Aspen Insurance Holdings Ltd (AHL) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. My name is Stacy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Aspen Insurance Holdings Third Quarter 2006 Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your host, Mr. Noah Fields. Sir, you may begin your conference.

Thank you, and good morning. The presenters on this morning's call are Chris O'Kane, Chief Executive Officer of Aspen Insurance Holdings, and Julian Cusack, Chief Financial Officer of Aspen Insurance Holdings.

Before we get under way, I'd like to make the following remarks. Yesterday afternoon, we issued our press release announcing Aspen's financial results for the quarter ended September 30, 2006. This press release, as well as corresponding supplementary financial information, can be found on our website at www.aspen.bm. I would also like to draw your attention to the fact that we have posted a short slide presentation on our website to accompany the call.

This presentation may contain, and Aspen may make from time to time, written or oral forward-looking statements within the meaning under and pursuant to the Safe Harbor provisions of the U.S. Federal Securities Laws. All forward-looking statements will a number of assumptions concerning future events that are subject to a number of uncertainties and other factors. For more detailed descriptions of these uncertainties and other factors, please see the Risk Factors section Aspen's Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC and on our website.

Finally, this presentation will contain non-GAAP financial measures, which we believe are meaningful in evaluating the Company's performance. For a detailed disclosure on non-GAAP financials, please refer to the supplementary financial data posted on the Aspen website.

Now, I'll turn the call over to Chris O'Kane.

Thanks, Noah, and good morning. In this morning's call, we will review our performance in this third quarter and for the year-to-date, comment briefly on current and prospective market conditions, update our guidance for 2006, and offer you some initial thoughts on 2007.

Our third quarter results for 2006 demonstrate the earnings power of our diversified business model. We've achieved excellent results in three of our four business segments and recorded strong contribution from investment income. Past performance in our property reinsurance segment benefited from the absence of major cat losses in the quarter. This is not a feature in our Casualty Reinsurance segment or, to the same extent, in Specialty Lines, where the underlying performance of our businesses has been strong.

Turning now to Slide 3, we reported net income of $95 million or net earned premium of $429 million in the third quarter 2006. Our combined ratio was $0.81, and fully diluted earnings per share were $0.94, equivalent to an annualized return equity for the third quarter of 18%.

The third quarter is typically the quietest quarter of the year in terms of underwriting activity, and this year has been no exception. During the third quarter, gross written premium amounted to $457 million, with gross earned premium up $513 million.

Taking each of our four product segments in turn, and starting with Specialty Lines, this division has now written approximately 80% of the total we planned to write for the year and, with the exception of the Aviation account, we're continuing to experience highly favorable pricing, terms, and conditions. In Aviation, competition is intensifying, particularly for airline business, and as a result, we have been repositioning our book away from the airline sub-segment. In general, Aviation's [a task], but if you dig deep, you can find interesting pockets of opportunity, and we have found a number of these, which offer considerably moare profit potential than Airline health.

Performance of our Specialty Lines segment has been extremely good this quarter with a combined ratio of 67.3%. This compares to a figure of 129% for the third quarter 2005 or 95.7% if we exclude hurricane losses. GWP increased by 36% from $57 million to $78 million, and prospects in this segment remain very good.

Moving to our insurance segment, on our last call I referred to the widening gap between conditions in the primary insurance markets in the U.S. versus the UK. This gap has continued to widen. We discussed conditions in the UK market as soft, and it is the reflection of the skill of our underwriters that our UK primary business has continued to perform extremely well. We are continuing, though, to reduce our top line premium to maintain profitability in this account.

For example, the combined rates we have achieved in our UK tiability account of 83.2% to date compare to 79.6% for the first nine months in 2005. I believe these are some of the best results in the industry, and this reflects both our risk selection and very strong pricing discipline.

[Now, but] the picture at our Boston-based Excess and Surplus Lines company is mixed. Our Casualty account continues to perform very well, but the performance of our Property account has been disappointing. This has two main causes. First, we have a strain in our rising [compliant] reinsurance spend, as a consequence of last year's losses and exposure, while at the same time having reduced inward premium, as we have sought to reduce our Florida catastrophe exclusions.

