Argo Group International Holdings Ltd (ARGO) 2004 Q2 法說會逐字稿

Good day, and welcome, everyone, to the PXRE Group Limited second quarter 2004 earnings results conference call. This call is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Goldberger. Please go ahead.

Thank you, Melissa. And again, welcome to PXRE's second quarter 2004 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 call over to Jeff for opening remarks, I will 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 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 today, in PXRE's annual report on Form 10K and in other filings with the SEC. We remember to you those sources for additional information. Lastly, I would like to point out the remarks made during the conference call are made based on information and understandings that are believed to be accurate as of today's date, August 5, 2004.

Because of the time sensitive nature of this information, it is PXRE's policy to limit the archive replay of the conference call for 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 content of the company is prohibited. With those announcements complete, I give you Jeff Radke.

Thank you, Jeffrey. And welcome to PXRE's second quarter earnings conference call. Today I will review our second quarter results and provide insight into key operating metrics and marketing conditions. I will 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.

During the second quarter, PXRE performed exceptionally well, generating an annualized return on equity of 22.4% and net income of 32.3 million, a 51% increase over the same period last year. Our core Cat and Risk Excess segment generated 95% of our net premiums earned, compared to 82% in the second quarter of last year. Illustrating our focus on Cat and Risk Excess and the deemphasis of our finite business, during the quarter, we decided to stop allocating resources to the finite business and will no longer enter into new transactions.

In keeping with this decision, starting with these earnings, finite results will be included in the exited lines segment. We now have two operating segments, Cat and Risk, and Exited Lines. Exiting the finite business represents the final step in our efforts to refocus PXRE as a pure short-tail reinsurance specialist. During the quarter, net premiums earned in our cat and risk excess segment declined 4%.

The decline was caused by the lower level of reinstatement premiums, as a result of the lower loss ratio this year rather than last year. A tradeoff that we're happy to take every time. Also contributing were moderate rate decreases and the nonrenewal of certain Latin American and us Australian programs, due to inadequate pricing. Based on the low loss levels and corresponding low reinstatement premiums for the first six months of the year, we now expect moderate growth in our net premiums earned for the year.

We were pleased by our continued success in rebalancing the geographic exposures in our underwriting portfolio. Our North American business, where rates are strongest, increased to 37% of premiums compared to 31% in the same period last year. Pricing in our Cat and Risk Excess market remains attractive.

In North America, pricing is down approximately 5-10% year on year, but well within acceptable return parameters. Internationally, pricing has become more challenging and has caused us to be more selective in our underwriting. On average, pricing in the peak zones of our international segment is down 10-15%. Certain international territories are more challenging. Most notably, Latin America and Australia, as I said.

In Latin America, the pursuit of geographic spread and the growing aggressiveness of branch offices of large reinsurers has resulted in prices that we will not support. This is a theme common in past market cycles. In Australia, we surmised that the rate reductions -- in excess of 20% on some of the programs -- resulted from the pursuit of spread, the efforts of large reinsurers who left the market trying to buy their way back in, and perhaps the fact that the commercial models do not include many of the perils that have caused losses to covers in Australia in the past, such as hail storms and brush fires.

In each case, we have been disciplined and paired exposure in response to inadequate prices. Overall, PXRE continues to be presented with strong underwriting opportunities. We are shown essentially all of the business in the market. We believe, and our clients have expressed to us, that after a certain critical mass in capital, which we have achieved, the yard stick for financial security is not size; rather it, is based on other measures, including the transparency of the balance sheet, a clear and concise business plan, a credible track record of superior service, responsible pricing, prompt claims payment and catastrophe risk management.

Our ability to demonstrate all of these critical measures has been a major determining factor in our continued success. We believe that our A ratings, unparallelled underwriting experience, exceptional technology and market position as the longest tenured short-tail property franchise in the market will favor PXRE as the catastrophe market becomes more difficult to navigate . Before I turn the call over to John, a final comment: We expect to register our outstanding convertible preferred shares in the shelf registration with the SEC shortly after we file our 10-Q. The shelf registration will also incluse the common shares into which the preferred shares convert.

