Aspen Insurance Holdings Ltd (AHL) 2007 Q3 法說會逐字稿

Good morning. My name is Cheryl, and I'll be yourself conference operator today. At this time I would like to welcome everyone to the Aspen Insurance Holdings third quarter 2007 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (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 Richard Houghton, 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, 2007. This press release, as well as corresponding supplementary financial information, can be found on our website at www.aspen.bm. I would like to draw your attention to the fact that we have posted a short slide presentation on our website to accompany this call. This presentation contains, 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 federal -- U.S. federal securities laws. All forward-looking statements will have 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 in Aspen's annual report on Form 10-K 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 and our earnings slide presentation posted on the Aspen website.

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

Thanks, Noah. Good morning and thank you for joining us. I'm pleased to report another strong quarter of earnings for Aspen. For the quarter we reported net income of $117 million, an increase of 23.4% versus the same period last year. This equates to an annualized return on average equity for the quarter of 20.2%. The combined ratio for the quarter was 84.5%. For the nine months of 2007 net income was $354 million and the annualized return on average equity was 21.2% with a combined ratio of 84.1%. Further details on results is set out in slides 3 and 4. These results were achieved against a backdrop of a declining market, and I'm particularly pleased with these returns as they reflect the changes we made to our business in 2005 to reduce downside risk, and I will come back to this later in the call. This quarter we also realigned our operating segments to reflect the current organizational and reporting structure of our business. These changes are reflected in slide 5. Our four new segments are: Property reinsurance; casualty reinsurance; international insurance, which comprises all of our non-U.S, based insurance operations; and U.S. insurance, which includes our excess and service lines business.

I will now comment on market conditions. Overall, rates are continuing to trend downwards but there is significant variations by lines of business. Rating pressure some of the lines we write, such as UK commercial property and UK employers and public liability is particularly acute. Therefore we wrote less new business, accepted reduced retention rates on (inaudible) in order to preserve underwriting margins, and return on capital. One consequence of this is a reduce in top line, which is reflected in gross written premiums for the third quarter of 18% less than the same period last year. Turning now to each of our business segments as shown in slide 6 and 7, we measure rate relativities on a premium weighted basis average -- I am sorry, I'll read that again. We measure relativities on a premium weighted average on business we renew.

Starting with our property reinsurance lines, overall rates remain flat on business we renewed this year, although rates have trended down from the record highs achieved in July 2006. In our catastrophe treaty book rates are actually up 3% on average n 2007 renewal business. However, the comparison between 2006 and 2007 is somewhat sorted because in January 2007 we saw U.S. prices that were up over 30% year on year and we increased our book in anticipation of rates softening later, which is exactly what happened. April renewal rates were flat, and we've since seen average price declines of 15% on renewals. The trend, however, in property cap pricing is clearly downwards. Our pro-rata treaty business has seen average rate declines of 1% in 2007, and our risk excess treaty business renewal rates were down approximately 4%, with some pressure on terms and conditions.

With property reinsurance as a whole, terms and conditions have remained stable, but we will continue to pay close attention to contract wordings, particularly as the market softens. However, in the underlying primary policies we protected there has been some erosion in terms and conditions.. In casualty reinsurance we've seen prices come down, although slightly less than our expectations. Our international casualty reinsurance account rates declined by approximately 5%, reflecting lower pricing in the insurance markets and we anticipate further rating pressure in 2008. In U.S. casualty reinsurance we recorded a reduction, also, of approximately 5% on our book. Overall, however, downward pressure rates is increasing, with clients referencing recent profitability and ongoing tort reform to press for rate reductions.

In our international insurance segment we have seen rates come off approximately 2% on average on renewal business, although this varies widely by line. In our energy physical damage account average renewal pricing declined 8% year to date, reflecting minimal loss exhibited. Marine liability insurance experienced a 10% increase in average rates due to a combination of market factors and past loss activity in some contracts, although we do anticipate some reductions in the coming months. We recorded a 6% increase in our marine hull account as a consequence of the increased frequency of losses in this line of business. Rates for aviation insurance are down 7%. However, there's some encouraging signs in the aviation market, as some business, which we had reflected as being underpriced, has come back to us at improved terms when the market had been willing to -- unwilling to complete the placement the previous firm order. UK employers and public liability have seen the largest fall off in rates, down 12% due to increased competition, and we've written 25% less premium in these lines as a result. We've also seen average rate declines of 4% this year on our UK commercial property account and our specialty reinsurance account, which we report within the international insurance segment, rates declined by, on average, 5%.

