Argo Group International Holdings Ltd (ARGO) 2003 Q4 法說會逐字稿

Good morning ladies and gentlemen and welcome to the PXRE Group Fourth Quarter Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following today's presentation. It is now my pleasure to introduce to your host Mr. Jeffrey Goldberger. Sir, you may begin.

Thank you, Elisa (ph.) and welcome to PXRE's fourth quarter conference call. Before I turn the call over to Jeff Radke for opening remarks, I will read the 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 provision of the Private Securities Litigation 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 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 in the PXRE annual report on Form 10-K and in 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 accurate as of today's date, February 12, 2004. Because of the time-sensitive nature of this information, it is PXRE's policy to limit the archived replay of this conference call webcast to 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 the express written consent of the Company is prohibited. With those announcements complete, I give you Jeff Radke, Chief Executive Officer. Jeff.

Thank you Jeffrey. During today's call, I will briefly discuss 2003 results, provide insight into PXRE's underwriting activities during the recent January 1 renewal season, and finally I will complete the call with 2004 guidance. After formal remarks, we will open the call for Q&A.

Before I discuss fourth quarter results, I'll review some of our key highlights for the year. Net income increased 50% to 96.6m. Net income per diluted share was $4.10 compared to $3.28. Underwriting income was up 30%. Net premiums written in the Cat and Risk Excess segment were up 46%. Return on equity was 19.2% compared to 16.5%. And finally, at December 31, 2003, book value per share was $22.24.

The fourth quarter and year-end 2003 results strongly affirm our strategy to concentrate on our core catastrophes and risk excess business, which accounted for 93% of net premiums written and virtually all of our underwriting income in 2003. For the quarter ended December 31, net premiums written in Cat and Risk Excess increased 23%. For the year, net premiums written in Cat and Risk Excess increased 46%. This follows an increase of 202% in 2002.

An obvious contributor to our positive results was the moderate level of catastrophe events in the fourth quarter. The largest losses were the California wildfires, but these did not reach levels we would deem significant. As a result, for the quarter, the Cat and Risk Excess business experienced a 33% loss ratio.

There were roughly $4.1m and $4.2m in incurred loss in finite and exited lines respectively during the quarter. I am committed to ensuring that our exited lines and the de-emphasized finite business are not a distraction going forward. So, we took the opportunity in this last quarter of 2003 to book the runoff business of these areas very, very conservatively.

I'm pleased to say that I've no significant comments on loss reserves. There was no material development on loss reserves for the quarter, we are confident that loss reserves for the Company at December 31 are adequate. PXRE had a very successful January 1, renewal season. We write approximately two-thirds of our business during this period. At January 1, our U.S. catastrophe business grew faster than our international business in keeping with our underwriting plan. The fact that we have a larger international book means that U.S. growth is less capital-intensive. From a market standpoint, U.S. rates were essentially flat on our portfolio while the international business saw some moderate rare erosion.

There were more programs that did not meet our return on equity hurdles in the market this year than in the past. Even though we had to be more selective, this did not hinder our ability to grow. We were able to increase our commitments on the better return on equity programs because of our superior spread and the fact that we do not have dominant outsized participations on these programs. Leveraging our relationships, we were able to achieve meaningful growth in our U.S. and international Cat business at January 1. Risk excess or individual risk business deteriorated in response to the large amount of capital chasing this business. We will not grow and actually we will shrink in this area.

In property retrocessional business, an area where we excels as the leader, we held rate steady and we were still able to grow. Aviation for the type of book we write, so our rate decreases of roughly 10% leaving a more than acceptable profit margin. Finally, satellite rates were strong in the wake of recent market losses and the exit of several writers of this class of business. We will grow in this line as well.

We continue to attract additional underwriting talent into the company to supplement our already excellent team. These underwriters coupled with our A ratings allow us to continue to grow our catastrophe business faster than many of our competitors.

And finally in December 2003, PXRE returned to the public equity market for the first time in 10 years. The affect of this successful offering was three-fold. First, it was an affirmation of PXRE from the capital markets and allowed us to tell the PXRE story to a broader investor audience. Number two, the increased level of capital and general momentum of the company helped us going into the January first renewal season. As projected, we've fully utilized the modest amount of primary capital raised in the offering. Last, the offering increased the liquidity of our common stock and broadened several new high quality shareholders. 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 fourth-quarter conference call. Similar to last quarter, I will review our recent results and provide some commentary on our balance sheet. Unless otherwise noted, all comparisons reflect the fourth quarter of 2003 versus the fourth quarter of 2002.

