Argo Group International Holdings, Ltd.
Q1 2010 Earnings Call Transcript

Published: 5 May 2010

[Operator:]

Good day ladies and gentlemen and welcome to the first quarter 2010 Argo Group International earnings conference call. My name is Veronica and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) I would now like to turn the conference over to your host for today, Mr. Michael Russell, Director of Investor Relations.

[Michael Russell:]

Thank you Veronica and good morning. Welcome to Argo Group's conference call for the first quarter of 2010. On the call today is Mark Watson, Chief Executive Officer, and Jay Bullock, Chief Financial Officer. We are pleased to review with you the company's results for the quarter as well as provide management's perspective on the business. Before we begin I’d like to mention that we will be participating in the Oppenheimer Insurance CEO Summit on June 8 and the Macquarie Small and Mid Cap Conference on June 15. Should you be attending one of these conferences, we invite you to sign up for [101] meetings with Argo Group management. I would like to remind you that this call is being recorded, and all participants are in listen-only mode. Following management's opening remarks, the operator will provide instructions on how you may queue in to ask questions. As a result of this conference call, Argo Group management may make comments that reflect their intentions, beliefs, and expectations for the future. Such forward-looking statements are qualified by the inherent risks and uncertainties surrounding future expectations generally and may materially differ from actual future results, involving any one or more of such statements. Argo Group undertakes no obligation to publicly update forward-looking statements as a result of events or developments subsequent to this conference call. For a more detailed discussion of such risks and uncertainties, please see Argo Group's filings with the SEC. With that, I would like to introduce Mark Watson, CEO of Argo Group.

[Mark Watson:]

