Aspen Insurance Holdings Ltd (AHL) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the 2Q, 2014 earnings conference call. All lines have been placed on mute to prevent any background noise. And after the speaker's remarks there will a question and answer session.

(Operator Instructions)

Thank you. I will now turn the conference to over Ms Kerry Calaiaro. Please go ahead, ma'am.

Thank you and good morning. The presenters on today's call are Chris O'Kane, Chief Executive Officer and John Worth, Chief Financial Officer of Aspen Insurance Holdings Limited.

Last night, we issued our press release announcing Aspen's financial results for the second quarter of 2014. This press release as well as corresponding supplementary financial information can be found on our website at www.aspen.co.

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 US 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.

This presentation contains 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 Aspen's website.

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

Thank you, Kerry. Good morning, everyone.

Aspen reported diluted book value per share of $44.84 at June 30 2014, an increase of 5% from March 31, and an increase of 9.6% for the first half of the year. We delivered an annualized operating return equity of 12.8% in the quarter and 13.8% through the first six months. We're pleased to report another strong quarter as we continue to execute in our strategy to improve return equity, increased book value per share, and gross share holder value.

The investments we have made in the business continue to pay dividends as we successfully navigate a dynamic market environment. Reinsurance had an excellent quarter with impressive year-to-date ex-cat accident year loss ratio of 51%. Insurance was also very successful with the US teams achieving the six quarter in a row of profitability and a particularly impressive ex-cat accident year loss ratio of 64%.

Our insurance business and our reinsurance business are both succeeding and positioned for continued success. We're growing in a responsible, measured way. We provide our clients with innovative, tailored solutions developed by trusted knowledgeable Aspen associates. As a result despite the varied market conditions, we're able to grow profitably.

Previously we have spoken about how we believe we will meaningfully increase operating leverage in the future, growing our premiums at a fast rate in both our expenses and the allocated capital needed for that growth. Over the last five years, we invested some $150 million in US insurance alone to develop the resources and infrastructures to support a growing business. Our US insurance operations are still a very young business with less than $600 million of premium in 2013 and several teams in the early stages of development.

We have nine teams that are underwriting in the US all hand-picked with excellent track records and who are now hitting their stride. It is this combination of skill, enthusiasm, and track record combined with the fact we're still building scale enables us to maintain a very impressive growth rate whilst accident year loss ratios remain low.

We've also continued to invest in our reinsurance business through Aspen capital markets and through our US regional reinsurance network while expanding our international offices in Zurich, Singapore, and Miami. We're now in a position with these investments in both insurance and reinsurance are driving profitable premium growth across diversified lines.

As a result, during the period from January 1 this year until December 31, 2016, we expect premiums to grow by approximately 35% while allocated capital will grow only by approximately 10%. The increased operating leverage is possible because our growth is coming from exposures with only limited correlation to our existing key exposures. Thus, the more efficient use of our capital base will in turn lead to increased ROE.

We expect to achieve this growth despite a rising rate environment which is subject to downward forces most notably in (inaudible). This growth is a result of three factors. Firstly, the strong and enduring relationships we have with our clients and the continuity of service we provide them. In some cases, our underwriters have been working with these clients for 20 years or more.

Second, the creative unique solutions we provide to our clients. We're able to operate in niche areas which provide both deep expertise and an underlying culture which is nimble and innovative. We recognize opportunities, thoroughly analyze the risk, and work collaboratively with our clients and our brokers to find the best solution.

Third, there are many new entrants into the catastrophe insurance business with differing risk appetites and costs of capital. Through Aspen Capital Markets, an increased use of retrocession protection, much of our growth, especially in property catastrophe reinsurance, is being redistributed. The end result is that we have a broadly unchanged but better balanced [retention]. We ensure that we maintain price adequacy on our business, while we continue to provide our clients with extraordinary service, such that they value our relationships and we're able to gain access to the most sought after risks.

Within Aspen Re, we continue to leverage our third party relationships with Aspen Capital Markets. We've now raised [$135] million of third party capital. As you saw (inaudible) we are able to utilize third party capital as well as increase retrocession to grow our growth exposures in property catastrophe reinsurance while keeping our net exposures fairly flat. Through ACM we have developed a symbiotic relationship with third party capital, whereby we can utilize ACM to enable us to offer increased line sizes to our clients, while providing our investors with enhanced returns.

In our US regional reinsurance strategy, we continue to gain momentum and we're excited about providing a full range of products to clients throughout the US As you know we established offices in Zurich, Singapore and the Latin-American hub base in Miami. We are able to use these offices to be closer to our clients. Clients want to trade with people who speak the same language and who understand their ways of doing business.

