Argo Group International Holdings Ltd (ARGO) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen and welcome to PXRE Group's first quarter 2004 earnings conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following today's presentation. It is now my pleasure to introduce your host for today's call, Mr. Jeffrey Goldberger. Sir, you may begin.

Thank you, Stephanie and again, welcome to PXRE's first quarter conference call. Representing the company today are Jeff Radke, President and Chief Executive Officer, and John Modin, the company's Chief Financial Officer. Before I turn the all call over to Jeff 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 the 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 SKR EUB described in the news release issued today and in PXRE's annual report on Form 10-K. And in other filings with the SEC. We refer you to these sources for additional information.

Lastly, I would like to point out the remarks made during the conference call are based on information and understandings that are believed to be accurate as of today's date, May 6, 2004. Because of the time sensitive nature of this information, it is PXRE's policy to limit the archive replay of the conference call to a period of 30 days. This call is the property of PXRE. Any distribution, transmission, broadcast or rebroadcast in any form without the express written consent of company is prohibited. With those announcements complete I give you Jeff Radke. Jeff?

Thank you, Jeffrey. Welcome to PXRE's first quarter 2004 earnings conference call. Today I will review our first quarter results, provide an update on the January and April renewals, and offer some insight into current market conditions. I'll then turn the call over to John Modin, our Chief Financial Officer, for a review of our financial and operating results. Finally, we'll open the call for Q&A.

I'm more excited about the first quarter of 2004 than any quarter since I joined PXRE. The progress we have made in refocusing the company is evident in this quarter's results. We are successfully executing the plan we described to you over the past 24 months.

For example, essentially all of our premium for the quarter came from our catastrophe and risk excess segment. Finite and exited lines had no material impact on the quarter; there was no adverse development in the quarter.

Net income for the quarter was excellent, at $1.18 per share. More useful is the operating earnings of $1.27 per share, an increase of 22% over last year. During the quarter, we grew our cat and risk segment by 7%. We expect this growth rate to increase to about 10% for the year as a whole, as our seated reinsurance costs reduce in the second half. You'll recall that we expect net premiums to be higher in the second half of the year than in the first. This expectation continues.

Turning to pricing, there's really no significant change to report. International catastrophe business has seen rate decreases of 5% to 10%; North American business is flat to down 5%. And retropricing is holding firm.

Despite moderate decreases in some trespasses from the recent pricing highs, our business continues to benefit from a favorable operating environment. We are being offered plenty of new business. However, the state of the market is such that we have to vet these submissions much more carefully than in the past 24 months. We continue to find opportunities to increase our shares on existing business, or to write new business, which meets our return hurdles.

This is the time and the market when our underwriting technology, together with our 20 years of experience and relationships will differentiate PXRE.

We grew our U.S. cap business 15% during the quarter. This was by design as market rates and our returns on allocated capital are higher on the U.S. business as we improve the balance of our portfolio. From a line of business perspective, for the quarter, our cat and risk segment breaks down as 50% catastrophe business, 28% retro, 9% risk excess, and 13% specialty, which is aviation and aerospace business for us.

Our GAAP loss ratio was 26.3% compared to 38.5 in the same period last year. This reflects benign cat experience, and our careful risk excess underwriting. For PXRE, the only notable losses were two large industrial risk losses, one in Algeria and one in Australia. These losses were not significant for PXRE.

During the quarter our expense ratio was 30.7, down from 32.9 in the same period last year. Adjusting for the severance charge, our expense ratio was 28.9%. We've told shareholders that reducing the expense ratio was a key objective. I'm pleased to see our efforts come to fruition with this pronounced drop. I expect to see some further improvement as the result of our recently announced 10% staff reduction. I'll now turn the call over to John for a discussion of our financials.

Thank you, Jeff. And welcome everyone to our first quarter conference call. Similar to last quarter, I will review our recent results and provide some commentary on the balance sheet.

We came out of the gate fast in 2004. The first quarter results were outstanding, which especially on the revenue side, bode well for the year. Net operating income per diluted share increased 22% to $1.27 in the current quarter, compared to $1.04 in the prior comparable period. Net income was 30.9 million or $1.18 per share compared to 23.6 million or $1.04 per share in the prior period.

This is the highest quarterly net income in PXRE's history, exceeding the previous high of 27.8 million established in the fourth quarter of 2003.

