Argo Group International Holdings Ltd (ARGO) 2006 Q3 法說會逐字稿

Good day. Welcome to the PXRE Group, Ltd. third quarter 2006 earnings results conference call. This call is being recorded. At this time, I would like to turn the call over to Mr. Jamie Tully. Please go ahead, sir.

Thank you. Representing the Company today are Jeff Radke, President and Chief Executive Officer; and Bob Myron, the Company's Chief Financial Officer. Before Jeff begins, I will read the following Safe Harbor statement. Statements made during the 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 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 is could cause or contribute to such differences have been described in the news release issued yesterday and PXRE's Annual Report on Form 10-K and other filings with the SEC. We refer you to those sources for additional information.

Lastly, I would like to point out that the remarks made during the conference call are based on information and understanding that are believed to be accurate as of today's date, November 9, 2006. Because of the time sensitive nature of this information, it is PXRE's policy to limit the archived replay of this conference call to a period of 30 days.

The call is the property of PXRE. Any distribution, transmission, broadcast, or rebroadcast in any form without the express written consent of the Company is prohibited. With those announcements complete, I'll turn the call over to Jeff Radke.

Thanks, Jamie. Good morning. I will comment very briefly on our portfolio of reinsurance business, provide an update on our strategic review process, and then turn the call over Bob Myron to comment on the financial statements. The exposure in our portfolio continues to run off as expected. For the balance of the year gross exposure outside of the U.S. hurricane zones will be approximately $200 million compared to $475 million on May 5. These figures are before reductions for traditional reinsurance in our catastrophe box.

We expect substantially all of this exposure to expire by January 1, 2007. As Bob will detail in his comments, our overall and KRW reserves continue to develop satisfactorily. The board's process of reviewing strategic alternatives continues. The board's objectives remains as it has been, to maximize value for shareholders. It is important to note that the review is ongoing and that the timing of any potential transaction, or whether a transaction will occur is uncertain.

In summary, we continue to focus intently on maximizing value for all of our shareholders through our reinsurance portfolio management and our continuing review of capital corporate structure and business strategy alternatives. Bob?

Thanks, Jeff. I'll discuss several items during my remarks including results for the quarter, the investment portfolio and I'll conclude with some commentary on the remainder of the balance sheet.

First the results for the quarter. As in prior quarters, the level of terminations and non-renewals had a significant impact on our top line during the quarter. We had approximately $21.2 million of gross earned premium and $5.6 million of net premiums earned. Our gross and net earned premiums for Q4 are expected to be marginally lower than they were in Q3 as the number of contracts that expired and non-renewed as of October 1, are not as significant as they were in prior quarters. Net premiums written in the quarter were $20.7 million.

There was no significant catastrophe activity in the quarter. As shown on our income statement, we had negative incurred losses of $6 million. The $6 million was comprised of $2.3 million of net favorable development on prior year loss reserves and $3.7 million of net favorable development on current year loss reserves.

The prior year development was comprised principally of favorable development on nonsignificant catastrophe reserves after increasing our reserves for KRW by $7 million. Such increase on KRW represents less than a 1% change to our $850.2 million ultimate net loss amount for these three events. We think it is important to note that on a year-to-date basis we have had net favorable development on our KRW loss reserves in the amount of $1.1 million.

The current year reserve release was due to lower than expected reported losses from the 2006 accident year. There has been no meaningful catastrophe activity in the 2006 year to date. That investment income was $14.6 million for the quarter and this was principally driven by an annualized invested asset rate of 5.2% from our fixed income and short term investment portfolio, and a return for the quarter of 0.9% from our significantly reduced hedge fund portfolio.

During the quarter, we recorded $4.8 million of other reinsurance related expense. As previously advised, this cost represents the quarterly expense from our second [cat. bond] transaction, A&W Re II, which we are counting for as the derivative. Given the transaction's derivative nature of the annual expense for this transaction it's not expensed on a pro rata basis over the year, rather the quarterly expense is linked to the timing of the underlying exposure periods. For Q4, we expect to expense the cost including amortization of offering cost to be approximately $7.1 million.

