Argo Group International Holdings Ltd (ARGO) 2003 Q3 法說會逐字稿

Good morning and welcome to the PXRE Group third-quarter conference call. (OPERATOR INSTRUCTIONS). At this time, I would like to turn the floor over to your host Mr. Jeffrey Goldberger.

Thank you, Melissa, and welcome everybody to PXRE's third-quarter earnings conference call.

Before I turn the call over to Jeff Radke for opening comments, I would like to read the following Safe Harbor statement. Statements made during this conference call that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor provisions of the Private Securities Litigation Reformation Reform Act of 1995 and are subject to uncertainties and risks. It should be noted that PXRE's future results may differ materially from those anticipated and discussed in the forward- looking statements. Some of the factors that could cause or contribute to such differences have been described in the news release issued yesterday and the PXRE annual report on Form 10-K and other filings with the SEC. We refer you to these sources for more information.

Lastly, I would like to point out that the remarks made during this conference call are based on information and understandings that are believed to be accurate as of today's date November 6, 2003. Because of the time sensitive nature of this information, it is PXRE's policy to limit the archived replay of this conference call and webcast for a period of 30 days. This call is the property of PXRE. Any distribution, transmission, broadcast or rebroadcast of this call in any form without express written consent from the Company is prohibited.

With those announcements completed, I turn the call over to Jeff Radke, Chief Executive Officer.

Thanks very much. Good morning everyone. We are very proud of the results attained by PXRE in the third quarter. Not only have we continued to benefit from a strong underwriting environment, we continue to execute extremely well in our core catastrophe and risk excess business. For the second time in the last three quarters, PXRE posted record net income, an achievement which can be attributed to the strength in our Cat and Risk Excess segment.

During the quarter, there were a large number of natural catastrophes, including hurricane Isabel in the U.S. and Korean typhoon Mamie. Despite the broad reach of these and other events, PXRE's underwriting results on its catastrophe business were excellent. While some luck was involved, I believe that to a large extent the low-level of losses can be traced to our strict underwriting approach and discipline. These events, combined with the Japanese earthquake, hurricane Fabian, and the California brushfires continue to focus the market's attention on the need to maintain rate levels.

For the three and nine months ended September 30th, net premiums written in our core Cat and Risk segment were up 51 and 56 percent respectively. At the same time, net premiums earned in the Cat and Risk segment for the three and nine months were up 37 and 56 percent. The Cat and Risk loss ratio for the quarter was a strong 19 percent. The success in profitably growing our Cat and Risk Excess business is a testament to the underwriting team we have assembled at PXRE and the franchise that we all enjoy.

Looking at market conditions for our key January 1 renewals, we believe the current favorable environment will continue. We are increasing the confidence that the U.S. renewals will experience roughly flat rates. We see signs of increasing demand from certain large companies as they respond to their risk management needs, which are often driven by changes in catastrophe models. This increase in demand may, in fact, place upward pressure on rates.

Outside of the U.S., the market is still digesting the departure of several large reinsurers. We believe this will result in slight increases in rates at renewal. These rate level expectations are supported by conversations at the Monte Carlo, Vod and Voden (ph) and Mamec (ph) industry conferences.

In summary, we believe the market has achieved stability. Not surprisingly, the large percentage rate increases could not continue indefinitely. Conversely we believe predictions of steep rate declines have been disproven. The current environment is very attractive for PXRE in our key classes of business. We expect that our strong A rating and PXRE's franchise will allow us to continue to profitably grow our property catastrophe business meaningfully in 2004.

Looking to our other segments, we have continued our strategy in finite, keeping the business relationships we have without expanding. The failure of many of the contracts to transfer sufficient risk to qualify as reinsurance has reduced the premium volume dramatically. When one includes investment income attributable to finite contracts, the segment was profitable for the quarter. In the Exited Lines, we continue to book the few remaining live contracts at very conservative loss ratios.