Annualized return on equity for the quarter was 22.7% compared to the ROE of 21.9% in the first quarter of 2003. The combined ratio was 57% during this quarter, as compared to 71.4% in the prior quarter. The cat and risk excess combined ratio was 55.5 as compared to the previous quarter of 46%. The only major loss activity during the quarter was the two risk excess losses Jeff mentioned. In addition, the one-time charges that I will discuss shortly resulted in a higher than typical expense ratio of 30.7% during this quarter. We expect that it will get down to the mid-20s during the remainder of the year.

Underwriting income was up 26% to 42.2 million in the first quarter of 2004, compared to 33.4 million in the prior comparable period. This increase in underwriting income and the reduction in combined ratio were due primarily to the absence of exited lines and finite underwriting losses.

Shareholders' equity grew 8.6% from 565 million at December 31st to 613 million at March 31. The increase in after-tax unrealized gains on our fixed income portfolio of 5.5 million served [to increase] shareholders equity as well as the overallottment net proceeds of 6.5 million associated from our December common share offering and 4.9 million of proceeds from stock option exercises.

Book value per share was $23.02 at quarter end. The cat and risk excess segment experienced growth in earned premium of 4.5 million or 7% quarter-over-quarter. This is on top of significant growth during 2003 and 2002 of 45%, and 193% respectively.

We expect to earn more premium than the 66.2 million earned during this quarter and quarters 2, 3 and 4 and expect we will grow this business by 10% in total for the year. If we miss, the most likely culprit will be lower than expected reinstatement premiums which obviously means lower than expected incurred losses. Exited lines and finite net earned premium were only 200,000 and 2.5 million respectively. As stated in prior periods we expect minimal premium from exited and finite lines during 2004.

Net investment income for the period was 6.9 million compared to 5.5 million in the same period last year. Our hedge fund portfolio continues to deliver superior returns, producing 3.4 million in income this quarter versus 2.2 million in the same period last year, and 3.5 million in the fourth quarter of 2003. The hedge fund return was 2.9% compared to 2% in the same period last year versus 3% in the fourth quarter of '03. Interest income on the fixed income portfolio increased from the prior quarter due to cash flow from operations and financing, offset by decline in yields.

The GAAP loss ratio for the quarter was 26.3% compared to 38.5 in the first quarter of 2003. The cat and risk excess loss ratio was only 25.7% reflect a relatively clean quarter. The loss ratio on this segment was 27% for the entire year of 2003.

Paid losses were 20.5 million during the quarter, versus 10 million in the prior period.

Operating cash flows were 29.3 million for the quarter, compared to 75.9 in the prior period. The prior period contained a $31 million inflow related to a finance treaty that was not renewed during 2004.

The GAAP expense ratio was 30.7% compared to 32.9 the same quarter of '03. The expense ratio for the cat and risk excess segment only was 29.9%, comprised of 10.8% commission and brokerage ratio, plus 19.1% operating expense ratio. The variable commission and brokerage ratio is in line with our expectations. The G&A ratio and the amount are higher than our typical run rate measures and should decrease going forward.

Operating expenses in the quarter were 12.6 million, compared to 9.2 million in the first quarter of 2003.

There were several one time expenses incurred this quarter that we do not expect in future periods. We recorded 1.3 million in severance costs most of which related to the previously announced reorganization of the underwriting and support operations. In addition, we restructured our incentive compensation and pension plans during the quarter which resulted in a one-time charge of 1.1 million and a one time benefit of 400,000 respectively. Future quarters will not contain these amounts and will also benefit from the restructuring expense reductions.

The expected effective tax rate for 2004 is 2% driven by the growth of business in the Bermuda operating subsidiary.

Also a few quick notes on our balance sheet and capital structure. Invested assets and cash grew 5% since year-end 2003. The growth in dollars is 54 million and it is due to operating cash flows of 29.3 million, and net external financing cash flows of 9.9 million. The balance of the increase is due primarily to unrealized depreciation on investments.

Total capital of March 31, 2004 was 780 million and at this point we're utilizing it fully to support our underwriting. We review our capital position continuously. We compare to what is needed for rating agency models, what is needed for regulatory purposes and what is needed for internal risk guidelines. Our balance sheet remains solid; 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.

