discussion about Southwest and the great hedging experience they
had in the past. But, unfortunately, that story does not continue. At the end of the day, as fuel prices go
up, so will Southwest’s costs and customers will end up paying for it.

Question 16: Can you talk about the equity portfolio in terms of valuation and composition?

Tom Gayner: He has more ideas right now than money. The big, global, multinational companies that
have decades of experience operating around the world are very reasonably valued. Dividends are high
and share counts are coming down. But, this is the same thing he would have said last year. Tom Russo
said that they should also look at smaller companies and special situations as well. You don’t want to
have too many of those in the portfolio, but it makes sense to look at them.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Question 17: Are there additional pressures on the business from regulators and rating agencies trying
to tamp down leverage?

Steve Markel: He is not aware that there is a move to de-lever the P&C industry like there is to do so on
the banking side. There are more conversations about catastrophe exposure and management as well as
risk management in general. A major modeling agency has updated its model because worst case
experiences are getting more expensive. Thus, industry-wide exposures are now higher based on this
model. This could eventually help pricing in this business. The rating agencies were scarred and are
doing more diligence. There is still too much capital chasing too few customers though.

Tom Gayner: Based on what he sees from the Basel process, there are some mechanical things that are
not necessarily that thoughtful. Governments and agencies are overacting. MKL is just trying to play by
the rules and do the best they can, given the circumstances. It is a level playing field for everyone.