Finally moving to our (inaudible) the market is seeing reductions typically in the range of 10% to 20% on E&S property and 12.5% to 15% on E&S casualty. Our renewal business however is very much better. By leveraging our producer and client connections and careful reselection, we've limited the rate reductions in our property account to 2%, casualty to 5%. Our new property underwriting team has been on board for just over six months and we're making progress and working with wholesale brokers so they understand the business we want. We've changed our [price to produce in] management and we've been more proactive in terms of originating business. The benefits of this will be reflected in our reported performance as we go through 2008. As you've heard from me today and others this earnings season our industry is in the middle of a softening rate environment, and I believe it is worthwhile spending a few moments our business model and why we're well positioned in this market.

Over the years we matured and divested as set out on slides 8 and 9. In fact, we've been pursuing our multi-platform multi-class approach since Aspen's creation over five years ago. We've added approximately $1.1 billion in new lines in 2004, with a particular focus on building, auto insurance, operations, and non-correlating lines. Our portfolio split is approximately 35/65% insurance/reinsurance and 60/40% property/casualty. We made some very deliberate changes to our business model in 2005, including a reduction in our risk tolerance to 17.5%, (inaudible) shareholders equity for one in 100-year event, and 25% or one in 250-year event, which reduced exposures right through the loss distribution curve. As a result we purchased significantly less reinsurance and (inaudible), which has a direct impact on our bottom line. For the record, our reinsurance charge for the nine months this year was $119.3 million, down from $254.4 million for the same period in 2006. In other words, we're very comfortable with the well-priced and diversified cat. exposures we hold and we believe it makes sense to keep these on our balance sheet. This is advantageous, both from a risk management and return on capital perspective.

This quarter we continued to diversify selectively and broaden our portfolio with the addition of two new lines. We began underwriting mainly international focus professional liability insurance account in London and announced our entry into excess cas. insurance with the establishment of dedicated underwriting units in Dublin. We expect to commence underwriting in excess casualty at the end of November this year. Gross written premiums from the lines should contribute around $150 million in 2009. Selective diversification through the addition of new underwriting team is a core component of our long-term growth strategy and we're likely to add other teams in 2008. It is our belief that good underwriters can source profitable business in all phases of market cycle. However, the amount of such business will be limited when rates are low, but this approach, we believe, is extremely well placed to expand rapidly when conditions are right.

We continue to enhance our risk management framework,which has been awarded a strong rating by Standard & Poor's, the second highest rating. Only three out of 29 global reinsurance companies rated by S&P on this basis have a higher rating than ours which we think is a significant achievement. Our tax rate rate has fallen from 20% in 2006 to 15%, reflecting a number of steps taken to improve our overall financial efficiency. Returns have been enhanced further by proactive balance sheet management through our authorized $300 million share repurchase program and we expect to complete the remaining $50 million by year end. The scrutiny we apply to our underwriting is also reflected in how we approach our investment portfolio. We continue to pick up yield without reducing credit quality by careful risk selection and managing the yield curve. This has a resulted in lar -- increasingly large contributions from investments overall results. I'm pleased -- extremely pleased in this connection to announce that Liaquat Ahamed joined our board earlier this week. Liaquat was head of the World Bank's investment department and was CEO of Fischer Francis Trees & Watts. I'm privileged to do have Liaquat join us and I'm looking forward to working with him.

With that I\d like to turn the call over to Richard Houghton.

Thank you, Chris, and good morning. I'm delighted to report on excellent third quarter earnings for Aspen, with net income of $117 million, up 23% on the same quarter last year, and year-to-date net income up 37% to $354 million. Book value for ordinary share for the nine months ended September was up by [21%] from last year and both our third quarter annualized return on equity of 20.2% and 21.2% for the nine months ended 30th of September show the quality and consistence of our performance. In an environment where many of product lines are suffering softening pricing, as Chris described, our third quarter and 2007 performance to date are the products disciplined underwriting, prudent reserving, and most pleasingly in the light of uncertain financial markets, strong investment performance. We have also, of course, benefited from our benign third-quarter cat. season. Our combined ratio for the quarter of 84.5% compares with 81% last year, which had no reported cat. losses. Our year-to-date combined ratio is virtually unchanged at 84.1%, despite pressure on margins, and our loss ratio for the same period is also virtually flat at 54.8%. Our combined ratio, excluding cat. losses, year-to-date was 79.3% compared with 84.3%.