Thank you, Mike, and hello to everyone. We appreciate you taking the time to join us today. In a moment our CFO, Jay Bullock, will provide you with some financial details on our first quarter and then we’ll take your questions. In a three month period with considerable catastrophic loss activity, we remained profitable, reporting earnings per share of $0.67 and operating earnings per share of $0.32. Our book value per share reached another record high, up 2.8% from December 31 and finishing at $53.81 and continuing a trend of sequential growth and quarterly book value per share. For the 12 months ended March 31, 2010, our book value per share increased by 19.2%. All things considered, first quarters are generally uneventful but as I’m sure you’re aware, this one was quite the opposite. The industry responded to major catastrophic losses in both hemispheres. Our first quarter results were affected by some of these events, primarily in our International Specialty and reinsurance segments and largely from the Chilean earthquake. From a risk standpoint, total capital exposed to first quarter catastrophes was less than 2% of year end shareholder equity. The estimated pre-tax losses for first quarter cats, net of reinstatement premiums was $29 million. $21.6 million of this amount was attributable to the quake in Chile an I’ll touch on that segment impact in a moment. Let me talk about capital first. One can conclude that the severity of catastrophes seen in the first quarter of 2010 might have a meaningful impact on the industry’s available resources and underwriting capacity. Yet we continue to be in the position of generating capital at our company, albeit modestly. This position results from risk management or investment portfolio and by a deliberate retrenchment from the market environment that is worse today than a year ago. Last year at this time things looked a little different. Opportunities appeared attractive due to the impact of financial markets and industry events from late 2008. Unfortunately as we moved into the second half of 2009 and on the back of financial market recovery, favorable trends in rate and terms and conditions began to reverse themselves and in some instances that happened quite rapidly. Since that reversal we’ve been operating in an industry flush with capital and confronting fierce competition from companies either building or protecting market share. Let’s talk about what’s going on with the top line for a minute. We believe that shrinking our top line is a sound strategy during this stage of the cycle and if you’ll recall from some of our previous quarters, we have said that we will shrink the top line for margin and specifically reduce our property exposure in the Lloyd's syndicate. This doesn’t mean that we’re standing by idly waiting for the market to turn. Rather, we’re evaluating and developing opportunities in new geographic markets and continuing to recruit top talent to the organization like Lou Levinson who we recently introduced as President of our E&S segment. Internally we’re streamlining our infrastructure and reducing expenses. While the effects of these efforts may not be immediately visible, we believe their impact will produce benefits for our customers, partners, and shareholders in the near term and position us well for the eventual market improvement. As part of our capital deployment strategy, last quarter our Board reinstated a quarterly cash dividend of $0.12 per share. This morning we announced another $0.12 dividend payment for shareholders of record on June 1. Additionally, during the quarter, Argo Group purchased approximately $40 million of its common stock at market prices and we’re pleased to be in a position to repatriate a portion of our capital directly to the shareholders through both dividends and the buyback of stock. Let me go through each one of the segments in a little bit of detail and Jay will hit some of the financial metrics in his remarks as well. Why don’t we start with the reinsurance segment, which continues to perform well. I would say it kind of adds design. The Argo [REIS] portfolio responded to the catastrophic events in the first quarter particularly the Chilean earthquake where we had losses of about $6.5 million net of reinstatement premiums. No other cat event had a material impact on the segment’s results in the quarter. As you may recall, Argo REIS book responded just as well after Hurricane Ike. Overall the reinsurance segment in the first quarter produced underwriting income of $6.5 million for a combined ratio of 73.9. As positive as these results are, reinsurance rates remain under pressure and there are signs of accelerated market softening. Competition remains high and the market has ample capacity, particularly as cedents feel more confident in their balance sheets, retaining larger amounts of risk and consequently, buying less reinsurance. Our results in our excess casualty business, the other part of the reinsurance segment, remains challenged by the slowed pace of global economic activity and the addition of competition from certain new and existing markets, although I think we’ll find that the magnitude of the Deepwater Horizon accident will be significant enough to move the casualty market over time. Let me next talk about International Specialty. This is where the premium contraction was the most evident during the first quarter. It was primarily from the planned reduction in certain property classes, mainly our binder business that I talked about last quarter and actually I’ve talked about it for the last few quarters. We’ve been underwriting our book of business and mainly de-risking the portfolio and that has come in the form of reduced premium, but we’ve in the process reduced our aggregates quite a bit and also at the same time, the Lloyd’s property business is becoming more competitive as well for all of the reasons that I mentioned earlier. The loss for the Chilean earthquake in International Specialty was about $15 million for the quarter. In the U.S. let me talk about our Commercial Specialty segments first. Actually, I think given the level of competition, and this is the part of the company where we have the most competition with the admitted market. I think we did okay. We came in with a combined ratio of 99.1. As pricing narrowed our margins a bit and we had some losses from the winter storm activity in the U.S. to deal with as well, keeping in mind that last year we had very little storm activity impacting our Commercial Specialty segment. For our Excess and Surplus Lines business we actually see more competition there than anywhere. Renewals and new business opportunities are down in most areas of the segment. The weak economy has all but eliminated the startups of new ventures. And as a result new business activity has slowed dramatically for the wholesalers with whom we deal. Admitted carriers continue to expand their risk appetites and are extremely aggressive in capturing new business that once was insured in the Excess and Surplus Lines marketplace. Having said that, the E&S segment produced a combined ratio of about 100 in the first quarter on reduced premium. Having said that, we did see our expense ratio stay flat as we have been able to take non-acquisition expenses out of the company's cost structure, and we intend to continue doing that for the remainder of the year. And also, as I mentioned earlier we recently welcomed Lou Levinson to Argo Group as President of our E&S segment, in charge of overseeing the underwriting and business operations of Colony, Argonaut Specialty and Argo Pro. Lou will be based in Argo Group's New York office. And Lou comes to us from ACE Westchester. I’m confident he'll have a meaningful impact on our E&S business, and actually after a month in the job he already has. We expect to see a number of initiatives that he's been working on in that time start to take hold, and I think you'll see them in the second half of the financial results for 2010. And with that, I'll turn the call over to Jay.