You will recall that the preferred shareholders have registration rights, and we have been requested to register the shares pursuant to those rights. We understand that one of our preferred shareholders is, as a matter of policy, invoking its registration rights for each of its portfolio companies. I am severely limited by SEC rules in what I can say about the shelf registration, other than to state that when it is declared effective by the SEC, the shelf registration of the shares will not obligate these shareholders to offer or sell any of these shares, and PXRE has not been asked to assist in any offerings of these shares by the preferred shareholders.

I would ask that you keep these SEC restrictions in mind during Q&A. This concludes my formal remarks. I'll turn the call over to John.

Thank you, Jeff. Good morning, everyone, and welcome to our second quarter conference call. Similar to last quarter, I will review our recent results and provide some commentary on the balance sheet. The second quarter and first half results were outstanding.

Net income was 32.3 million, or $1.20 per share, compared to 21.5 million, or 93 cents per share in the prior period. This is the highest quarterly net income in PXRE's history, exceeding the previous record of 30.9 million in the first quarter of 2004. Net operating income per diluted share increased from 92 cents per share to $1.21 in the current quarter. Annualized return on equity for the second quarter was 22.4% compared to the ROE of 18.8 in the second quarter of 2003. The combined ratio was 54.5 during this quarter, as compared to 81.7% in the prior quarter.

The Cat and Risk Excess combined ratio was 49.6, as compared to the previous quarter of 67.8. Underwriting income was up 61% to 41.5 million in the second quarter of '04, compared to 25.9 million from the prior comparable period. This increase in underwriting income and the reduction in combined ratio were due primarily to the light catastrophe activity. Last year cats, 88 and 88 days of the Midwest storms, impacted the quarter, but there have been no significant cats so far during 2004.

In addition, the decrease in impact from exited and finite lines contributed significantly to the improved results. Shareholders equity grew 3.6% from 613 million at March 31st, to 635 million at June 30th. Offsetting the net income this quarter was an after tax 14.9 million unrealized loss on our fixed return portfolio, attributable to the rise in interest rates during the quarter. Our aversion to interest rate risk mitigated the impact of these rate increases, and a short duration of fixed income investments will allow us to quickly reinvest cash flow from interest and principal into higher yielding investment products.

Net earned premium in the Cat and Risk Excess segment was 66.2 million during the quarter, the same amount as the first quarter of 2004. For the first half of the year, net earned premium is 2% greater than the prior period; but as mentioned previously, we expect more net earned premium in quarters 3 and 4, which should result in moderate growth for the year. Growth during 2004 comes on top of significant growth of 45 % during '03 and 193% during '02.

At this juncture in the year, a key variable for whether or not we meet our premium target is reinstatement premiums. Our earnings and revenue guidance contain loss ratio and reinstatement premium assumptions. To the extent our actual loss ratios are less than planned, we will earn less reinstatement premium, which taken together, result in higher earnings. As Jeff mentioned, we have completely exited finite underwriting. Effective this quarter, we are including the results of finite within our Exit Lines segment.

Combined premiums from Exit this quarter was 3.4 million, almost all of it from what was previously called finite. We expect that the net earned premium from all Exit lines will be less than $1 million for the rest of the year. Net investment income for this period was 4.9 million compared to 8.6 million in the same period last year. The decline is due primarily to the hedge fund returns of 70 basis points during this quarter, as compared to 470 in the second quarter of 2003, which was exceptionally high.

The net income [PHONETIC] return on the first quarter was 290, so the year to date is approximately 360 basis points positive, ahead of most hedge pond in equity indices, and obviously better than fixed income total returns. Interest income from the fixed income portfolio increased slightly from the prior quarter, due to cash flow from operations and financing, offset by slight decline of book yields. Total return on the fixed income and short term investment portfolio was approximately negative 1.5% off of that 225 on the unrealized loss, offset by.75% of book yields.