This amount, of course, assumes that there are no loss recoveries under the transaction in the fourth quarter.

Operating expenses were $11.3 million in the quarter due principally to the falling operating expenses being higher than they would be in a normalized circumstance. Legal fees of $1.9 million, financial advisory fees of $0.4 million and retention and severance fees of $2.8 million.

Now some commentary on the investment portfolio. As of September 30, 2006 our fixed income portfolio had a duration of 1.1 years and overall was rated AAA. As shown on the face of our balance sheet, we had $737.2 million of total fixed income portfolio and short term instruments. We have elected to keep such a large percentage of our fixed income portfolio in short-term due to the shape of the "O" curve to allow us to continue to meet the needs of counter parties and to maximize our financial flexibility in the context of our strategic alternative review.

During the quarter, the market value of our fixed income portfolio increased by approximately $7.6 million. This change is reflected as a decrease in accumulated other comprehensive loss which is a component of shareholders equity on our balance sheet. This increase in value added $0.10 to our book value per share for the quarter.

As shown on our balance sheet, we have only $18.7 million of hedge fund assets remaining, down from $148.2 million at the beginning of the year. We continue to receive redemption proceeds in an orderly fashion with respect to these hedge funds.

Now some commentary on individual caps on the balance sheet. With respect to loss reserves, during the quarter ended September 30 we paid approximately $94.8 million of net losses. With the respect to the payout of loss reserves based on historical patterns and experience we have seen on KRW to date we expect to have paid 19% of the September 30, 2006 loss reserves by the end of this year, and 57% by the end of next year.

We will have some additional details on the breakout of our loss reserves between [INAUDIBLE] in our 10-K that will be filed later today. Specifically, of the $690.6 million of net loss reserves on our September 30, 2006 balance sheet $550.5 million is case reserves, and $140.1 million is IBNR.

As of September 30, 2006, we have paid $393.8 million in net claims for Katrina, Rita and [Loma] which represents approximately 46.3% of our ultimate incurred losses for these events. With respect to premium receivables, the balance of $110.3 million on the September 30 balance sheet includes approximately $84.7 million of reinstatement premiums due on losses incurred. This asset contains a little counter party credit risk due to contractual offset clauses. The remainder of the balance relates to other premium receivables due to us in the normal course of business and we don't expect any material issues with respect to the recoverability of these assets.

With respect to reinsurance recoverables on paid and unpaid losses the balance combined stands at $39.3 million at September 30. That's a decrease of $13.5 million since June. Approximately 93% of these recoverables are either fully collateralized or reside with [INAUDIBLE] rated A minus or higher by Investor S&P.

Just some detail of the other asset caption. The balance of $31 million principally consists of fair value of the derivative asset from A&W Re II transaction in the amount of $8.2 million. Our investment in the building we occupy in Bermuda of $8 million and some other small balances. The other liability caption of $27.9 million consists of the offsetting fair value liability for the A&W Re II transaction I just mentioned, contingent commissions payable of $7.8 million, $2.1 million of accrued interest expense on trust preferred debt, some unearned fee income assumed deposit contracts and a series of other small balances.

Our shareholders equity as of September 30 stands at $515.7 million. Combined with $167 million of trust preferred debt we have approximately $683 million of total capital as of September 30. Fully diluted book value per share is $6.65. Fully diluted shares outstanding are approximately $77.5 million and this amount is comprise of issued shares outstanding of approximately 72.4 and convertible preferred shares that convert to 5.1 million common shares at the September 30 conversion price of $11.30.

As shown in the press release, the statutory surplus of our Bermuda entity was approximately $573.1 million and the statutory surplus of our U.S. entity was approximately $136.6 million at September 30. That concludes my prepared remarks. With that we will now take any questions.

