Argo Group International Holdings, Ltd.
Q2 2013 Earnings Call Transcript

Published: 7 Aug 2013

[Operator:]

Welcome to the Argo Group 2013 Second Quarter Earnings Call. My name is Adrianne and I will be your operator for today’s call. At this time, all participants are in listen-only mode. Later we’ll conduct a question and answer session. Please note this conference is being recorded. I’ll now turn the call over to Susan Spivak Bernstein, Senior Vice President, Investor Relations. Susan Spivak Bernstein, you may begin.

[Susan Spivak Bernstein:]

Thank you and good morning. Welcome to Argo Group’s Earnings Conference Call for the second quarter of 2013. Last night, we issued a press release on earnings which is available in the investors section of our website at www.argolimited.com With me on today’s call is Mark Watson, Chief Executive Officer and Jay Bullock, Chief Financial Officer. We’re pleased to review the company’s results for the quarter as well as provide you with management’s perspective on the business. As the operator mentioned, this conference call is being recorded. Following managements opening remarks, you will receive instructions on how to queue in to ask for 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’m pleased to call – turn the call over to Mark Watson, Chief Executive Officer of Argo Group.

[Mark Watson:]

Thank you, Susan. Good morning everyone and welcome to Argo Group’s second quarter earning’s conference call. I’ll briefly share my thoughts regarding this quarter’s highlights after which Jay Bullock, our CFO will add more detail to the quarter’s financial results. Overall, we’re pleased to report our results for the second quarter having generated $31.7 million or $1.13 per diluted share of net income, which is up from $24 million or $0.84 per diluted share in the second quarter of 2012. Our second quarter for 2013 operating earnings were $0.74 per share compared to $0.50 in the comparable quarter in 2012 or an increase of almost 50%. During the second quarter, the capital market separated as a result of interest rate volatility and like everyone else our investment portfolio was affected by the significant rise in rates, widening of credit spreads and the June decline in equity values. From year end, the decline in our unrealized gain position was approximately $80 million on a pretax basis. As a result, we ended the quarter with diluted book value per share at $55.73, which was still up modestly from $55.22 at year end December 31, 2012. Fortunately, with the market recovery in the month of July, we regained approximately 50% of the second quarter decline. This is mainly from the diversity and asset classes added to our portfolio over the past few years. That said the decline in rates over the past several quarters and changes we’ve made in asset class select have impacted our net investment income and will likely continue to do so for the next few quarters. Our objective is to create long term value for our shareholders and we believe the decisions we’ve made will do just that, so in the short run, our investment income will likely decline as the duration of our bond portfolio shortens even more than in the past. We’ve maintained a measured pace at return of capital to shareholders in the quarter. While our stock prices moved up quite a bit this year, we continue to think of our – we continue to think our franchise is undervalued and still we use share repurchases on discountable value as a great investment. In the first six months in this year, we’ve repurchased approximately 750,000 of our shares or 3% of our 2012 year end share base. In the second quarter, we repurchased $17.8 million or 427,751 shares at an average price of $41.58. Our dividend remains consistent with the previous quarter at $0.15 per share on the slightly larger number of share as for total dividend payment in the quarter of just over $4 million. Turning now to our underwriting business, in the second quarter, we produced consolidate gross return premium of approximately $543 million, an increase of 14.3% from the second quarter of last year. All of our segments contributed to the growth this quarter with the exception of our commercial specialty business, but as I forecasted on our last call, that was as expected. In terms of market conditions, we continue to experience rate improvement consistent with the first quarter of 2013 and within our expectations for each of our businesses with the soul exception of our property catastrophe business where we’ve seen slight rate increased. While signs of increased competitions are becoming evident in the market