First, a summary of our overall results. Net income for the current quarter was $27.8m or $1.14 per share, compared to $16.3m or 73 cents per share in the prior period. This is an increase in net income of 71%. For the year, net income was $96.6m versus $64.5m in the prior period. 2003 net income was the highest in the company's 17-year history. Annualized return on equity for the fourth quarter was 22.2% and the ROE was 19.2% for the year ended December 31, 2003. The 2002 ROEs were 14.6 and 16.5% respectively. If we strip out all segments other than our Cat and Risk Excess business, the ROE for 2003 would have been 25% and the combined ratio would have been 54%. Shareholders equity grew 8.5% from $520m to $564.5m at December 31. The reductions in after-tax unrealized gains on our fixed income portfolio were $4m served to reduce the increase in shareholders equity.

We continue to grow the profitable and shrink the less profitable pieces of our business. The Cat and Risk Excess segment experienced growth and earned premium of $13m or 24% quarter-over-quarter and 44% for the entire year, this as Jeff mentioned earlier is on top of significant growth during 2002.

Exited Lines net earned premium was only $1.7m for the quarter and $5.2m for the entire year. Finite net earned premium declined by $16.5m to $14.3m for the quarter as enforced business continues to run off. Using net written premium to measure the future illustrates this point even better. Finite net written was only $8m for the entire year. Net earned premium in both of these segments will be insignificant in 2004.

In summary, the revenue and profit metrics reflects our focus on the core Cat and Risk Excess business, plan the emphasis on our Finite segment, and the continued runoff of the Exited Lines. Net investment income for the period was $6.9m compared to 7.4m in the same period last year. Our hedge fund portfolio continues to deliver outstanding returns producing 3.5m in income this quarter, versus 3.7m in the same last year and 2.4m in the third quarter of 2003. The hedge fund return was 3% compared to 3.4% in the same period last year, versus 2.1% in the third quarter of '03.

For the year, the hedge fund return was 12%. We allocated assets to hedge fund now for seven years. And have had only one quarter at of 28, in which these assets produced a negative return.

Interest income on the fixed income portfolio decreased from the prior quarter, due to a decline in yields. Principal preservation remains a priority with respect to the fixed income portfolio. The weighted average credit rating is AA+ [both] securities and investment grade, and the duration is 2.4 years. Given the risk reward relationship of foregone net investment income, versus the book value, we remain on the conservative side and for capital preservation in front of yields.

The GAAP loss ratio for the fourth quarter was 54.7%, compared to 47.9% in the fourth quarter of '02. The Cat and Risk Excess loss ratio was only 33.4 reflecting a relatively clean quarter, despite the California wildfires. The loss ratio on this segment was only 27.2% for the entire year. Paid losses were 31.4 -- 31.5m during the quarter, versus 24.5m in the prior period. The GAAP expense ratio was 21% compared to 36% in the same quarter of ‘02. Expense ratio for the Cat and Risk Excess segment was 24.4%, comprised of 10.2% commission and brokerage ratio plus 14.2% operating expense ratio. This expense ratio was 26.6% for the entire year.

Operating expenses in the quarter were 9.4m compared to 10.7m in the fourth quarter of 2002. The decrease is due primarily to certain nonrecurring costs incurred during the prior quarter. During the fourth quarter, we shoot up our tax rate for 2003, the result of which was lowering our effective tax rate for the entire year from 4% to 1%. This was driven by the amount of premiums written for the year into the Bermuda operating subsidiary as well as a disproportionate share of the exit lines losses reported by the U.S. company.

Also a few quick notes on our balance sheet and capital structure. Invested assets in cash have grown 26% since year-end 2002. The growth in dollars is greater than 200m and it is due to operating cash flow of 154m and net external financing of 49m. Our balance sheet remains strong, we are A rated by both S&P and AM Best. We have a conservative debt-to-capital position, a portfolio of liquid investments, and adequate loss reserves.

As you can see, total interest expense remained fairly level from period to period, but the underlying components of the debt have changed. At year-end 2002, our total debt of 124m was comprised of 94m of trust preferred and 30m of short-term bank debt. Currently our debt capital is comprised entirely of 157m of long-term trust preferred obligations.

During the fourth quarter, we closed on two trust preferred transactions from which we raised 30m. Including these, the weighted average after-tax cost of these debt [updations] is 6.7%. Reinsurance recoverables decreased to 162.4m from 237m at December 31, ’02 as several historical catastrophe events proceed to resolution. Of our reinsurance recoverable, 91% is due from entities A minus or better or is fully collateralized.