Thank you, the question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). We'll pause for a moment to assemble the queue. We will take our first question from [Aidan de Brenner] with Morgan Stanley.

Good morning. It's [Aidan de Brenner] from Morgan Stanley. I was bounced out of the first part of the call. Could you just repeat, Jeff, I think you were saying what the exposure on the book now is through to the end of the year pre any receivables and pre the cap bonds. I thought I heard 200, but it would be useful if you could confirm.

That's right, Aidan. Good morning. $200 million gross of everything outside of the hurricane zones. Implicit in that comment is that the hurricane--the U.S. hurricane zones are slightly higher, but only slightly.

Okay. And that risk is on the book to the end of the year?

Correct.

Okay.

And then the other thing I confirmed is that substantially all of the exposure is gone on January 1.

January 1. Okay. Thank you. Then the second question was just on the expenses, you kind of stripped, I think, Bob stripped out what kind of exceptionals, of the 11.4 we could look to see 6 million a quarter, going forward? If you look, I was just looking at the other P&L expenses you have got. Still looks like it is going to be tight. It doesn't look to me like the investment income is going to completely cover that. Is that consistent with what you are seeing?

Well, I think first of all, I don't want to give the impression that those--if you strip out those fees that's necessarily going to be a normalized run rate. We certainly could incur legal fees, financial advisory fees, and retention and severance fees on a going forward basis. Those are just some not normalized circumstance amounts that I thought was useful to break out.

Okay. Thank you very much.

Our next question comes from Ron Bobman with Capital Returns.

Hi. You provided a lot of really good disclosure. My only fault is you spoke too fast. If you wouldn't mind, particularly, I lost you on the share count. Can you do it again a little slower, please?

Sure. It is fully diluted shares outstanding is about 77.5 million. That's comprised of issues and outstanding of approximately 72.4. Then, the convertible preferred shares converting to 5.1 million common shares using a conversion price of $11.30.

Okay. Okay. Thanks. And I didn't really sort of compare the text of the two press releases this quarter and any of the prior quarters, but what did catch my eye was the reference in this quarter is that the board is continuing to explore the strategic alternatives and that we remain optimistic that we'll find a solution, other than runoff. I thought it was in the past, I don't know, maybe a little bit more balanced or likelihood of runoff. Is there any sort of directional change or am I--

No, I think I don't think that there was an intended directional change. One quarter we perhaps were more literate than in another quarter. Essentially, the board's -- the situation and the board's focus remains the same, which is runoff is a very real alternative because it represent a value to shareholders that we feel like we have a pretty good handle on. We will seek out and continue to evaluate alternatives to explore whether there is an alternative to shareholders that's better than that runoff value.

Uh-huh.

And I think what we did say last quarter, is that there were things that we expected might affect the timing of any transaction, and that included time for the reserves to season and time for our reinsurance exposures to run off. The one thing that's happened--well, both of those things have happened with the passage of time. The reserves have seasoned and the exposure has run off. We are not signalling in the text any sort of change in direction or change in degree of optimism. It is impossible to call. It is uncertain.

Okay. Okay. I appreciate that. I had one other question and, obviously, on any insurers balance sheet, I guess loss reserves are the biggest category and with the greatest potential for variability and, obviously, the seasoning of late has been quite good and firm.

I was just curious, because I do know at least from the outside, I have never been inside you occupy on attractive building in Bermuda, I was curious that on the balance sheet, do you own that? And is there, is that an area on the balance sheet where realizable value is meaningfully different from the carrying value? Or do you just sort of lease it and those are leasehold improvements on the balance sheet?

Well, while I let Bob formulate a response. First, let me invite you over for a cup of coffee or a Diet Coke any time you'd like to come inside. Now to answer the question.