The second issue, which has become more apparent during the third quarter, is an unduly high loss ratio for fire business. We have identified this problem and have taken steps to address it going forward. With the exception of our Property Excess and Surplus Business, the remainder of our Insurance segment continues to perform very well, excluding losses in the Property E&S account, the combined ratio for the Insurance segment was 87.1%.

There's relatively little renewal activity on our Casualty Reinsurance segment at this time of year. Underwriting conditions in this segment continue to be good, although we're seeing increased competition in certain lines. I'm pleased with our performance in Casualty Reinsurance for the third quarter, where we reported a combined ratio of 85.4%, including a reserve release of $7 million, compared to 92.4% in the same period of last year.

Concluding with our Property Reinsurance division, very little business is underwritten for inception after the first of July. The pricing achieved in [inaudible] was some of the most attractive we're seeing, reflecting the predominance of U.S. wind exposed accounts, which renew at that time.

Slide 4 illustrates that our decision to pull back our capacity at January 1 in anticipation of significant improved pricing later in the year was the correct one. This shows the waters in January, when the average rate increase in our U.S. cats book was 18%. We renewed only 55% of expiring premium. But by the third quarter, we renewed 149% of expiring premium, with average rate increases of 96%. We judged the markets very successfully.

The renewal activity we have seen in this quarter has been largely in the UK, however, where we've seen rate increases on two contracts be renewed, averaging 10 to 15% on an exposure adjusted basis, which is very encouraging. In the U.S., the strong pricing environment prevailing in July carried on through August and September.

In summary, the markets we operate in continue to require underwriting judgment and careful risk selections to achieve good performance. And I believe this situation will continue in 2007.

In a way, you could categorize our business in three broad groups. The first category comprises lines such as U.S. wind exposed property catastrophe reinsurance and offshore energy physical damage insurance in the Gulf of Mexico, where the pricing dynamic remains extremely favorable, reflecting the fact that demand far exceeds supply. In this category, we're doing everything we can to take full advantage of opportunity consistent with our risk appetite.

The second category of our businesses comprises classes such as UK property insurance, UK liability insurance, and aviation insurance, where pricing is less attractive and calls for a different response. Here we apply our risk criteria unwaveringly, test every risk to see if it meets our return criteria, search for niches which are outside of the broader market dynamic, and are ready to sacrifice top line to maintain underwriting margins.

The third category comprises the remainder of our accounts and represents approximately 70% of the premium we expect to write in 2006. Here the pricing discipline is generally very good. Margins remain satisfactory, and rate changes typically vary from minus 10% to plus 5%, a situation which we think will carry on for this part of our portfolio during 2007.

The hurricane season has actually been quite active this year but extremely benign in terms of the number of major land-falling hurricanes striking the United States. A number of hurricane forecasters have revised their opinions to take into account meteorological conditions that have been less dangerous than expected.

For example, the Atlantic sea surface temperature, while warmer than average, is not as warm as last year, and weak El Nino conditions, which suppressed the formation of hurricanes, developed in late summer. It is absolutely vital to understand that we can make no meaningful deductions about the long-term hurricane trend based on this year's apparently benign season. This is illustrated by Slide 5, which shows actual hurricane frequency this year versus this year's expectation versus the historical long-term average.

Our pricing models take account of both long-term trends, seasonal forecasts, and intra-seasonal variations. We do not believe there is any basis to alter our pricing approach based on one benign season, and we will not be adjusting our models at this time as a result.

One other major change that we've seen this year is the change in the supply and attractiveness retrocessional cover. A couple of years ago, we had no doubts about the wisdom of an approach based on selling a considerable amount of insurance and reinsurance but redistributing much of the catastrophe risk to the retro markets. At this stage, we're compensating, buying little or no retrocessional protection in 2007. We're doing this because we believe our incoming property business is very well priced, and that it makes more sense to retain a higher proportion of it, rather than sharing it at unattractive terms for us, with our retrocessional partners.

The additional profits we expect -- we must go straight to our bottom line. And to give you an idea of a likely [content], in 2006 we spent $130 million on this form of protection and anticipate spending not more than $50 million in 2007. We're able to do this for 2007 because we made some major changes earlier this year to our catastrophe exposures, which has reduced our need to purchase retro and would allow us to operate in 2007 on a gross [equal with] net basis.