I'll now take you through some of the highlights of our financial performance and provide an update on both year-end guidance and capital management activities. Starting first with our third quarter claims performance, I'm happy to report that the only significant weather related event was the July floods in the UK, for which we have set aside reserves of $7 million, substantially less than the June flood reserve. We have also reduced marginally our June UK flood reserves to $22.5 million. Our total cat. losses year to date are $64 million compared with none last year, with benign third quarter experience balancing heavier-than-expected losses in the first half through wind storm [Kiro] and the June UK floods. We released $29 prior reserves in the third quarter compared with $12 million in 2006, bringing our year-to-date releases to $73 million, slightly up on $58 million at this point last year, but still representing only 3% of net reserves at the start of the year. This quarter reserve releases came predominantly from our international insurance book, and more specifically from both our UK liability book and aviation accounts, as claims were settled favorably.

Our expense ratios is 32.1% for the quarter compared to 27% in the corresponding quarter in 2006. The operating and administrative expense element of this is 14% in the quarter, up from 8.6% in 2006. The key factors driving this increase were the costs of hiring new teams, restructuring our U.S. insurance operations, a higher charge for performance-related remuneration, and higher cost in dollar terms due to the strengthening of Sterling, where over 50% of our costs are incurred compared to the dollar. As Chris already noted, we have slightly amended our segmentation for reporting purposes and the details are set out on page 5 of the slides. We presented our results on both old and new basis in the financial supplement. Gross written premiums were down 18% in the third quarter to $374 million, a reduction of $84 million on last year, of which a decline in property reinsurance contributed $62 million. This reduction is due to softening market conditions, nonrenewal and rejection of business which did not meet our required rates of return, and a change in the seasonality of our property reinsurance business.

In 2007 we wrote proportionately more business earlier in the year than in 2006, making third quarter comparative premium appear low. The timing of our writing in 2006 was delayed, as we anticipated correctly the rates would improve, shifting premium to later in the year than for this year. This year-on-year reduction should be seen in the context of a year-to-date reduction of $43 million or 8%. Property reinsurance, driven by disciplined underwriting and a benign loss experience in the third quarter, made an underwriting profit of $39 million compared with $29 million last year, an excellent combined ratio of 69.1% better the solid 2006 performance at 77.8%. The performance of our casualty reinsurance segment this quarter was affected by a number of one-off considerations and we reported an underwriting loss of $2 million compared with a 2006 profit of $19 million, the latter including a reserve release of $7 million. Our year-to-date combined ratio is 94% versus 82.6% last year, while the combined ratio for the quarter was 101.7% versus 85,4% last year. We expect that year-to-date combined ratio is more indicative of the future performance of the book in the medium term. Our international insurance segment enjoyed a steady quarter, with underwriting profit of $28 million and a combined ratio of 80.9% versus $45 million and a combined ratio of 68.7% last year. Strong positive prior-year developments on both the UK liability, and aviation accounts was offset by a single aviation loss in Brazil of $10 million and July flood losses of $4 million.

I'm please to do report our U.S. insurance operation made an underwriting profit of $1 million in the quarter compared with a loss of $11 million last year, as we continue to restructure the property accounts, in particular. Our investment activities have again produced an excellent performance in the third quarter, generating $72 million of investment income, up by 53.1% on 2006. Details of our portfolio are given on slides 10 and 11. Our performance is driven by increasing book yields in our fixed income portfolio, strong operating cash flow, which has increased our portfolio to $5.8 billion, up by 20% from this time last year. Our investment portfolio remains dominated by high-quality, liquid fixed income investments representing over 91% of our portfolio. The book yield on the fixed income element of our portfolio increased to 5.08% at the end of the quarter, up from 4.94% as of June 30, 2007 and compared with 4.44% at the same point last year. We have an average portfolio rating of AA+ with 89% of our portfolio rated A or better. Only 1.7% of our book is rated BBB and we have no high-yield securities.

There's been much interest in the performance of our investment in funds of hedge funds over the quarter, given the turmoil in the financial markets, and I'm please to do report our multi-manager, multi-strategy diversified selection criteria protected us from extreme volatility. And this portion of our portfolio produced an annualized 6.5% return in the third quarter, contributing $8 million to the quarter's investment income and an annualized return of 13% at the end of the third quarter. Funded hedge funds currently represents approximately 9% of our total portfolio. Turning to capital management, we undertook a further stock buyback of $50 million at the end of the quarter through an accelerated stock repurchase, leaving a further 50 million buyback to complete the $300 million authorized buyback authorized by our board in 2006. We will seek to complete this remaining portion by the year end, subject to market conditions. I expect to provide a further update on capital management on our next earnings call following the year-end results.