Yes. The standard situation in Bermuda is we can't own more than 40% of locally owned property, so to speak. So we have a 40% investment in a joint venture that the building is in. The principal component of the $8 million that is on our balance sheet is a loan to that joint venture. With respect to our 40% investment in the entity, I wouldn't expect, certainly I expect the fair value of this building is more than it was when it was built back in 2001, when it began to be built in 2001 and the deal was originally struck. But I don't think it would have a meaningful impact on the balance sheet, as a whole.

There is a meaningful upside but the figures in the balance sheet are certainly safe.

Okay. Thanks a lot.

Sure.

Our next question is from Brian Smith with USAA.

Hi. If I could just clarify, if I understood you correctly, it sounds like, barring anything else happening by the end of the year potential exposures will pretty much go away and anything left on the books will play out as they are paid. Is that correct?

Just to be sure that I understood the question right I'll answer it sort of carefully. By the end of the year, we won't have, substantially all of our in force exposures will have been expired. So we don't currently intend to have reinsurance exposures in force in any significant amount after January 1, sort of period, paragraph. Then when you reference what's left on the books, my--for me to agree with that, what I'd have to say is that the reserves are going to play out how the reserves are going to play out. I guess what I'm saying is there won't be any in force reinsurance policies of any significance on January 1, does that answer the question?

Yes, and that's exactly right. The reserves, as you say, assuming you had everything correct they would pay out as you get claims submitted. I guess my question then, along those lines is -- I know you can't give an exact answer but what would be your best guess for how long that would play out in a runoff scenario if that's the way the firm chooses to go?

The reason I am not going to venture an estimate is because it is completely out of our control. It is controlled by several entities. Many of them are regulators. It is so uncertain that a guess by me, I'd be concerned, would take on more weight than it deserves. It is uncertain.

Okay. All right. It's interesting. You are able to make reserves, though, that are uncertain. Certainly this would not be held, you would not be held to it, obviously. Okay. Thank you very much.

Thank you.

Our next question comes from [Aviva Schneider] with Silver Point Capital.

Hi. I notice in your written release from yesterday, you mentioned that you wrote premiums in the third quarter of $21 million and I was just wondering what that business was? And if that is still going to be on the books come January of next year?

It has to do with the way we account for written premiums. We haven't actually written any new policies since January 1, 2006. But we book written premiums based upon the associated deposit schedules for the contracts that we write. Most of the contracts are 12 months in duration and have either quarterly, semiannual or in some rare instances, annual deposit premiums. Given that the quarter began on July 1, and a fair component of book has semi-annual deposits, we booked written premiums associated with contracts that were written back on January 1, we would have booked half of the policy premium as written on July 1 in that example. Does that make sense?

Yes.

There is no effect on earned premium of how we do this, it is just how we book written.

That makes sense. Thank you.

Okay.

[OPERATOR INSTRUCTIONS] We will take a follow-up question from Ron Bobman with Capital Returns.

Hi. I had a question actually of the composition of the loss reserves. If I -- the $691 million of loss reserves, what's the split between property and casualty?

There is -- without sort of giving an exact answer in terms of dollars, we haven't written any casualty reinsurance premium basically for the last five or six years. There is a small component in our exited line reserves that's actually casualty reinsurance related. But, it is a pretty small component of the overall net reserve balance. It is basically, it is less than 10%.

Yes. But, so what I'm trying to understand is, obviously, that, in my mind has the longest tail, so --

That's right. So the medium to long tail piece of our reserves is a very small percentage of the total.

Right. Thankfully, five plus years have passed. And the 691, is that gross or net?

That is net.

What's the gross number?

$727.8 million, which is just on the face of the balance sheet netted down by reinsurance recoverables on unpaid losses of about 37.1.

Okay. Should I assume that the reinterest recoverable all relates to the property book?

The majority of it relates to the property book, yes.

Probably bigger than the 90.10, it is probably 95.5.

So, when you say less than--back to casualty question, when you say less than 10%, so we are talking it could be as high as $73 million on a gross basis, right? Why can't you be more specific?