A final item before I turn the call over to John. Coming into my first full quarter as CEO, I committed our team to resolving the adverse development issues affecting our Exited Lines segment. Not only has this overshadowed the tremendous results of our core catastrophe and risk excess segment, the overhang of this business has been a distraction to the team. During the quarter, we initiated a reserve review of our exited lines segment, which included an analysis by an independent nationally recognized actuarial firm. I made the decision to hire an outside expert to gain the benefit of the broad market perspective their exposure and experience provides. Specifically the actuarial firm reviewed the general liability business previously written by our former direct writing unit, which you will recall had been responsible for substantially all of the adverse loss development during the past four quarters.

As a result of the review, our third quarter included a $6.1 million after-tax net reserve strengthening. With this increase, our loss ratio for this line of business is 154 percent, which according to recently published reports is in excess of a loss ratio carried by other reinsurers writing this line of business during the same period. Additionally our carried reserves now exceed the best estimate of the third-party actuarial firm.

In past quarters, we have warned of the difficulty in setting loss reserves for these underwriting years. We believe that PXRE's reserves at September 30th, includes sufficient provisions for this uncertainty. Accordingly, we have no plans for further third-party or extraordinary internal reserve reviews at this time. It follows that we are not expecting further charges in the fourth quarter related to loss reserves.

At this time, I would like to turn the call over to John Modin for a review of our financials.

Thank you, Jeff, and welcome everyone to our third-quarter conference call. Similar to last quarter, I will review the quarterly results and provide some commentary on our balance sheet. Unless otherwise noted, all comparisons reflect the third quarter of 2003 versus the third quarter of 2002.

First, a summary of our overall results. Net income for the current quarter was 23.7 million or $1.01 per share compared to 11 million or 50 cents per share in the prior period. This is an increase in net income of 116 percent. Annualized return on equity for the third quarter increased to 20 percent. The comparable ROE from the prior period was 11 percent. Shareholders equity grew 4 percent from $500.5 million at June 30th to 520.1 at September 30th.

Book value per share was $21.72 at quarter-end versus $21.32 at the end of June 2003 and $20.05 as of September 30th, 2002. Overall revenues and net premiums earned were 72.7 million and 69.1 million respectively compared to 86.5 and 75.7 million in the same period last year. As planned, finite net earned premium declined by 12.8 million, and Exited Lines net premium declined by 8.3 million. Offsetting these decreases, as Jeff noted earlier, the Cat and Risk excess segment experienced growth of 14.1 million or 30 percent quarter-over-quarter. The prior period's revenue also included $4.8 million of capital gains versus only 500,000 this year. In summary, the revenue metrics reflect our focus on the core Cat and Risk Excess business, planned deemphasis on our finite segment, and the continued runoff of the Exited Lines.

Net investment income for the period was (technical difficulty)-- million in the same period last year. Our hedge fund portfolio continues to produce outstanding returns. It produced $2.4 million in income this quarter versus 500,000 in the prior period. The hedge fund return for the quarter was 2.1 percent compared to .5 percent in the same period last year. Offsetting the hedge fund increase was a decrease in the net investment income on the fixed-income portfolio related to a decline in yields. The decline in fixed-income yields is primarily due to the shortening of our duration. We continue our risk adverse stance in the fixed-income portfolio. The weighted average credit rating is AA+, and the duration is 2.7 years.

The GAAP loss ratio for the third quarter was 51.2 percent compared to 63.7 percent in the third quarter of 2002. The Cat and Risk excess loss ratio was only 19.3 percent, reflecting a relatively clean quarter despite the multiple events that occurred during the quarter. The prior quarter included a 15.7 million loss related to the European floods. Paid losses were 32.8 million during the quarter versus 23.5 million in the prior period. The GAAP expense ratio was 18.3 percent compared to 25.4 percent in the same quarter of 2002. The expense ratio, excluding the finite segment, was 26.2 percent. The commission and brokerage ratio, excluding finite, was 9.7 percent for this quarter versus 9.1 percent in the prior quarter.