Finally, a few comments on four accounting and presentation changes in our first quarter 2004 financial statements. The first is that we now only have three reporting segments instead of four. We collapsed what was previously called the "other" line which was comprised of one property pro rata treaty into the cat and risk excess segment this quarter.

The second is that our income statement now contains a line item for foreign exchange gains and losses. All FX impacts realized, unrealized, premium-related, loss-related will be consolidated into this row and will represent the net impact of foreign exchange for the appropriate period.

The third is the adoption of FIN 46 during the quarter which impacted both the balance sheet and the income statement. We are no longer consolidating the five trusts that issued our trust preferred securities. As such, we have [indiscernible] the assets and liability in the balance sheet by 10 million and renamed the liabilities subordinated debt and shifted them North into the liability section of our balance sheet. The income statement now reflects the interest income and expense related to these items.

In addition we reported a net of cash cumulative loss adjustment of 1.1 million or 4 cents per share related to the reversal of gains on trust preferred securities previously bought back. There was a minimal effect on shareholders' equity since the underlying investments have increased in value since we purchased them and such appreciation was recorded in other comprehensive income.

And the fourth relates to our statement of cash flows. We switched to the direct method to make the statement more meaningful and cash flows more transparent.

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

Thanks, John. In summary, PXRE is highly profitable, and we continue to grow in our core business. We've taken steps to improve the efficiency of the company; we're well-positioned to capitalize on the attractive property cat market. Again, we thank you for your time and continued support of PXRE; we're proud of our first quarter results and we look forward to additional updates throughout the year. At this time, we'll open the call to your questions.

Thank you. The floor is now open for questions. [caller instructions] And our first question today is coming from Charlie Gates of Credit Suisse First Boston. Sir, please pose your question.

Hi, good morning.

Morning, Charlie.

Hi, Charlie.

I have a couple of questions. Approximately how many employees did you have at the beginning of the quarter, and at the end?

Charlie, in the beginning of the quarter we had approximately 70, and at the end we have approximately 63.

Okay. And what area did those seven guys leave from?

It was primarily administration and finance.

Primarily. However, the there were impacts throughout the organization.

Okay. That was my first question. My second question: I believe at the beginning of the call one of you said that something was going to be higher in the second half of the year than the first half. What were you referring to?

Net earned premium. I guess what I was reiterating is what we've said in the past, both myself and John, that we expect our seated reinsurance costs as a percentage of gross written to go down as the quarters and the year progress. Did that address your question, Charlie?

Yes. How can we have any exited premium? I realize it's only 100,000 bucks, but how can you have any premium from those exited lines?

I don't know how many individual treaties are included in exited lines. It's a relatively large number. And as you know, Charlie, most of our reinsurances provide that the premium we receive is some rate or some percentage of the original subject premium income that the reinsured writes. That's a long-winded way of saying that I bet you for five years most contracts have slight adjustments up or down. But that's where the premium comes from.

My final question: Could you elaborate on what you currently see for property catastrophe reinsurance pricing, how you see that evolving, assuming no major catastrophe in 2004?

Okay. To set the stage for that, before I give sort of my prediction, let's -- I think it might be useful to remind ourselves of what we've seen so far. On the international cat front, we're seeing price reductions of 5 to 10%, 10 being the worst, sometimes they're flat. But on average they're between the 5 and 10% number.

By internationally you mean outside the US of A?

Yes, sir. North American business, flat, down 5%, and retrocessional business the pricing is stable. Without----or absent significant catastrophe activity, for the balance of 2004, my expectation would be at seven-one and ten-one we're going to see similar changes to those contracts as they renew. So down that percentage level from the 7/1/03 renewal price or the 10/1/03 renewal price.

Okay. Thank you.

Sure.

Your next question is coming from Dan Farrell of Fox-Pitt Kelton. Please pose your question, sir.

Good morning.

Hi, Dan.

A couple of questions. First, it's great to see the exited lines have underwriting gains following tough quarters. Given all the stuff you've done there, can you comment on what we could expect from underwriting contribution for that line going forward?

And then my second question relates to the other operating expenses. Excluding the severance charges it seems like those were tracking a little bit higher than they previously have. Can you kind of comment on that specifically for the quarter?

Sure. How about if I handle the first and I'll ask John to handle the second?