The GAAP loss ratio for the first quarter was 26% compared to 53.1 in the first quarter of '03. The Cat and Risk Excess loss ratio was only 21.3%, reflecting the quarter with very few losses. The GAAP expense ratio was 28.5%, compared to 28.6 in the same quarter of '03. Our operating costs, which are on track with what we expected since our expense restructuring, were 9.9 million during this period.

The favorable earnings recorded so far this year resulted in an increase in the effective comp accrual during the quarter. Continuing at this pace with respect to net income, the operating expenses, including the effective comp charge, should be between 9-10 million for each of the remaining quarters. The tax rate for the quarter and expected effective tax rate for the entire year is 2%. This rated was driven by the predominance of business written in the Bermuda operating subsidiary.

In wrapping up, our results for the year have been strong and our balance sheet remains solid. In fact, our A rating was affirmed by A Invest this past May, and with this came a change to a stable outlook. This concludes my prepared remarks, so I will turn the call over to Jeff for some closing comments.

Thanks, John. To try and summarize the quarter, we're very proud of our results for the first half of the -- first half of 2004. Looking forward to the second half of the year and the key January 1, '05 renewal season, we remain optimistic about our underwriting opportunities. At this time, we'll open the call to your questions. Operator?

Thank you. Our question and answer session will be conducted electronically. For those of you that have a question today, please press the star key followed by the digit one on your touch-tone telephone at this time. If you are joining by speaker phone, please ensure your mute function is turned off to allow your signal to reach our equipment. And once again, if you do have a question, please press star-one at this time. And we'll pause for just a moment. We'll take our first question from Steve Shapiro with SF Investments.

Yes, good morning. I didn't hear anything on the call about reserves for exited general liability lines, and I presume that that's a good sign. Can you comment on that?

Sure. You're right. You didn't, and that is good news -- gratifying news. The -- after a difficult period, stretching back sort of 24 months, we have those reserves at a level where there is slight wiggle from quarter to quarter. Last quarter, if memory serves right, when you ran the actual -- actuarial formulas, there was something like a $300,000 release. This quarter, I believe that there was a slight increase, but less than a million dollar type of thing. John, do you want to correct me?

Yeah, that's right. I mean, the good news, when you look at our total underwriting income for the exited lines was $1.7 million loss. What I would add is that the finite component of that, we're in a -- a good component of the loss was legal expenses related to a lawsuit we're in. So what that means is that the loss was not necessarily driven by adverse development on reserves, but rather -- rather events going on today. So the GL behaved itself for another quarter.

Great. Thank you.

Sure.

And we'll take our next question from Charlie Gates with CSFB.

Hey, good morning, guys.

Good morning, Charlie.

Good morning.

Could -- could you elaborate on the pricing environment as you see it today in your two principal lines, and how you see that evolving over the next six months, please?

Charlie, I guess by necessity, this is going to be a summary. North America, the 2004 prices are approximately 5 to 10% lower, adjusted for everything, than they were in 2003.

That's property cat, that's not risk cat?

That's property cat, exactly right.

Okay.

Internationally and property cat, we would say that on our book, it works out to be 10-15% down. Now, there --

Why is it more down internationally than here?

I don't think I can give you a meaningful response, other than to say there seems to -- the historical precedent of increased competition for international cat exposures seems to be repeating itself. I don't know if it's a pursuit of spread by companies that are more heavily exposed in the United States. I don't know if it's the fact that there are several very, very large professional reinsurers that view the international arena as their back door -- backyard, I guess is the expression. I can't really answer why, I can just say what we're seeing. Risk excess is more pronounced. As a component of Cat and Risk, risk excess is 9% this year, and that's down from last year. The reason it's down is we see increased competition in that line. I -- I would guess that those rates across the board are 15-20% down.