By having regional offices, we're better able to understand our clients' needs and the risks that we write. We will continue to utilize our international networks for growth, especially in our highly profitable specialty reinsurance offerings.

In summary, our key profitable growth aspects within Aspen Re comprise Aspen Capital Markets, US regional reinsurance, plus Latin America and Asia Pacific.

In insurance we are continuing to see the benefits from [profit] investments come through in our results. About a year ago we articulated a level for US insurance of $550 million in net earned premiums in 2015 which will equate to a 16% G&A ratio. We are on track to reach this. That does not mean that the growth or focus will abate when we reach this level of premiums. It is merely a milestone that we want to highlight as we believe the G&A ratio at that point will be competitive with our peers.

In April 2013 we hired Tony Carroll to lead our US Energy and Construction business, and he has had a very strong first year. We recently opened a regional reinsurance hub in Miami to help expand our presence in Latin America. Initially this office will focus specifically on the onshore energy market where we plan to roll out additional products across Latin America in due course.

We also look forward to continuing to expand in our financial professional lines area, particularly in credit and political risk and technology liability. As you can see we're very excited about insurance and the variety of opportunities across many different lines and regions. We're happy with the progress and performance of our business in the first half of the year.

This progress has been achieved against some head winds. We do remain in an environment of low investment returns and the market has seen pressure on rates in certain insurance and reinsurance lines. Within insurance, aviation, and energy property are the most profoundly affected.

That said, following the Malaysia Airlines losses, we expect that there will be meaningful outward pressure on the aviation war accounts. On the primary side, we will be pushing for increases of 100% in aviation war and we do expect to receive these increases.

In the aviation reinsurance war area, we're expecting that rate increases could take place in the range of 200% to 300%. Thus, a small but very [assumed] market opportunity is opening for us. At this stage we expect the hard market that exists in aviation war not to spread more further afield into the primary aviation (inaudible) area.

Now, we're more than halfway through 2014 and I can say with even more confidence that we're well on the path to achieving, if not exceeding, our 10 '% return equity target for 2014. Currently, based on the assumptions we have stated in our earnings release, we expect an 11% ROE for 2015 and between 11% and12% for 2016.

I'll now turn the call over to John for some commentary on the financial results of the quarter.

Thank you, Chris.

I'll begin with an overview of the results for the quarter and then provide an update on our investments and capital management (inaudible).

Operating earnings per diluted share for the second quarter of 2014 were $1.40, and annualized operating return on equity was 12.8%. Gross written premiums for the group of $779 million, increased 13% in the second quarter compared with a year ago, with underwriting income of $83 million.

The combined ratio was 90.1% with $22 million or four percentage points of net catastrophe losses in the second quarter. For our reinsurance segment, gross written premiums were in line with a year ago and the segment recorded underwriting income of $68 million in the second quarter which is more than doubled compared with the second quarter of 2013.

The resulting reinsurance combined ratio was very favorable at 76% with $12 million or 4 percentage points of net cat losses in the quarter, mainly related to Japanese snow storms and US winter storms. For the first half of the year, reinsurance had a combined ratio of 74% compared with 84% for the first half of 2013 while the accident year ex-cats loss ratio was 49% consistent with that of the same period a year ago.

In our insurance segment, gross written premiums increased 24% to $481 million in the quarter. The US teams account for the majority of the growth where new teams are seeing initial success and they are still growing their books. The combined ratio for the insurance segment in the second quarter was 95.5% with $10 million or 3 percentage points of pretax catastrophe losses net of reinsurance recovered related to tornadoes and hail storms in the US.

In reinsurance, favorable reserve developments was $28.4 million or 10 combined ratio points, largely from short tail lines. In insurance, there was favorable reserve development of $3.4 million or one combined ratio point reflecting insurance being a maturing business.

Prior year reserve releases for the group were $32 million or five combined ratio points. This compares to $27 million in the second quarter of last year. As we have mentioned before, we like to maintain our reserving level in the mid to high 80th percentile and our reserving strength at the end of the quarter remains stable at the 86th percentile.

For the group, the overall operating expense ratio, excluding bid defense costs, was 34.5% for the second quarter compared with 35.8% a year ago. The acquisition expense ratio decreased mainly in reinsurance. The acquisition expense in the second quarter of 2013 included a number of commutations which resulted in a higher than normal acquisition expense ratio during that quarter.

The general and administrative expense ratio was 16.8% compared with 16.1% a year ago. The increase was a result of strengthening in Sterling against the Dollar, as well as higher performance based compensation.