place, our established positions in our selected areas of focus have allowed us to continue to push for rate increases. As we noted last quarter, in businesses where we identify the greatest need for rate improvement, we’re still achieving our plans. Unlike the first quarter, the second quarter of this year presented a higher frequency as small to mid-size catastrophe and weather events. The effects of which were experienced across the market. Despite this higher activity, our combined ratio improved just over four point year-over-year. We continue to benefit from favorable reserve development on prior years and receive the benefit of our past and ongoing repositioning efforts in certain businesses. While we had our share of large loses in the quarter and we’re impacted by some of the catastrophe events; the incident of loss to us is reduced relative to a similar set of events two years ago. A good example of this would be the European flood. The impact of which was approximately $4 million to us. If we had this happened a couple of years ago before the re-underwriting action that we’ve take, we would have seen a much larger loss. As we said in past quarters, our expense ratio remains higher than it's acceptable to us. It is however a reflection of our long-term investments in the business and we expect to see continued quarter-over-quarter improvement as our initiatives take hold in our recent growth begins to flow through our results. Let me briefly comment on each of our operating segments before turning the call over to Jay to discuss our financial results in more detail. Our Excess & Surplus Lines business grew just over 22% in the second quarter. We continue to build on the positive momentum from the first quarter and last year, driven by continued improvement in rates, strong submission activity and good growth in new business. We are particularly pleased that much of the growth is in our most profitable segments. Our practice of reserving prudently incurring accident year has been most pronounced in this segment whereas in prior quarters we’ve benefited from positive prior year development. In commercial specialty, as expected we saw a decline in gross written premium which has direct result of our strategy of our moving underperforming accounts. The decline was partially offset by rate increases and modest growth in other business units. I have to say I feel very positive about the progress we are making year to date as we are achieving rate increases in excess of our plan at least at the moment. And I want to thank everyone who’s been working on the implementation of this turnaround over the past 12 months. You will recall that we had a paramount of negative reserve development in this quarter a year ago and fortunately that hasn’t happened this year. Our international specialty segment achieved an increase of 14% in gross written premium, benefiting from growth in all of our business lines. Now we’re seeing the market challenges in the property catastrophe business I mentioned earlier, we actually grew premium modestly. The build out of our Brazilian operations is moving along as planned as well and market conditions continued to improve and small increments in our excess causality and professional liability businesses here in Bermuda. Fortunately, our margins and I should also say that our margins in these businesses remained good. Rounding out our segment discussion is our moving Syndicate 1200 which had another good quarter. Gross written premium grew over 20% in the quarter benefiting from increased writings in our property book as well as stronger than expected additional reported premium from recent years of account on binding authorities in both small account property and liability units. Our specialty business was down in the quarter within the Syndicate as we exited certain geographies in the energy sector due to declining rates which I’m pleased we get. In summary, the results for the first six months of the year are an improvement from a year ago and certainly two years ago. We continue to focus on growing where we can in an intelligent manner, improving our underwriting margins, focusing on expense management and producing consistent results across our business units. We’ll continue to invest in our stock and return – in our stock and return capital to shareholders while carefully against risk adjusted returns of other capital uses. With the investments we’ve made in our people, systems and processes, 2013 is shaping up to be a pivotal year for Argo and I’m optimistic about our long-term outlook. With that, I’ll turn the call over to our CFO Jay Bullock.