My follow-up question -- you had this second announcement this morning with regard to the convert holders. What does that mean?

I'm going repeat myself a little, but I'll try and say it in words that an attorney didn't write and maybe that will help.

Okay.

The preferred shareholders have a right to register their shares. They've instructed us to exercise that right. As -- by way of background, it's our understanding that one of our preferred shareholders is doing this with each of their portfolio companies as a matter of policy. I can also say that none of these preferred shareholders has asked the company to assist in any offering. And I think that -- that's as much color as I can give, given the restrictions that I understand the SEC places on comments about shelves.

Okay. Thank you.

Sure.

And as a reminder, if you do have a question, please press star-one on your touch-tone telephone. We'll pause for just a moment. We'll take our next question from Richard Priori with Delfi Management.

Good morning. I guess you answered the pricing questions I had. You guys seeing any impact from any major world events right now on any of your losses, or are your losses pretty well spread out?

The losses that we're booking in this quarter are largely IB&R losses, loss reserves we're putting up for -- for losses that haven't been reported to us yet.

Yep.

Given the industry experience, just because you don't hear about it, even in property cat, doesn't mean there hasn't been some small loss here and there, but I can tell you that on a reported basis, there has been nothing of significance in either the cat or the risk side.

All right. Are you guys writing any terrorism policies?

No specific terrorism policies are written, but as I'm sure you know, there is terrorism exposure that seeps in, both in the U.S. and outside of the U.S. under the normal cat covers, but no specific terrorism policies.

Are you doing anything to try to price that?

We try to -- frankly, we try to avoid it.

Okay.

And when we have to price it, rather than -- rather than try to approach an unscientific problem scientifically, what we try to do is minimize it and -- and get -- on an unspecified basis, get paid as much as we feel like we can for it.

I see.

I wouldn't hold that out as a great example of our underwriting technology.

All right. And do you feel you should still be in hedge funds on the investment side?

Yeah, I would say that every quarter that goes by, my confidence in that portfolio increases. We've been in since '96. We've had one down quarter, and it's more -- quarters like this increase my confidence, where many of the indices are off significantly, and we manage to make a reasonable return. Even for the quarter, let alone for the year to date, I'm very, very comfortable with that portfolio.

All right. I'll let someone else ask questions and requeue. Thank you.

Thank you.

And from Fox Pit, Dan Farrell has our next question.

Hi, good morning.

Hi, Dan.

Just a quick question. You talked about the earned premium and your expectation would be probably modestly positive for the year. Can you talk a little bit about -- about net written premium? It was down 9% this quarter and it was down 1% in the first quarter. If the pricing environment were to stay roughly the same where -- where -- that you describe now, is that, you know, down, you know, 5-10%? I s that a reasonable expectation for the remaining quarters of the year?

So the question is, for the remaining quarters of the year, what do we anticipate for net written? Is that right?

Yes.

I'm going to probably, not too gracefully, avoid that question. Let me tell you why. Net written premium or written premium of any kind is pretty difficult to predict.

Okay.

Timing -- timing causes trouble, whether someone renews at 6.1 or switches their cover to 7.1. Also, the timing of the deposit premium schedule, the way we account for written premium, makes a difference. I have a high degree of confidence about the earned premium growth, and on the written premium side, eventually it's going to have to work out, obviously, as you know. It's going have to work out to be slightly up, but I don't know where that's all going to come in quarter to quarter.

Okay. Okay. That's helpful. Thank you.

Sure.

And as a reminder, if you do have a question, please press star-one at this time. And we'll take our next question with William Nobler with Atlantis [INAUDIBLE].

Thank you. On the expense ratio, I was under the impression -- the comment was made after the first quarter that that could dip into the mid-20s for the rest of the year, and it was fairly flat in the quarter. Would you comment on that, particularly going forward?