I'll now move on to investments. Net investment income was $46 million in the second quarter of 2014 in line with a year ago. Despite declining yield, our investment income remains stable reflecting a larger asset base of $8.6 billion for the second quarter of 2014 compared with $7.9 billion a year ago. We expect investment income to approach $45 million a quarter on average for the remainder of the year.

Realized and unrealized investment gains for the quarter were $25 million compared with just a small gain a year ago. This includes unrealized gains of $25 million from our fixed income and equity trading portfolios compared with $18 million of unrealized losses from the portfolio a year ago.

For the quarter our aggregate investment portfolio had a total return of 1.3% compared with a total return of negative 1.2% in the second quarter of 2013. The fixed income book yield for the second quarter 2014 was 2.61%, down 7 basis points from the first quarter of 2014 while the duration of the fixed income portfolio was 3.1 years including swap, in line with the first quarter.

A consequence of our strong performance here to date is that our capital has increased. And as you know, we have a strong commitment towards running a capital efficient organization and we have an excellent track record of returning capital to shareholders if it cannot be put to work profitably in executing our business strategy. We believe, however, that it would be more prudent to address this later in the year.

In summary, our business is performing well and in line with our expectations with another good quarter's results. We continue to allocate capital to drive shareholder value whether it be investing in new business opportunities, seeking higher risk adjusted returns in our investment portfolio, or returning capital to shareholders.

I'll now turn the call back to Chris.

Thanks, John. Those of you who are long-time listeners to earnings calls will recall that in February 2013, John and I explained the steps we're taking to improve profitability and the performance of our business. Since 2013, our business has grown stronger and stronger. This is well exemplified by our performance in the first half of 2014.

Our Board and our management both see this as an important evidence of the direction towards further value creation in which Aspen is moving. We've about a thousand employees across the world. Every single one of them is extraordinarily focused today on carrying out this exciting value creating mission.

Thanks for listening to us. John and I would now be pleased to take any questions you may have.

(Operator Instructions) Your first question comes from the line of Amit Kumar with Macquarie.

Thanks and good morning. Two quick questions. Number one is just going back to the discussion on capital and relisting it down the road. I'm assuming that when you say that it's probably post hurricane season discussion, or are we talking maybe about 2015 here?

Amit, no, you're right, it's post-hurricane season. I mean, I think the main thing is that we very much remain committed to efficient capital management, and we just want to see how the next few months play out.

So just going back to the discussion on the strategy and the growth, all this being equal, would it be fair to assume even if there is capital management, that will be a small part of the story going forward?

It's one of the three levers that we outlined last year and it's an important lever in terms of achieving our ROE objectives. Our level of capital has increased over the last quarter as you might expect given the strong earnings that we've achieved, but we are going to manage it very efficiently, continue to manage it very efficiently, and it continues to be a very important part of our strategy. Whether it's reducing capital, for example, by buybacks or finding new investment opportunities.

Got it. The other question I have is, can you give us an update and this is a broader question, talk about the political risk exposure you might have based on the recent developments and what exposures you might have to the recent airplane losses?

In terms of the risk, we've been pretty cautious in and around Russia for some time. We haven't written any risks and we don't know of any significant exposure we have in the Ukraine from a sort of financial risk end of things, partly because of sanctions, but also for reasons of [stencil] underwriting. We've rather been avoiding Russia since the crisis blew up, so those have run down very significantly.

I think you're also using political risk to cover the sort of political violence end of things, such as the rather tragic shooting down of the Malaysian jet over Ukraine the other day. We do write many foreign airlines. It's an area we like to be on and aviation war is part of our portfolio.

But if we look at both of the Malaysian tragedies and we also look at Tripoli Airport, we find that our involvements are very, very modest indeed. Some of these events are a bit too recent to give you precise numbers on, but let me say that neither John or I are losing any sleep about any of these individual events and frankly we're not losing any sleep about the totality of those events.

As I mentioned on the call, however, there has been enough going on in the aviation war markets to turn that market around. I think our products, our services is going to be very much in demand.

As I said in the call, our underwriters would be expecting to probably double the pricing in aviation war going forward and probably even bigger increases on the reinsurance side maybe two to three times.

Got it. That's all I have. Thanks for the answers and good luck in the future.

Thank you, Amit.

Your next question comes from the line of Josh Shanker with Deutsche Bank.

I want to talk a little bit about understanding this quarter compared to or this half of the year compared to the previous half year. If I look at the insurance loss ratio excluding cats prior development in Costa Concordia, you guys had about three hundred basis points of improvement in that number. But if I go to look at Q1 13 vs Q1 12 you had about 300 basis points of deterioration.