Lastly, I'd like to update our guidance for 2007 based on our experience year to date. You'll see an updated set of metrics on page 12 of the slide presentation. In brief, we have narrowed our combined operating ratio guidance to 83% to 86%. Investment income has been increase to do a range of $280 million to $300 million, embedding improving book yields further into our expectations. We've reduced the tax rate range to 14% to 16%, driven by the strong performance of our Bermuda domicile book. Lastly we reduced our assumed cat. [low] for the full year to $90 million to reflect year-to-date experience. To conclude, this is the seventh quarter in a row that we've increased book value per share and our returns on equity for both the quarter and year to date are, we believe, testament to our disciplined underwriting, diversified book and considered approach to our investment portfolio. Our future capital plans will continue to align our balance sheet to the opportunities currently available in the market.

On that note I would like to turn the call back to Chris O'Kane.

Thanks, Richard. Well at Aspen we have a seasoned management team with many years of experience navigating through soft markets. Our approach is predicated on targeted management of the underlying drivers of ROE. Underwriting discipline and risk selection, coupled with prudent capital and balance sheet management, plus strong investment returns are key to performing well in a softening markets. As I've outlined above, we've taken a number of steps to build on our strong underwriting results and position Aspen to continue generating attractive returns and book value growth.

With that I will turn the call over to questions.

(OPERATOR INSTRUCTIONS) Your first question is coming from Alan Karaoglan of Banc of America Securities.

Good morning. I have a couple of questions. Could you comment a little bit on the casualty reinsurance results that had a combined ratio of above 100? And also the expense ratio ticking up you mentioned a few reasons, hiring new people, is that going to force them to write more business in an environment that's softening? And, Chris, how do you make sure that your new team do not do that and still write the business that you want them to write in spite of being just hired?

Okay, Alan. Let me take the beginning of this call and I'll hand it over to Richard to give you more of the hard data. Our view is that high-quality underwriters, particularly teams we like to hire, have a following in terms of breakers/producers, and in terms of clients that they like to do business with that tends to be loyal to them in hard markets and soft markets. The best quality business makes some money in a soft market, it makes more in a hard market obviously. So our view is to bring teams on board now, even in a softening market, will actually yield us some small amount of profit. But it also sows the seed for very rapid expansion when the market turns. I think we can really leverage that distribution capability we have when the rates are better. That's what we're doing and I guess I've done it for my underwriting career and I know it can work.

How do we know that they're not going to write bad business just because that's what underwriters want to do? We don't give them very demanding premium targets. We look at it pretty carefully. We look at what's available. We look at our own track records. We essentially say success is in your underwriting margin -- profit margin, not in your top line. In fact, that's true for the new teams and it's true for the existing teams. No one at Aspen is told that top line is an important thing to deliver, so underwriting margin. Then I guess there is a control apparatus through the Company between underwriting audits, internal audits, line management, interviews with me if it looks a bit strange are also part of the apparatus control. But to be honest, I think our guys right across the Company know what's wanted of them and it's extremely rare that we ever have a conversation to do with, are you writing more business than you ought to be? So the point here is there is an expense ratio uptick as a result in the short-term. The expenses come first, the revenues come later. We look at it, if you like, on a net present value basis, and over three years every team we hire appears to make a lot of sense. I think you also asked about the casualty reinsurance in detail and the expense ratio. I'm going to ask Richard to help on that.

Thanks, Chris. Just to tidy up on the expense ratio. First of all, if I could, I think Chris has outlined most of the issues here, but there were really good news stories for me in the expense number, even though it 's moved adverse. I see the investment spend in new teams, and as Chris said, that comes before the income starts to flow, but we've done some exciting things this quarter and it's cost us some money and we look forward to enjoying the benefits of that in 2008 and going forward. The other sizable element in the expense ratio is our bonus costs, because that's driven by a very strong performance in our year-to-date position. So again, I think that's good news hopefully for our shareholders and our employees. There is also a small 4 X element because we do hold a portion of our cost base in Sterling, and that's just a product of the way the currency has moved in the quarter.

There's nothing, to me anyway, particularly concerning in the Q3 expense ratio. In fact, I think there's quite a few positives in that, but you clearly have to continue to explain the increases in terms of investment and what's positive and if there are any negatives, I will of course be telling you, but that's not the story for this quarter in my view. Turning to the casualty reinsurance book, as usual I think you've got to get away from the noise to try and work out what the underlying performance of the book is here, because we have found some reserve release movement, both in the last year and this year. So I think the really salient ratio that I'd ask you to consider is our year-to-date combined operating ratio for the accident year is 99% versus 97% last year. Chris referred to tough market conditions in this particular section of our book, but if you strip out some of the one-offs that we've had in the quarter that relate to reserve releases, et cetera, then our underlying performance is, we believe, satisfactory.