Okay.

I would love to tell you that we expect exited lines to be zero. Quarter in, quarter out. I don't think that they're going to be zero. I think that they're going to be very, very small, up and down, as the actuarial formulas are applied to the activity of the quarter. It would be an extraordinary coincidence to come out at zero. Do you understand what I mean? Did I explain myself well?

Absolutely. So basically some variation around that number. But I guess what I'm saying is, probably not -- it would be unlikely to see the large losses that we previously saw?

Yeah. I'll say it more strongly. Most of our efforts over the past 12 months has been focussed on maximizing the odds that exited lines is behind us. The first quarter's performance, the last quarter, the lack of significant adverse development, we feel increasingly confident that we got our arms around it.

So I would certainly agree that you're not going to see a significant negative out of that number. Sorry, out of that segment. Barring some sort of extraordinary industry-wide phenomenon on the 98 through 2000 business.

That's great. Thanks.

Dan, on the operating expense question, we were a little -- we were higher this quarter, 12.6 million. There were about $3 million of one-time-type charges, not all of which we included in our pro forma -- in our operating that we incurred in the first quarter. That would bring us down in the range we ran last year, the mid nine's roughly.

The restructuring we did earlier this quarter will shave it out 900,000 to a million off of each quarter. So we'll dip down below nine million in future quarters. But this quarter was higher due to the one-time charges, including the severance and the other items.

The other items flowing through was that the accounting change flowing through or was that -- what were the other items in addition to the severance, I guess?

The accounting change is not, that's down below the line. So that's not in there. It's severance charges, it's restructuring of our incentive comp plan.

Okay.

that resulted in a one-time expense this quarter that won't be there in future quarters. Those two items comprise most of the one-time items.

Great, that's very helpful.

Your next question today is coming from William Nobler of Atlanta [Sornoff].

Hi I had a couple of questions. Your tax rate this year estimated at 2%, what would that compare with last year?

2%.

So it's the same the rest of the year?

Our '03 tax rate was 2%, and that's what we think our 04 rate will be also.

Okay. The returns on the hedge fund, what percent of your investment portfolio now are in hedge funds?

About 12% of our portfolio is in hedge funds. In total, on the face of the balance sheet, on the release last night you could see we had about 120 million of hedge funds and our total investments are about a billion.

Great. And in terms of higher interest rates, how do you see that affecting your returns on your portfolio and of course the outlook for the unrealized gains that you currently showed in the first quarter?

Yeah, the -- you know, bad news, good news. There was about a 70 to 80 basis-point increase in interest rates in April, so our unrealized gain flipped by about after tax, $8 million. Now, the good news is we repositioned our portfolio to a short duration last year, in anticipation of -- to preserve principal in case of an increase in rates. So a short duration----we'll reinvest the proceeds from maturities into the higher yielding investments. So prospectively, interest income could go a little higher.

Right. On the flip of 8 million, you're saying that you went from a loss to a gain because of a drop in rates; is that what you're saying?

From a balance sheet perspective.

Yeah.

We went from an unrealized gain. We reduced our unrealized gain by $8 million after tax.

Let me jump in here. Maybe I can help make it clear. What John's saying is if you take our duration of --

2.3 years.

-- 2.3 years and apply the shift in interest rates that occurred after the end of the quarter, doing some simple math, you come up with that sort of expected switch. Just to be clear, what we weren't talking about is the impact on our financials following the end of the quarter. I'm just sort of doing back of the envelope math to help you.

And also to be clear, that -- I'm calling it a loss but it doesn't flow through our income statement, as you probably know. Our bond are carried as available for sale and the changes in the fare value, when they went up in value last year, they went through the balance sheet, other comprehensive income. When they go down in value, they go through the same section.

And my last question: Looking at your stated book of 2302 in the current price of the stock, and also apparently plenty of opportunity to employ your capital, how do you see returns to shareholders -- using the cash in terms of either the business, returns to shareholders, and so on over the intermediate period?

I was looking forward to your question until you said intermediate period. That made it much harder.

Short intermediate or longer term. [laughter]

Let me tell you or describe how we and the board think about it, and hopefully that will get you to where you want to be. As John said, we frequently take a look at the capital inside the company, and the opportunities we have to deploy it in the business that we're good at, which is the core cat and risk excess business.