Finally, a few comments on the common stock offering that we completed in December. The offering was our reintroduction of sort into the public capital markets. Jeff and I enjoyed telling the story on a face-to-face basis to many of you in the reinsurance investor community and the support was appreciated. We sold 1.4m shares and contributed the net worth proceeds of 27.2m to our Bermuda subsidiary on the days we received it. This concludes my prepared remarks. So, I will turn the call over to Jeff for some closing comments.

Thanks John. During 2003, PXRE successfully expanded its presence in Cat and Risk, continued to deemphasize finite and put the exited lines business behind us. These efforts culminated in a very successful January 1 renewal season. Based on this January activity, we expect 2004 earnings per share of 4.40–4.80. This guidance assumes low double-digit growth in Cat and Risk premium and normalized catastrophe activity. That concludes our prepared remarks. Operator, at this time we’d be pleased to open the call to questions.

Thank you. The floor is now open for questions. If you do have a question, you may press the number “1” followed by “4” on your telephone keypad at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the “#” key. We do ask that while you pose your question to please utilize your handset to provide optimum sound quality. Once again, that is “1” followed by “4” for any questions at this time. One moment while I poll for questions. Once again, if you do have a question you may press the number “1” followed by “4” on your telephone keypad at this time.

Our first question is coming from Mike Hallett of Fox-Pitt Kelton, please go ahead with your question.

Good morning.

Hi Mike.

Quick couple questions here, firstly and most importantly I was hoping you could flush out some more color on the exited lines, you mentioned in your prepared remarks that you didn’t have any adverse reserve development, but the loss ratio or the loss in acquisition ratio; looks like its over 340% in the quarter that seems very conservative. Can you just give us some more insight into that? That’s my first question.

Sure we had and -- we had premium earned in the quarter from lines of business in exited line segment. Given our horrendous experience on that business, and given our repeated commitment to get the stuff behind us, booking that at anything less than astronomically conservative ratios seems foolish and was not what we wanted to do. So, essentially, we took the worse case scenario for that business that would still being earned in the current accident year, I don't even know what the ratio was because that’s not how we looked at it. We looked at it as trying to get as close to the theoretical worst case associated with that earned premium is possible.

Okay, and then I think John mentioned that you expect the earned premium going forward to be relatively small, but even small number on high level of losses could impact 2004. Can you give us a clear sense of what you expect earned premiums in the Exited Lines to be.

But let me answer that it different way that I think gets us do the same spot that you want. We expect Exited Lines underwriting loss for 2004 to be zero.

Okay that's useful. Thank you.

And -- sorry. Now I am going to have a follow on my answer. The reason for that is the only premium that we are aware of that should continue on in 2004, will be accounting adjustments. Accounting adjustments should not bring with it actual exposure to loss.

Right.

There shouldn't be additional exposure to loss associated with accounting premium adjustments.

Okay, my next question you mentioned that you planned to be cutting back in your Individual Risk segment, what was the premium contribution from Individual Risk in 2003?

If it's okay I can do percentages off the top of my head.

Sure.

In '03 it was 14? of Cat and Risk, I would not be surprised to see that fall to 9 -- 8 or 9.

Okay, and can you give us a sense of the composition of the Cat and Risk segment in terms of reinsurance and retrocessional?

The way I would describe it is the catastrophe component of Cat and Risk Excess, is expected to increase to roughly 49% in 2004. The retrocessional component is also expected to increase to about 33%.

Okay. And what were those percentages in 2003?

47 and 30.

Great.

And where is that coming from? That is coming out of the Risk Excess or Individual Risk business, which will drop from -- as I said, I think, it will drop to below 10%. And also Marine and Aviation will shrink.

Okay. My last question, another Cat specialist, Renaissance Re, in their quarterly conference call, indicated that they saw portfolio quality in their property Cat reinsurance book deteriorating to a levels around 2000 underwriting year, did you experience the same deterioration in your Cat book at January renewals and maybe you can just give us a sense of how you are feeling about that?

Sure, I didn’t hear those remarks, so I can't really comment on what that particular speaker meant, here is what I can say about the business from PXRE's perspective, if you blend the two main sort of Cat rated catastrophe rate indexes, that index blended went from about 190 in 2001, to something like 250 in 2003. So let's say as an industry, you lose about 5% off the index in 2004. With that math if I am following at you are right, we end up at like 240, 238. So clearly rates are higher than they were in 2001. Of course, return on equity on any Cat book is a function of both rate levels and the spread of the company's portfolio. With our large non-U.S. book, which as, you know, Mike is a differentiator for PXRE. I can say that the expected return on equity from PXRE's portfolio increased following the January 1 renewals. How can this be? Well, we were able to increase on well-rated programs and improve the diversification of our portfolio, such that whatever modest rate erosion there was outside of U.S. on international Cat business we more than made that up in a more efficient portfolio. So I guess I don't know what quality means, but in terms of expected return on equity, we are happier today then we were in December.