[Jay Bullock:]

Thanks Mark. Let me add a few additional details on the quarter, then after that we'll take your questions. Even as market conditions in both our Underwriting and Investment business remain quite challenging, we've been able to maintain our financial strength through tactical underwriting and capital management decisions. In reaction to the current environment, net written premium and earned premiums were down 18% and 6% from the prior year's quarter respectively. Net income was also down from the prior year's quarter. Despite this reduction in our top and bottom lines, we were able to grow our book value per share in the quarter by 2.8%. And at the conclusion of the quarter we can report a compound annual growth in our book value per share of 12.2% since the end of 2002. Away from the reduction of the top line of three of our segments, our underwriting results were impacted by catastrophe losses in the quarter. Our combined ratio of 105% was impacted by 9 points from a series of events, most notably the Chilean earthquake which resulted in losses of $21.6 million, net of estimated reinstatement premiums. By segment, the $29.1 million of catastrophe losses were incurred as follows

[Operator:]

(Operator Instructions) Your first question is from Scott Heleniak – RBC Capital Markets.

[Scott Heleniak:]

I wonder if you could talk about, first International Specialty. How far you feel like you're along in refocusing the books so far, and how quickly you expect to deploy some of that capital to some other areas. If you could touch on that a little bit.

[Mark Watson:]

We should finish derisking the binder business by the first of July, so we're just about finished. And we have a couple of underwriters who we have either announced are coming on or just coming on to the syndicate in the second half of this year. They won't write as much premium as we're letting off the books this year, but they'll be getting going for next year. So we expect to see a decline in premium for this year, but I think that when we look at the opportunities that we have for 2011 I think that we'll be fully utilizing the capacity of the syndicate for 2011.

[Scott Heleniak:]

So you said that since most of the business you're not renewing is pretty much all property?

[Mark Watson:]

It's all property. It's all cat exposed property in remote regions of the world where the margins look great right until an event happens, and then all of a sudden they don't look so good.

[Scott Heleniak:]

Also, expectations for the expense ratios is about 3.5 center, so what are your expectations on where that might end it for the year? I know you talked about some initiatives on getting the expense ratio down; but where do you see that heading over the next few quarters?

[Mark Watson:]

Let me go first and then I’ll let Jay supplement my answer. Part of the expense ratio is a function of mix in business. A lot of that expense ratio is being driven by Argo International, in fact, most of it is. And so as we continue to move away from the binder business or the cover holder business; it has a higher acquisition cost and as we reduce some of our personal accident books; which also has a high acquisition cost, you’ll see the expense ratio start to move down. The second thing that will drive it will be the continued, what I’ll call consolidation of our back offices; not only in the U.S., but in the UK as well, and that’s an ongoing process that probably still takes another year to finish. I don’t know that we’ll see a lot of expense ratio improvement from that because I suspect that the market is not going to improve in terms of competitiveness for the year. I would expect that we will continue to see our top line decline during the year. So any expense improvements we get are likely to keep the expense ratio fairly neutral, as opposed to improving it. And as Jay was mentioning in his remarks, a lot of that expense ratio challenge is coming from the change in deferred acquisition costs, as well.

[Jay Bullock:]

Right. I don’t really have anything more to add to that. I mean, you can take the $8 million off from a ratio standpoint; and that is kind of what the underlying numbers look like. But I think there still will be some additional back unwind because the rate of decline is going to cause the back to reverse.

[Mark Watson:]

I think that becomes even more clear when you look at our cash-flow statements; which we will publish in the 10-Q in the next couple of days.

[Scott Heleniak:]

Okay, that makes sense, that’s helpful. The only other question I had was reinsurance heading into July 1 renewals; do you expect your mix data, I don’t know exactly how you much you write, I don’t think you write a whole lot or renew a whole lot in July, but what is your expectation for renewals there? Do you know where pricing is, I guess in Florida and any other places you would renew?

[Mark Watson:]

Yes. Most of the business that we’ve yet to renew for the Property Cat Reinsurance book is U.S. focused and the majority of that is wins in Florida and other parts of the Gulf and the Atlantic seaboard. Given how much more ceding companies are taking on a net basis and while there is some additional capacity this year versus a year ago, on the reinsurance side, the real change is that demand has dropped significantly. And so, I think that we still have a chance to keep ourselves positioned on the programs where we want to be, but as cedents continue to increase their net retentions, that business gets a bit more volatile. Sorry, the part that we end up reinsuring gets a bit more volatile and whether or not we, as an industry, get the right price for that I think is going to be a real challenge between now and July 1. For our portfolio, we don’t have that much coming up. So I don’t think we’re that challenged, but you are asking the right questions.