Currently, on all sorts of measures, most importantly being annualized ROE, we're fully utilizing our capital. If that were to change, if we were to have excess capital, John and I have said to several shareholders for a long time that we're going to give that excess capital back to shareholders.

What I can't tell you is the most effective and efficient way to deliver that excess capital at the time. I don't have a crystal ball. It will be some combination I would expect of share buybacks and dividends when we find ourselves in that position of excess capital.

Great. Thank you.

Sure. Thank you.

Once again, to ask a question, please press star 1 on your touch-tone telephone at this time. Our next question today is coming from Ron [Bogman] of Capital Returns.

Hi, good morning everybody.

Good morning.

I had a question, I've heard that the Florida, I guess hurricane, the Florida state hurricane body, whatever its name is, and the California earthquake authority maybe adjusting their retentions or considering adjusting their retentions in their programs, I was wondering the prospect for that affecting the demand/supply relationship in the property cat market in any material way? Could you maybe educate me as to what is a prospect out there as regards those two states?

The Florida fund in 2004, if my memory's correct, was 15, the coverage provided for lack of a better term, it's coupled together with several different financing techniques, but in 2004 I think it's 15 billion excess of 4 1/2 billion.

Uhm-hmm.

There is an expectation that may have turned into fact that in 2005 it will go to 15 billion excess of 4 billion, so a reduction of 500 million in the retention or deductible.

Uhm-hmm.

All things being equal, that will decrease the demand for cover at higher return periods or higher probability of loss, and again theoretically everything else being equal, it would increase the demand through the top, or on top of the Florida hurricane cat fun. That would mean less aggregate dollars into the reinsurance arena. I've now made so many theoretical leaps where we expect everything -- all else to remain the same, that by -- in the end, I wouldn't expect any material impact on our U.S. catastrophe business from this change. I think it's relatively moderate.

Okay. And again, it's --

I sort of feel the same way about the CEA. And my memory isn't providing any helpful facts or figures there. But the restructuring of the CEA really isn't going to impact the California earthquake coverage that we sell tends to flow much more from commercial business than from personal lines business. So we would not expect a major impact in the demand.

Because is the CEA really focussed on personal lines?

It seems to have the biggest effect in reinsurance buying habits of companies --

Personalized carriers.

With personal lines exposure.

Okay. Okay. And then somewhat related, all state, the prospect or the actual event of Allstate coming into the property casualty market, is that more material in your mind than these two items I mentioned?

Yes. If Allstate or indeed anyone else were to come into the market in a larger way or return to the market, that would have a significant impact on our business, assuming that the pricing terms and conditions were acceptable to us.

Uhm-hmm. Right. And have they bound coverage?

I don't -- one of the rules that we try to live by at PXRE, and indeed the whole market is, I don't feel comfortable talking about what another -- what a client may or may not have purchased. So I --

Thought I'd ask anyway, I respect that. My -- I had two more questions. Have there been any meaningful cats, second quarter to date, not necessarily speaking to PXRE in particular but sort of, you know, facing the industry as a whole, in the first almost 30 days of this quarter?

No sir. The only thing I can think of to mention is the California wildfires, which it seems like the weather is helping out the firemen there, and it would appear it's not going to turn into anything significant. But it's early days yet. Literally they're still burning.

My last question was: Do you do any retrosession business or retrosession type business with the hedge funds that are also managing parts of the investment portfolio?

I think the legal answer would be no. However, to be sure that it's as complete an answer as possible, be aware or I point you to the disclosure in our 10-K and 10-Q that Mariner Capital who manages our hedge fund investments is associated with and I can't remember the disclosure, so I'll just use that vague term, is associated with Select Re. And Select Re we currently seed business to Select Re.

And that's it?

Correct. I would describe that as different, but I think it was close enough to the question that it was appropriate to --

No I appreciate that. Okay, continued good luck and success.

Thank you very much.

Thanks.

Thank you. That does conclude the question-and-answer session of today's teleconference. I'd like to turn the call back over to the speakers for any closing comments.

Once again, thank you very much for your time. We remain confident about the balance of the year, and look forward to talking to you next quarter. Thank you.

Thanks.

Thank you for your participation. It did conclude this morning's teleconference. You may disconnect your lines at this time, and have a great day. Thank you.