Further, we will continue to monitor retro pricing, the catastrophe bond market, sidecars, and so on, and we will change our approach if circumstances change and the economics of these types of options become more effective.

Now with that, I'll hand you over to Julian.

Thank you, Chris, and good morning.

We have announced a profit for the third quarter of $95 million after tax, which compares with a loss of $362 million after tax in the third quarter of 2005. Our overall combined ratio was 81%. This result has a number of key drivers that I will explain in further detail.

Gross written premium was $457 million in the quarter, 7% less than last year. The biggest reduction was in property reinsurance, which is down $60 million. However, the corresponding figure in 2005 includes $58 million in future reinstatement premiums arising in 2005 from the hurricane losses. Excluding reinstatement premiums, we have therefore written a similar dollar level of property reinsurance premiums; although the much stronger pricing environment means that this comes with much less exposure.

Excluding all hurricane-related reinstatement premiums, the level of total gross written premiums is up by 5% on a like-for-like basis, as shown on Slide 6.

Reduction of $12 million in the Insurance segment reflects increasing competition, in particular within the UK liability and commercial property accounts, where we have given up business in order to reduce the impact of falling rates.

Our Specialty Lines and Casualty reinsurance segments recorded increases in gross written premiums of $20 million and $15 million respectively, with the growth in our Specialty segments driven by rates increases in offshore energy and new business in aviation, hull, and liability as the accounts matures. Slide 7 gives a breakdown of the Specialty segment GWP into its component parts.

Our overall loss ratio in the quarter was 54% compared to 180% in 2005. This quarter has benefited, of course, from there being no major hurricanes. Excluding the impact of hurricanes, the loss ratio in 2005 was 62.6%. The changes in the underlying accident year loss ratios offset out on Slide 8.

This quarter, we have released $12 million of prior year reserves compared to releases of $11 million in the corresponding period of 2005. The $12 million release is net of deterioration on the net hurricane claims reserves of $14 million equivalent to 2.4% of our net [ARW] of losses.

This has a bottom line impact, however, of only $4 million after deducting additional premiums receivable and tax. The overall release also includes $17 million from our Insurance business, $7 million from Casualty Reinsurance, and $3 million from Specialty Lines.

Our expense ratio in the quarter is 27% compared to 27.1% in the corresponding period in 2005. This continues an improving trend from Q2, at 29.4%, and Q1 at 32.7%, and is illustrated and analyzed further in Slide 9.

I will now turn to our underwriting results on a segmental basis. All of our four business segments were profitable during the third quarter. The combined ratio for the Property Reinsurance segment was 78%. As will be expected given the lack of hurricane activity, the results for cash in the excess of loss treaty is excellent. However, the results from risk excess treaty were impacted by an $8 billion [inaudible] and fire loss reported in the quarter and some late reported claims activity from 2000 to 2004, which also lead us to adopt a more cautious position in reserving for accident year 2006.

The Casualty Reinsurance segment has produced a combined ratio of 85.4% compared to 92.4% in 2005. New adoption in the loss ratio relates to strong accident year performance and continuing favorable development on the business written in our international casualty and U.S. casualty accounts. This has given rise to releases in relation to prior periods of $7 million in this quarter, equivalent to 5.5 points off the combined ratio.

Casualty Reinsurance loss reserves at the end of the quarter have risen from nearly $890 million from $675 million at the end of last year.

The Specialty Lines segment has outperformed all other segments this quarter, with a combined ratio of 67.3%, with effect from a benign loss experience in the quarter, strong rates in offshore energy, a favorable development of 3% on prior years.

The Property and Casualty Insurance segment has a combined ratio of 98.4% in the quarter compared to 70.6% excluding hurricane losses in 2005. This account benefited from favorable developments on our UK liability and UK commercial property accounts, which have resulted in releases from prior years of nearly $17 million in the period. However, this has been offset by underwriting losses of $13 million in our U.S. surplus lines property insurance business in the quarter, as referred to earlier by Chris.