Operating expenses in the quarter were 10.6 million compared to 6.7 million in the third quarter of 2002. The increase is due to $1.1 million of expenses associated with our move to Bermuda, and $1.6 million related to a change in foreign exchange income. Included in the 10.6 million of operating expenses this quarter was $800,000 in losses related to assets denominated in foreign currencies. For the most part, decreases in claim payments and loss reserves offset this amount but are embedded in our incurred losses and not separately presented.

Also, a few quick notes on our balance sheet and capital structure. Invested assets and cash have grown 25 percent since year-end, but included in the current amount of 1.01 billion is an $83 million of unsettled trades. The as settled increase was $122 million, which was almost entirely attributable to cash flow from operations. As you can see, total interest expense remained fairly level from period to period, but the underlying components of the debt have changed.

At September 30th, 2002, our total debt of 125 million was comprised 95 million of trust preferreds and 30 million of bank debt. Currently our debt capital is comprised entirely of trust preferred obligations. The after-tax cost of these obligations is 6.4 percent and will remain constant until May 2008 at which time a callable portion converts to floating. The more permanent and less-expensive trust preferred securities have basically replaced the bank debt.

In October of this year, we closed on another trust preferred transaction for which we raised $20 million. The cost of this capital is fixed at 7.7 percent for the first five years, at which time it converts to floating and becomes callable at par.

Finally and somewhat related to the above, we adopted FAS 150 this quarter, which required that we classify the 126.8 million of trust preferred obligations as a liability. The accounting pronouncement requires that the year-end balance of 94.3 million remains in the mezzanine section of the balance sheet.

This concludes my prepared remarks, so I will turn the call over to Jeff for some closing remarks.

Thanks, John. In closing, PXRE remains confident in its ability to increase shareholder value. We also remain comfortable with our previously released guidance of net income in the range of 4 to 425 per share subject to normalized loss ratios. We are excited about the prospects of our core Cat and Risk business and look forward to entering the January renewal cycle. The relocation of our underwriting platform to Bermuda has proven successful in providing us access to both customers and underwriting talent.

Before I open the call to questions, I would like to review the information released last night announcing our intention to do a public offering in December. Per last night's press release, PXRE is planning a December public offering of up to 2.7 million shares of common stock. 1.6 million shares are to be offered by the Company and the remainder to be offered by Phoenix Life Insurance Company. These shares will be offered under the terms of an existing shelf registration, which has been declared effective by the SEC. We expect to use the net proceeds of this offering for general purposes, including contributions to the capital of our Bermuda subsidiary to support growth.

We will not receive any of the proceeds from the sale of common stock by Phoenix. Merrill Lynch will act as the lead underwriter.

Adhering to SEC rules, this is the extent to which I can describe or discuss the proposed transaction. Accordingly, I cannot take any questions pertaining to the offering during Q&A. Please limit your questions to third-quarter results and general business activities.

With that, we would be pleased to open the call to your questions. Operator?

(OPERATOR INSTRUCTIONS). Greg Levin, Citigroup.

It sounded pretty good in terms of the reserve deficiency, and I am just wondering if in the rating agency's mind, if you have freed up decent amounts of capital given that the amount of creep they expected was probably on the order of five times more than the reserve charge you have taken.

I think obviously it is dangerous to predict what someone else is thinking. But obviously we read the same press release that you did where that math was included. I think it is fair to say that if we did not release capital, the rating agencies were certainly encouraged by the fact that we had an outside view of the reserves, and they were also encouraged by the number that the outside firm felt was required. Whether it released the excess capital, I think that might be pushing it too far.

What kind of feedback are you getting from the brokers in terms of, not just the renewal season but the players? Do you have some type of target in terms of increasing your shares in programs with those other competitors that are dropping away and with score being the most recent?

Obviously we and more specifically the underwriters that focus on each individual market have targeted on which they want to increase. Starting from a relatively small base, it is probably easier for PXRE to increase than for someone who is already very large on a given program. I am sure that the thought process includes -- the underwriters thought price process includes knowing that a company that perhaps is pulling out of the business or is having difficulty featured prominently on that particular program. But I would say overall our expansion strategy is much more focused on which customers do we want to expand our relationship with rather than where can we.