Two questions, two follow ups, one on the expense ratio. Could you quantify the performance part of the expense ratio? And then second is a 99% or 97% casualty combined ratio at this stage of the cycle acceptable or you're saying reserves are conservative. Could you comment on that?

Yes, sure, okay. On the expense side my variance year on year we're up about $6 million for the quarter and that reflects our year-to-date performance, so that's the number in there. In terms of long-term performance, is 99% adequate? Well you do have to remember what sort of investment performance we can drive from the casualty reinsurance book, so that is still a more-than-adequate combined operating ratio for us to work on.

Okay. And the last question has to do on the guidance. The implied ROE of 16%, to reach the bottom end of that return on equity it suggests a pretty bad return on equity in the fourth quarter. I guess the question that I have, any reason why you didn't tighten up that range, as well, the way you did with the combined ratio and with the cat. losses by moving the bottom part of it up?

I'll confess to my usual accountants prudence I think, allowing the wind blowing a little bid in Bermuda as we sit here today. We still don't quite know what's going to happen in Q3, but as you can see from all the metrics, they're virtually all going the right way, so I will be very, very hopeful that we'll be moving towards the top end of the ROE guidance that we've got in there.

Great. Thank you very much.

Okay, thanks, Alan.

Thank you. (OPERATOR INSTRUCTIONS) Your next question is coming from Vinay Misquith of Credit Suisse.

Hi, good morning. Sorry to beat a dead horse but just wondering with your expense ratio -- with your operating expense, I wanted to know whether this was really the run rate for the next few quarters or would you be spending a little bit more money on your new teams and offset by some reduction maybe in the next few quarters from the bonus accruals. So I just want to get a sense for whether your run rate of about $59 million this quarter will be the run rate going forward for the next few quarters?

This quarter feels slightly on the heavy side, Vinay, is what I would say, but you've got to remember how the ratio's prepared. As you know it's driven off premium, so our focus is on the bottom-line underwriting discipline, so I don't want to get too hung up on the expense ratio, but I would say it's slightly heavier than I would anticipate because of the take on the new teams that we've had and the way we've accounted for bonuses in Q3.

That's fair enough. And I don't know whether you have, but if you could just provide us with a breakdown of the historical performance of the new segments that would be helpful? And on the property reinsurance -- well, looking at the consolidated reinsurance that you purchased, it was roughly about 11% of gross premiums this year. Do you anticipate buying a similar amount next year?

In terms. the historical and the new segments I believe we have disclosed that and will continue to do that for the immediate future so that it would assist in you making comparisons. I;m sorry, could you repeat the other part of your question, VInay?

Sure, it's the --

Reinsurance.

Right.

We're looking at that at the moment. I think a reasonable working assumption is that we would spend approximately the same next year as we did this year, very approximately. It depends a little bit on how prices in that market move and we don't yet know how they're going to move.

Fair enough. And in terms of the top line, just wondering, you have three new segments or new sets of teams (inaudible) that came on board in the U.S. Just curious what you're looking at next year? Would we still see down premiums because maybe you'll be pulling back some more on the casualty reinsurance side and maybe on the property reinsurance, but your three new insurance teams would start to kick in some premiums next year, so just wondering what you could give us --?

I can't give you very much this morning. Next call we'll talk about 2008 guidance. All I'd say is I'm thinking about the new teams replacing lost revenue in stra -- in difficult markets in who knows where, as opposed to necessarily making for absolute growth. I think the line -- your line of thinking that you're on is probably about correct.

Fair enough. One last numbers question, maybe for Richard. The $10 million in cat. losses, which lines does it flow through exactly?

That would have gone through the international insurance line. That was in relation to the UK floods.

Okay. So the entire $10 million would have been that line? Okay.

Yes, there's was about $7.5 million in relation to the UK floods, of which $4 million was in the international insurance line.

Fair enough. All right. Thank you.

Thanks.

Thank you. (OPERATOR INSTRUCTIONS) There appear to be no more questions at this time. I will turn the floor over back to your host, Mr. Chris O'Kane for closing remarks.

I -- actually we may have one more question. Let me just check.

Sorry, we have Jay Yang of Perry Capital.

Good morning. Could you just put the assumed average cat, load in perspective? Do you have any year-to-date number for cat, that you reported?

Yes, sure. It;s around about $64 million year to date.

$64 million?. Okay, great. Thank you.

Thank you. There are no more questions at this time, sir.

Okay. Well, I think that really is the end then, so thank you very much for your attention this morning. Have a good day. Goodbye.

Thank you. This concludes today's Aspen Insurance Holdings third quarter 2007 earnings conference call. You may now disconnect.