Net investment income in the quarter of $47 million, or 61%, higher than for the third quarter 2005, due to both rising [cost] for the book yields, favorable movements in interest rates, and [posted] cash flow. We did suffer a loss of $3.7 million from our investments in fund-of-fund hedge funds, which we made last April. This was due to a small share in Amaranth held by one of our funds, and it results in flat overall returns from hedge funds for the year-to-date.

Cash and invested assets increased by 38% compared to the corresponding third last year. At the end of the quarter, the bond portfolio had a book yield of 4.44%, a market yield of 4.97%, and a duration of three years. Slide 10 shows the rising trend in book yields over a period since December 31, 2004, which has been driving much of the increased contribution of investment income to earnings over that period.

At September 30, 2006, our gross reserves, or losses and loss adjustment expenses, were approximately $3.0 billion, of which 46% represented estimates for losses incurred but not reported. This is down from 52% at December 31, 2005, as a larger portion on the hurricane losses within the IBNR at that time, have now been notified.

Reinsurance recoverables have reduced significantly from $1.19 billion at the end of 2005 to $788 billion, with effect in the collection of reinsurance claims as we pay the hurricane losses.

The gross balance sheet figure, in fact, overstates our net credit position with reinsurers, which is reduced by collateral held and by reinstatement of previous payables. The total net credit position is $615 million compared toe $824 million at June 30.

I would now like to update you on some of the factors that are likely to influence our full-year results for 2006.

We currently expect GWP for the year to be down 6% -- 10% on 2005, a smaller decline of less than 5% in net written premium because of lower reinsurance costs. We are narrowing the combined ratio range for the full year to 85 to 87%, including a cat load for Q4 equivalent to two percentage points, meaning that the combined ratio range, ex-cats, is 83 to 85%.

Investment income guidance for the year remains at $190- to $200 million.

I will now turn the call back over to Chris.

Thanks, Julian.

We've been going through some major changes in recent months, and I anticipate further strengthening of the way we operate, of our people, and our processes in the near future. One of the key themes for 2006 we discussed with you on Investor Day in June this was improving the quality of our execution, and we have made good progress in this regard.

Many of you will have seen that we recently announced that Stuart Sinclair joined us as President and Chief Operating Officer starting on September 20. Stuart brings with him a wealth of experience and his track record of creating shareholder value in a variety of businesses within the financial services arena.

At Aspen, Stuart will be building on progress we've already made over the year by creating greater alignment between our systems, our processes, and our underwriting teams, and by improving our operating effectiveness and our operating efficiency.

While Stuart is our most significant recent hire, we are currently in discussions with a number of very high caliber individuals, both in underwriting and elsewhere, to strengthen further our organization, and I will keep you informed of our progress in due course.

Aspen is, of course, first and foremost, an underwriting company. Market conditions continue to be very favorable in a broad cross-section of our lines of business, and the prospects for 2007 are attractive.

The question we have to answer as an underwriting company is what is the best way of delivering the highest risk adjusted returns to our shareholders. This is a complex question, and I'm now going to bring together some of the themes from this call in addressing it.

First, there are a number of classes where pricing is extremely attractive and we could write considerably more of such business. However, we have set ourselves a risk tolerance of 17.5% of surplus, or a 1-in-100 year event, because we believe that a higher tolerance implies an unacceptably high level of volatility.

Second, we're matching our exposures with our capital base in such a way that we no longer need to purchase retrocessional protection, and this allows us to obtain more of a profitable business -- to eat more of our own cooking, if you like.

Third, we're looking at ways to reconstitute our capital structure more efficiently and increase financial leverage and are likely to implement a number of capital management measures as a result.

In conclusion, we believe that the effect of the three components I've just outlined, together with a continuing focus on manage our top line through underwriting discipline and a rigorous risk selection, will have a very positive effect on our business.

We'll now turn the call over to questions.

[OPERATOR INSTRUCTIONS]

Our first question is coming from Vinay Misquith from Credit Suisse.

Hi, good morning. Question on your portfolio restructuring of the property business -- is that largely done this year? Or do you propose to do more of that next year? I think you mentioned earlier that it's largely done and that you're looking to keep more business net rather than write more business. If you could expand on that for next year, that would be great.