I was wondering what was going on in the first half of 2013 that caused it to be elevated, given the fact you've been on a multi-year strategy which should be consistently reducing those numbers.

The question if I heard it right, Josh, is around the first quarter of 2013.

I guess that's what it is, yup.

At that point going back a year or so now, there were a number of attritional losses that we experienced during that quarter which put off the overall loss ratios.

I guess what I'm getting at, if I think about the first half of 2014 and first half of 2012 being about the same in loss ratio, I'd actually find that surprising given the improvements you made in the business.

Should loss ratio be coming down in insurance or is it the additional business you're writing being written at the same margins as the former business?

The business that we're writing is in a pretty much consistent view. There's no significant difference in terms of the margins, I would say, comparing those two periods. If you think about the first quarter of 2013, to your point being a bit more lumpy.

Okay. So it's basically the business, even though it's been growing, it's kind of being written with the same loss profile consistently for the last three years. You just had those attritional losses back one year ago.

Yes, that's fair.

Josh, this is Chris. You do get a little random variation in loss patterns from quarter to quarter. And we happen to have a little bit of that fluctuation going on.

I think if we look to the underlying, we're not seeing that. We want to stress pricing criteria have not changed. We're still pricing consistent with the overall ROE goals. I think you just need to put it down to that kind of short-term, random fluctuation you sometimes see.

That's perfect. And on reinsurance, loss ratio has been coming down pretty steadily now for two years, but also acquisition expenses coming down.

In terms of the type of business, are you moving more to access of loss business? Because we hear in the market that treaty business is having higher ceding commissions, which I would think take up acquisition expense ratio.

That's broadly correct. It's a business mix thing, it's not that we're negotiating lower acquisition costs on any given line of business. It's just that the business mix has evolved and the pro rata treaty is a bit smaller than it used to be.

Does that mean there's any additional risk in an extreme scenario on the book? I mean your P&Ls aren't really going up, but by your exit loss content --.

We're still managing -- we publish the figures every quarter and it's an absolute key metric for us. We've had our risk tolerances per cap unchanged since, I think, 2005, towards the end of 2005. We like to live within tolerance and that's what we're still doing.

All right. It's a very good quarter, and I congratulate you all.

Thank you, Josh.

Thank you, Josh.

Your next question comes from the line of Brian Meredith with UBS.

A couple questions. First, could you remind us what the interest rate assumptions you are using in your projections going out? Are you just looking at the forward curve?

Yes. We're looking at the forward curve increasing, although what actually might happen, is as experience has shown, is anybody's guess at the moment. We are anticipating a modest increase.

So if we're looking at your ROE assumptions on what you're assuming for interest rates, just look at the forward curve? I'm trying to figure out your ROEs. What component is interest rates versus underwriting profit expansion?

In terms of the contribution to ROE. The contribution to ROE from any interest rate increase is modest.

Okay. Great. That's helpful.

And then secondly, Chris, I'm just curious, there was some discussion, G&A expenses up because of some additional incentive comp. Some of the distractions with some of the Endurance stuff that's going on right now, has that resulted in having to have any state bonuses and stuff or to retain people?

I think we talked about that on the last call, and we were just in the process of putting those payments in place at that time. We did that.

We haven't done anything more of that, which is good. Those are essentially retention payments. They're not huge, but there is potential for the key individuals concerned. And they do require those people to be working successfully with us at the end of a set period in time.

The good news is that employer retention has been very high actually, although many, many competitors. And I think that's perfectly understandable, do approach our guys and say you like working where you're working, but something bad might be about to happen to you. You might want to avoid that and move jobs now.

In fact, for our underwriters I think at the moment, touch wood as I say this, 100% of our underwriters decided to remain with us, which is great. And because they remained with us, so the client and the broker both remains with us, which means that we can keep on driving growth. It's a pretty good news story so far.

Absolutely. So the G&A expense increase in the quarter, part of that actually was these retention bonuses?

Yes. If I could help on that.

Not really. That's not been a material amount. It's a story of two haves really. On the insurance side, the G&A expense ratio has decreased, which is what we anticipated as we continue to grow into the cost space in the US. That decrease overall is despite the impact of stronger Sterling which has impacted the UK side.

On reinsurance it has increased. That's a function of a better first half in reinsurance this year compared with last year in higher incentive base compensation accrual.

Great. Thank you.

Thank you, Brian.

(Operator Instructions)

Your next question comes from the line of Max Zormelo with Evercore.

Hi. Good morning.

I was wondering if you could give us a little bit more color on the 35% gross written premium growth target in 2014 to 2016. I was wondering what lines of business would drive the growth, and given market conditions, it should be expected to be front-loaded or evenly spread over three years?