Let me, I actually will be more specific because as mentioned we're going to have some additional disclosure on our 10-Q that's going to be filed later today. Of the $690.6 million of net loss reserves, the Exited Lines segment reserves component of that is $47.1 million. Only a portion of that Exited Lines segment is actually casualty reinsurance related reserves. Hopefully, that helps you out a bit in sort of putting some numbers or parameters around what the number would be.

Okay. What sort of Exited Property Line did you used to write?

I think we have the non-traditional writings that the company did up till 2001-2002.

Like those habitational risks that you used to write, or is that the casualty --

We did combine lines, some facultative reinsurance, all that is in Exited Lines. But the reason you can't give a precise casualty loan number, some of the treaties we wrote that are in Exited Lines covered both, and the reserves are done on a program by program basis in that area.

Okay. My last question, and sorry to take up so many questions. How has, of late, say the last 12 months, how have the reserves held up in the Exited Lines?

I'd say as before, which is each quarter the actuarial formulas are churned through once again and small changes up and down have occurred, I think every quarter, right?

Yes.

The same thing that we're seeing on KRW now. You churn through an actuarial formula that has very little judgement involved in it. Small wiggles are produced. Depending on the quarter, sometimes up, sometimes down.

What's the IBNR case split for that? For Exited Lines?

Case reserves $28.7 million and IBNR is about $18.4 million.

Okay. Thanks a lot. I've had enough. Bye guys.

Moving on. Our next question comes from Jay Weinstein with Oak Forest Investment Management.

Hi there.

Hi.

I wanted to compliment you on coming up with 32 important factors we have to think about when you are looking at your security, I think that was a record as far as I could tell.

Thank you. I'll pass that on to the appropriate recipient.

That was tongue in cheek, so you can laugh. Anyway, some lawyer probably got paid a lot to write that. Anyway, serious question, the cat. bond transaction, which always confuses me, does that only run for the calendar year 2006? Does it end December 31?

No, we have actually got two catastrophe bond transactions. The one that we, that I talked about specifically is the second one.

Okay.

That goes for two more years, 2007-2008. The size, the notional size of the transaction actually gets cut in half at the beginning of 2007. It provided $250 million of coverage this year, but only $125 million for the next two.

Okay.

The first cat. bond transaction was, is $300 million, five-year transaction accepted in November 2005.

Okay. On the balance sheet, what's the value of those?

They're basically isn't--well, let's talk about the first one. The first one is treated as a seeded reinsurance arrangement. So we just expense sort of the quarters seeded earned premium on a pro rata basis over the term of that catastrophe bond.

Okay.

Really, because there hasn't been an event large enough to trigger it there is no recoverables or sort of any balance sheet effect of that transaction.

So that's an income statement every quarter?

Yes.

What does that roughly run a quarter?

That runs about $6.5 million a quarter.

Okay. So that will essentially run on for, till 2010, is that correct?

That's correct.

If it runs tax free. We point you toward the 10-Q. There is a disclosure I won't try and remember about what our termination rights and expenses associated with those rights might be.

Like I say, these things always confused me. In the second one I think you said you expensed $7 million or $8 million in the fourth quarter, assuming no events that trigger anything?

Yes, that will be the amount. $7.1 million in the fourth quarter. That's correct.

Okay. What about that one going forward?

That one going forward will be about $8.5 million per annum.

Per annum. So when it gets cut in half, again assuming of course all along no trigger events, right?

That's correct.

So one goes through the income statement and one just runs through the balance sheet comprehensive income?

The other one also runs through the income statement, it just runs through a separate line item. It is called other reinsurance related expense on the income statement.

Okay.

And so the first one goes through, in effect, net bring premiums earned, it lowers net premiums earned, and then the other one goes through that other line item I just described.

So when we are sort of forecasting what everything's going to look like when you are not writing any business and your exposures, we still have to factor in these future costs of these transactions, is that fair?

That's right.

Either that or the termination.