[Jay Bullock:]

Thanks, Mark and good morning everyone. I'll take everyone quickly through some additional detail on the financials and then open it up to Q&A. As Mark has already been through growth by segment, I’ll point out that the variance in growth rates. In total, the gross written, net written and earned premiums largely a function on the change in the timing and composition of one of our larger reinsurance programs. Overall, our underwriting margins for the business continue to improve. Inclusive of cat losses on a higher than normal incidents of large losses, our accident year loss ratio improved by almost 200 basis points over the first six months of 2012. These improvements are primarily due to rate and underwriting initiatives. At the same time, our expense ratio improved by almost a 100 basis points over the same six months period in 2012 and by 200 basis points when you strip out the effect of the additional equity compensation expense incurred as a result of the increase in our stock price during the first six months of the year. Not a bad improvement but not where we wanted to be yet. And away from the current action at year, we experienced favorable reserve development in each segment. In E&S, positive development of 9.2 was primarily – was $9.2 million and was primarily from action at years 2008 and prior with smaller amounts coming out of nine and ten. In commercial specialty, the positive development totaled $1 million which was the net of positive results in Rockwood and Surety offset by small movements in Argo Insurance and Trident. In international specialty, the result was a positive $300, 000 and the net effect of small favorable movements and liability lines offset by small changes in short-tail lines. And finally, in Syndicate 1200, the positive result of $1.3 million was a net of small positive movements in property offset by small negative movements and liability. In the quarter, losses from cats totaled $9.7 million, coming as Mark mentioned from the European floods and U.S. storms and were largely in line with our expectations. The only other thing to mention on the income statement was the effective tax rate. For the quarter, the rate was slightly higher than expected given the larger proportionate share of income generated in taxable jurisdictions. For the first six months, the effective tax rate was affected with the same as our expected tax rate of approximately 20%. Turning to investments, the overall size of the investment portfolio, including cash, declined approximately $200 million through the first six months of the year, reflecting decline in asset values from the market movements in June that Mark referenced and from the transfer of approximately a $100 million in assets related to the over count quarter share transaction for 2009 and prior in the Syndicate we talked about at year end. There remains approximately $100 million of additional assets yet to be transferred related to that transaction. We’d note again that any associated investment income including the income from assets held on our balance sheet goes to the benefit of our counterpart. The impact of the transaction combined with continued lower investment yields, reallocation of the portfolio, certain strategies targeted towards total return rather than income and modest shifts in portfolio duration resulted in the decline in net investment from this quarter versus the same period of last year. The book yield on the fixed income portfolio was 3.2% this quarter compared a 3.4% in the first quarter of 2013 and down from 3.6 from the second quarter of last year. We recognized pretax realized gains of a $11.5 million included in realized gains was approximately $6.5 million in gains from our equity strategies as we took the opportunity to reduce position slightly during the market strong first half performance. As well gains included approximately $3.4 million from small mandates we’ve made in the past twenty four months that would have historically generated net investment income but because of the structure of the investment are counted for and realize gains and losses. We ended the quarter with a pretax unrealized gain position on the portfolio of $225 million at quarter end down from $305 million at the year end. As mentioned July was a strong month and a meaningful portion of that decline has been recovered. That said, the duration of our bond portfolio is designed to support to our liabilities giving us the ability to hold fixed income investments to maturity. At June 30th, while the spread of duration across the portfolio was tightened a bit, the overall variation remained effectively unchanged and the average credit rating on our fixed income portfolio was doubly in minus. Our equity position at June 30th was approximately $1.5 billion and our total capital approximately $1.9 billion. Both our financial and operating leverage remained modest which provides us the flexibility to respond to market opportunities. We’ve returned $22 million to shareholders in the form of dividends and share repurchases in the quarter and have continued to just spread in the market post quarter and through (inaudible) program repurchasing approximately another 120,000 shares for $5.5 million. As always, we evaluate all alternatives to deploy our capital and continue to buy back stock – to buy back our shares as warranted by the availability of completing our investments relative to the compelling valuation in our stock. Operator, that concludes our prepared remarks, we’ll now – we’re now ready to take questions.

[Operator:]

Thank you. We’ll now begin the question-and-answer session. (Operator Instructions). And we have Amit Kumar from Macquarie Capital on line with the question, please go ahead.

[Amit Kumar:]

Thanks, Amit Kumar from Macquarie Capital, congrats on the quarter. Just a few quick questions, maybe starting with the E&S lines, can talk a little bit more about I guess the increased submissions and how do you feel about the quality of these submissions?

[Mark Watson:]

I think that we’re seeing more submission activity for a number of reasons, I’ll focus on two. One I think more business is flowing back into the non-admitted marketplace and second I think that we’re doing a better job of executing, meaning I think we’re doing a better job of working with our distribution partners and getting out and making sure that we’re meeting their needs and they understand the products that we have available to them. So I think working harder is generating more opportunity.

[Amit Kumar:]

Okay, and – so there’s nothing specific going on in a specific sub segment, which is generating –it’s just a broader trend?

[Mark Watson:]

Yeah – no, I think that’s across the board within our business. It’s not coming from one part of the E&S.

[Amit Kumar:]

Okay, now that’s helpful. The other question is going back to the opening remarks regarding I guess the discussion on the commercial side regarding the underperforming accounts, the retooling of the book, can you sort of expand on that and how should we think about going forward from here?