Well, Max, most of the growth will come on the insurance side and relatively little will come on the reinsurance side. On the reinsurance side, just to get out of there quickly, we think Aspen Capital Markets is a growth area and clearly that involves our writing risk to third parties.

We may over the three-year period, depending on the direction of rates, actually be retaining less of that business on our balance sheet, but providing it to those whose risk appetites and cost to capital make it more efficient for them to assume it.

Elsewhere within reinsurance we do see some growth in our Latin-American operation. We do see some growth in Asia Pacific and we do see some growth in the US regional area. But our core businesses in, for example, US casualty reinsurance and property cats, we don't particularly see any growth.

On the insurance side, growth is, we anticipate, reasonably spread throughout the world, but the faster growth currently is coming to the US and we do project that to carry on. As you know, we're in essentially nine lines of business in the US and we see them all having growth potential.

Currently property is probably a bit more challenging than the rest. We're seeing generally rate stability across the US. In some areas like general casualty we might even see some primary bases, at least some rate increases.

The property has a downward trend there. That's short term. The next 12 months is what I see. In general there's growth there.

Financial professional lines, done out of the London operation and also to some extent done some of our smaller international offices, is also going to provide some growth. It's pretty uniform there.

In terms of your question about front-loading, in percentage terms, yes. The percentages have started to come down so the growth rate will decline over the next two years. I don't think I've got any sort of detail to give you on the quantum premium contributed in each individual year, however. But I can tell you that the growth rate itself will come down in each of the next two years.

Okay, that's helpful.

The second one I have, I was a little surprised. The premium retention ratio in primary insurance stayed flat this quarter vs last year. I'm just wondering, when you will start to see the retention ratio rise in primary insurance, as you restructure the reinsurance program?

Max, it's probably best to look at the year to date numbers. They're less impacted by seasonality factors. So if you look at first half of 2014 retention ratio, and I think you mentioned insurance, that is increased to 76% from 72%.

That's a function of the changes in reinsurance purchasing.

Okay. Would the rate of retention rise in future quarters?

What I would say is that we're seeing the benefit of the more efficient reinsurance arrangements coming through and that we'd expect to see a greater benefit during the second half of the year compared to what we've experienced so far.

That's helpful.

And last one if I may, Chris, in your prepared remarks you talked about what drove the growth in property cat reinsurance. Just wondering if you could give us a little bit more on that. Because looking at the margins on the reinsurance business, margins actually declines for year over year. I was just wondering, topline10% there, given market conditions, is a little surprising.

I'm just wondering if you could give us more color on that.

Thanks. I would be happy to do that, Max.

First of all it is true that the margins are compressing in property cat, but they're compressing from a very, very good place. A very good place indeed two years ago, but they've fallen quite a lot.

As we look at the blend of opportunities that make up an ROE that we anticipate this year being 10%, or perhaps a little better than 10%, we would still say property cat is one of the lines of business that more than pays its way. Expected ROE is better than the average.

And the reason that I think I can say to that is that Aspen Re is a very well established, very well connected reinsurer. We have long time, very strong client relationships and very strong broker relationships. We have the faith and loyalty of our clients. We have the support of our brokers. So when we say we want to have a share of an better priced business, we generally find they say yes.

Now, it is true we have competitors about whom that is not true. What the clients are saying today is we want to reduce the number of counter-parties. We want to concentrate our exposures on a smaller number of more significant longer-term clients. So there are those who are losing out and those who are gaining. We're very careful that we're of one of the ones who gain, but when we gain, we gain on the better priced business. So that's the first part of the answer.

The second part of the answer is actually we have not increased our net cat exposures at all. What we've been doing in the course of this year, is taking a bigger growth position and we're using Aspen Capital Markets to redistribute some of that risk, and we're also reacting to changes in the retrocession markets, transfer more of that risk this year than we did last year on to retrocessional players. So we think it's appropriate to take a bigger gross position, but we don't necessarily think it's appropriate to take a bigger net position and we haven't done so.

And I think I've also said in response to another question, as we look forward into -- of course nobody really knows what's going to happen in the cat market this summer, let alone next year. But assuming that there's an absence of major loss this summer, then we'd anticipate further downward pressure on property cat pricing, and I think our net retained exposures therefore may begin to decline, although I'll make no comment about directional or gross exposures at this time. That would be a function of third-party capital appetite and also retrocession markets.

Hope that covers it for you.

Thanks. Thanks for the answers.

Okay, good.

At this time there are no further questions in queue. I'll turn the call back over to the presenters.

Thank you very much for listening to our call this morning. Have a good day. Goodbye.

This concludes today's conference call.