Interesting. That's very comprehensive. Thanks very much.

Sure.

Thank you our next question is coming from Charles Gates of CSFB, please go ahead with your question.

Hi, good morning.

Good morning.

My first question, what was the addition to reserves for earlier losses, if there was one during the quarter specific to the Exited Lines or specific to your book of business in total would be a better question?

For the Exited Lines, the addition in prior year, [accident] years was less than $1m. It was associated with one treaty and then I'm afraid, Charlie, you broke up a little bit.

So, in the fourth quarter the addition to reserve for earlier losses was only $1m?

In the Exited Lines?

In the Exited Lines, was there a significant addition to reserve for other lines during the period?

No, in total it was immaterial.

Okay, that's my first question. My second question, reading from you text, where you were talking about a normalized catastrophe activity, could you elaborate on what is normalized catastrophe activity, what kind of loss ratio would you be assuming, for example?

John, why don’t you --

The range, Charlie, we gave you the best guidance of 4.40 and 4.80, the loss ratio range there was 33-40%. And that was the main driver behind the reason for a range and getting it, there are very few other moving items within our guidance for '04.

And Charlie, to add a little bit more color, there are sort of two ways to arrive at normalized, one is what the portfolio of model we would expect over the course of a 100,000 years and the other way to look at it is what has happened on a byline basis over the recent past, say, 10 years and that’s really the source of the range.

Okay. The other question, you made reference in your prepared remarks, I think, Jeff, to this risk excess business, where there is a large amount of capital chasing in this business, how important is that business, and what kind of pricing erosion is occurring there?

That business isn’t a terribly large component of our book, either in 2003 or projected 2004. It will shrink, it was below 10% in 2004 -- I am sorry, it was below 10% in 2003, and we expect it to shrink further. What kind of rate erosion was there? When we combine sort of worsening terms and conditions, my very rough estimate and this is a lot rougher than any of the other estimates I have given on this call, would be 10-15%.

Thank you very much.

Thank you. Our next question is coming from Paula Federman (ph.) of First Albany. Please go ahead with your question.

Thank you. My first question I have is could you explain the loss in the Finite Risk segment.

Sure, we have premiums coming through and we have loses being incurred as I am sure you know with most Finite Risk business, future investment income is a key component of the overall pricing of the transaction, however, the GAAP accounting model doesn’t allow you to present value those loses. So, as we had income -- as we had premiums being earned we booked them to very conservative loss ratios, which resulted in GAAP underwriting loss. Now what isn’t reflected is what we believe the ultimate investment -- or the future investment income of the ultimately present value of the loses will be, which obviously serves to moderate that loss dramatically.

Do you expect ultimately to see loses on that book, from that --

From an economic perspective no, no.

You expect to see earnings?

From an economic perspective, I would say no just to be sure that I am as complete as possible you will note that in periods past we disclosed litigation on one large Finite Risk treaty. That could be the source of an economic loss that’s old news but I just want to make sure I answer the question completely. In terms of future earnings, I don't think they will show up in Finite Risk because they will show up in investment income and the way the GAAP accounting model works is there its assets that we are holding and that were on any investment income on. So I am [torn] as to whether to say yes ,we’ll have earnings in the future that show off an investment income I think it’s the best way to answer that question.

Okay given the fact that you didn’t have any significant losses or that prior year losses of activity in the quarter, do you intend to revisit your outlook with S&Ps, since they seemed to have changed their outlook based upon some expectation of near-term reserve adjustments?

I, John and myself have been talking to S&P as we always do pretty regularly and obviously those discussions with S&P center around the negative outlook because of the absence of the adverse loss development, the excellent performance of our franchise. It would be dangerous for me to say I predict a removal of that negative outlook. We’re doing our best.

Okay and do you have some type of consolidated statutory capital number for the year?

John.

At December 31, 2002, the consolidated stat surplus was $711m.

Okay and were there any additional movements of capital in the fourth quarter?

No.

Okay thank you.

Sure.

Thank you. There are no more questions at this time. I would like to turn the floor back over to Mr. Radke for any further remark.

Thank you all for participating in this conference call. We look forward to a very profitable 2004 and talking to you in roughly three months. Thank you for your time and attention.

Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.