I will. There's two components of the expense ratio. There's the -- what I refer to as the variable piece, which is basically the commission and brokerage divided by the net earned premiums, as well as the G&A, which is more fixed. On the first piece, the commission brokerage, there was a slight spike-up this quarter to about 13%. It typically runs like 11 or 12, and there was two reasons for that. The first reason is that there was a seated reinsurance contract that we did not book a seating commission on, so therefore it reduces our seating commission and increases our commission and brokerage on how we record it. The second reason is -- in fact, we mentioned in the call that we really had very low reinstatement premiums this year as compared to prior years, and that in the way that works is that reinstatement premiums generally have a very low acquisition ratio associated with it. Sometimes there is not even a brokerage on that and sometimes there is, but it's a smaller piece, or it's on a smaller component of the total. So our -- the first piece, the commission and brokerage ratio -- was probably about 100-150 points higher than it typically is -- 1 or 1.5% -- than it typically is. Second piece on the G&A, we're at 9.9 for the quarter and I think we'll probably be more toward the mid 9's in Qs 3 and 4. And the reason why that is so is that we're, you know, we're having a favorable year with respect to net income and return on equity, and we're accruing our best estimate right now of what our incentive compensation will be at year end. So it's -- it kind of spiked up a little this quarter. But it's 28 and I think mid-20s. Yes, it should go down -- based on what I described, it should go down more towards the 26 range or so for quarters 3 and 4.

But I think generally it's true that within one or two percentage points, if we do better -- in terms of the net income and return on equity -- if we do better than we planned, or than our guidance, the expense ratio will be marginally above our guidance, because of this incentive comp portion of the employee compensation of the company.

That's right.

All right. Since you brought up doing better than the -- the guidance, I noted, of course, that you didn't reaffirm your previous guidance. Would you comment on that?

It's reaffirmed. 445-485.

Okay, and my last question, with you stock selling at book, and with the yield 1%, and in the current environment, and with a pretty good year hopefully, have you given further thought in terms of how you allocate some of that capital shareholders?

Yes. I think PXRE -- certainly the board meetings, it's a meaningful percentage of the time spent, is a discussion of capital management, as well as with management away from the board meetings. I don't want -- I want to be very careful to manage expectations, if I could. With -- with the growing book of business and returns on equity in excess of 20%, and going into the U.S. wind storm season, I don't feel like we have excess capital today. When we determine that we have excess capital -- and there are a lot of different constituencies there, like there are the rating agencies, there's regulatory -- there's regulatory constraints -- although they are relatively weak -- there are internal capital models -- when we determine, based on all three of those things, that we have excess capital, I'll renew what I've said before. We intend to return that capital to shareholders in the manner that's most efficient at the time. But, again, I want -- I want to be sure to manage people's expectations about when that excess capital is likely to show up, and it's not this year.

All right. Thank you.

Sure.

And one final reminder, if you do have a question, please press star-one on your touch-tone telephone at this time. We'll take our next question from Hardin [INAUDIBLE] with BRC. Hey guys, how are y'all?

Hey, Hardin.

Actually, I think my question was already asked and answered, related to reaffirmation of guidance, and I just want to make sure I understand the components of that, again. John, if you would go through with me your expectation for loss -- loss ratio.

We're running our loss ratio for the first half of the year lower than we anticipated. We have a loss ratio of 26% for the first half. Our guidance is between 445 and 485. The loss ratio in my model for Q's 3 and 4, Hardin, is approximately 40%.

And again, I'm sorry, I'm going to interrupt John here. We historically have given guidance where you have to pick some loss ratio for the guidance, and what we do is we use the rate adjusted historical mean on a line by line basis. So that's what that number that John said for the loss ratio is going forward.

Great. Thanks.

Sure.

And Mr. Radke, I'll now turn the conference back over to you for any further or closing comments.

Thank you very much, all of you, for your time and attention and for joining us on this call. I look forward to speaking to you at the end of next quarter. Thank you.

Thank you.

And that does conclude today's conference call. We thank you for your participation. You may now disconnect.