Okay. No other questions. Thanks.

Mark Fife, EnTrust.

I did not have a question. I did not hit the button, but thank you.

Jim Wolf, RBC.

Two quick questions. First on the PXRE company surplus, were there more dividends that were paid in the third quarter, and outside of that, can you just reconcile the change in surplus from June to September? And, Jeffrey, you talk about expansion strategy focusing on expanding existing relationships, but can you talk about -- it seems like given the amount of capacity you are going to have as you hit the January renewals, there is obviously going to be a need to add some new relationships, and can you talk about how that is going and how you expect those to develop?

Sure. I think we will do it in reverse order if that is all right. I think generally you are right. Obviously new programs or new customers is probably the easiest and fastest way to grow, and certainly we have that included in our plans. However, again, PXRE is starting from a relatively small base. We expanded our average program participation by something like roughly 50 percent from 2002. There is room to do that again on many programs before we reach the maximum amount that a particular customer would wish to have from any one market on a program.

So you asked how do we intend to do that? I think one of the benefits of having done this business for over 20 years is the stable of customers and companies. If the companies are not the same, many of the people are the same. Our underwriters several writers have relationships with the brokers and the ultimate purchasers, the ultimate customers, which allow us to have a point of view about where we can and wish to expand inside the U.S., outside the U.S., both on property, as well as aviation and to a lesser extent aerospace.

So I think what it is is really a function of taking a look at what programs you write versus what programs you like to and at what share. And the process starts very early on with intermediaries and with customers, and it has been ongoing all year. Now the nice thing about coming to November and December is we find out whether those efforts will reap their rewards. As I have said, we are relatively comfortable that just as we did in '02 and and '03, we are going to have attractive growth into '04.

Okay. Good.

On the surplus question --

There were no dividends during the quarter from PXRE reinsurance company. The surplus at September 30th is 700 -- the combined surplus is $740 million. As we discussed last quarter, included in that amount is $132 million of an investment, intercompany investment that in consolidation will be eliminated, so the $608 million is our group surplus consolidated.

I was just focusing on PXRE Company where it looks like it went down from 423 to 411 from June to September. I did not think that the intercompany elimination should affect that number.

The PXRE reinsurance company?

Yes.

As we have discussed in terms of our refocus from Bermuda -- refocus to Bermuda, surplus in the U.S. company will remain constant or decreased as profits are booked. More of the profits are booked offshore than onshore.

Does that imply that they actually had negative income in the quarter?

Plus reduced. Yes, there would have been a loss during the quarter.

Just to provide some color, the vast majority of the Exited Lines are on the PXRE reinsurance company paper. So that is what drives it.

So the reserve is going to hit --

Disproportionally.

Harden Pathe (ph), DePrince, Race and Zoll (ph).

My question is related to the GAAP ratios section of the press release. I think previously you have given a loss ratio for continuing lines, whereas this quarter, you just gave it for the Cat and Risk Excess. I am wondering if you could provide that same loss ratio for I guess it would be Cat and Risk Excess and finite?

Sure. While John works his 12C, I will buy him some time by telling you why. In the finite segment this quarter, we had a client who chose to recover -- we owed him a pile of money. And that client chose to recover that money in losses, which caused a very dramatic reduction in commission expense, so infinite losses went up and commissions went down.

So when John finishes the numbers, it is going to be a very big number, and that is why we did not -- the reason we did not have that in the press release this time is we think it is misleading to look at just loss ratio. Having said that --

The loss ratio for continuing lines is 33 percent, so the Cat and Risk Excess loss ratio of 19 was brought up to 33 when you include finite and other.

Okay. Thanks.

(OPERATOR INSTRUCTIONS). We are showing no further questions in queue at the time. Gentlemen, do you have any closing comments?

Sure. Thank you everyone for participating in our third-quarter conference call. We appreciate your support, and we look forward to talking to you next quarter with a successful year and more insight into how the 2004 renewals went. Thank you.

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time.