Vinay, I would be very happy to do that. I think it's fair to say that the restructuring is almost complete. As you know, we reduced the critical zone cat exposures, particularly Florida, by something of the order of 50 to 55% at a gross level this year compared to last year, and we bought less retrocession this year. We bought it -- the retro we bought for '06 -- we bought it earlier, and I think we bought it at fairly attractive prices compared to what happened to retro prices later on in '06.

As we look forward into '07, we think that retro is not a sensible purchase -- not likely to be. Consequently, it makes sense to reduce our critical zone exposures a little bit more. It will just be Florida if we reduce this way, and if we reduce that little bit, we would not need to buy any retro whatsoever. The consequence of that is -- I think you summarized it correctly -- is that, while our gross exposures would reduce a little bit in Florida, our premiums, because we would write other zones of exposure, a little more than we've been doing this year, will be stable or even slightly increasing. But our net retained premium would increase very considerably, and hence, our earning power would increase very considerably.

That makes sense. On the casualty premium increase -- I know it's not a begin quarter for casualty reinsurance, but why did the premium growth pickup on that line?

The pickup is mainly in U.S. casualty business, rather than in international accounts, and there is some fluctuation from quarter-to-quarter just because of the opportunities that are presented, particularly in our structured risks operation. But [anyhow], the straight answer is it's in the U.S. account rather the international.

But, I mean, because it was our impression that competition is increasing in the U.S. casualty reinsurance. I'm just curious as to was it just a timing issue or just a quarterly quirk? Or was it something more?

I wouldn't read very much into it, Vinay. I would say, though, that our U.S. casualty reinsurance, it's a treaty excessive loss account. It's most of it written from London, and it's very, very highly specialized indeed. We focused on selling excessive loss contracts with a loss ratio cap to medical malpractice and workers' compensation clients, and in some states, we find good opportunity, and with some customers we find good opportunities to sell, other states it's very unattractive.

At the same time, another phenomenon is going on, disguised by your question, which is workers' comp on a catastrophe clash basis. Actually rates there are falling. We're doing less of that. I think that the change is more of a momentary blip in the quarter, rather than a symbol of a change in direction for us in overall.

All right, that's great. And on the departure of senior executives. You said you just hired one person recently -- oh, Stuart Sinclair -- and you're in discussions. How soon could we expect that? And the departure of these three senior people, what effect has it had or do you expect to have on the business -- at least in the next few months?

Okay, let me take the second part of your question first. It's the easiest part. I think it's going to have no impact at all on our ability to produce business. The guy who left -- good guys, experienced guys -- were in managerial positions. They were not the, in general, the custodians of the client relationships or the broker relationships. So our underwriting teams are unaffected by this.

They are still there. They're seeing the brokers. They're seeing the customers. We've [inaudible] opinions, and we really do not have any concerns in that regard. I think it's fair to say that the three people missing in the managerial ranks, that needs to be addressed, but it's more of a management than a premium production issue.

I can't be too specific about the first part of your question. We're talking to a number of people. Several of them, I think, are very, very good people and we'd be delighted to have on board, but inevitably, it's negotiation with human beings, and it's very hard to predict how long it will take. All I can say is that we're talking about significant hires, and if in -- at the point where we make, we will be announcing it fairly prominently. You will know almost as soon as we hire them.

All right, that's fair enough. And on the capital management front, I believe you said that you would increase leverage. So would that involve stock buybacks?

Vinay, at this stage, I think we would state that our objective is increase balance sheet leverage. And there's a number of ways in which that could be achieved, and we have yet to determine exactly how we're going to proceed.

All right, and you haven't had discussions about that with the rating agencies that you have, correct?

We have been talking to rating agencies about our capital position and our capital plans, and those discussions are ongoing.

All right. And one last question -- and I'm sorry for so many questions. In the property insurance, I believe you said that you had one -- or said that there was unduly high loss ratio for fire. Now was it in the UK or in Europe? And I believe you mentioned that it will show in the future, that's why you're reserving that business to a higher level -- if you could expand on that, please.