[Operator:]

Your next question comes from the line of Amit Kumar - Macquarie Group, Ltd.

[Amit Kumar:]

Can you just talk about your exposure to the Transocean oil rig?

[Mark Watson:]

It doesn’t appear that we have any exposure from our property account, Amit. We do believe that we will have some exposure from our excess casualty business, underwritten out of Bermuda for some of the energy accounts where we sit on some of their excess programs. But at this point, it’s too early to tell exactly what that’s going to look like. We did not insure Transocean, and of course, [BP] is self-insured.

[Amit Kumar:]

And is there a range in your mind as to what that number could be?

[Mark Watson:]

At this point, based upon what we know today, I think it is millions of dollars. It is certainly not hundreds of millions of dollars.

[Amit Kumar:]

Okay, that’s very helpful. Moving on, and this is the final question, in terms of the capital position; obviously you are doing the buy-back, you have a $0.12 dividend this morning, can you sort of just broadly talk about your capital position from this point onward; how you think about it. And once the ASR is done, what are your thoughts on a possible reload on that and maybe even increasing the dividend down the road?

[Mark Watson:]

I think that we always have the option of increasing the dividends. As you’ve seen from what we’ve done in the past when we thought we had capital we could repatriate. We have done one-shot large dividends in the past, most recently in 2007. I think for now having the $0.12 dividend each quarter is just fine. I think that if we are going to repatriate additional capital, it’ll probably be in the form of additional share buy-backs. And I don’t know that we would necessarily reload what we’re finishing, as respects to the accelerated share buy-back; probably, we would do something similar to that.

[Operator:]

Your next question comes from the line of Robert Farnam - Keefe, Bruyette & Woods.

[Robert Farnam:]

Did you have any losses related to the mine explosion in West Virginia?

[Mark Watson:]

We did. We had a small property loss out of the syndicate, and I think it’s about $1 million. But we didn’t have any of the worker’s compensation exposure from our U.S. companies. We weren’t on the risk.

[Robert Farnam:]

That is what I was wondering…

[Mark Watson:]

The syndicate just happened to be on Massey Energy’s Global Property program.

[Robert Farnam:]

Okay. You’ve given bits and pieces about what your growth expectations are by segment. Could you just kind of refresh… It’s not like the U.S. ops were still competitive and they are going to expect premium decline for the year. Is that accurate?

[Mark Watson:]

Yes, I would expect premium declines in the high single digits to the low double digits, year-over-year for each quarter. I think that we will continue to see a contraction in the top line… We will see a contraction in the top line of our International Specialty segment in the second quarter as we continue de-risking the binder business. I think I mentioned this in one of the other questions, and that is that should be done by the first of July. So I think we’ll see a temperament in the rate decline for the syndicate. The reason I hesitate is the property market is getting pretty competitive now. And so, while the maturity of our premium that’s underwritten through the syndicate is property from our Direct and Facultative book. I think it’s going to be challenged for the reinsurance business. I think there’s not that much to be written in the second half of the year. Most of it is written in the first half of the year, with the exception of July 1 business that’s booked on July 1. I think the Transocean claim we were talking about a minute ago will start to move casualty rates later in the year as losses start to trickle through. But, I wouldn’t see that straightaway. So, I think that we’d rather focus on margin right now than on market share. And I think that means continuing to plan for top-line declines in the short run as some of the investments we’re making now come online towards the end of the year and next year. It’s a little early to talk about next year, but I’m a lot more optimistic about next year than I am 2010.

[Operator:]

Ladies and gentlemen, there are no further questions. I will now hand the call over to Mr. Mark Watson for closing remarks.

[Mark Watson:]

Thank you. I appreciate everyone taking their time today to join us for our first quarter call. It’s been a pretty choppy time for all of us in the marketplace and we will remain focused and look forward to talking to you all at the end of the second quarter and report on our results and our progress then. Operator, that concludes my remarks, and thank you again.

[Operator:]

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.