[Mark Watson:]

Well, so let’s back and think about the last year it was on this call a year ago that we talked about the significant adverse development that we recorded was over $10 million and of course we didn’t see that this quarter. We spent – as we’ve done with the other portfolios which we’ve talked about on various calls, we spend a lot of time going back and culling and getting back to really more of our core business for that underwriting team. And we’ve now been then added for about a year in one portfolio and well, probably pretty close to that in the other, so I think a lot of the hard work has really been done particularly as of the 1st of July, recall that that’s a really big date for renewing much of our public entity business. I don’t mean to suggest that we don’t need to continue working to optimize our portfolios and how we interact with our distribution partners, but I’m really pleased with how hard everybody’s been working and I think that because – I think that the fact that we haven’t seen a lot of additional negative reserve development, speaks well for getting to it soon and the fact that our premium didn’t decline more than it have then it’s good, I think it’s a good thing as well. It is possible and we should plan for the topline in Commercial Specialty to be lower for the remainder of this year as compared to 2012. I think, it’s reasonable to think that in 2014 it will flatten out relative to 2013.

[Amit Kumar:]

Got it, the – I guess, the final question and I’ll stop here is, in the opening comments regarding buy back you mentioned the stock price, the price report I guess and I know that we’ve chatted about this in the past few quarters. Based on your business mix would you slow down the hurricane season or the trend line should generally continue?

[Mark Watson:]

Well, it’s a practical matter. I think we all tend to slow down a bit during the hurricane season. Having said that as Jay pointed out in his remarks a minute ago we’re in the hurricane season now and we’ve still been buying back a modest amount of stock. So we’ve been a buyer in the market for quite a while and I suspect we’ll stay in the market in some way from now until the end of the year.

[Amit Kumar:]

And how do you think about buyback, is that buy back plus dividend equal to sort of net income kind of thought process. I’m trying to recall what we have talked about in the past.

[Mark Watson:]

Well, I know that a lot of companies think about it in the formulaic manner. We think about it differently and perhaps it’s just worth repeating. Capital – we first use capital to support balance sheet in the risk we have on it today. The second use of capital is to support our organic growth and really adjacency growth is very core to our business and the business that we’re riding today. Third, depending upon where our share prices are – I’ve either put capital repatriation next or new business opportunity beyond what we’re doing today and then in the last few years I have focused more on capital repatriation. I can’t – when our stock was trading in $0.50 on the dollar it was hard to imagine a better use for what we thought was excess capital than buying back our stock. As our share price comes up then we may look at other opportunities on a risk adjusted basis, but if you can just – if you look at what we’ve done over the last couple of years, we’ve clearly still been very focused on buying back our stock relative to making other investments not withstanding our share price coming up. So it’s – we’re looking at how we can best invest that capital and it’s not necessarily just a function of repatriating earnings relative – repatriating capital relative to earnings. We don’t think about it that way, we think about how we can best use our capital.

[Amit Kumar:]

Got it, okay that’s all I have for now. Thanks for the answers.

[Operator:]

(Operator Instructions). And we have John Thomas from William Blair on line with the question, please go ahead.

[John Thomas:]

Hi, why did the expense ratio decline so much in Syndicate 1200 for the first half of 2013 relative to 2012?

[Mark Watson:]

Our earned grew substantially year-over-year from about $80 million to $107 million.

[Jay Bullock:]

And that’s just for the quarter…

[Mark Watson:]

Right.

[Jay Bullock:]

I mean some of the first six months.

[Mark Watson:]

It was a 151 versus 198, so it's.

[Jay Bullock:]

Sustains with better leverage.

[Mark Watson:]

The denominator went up faster than the numerator.

[Jay Bullock:]

And as the -- as successful years have progressed as well that make some businesses changing a bit there such that the acquisition cost is slowly working its way down, it won’t change dramatically but there is a modest impact from that as well.

[John Thomas:]

Okay, and then international specialty if you comment on the growth that you’re seeing there and what lines you’re expanding in?

[Mark Watson:]

Well as I mentioned in my remarks, we’re seeing a modest amount of growth across everything within international specialty whether it's property cat, excess causality, excess professional liability, the piece that’s growing the most on the percentage basis would be Brazil but that just because it’s coming off a smaller base.

[John Thomas:]

Alright, thanks.

[Operator:]

And we have no further questions.

[Mark Watson:]

I would like to thank everyone for dialing in this morning. We look forward to talking to you again at the end of the third quarter and hopefully we will be able to continue talking about continued progress in running our company. I’d like to thank everyone as our company for working hard over the last year, it starting to show in the financial results and we’ll talk you next quarter, thank you.

[Operator:]

Thank you ladies gentlemen, this concludes today’s conference. Thank you for participating and you may now disconnect.