Vinay, we made two separate points about property losses. The first reference that you picked up to fire losses was in our U.S. surplus lines business, and there we're distinguishing fires losses from the -- [like] cat losses that we might have expected in a hurricane active season. And in the U.S. surplus lines property business, we -- I think we've identified the source of the abnormally high fire loss ratio and that that will need to be addressed going forward.

The other reference I made was in our property reinsurance risk excess accounts, where as a result of some late reporting activity from 2003, we have strengthened our ex for the year 2006, reserving IBNR position in case that sort of late reporting is repeated on an ongoing basis.

All right, thank you.

Thank you, Vinay.

Thank you. Our next question is coming from [Adam Galeeski] from Goldman Sachs.

Good morning. I'm just wondering on the capital management front -- I recognize that those conversations with the rating agencies are ongoing, but do you anticipate bringing yourself to a level of leverage that's inconsistent with your current credit ratings?

No, absolutely not. I envision that the level of leverage that we would aspire to would still be conservative against rating agency expectations and, indeed, I expend financial prudence.

Okay, so it's simply, really -- I mean, I don't want to simply things too much here, but it sounds more like it's an exercise in making your balance sheet as efficient as possible given the ratings that you currently have, rather than accepting a lower rating in exchange for higher financial leverage. Would that be a fair characterization?

Absolutely right, yes.

Okay, thank you.

Thank you. Our next question is coming from Donna Halverstadt from Goldman Sachs.

My question was asked a couple times. Thank you.

Thank you.

[OPERATOR INSTRUCTIONS]

Our next question is coming from Tom Chalnoky from Goldman Sachs.

Goldman Sachs' is monopolizing this call.

Always a pleasure to do business with you, Tom.

Well, I'm glad to hear that. Just -- Julian, looking at Page 18 of your release, which shows reserves by business segment -- could you give us an idea of what kind of IBNR sits in each one of these buckets right now or what percentage of those reserves represent IBNR?

Well, I don't have exact figures with me, but I can give you directional indications. The largest buckets of IBNR are in the casualty reinsurance area and in the casualty insurance parts of the account, as you'd expect. In property reinsurance, for the 2006 accident year, we are carrying something like $60 million of IBNR, with respect to our -- mainly our risk and pro rata accounts. So that gives you some evidence there, but I could then -- Tom, I can call you later today and give you exact figures for the splits across each segment, if that would be helpful.

Okay, and then just as a follow-up -- can you talk about the IBNR you have for the '05 hurricanes? So if you can refresh me or -- or is that all case reserve for the '05 hurricanes?

Yes, I mean the vast majority of our reserve is either reported losses or it client-specific reserves where we anticipate the clients' [spikes] going higher. There was an element of general non-client specific IBNR in offshore energy accounts, which is about $2 or $3 million, and in our property cat accounts. But the vast majority of the current reserve is [ENR] to specific clients where we expect relevant.

Okay. And then just an income statement item -- what is this other income expense of $7 million, which seemed to, like, jump out of nowhere?

Well, that is the change in the fair value of our cat-swap derivatives in the quarter, which is the result of the passage of another quarter with no additional events that could give rise to recovery. So if this cat-swap had been a straightforward IRW -- property reinsurance, for example -- that [benefit] would have appeared as a reinsurance premium, but because it's a derivative accounted for on a mark-to-market basis, we have an amortization in effect of the value of this swap in the quarter.

And what was the impact of that on that line item?

$7 million.

It was $7 million?

Yes.

And how should we think about that in the fourth quarter and in 2007?

It will be a lower debit in the fourth quarter and, indeed, in the first two quarters of next year because the majority of that relates to the passage of the wind season in third quarter of '06 and the results of there being no hurricane events that could have triggered a recovery. That part of the premium was written off.

Okay. That's fine.

The remaining unamortized value there is something of the order, I think $5 or $6 million, to be written off over the period from now until the contract expires in August of next year.

Not a problem

Indeed.

Okay, thank you.

Thank you.

[OPERATOR INSTRUCTIONS]

Sir, there appears we have no further questions.

Okay, well thank you all for joining us on our call this morning. Have a good day. Bye.

This concludes today's Aspen Insurance Holdings Conference Call. You may now disconnect your lines at this time, and have wonderful day.