Okay. Well I will definitely look at the queue, and last question, of the hedge funds you have left, I know it is not a huge number. Have you revealed the strategy which any of those are? What are they trying to do for you? The ones you have left. And they are mostly run off by March, if I remember correctly?

Yes, we continue to receive proceeds on those actually into the fourth quarter. What, sort of the--so even as we speak, sort of, the exposure there continues to decrease. The piece that will come in next year, March, April, sort of May time frame, is largely is the hold back, so to speak, whereby we have got 90% of the original proceeds within a certain number of days of putting in the redemption notice and then the last 5% or 10% based upon the completion of the hedge fund's audit or something -- is generally sort of the way it works.

So, what we have is, really what we have is sort of a smattering of small investments in various -- across various strategies --

I see, so it is not like one holding in one fund left or anything like that?

Yes. That's right.

It is not likely to big enough to make a big difference. That's probably accurate. I know you don't have to agree with that, but these likely the case.

Likely the case, but as you are eluding to, I'd caution that.

I'm stating that not you.

Fair enough.

Thank you very much, guys.

We will take our next question from Tom Kaylor with CRT Capital.

Hi, thanks for taking my call. Just one quick question. With respect to the U.S. subsidiary, you mentioned there was about $136.6 million in statutory capital, right?

Yes.

Can you refresh my memory, I think in the last call you talked a little bit about the exposure with respect to insurance contracts, or reinsurance contracts, in that subsidiary, can you just refresh us on that?

Yes, that entity has a smaller component, a very small component of the in force book running through the end of the year on contracts written for third parties. And, in effect, that entity will also be fully off risk with respect to third party contracts. There also is, as I think we mentioned on the last call, a $40 million inter-company contract that that entity wrote for PXRE Reinsurance Limited. Said another way, PXRE Reinsurance Company reinsured PXRE Reinsurance Limited, our Bermuda company $40 million excess of $150 million ground up loss.

I think you wouldn't be far off saying the U.S. company has 40 part of our gross 200.

Okay. And when does that expire again? Is it April?

I believe it is the end of the year.

End of this year?

Yes.

Okay.

Either way, no matter when it expires, because the in force book expires, the 40 might not be over but it won't be exposed, you with me on that?

No I'm not. Sorry.

The contract may or may not extend past 12/31. I personally can't remember. But the underlying exposure, i.e., the business written by PXRE's Bermuda company will be gone.

I got you. So whether, I'm with you okay. No problem. Okay. Thanks you very much.

Sure.

Okay.

Our final question comes from Ray Fedorak with DuPont Capital Management.

Actually, getting back to his question, when that $40 million goes away from the U.S. company, is that the only--the only other liable is just the bonds sitting at that entity?

No, it's got loss reserves. It has lots of other liabilities that just come from an operating company and it has less than 10 contracts, all of which should be no longer in force as of 1/1. Less than 10 reinsurance contracts to third parties.

Okay, I'm kind of like a generalist, I don't know a ton about insurance. You guys talk about alternatives and you talk about possibly being a runoff and you really don't want to give a time frame, but is there a time frame, what are the inputs in really making the decision whether you are looking at alternatives?

And hypothetically, what are some of those alternatives? When would you expect us to kind of get a feel of what you guys are thinking about doing? Is it six months? Is it a year? Very broadly, like what are you guys thinking?

I think the question the board has to answer is really an HR-related question. For example, if the board were to decide today that runoff is the way we are going to go, we are not going to listen to any offers to buy the Company or to merge the Company, I don't know why the board would do that. But, if it did the question would be, what's the most effective way to get our human resource, human resources down to only what we need? As Bob mentioned, in this call and and in previous calls, our head count has dropped pretty dramatically. Where does it stand now?

45 people.

At 45 people we are down, what I would argue is close to but not the minimum, to run a public company, even if it writes no additional business. Essentially, I fear this is not going to be a satisfying answer, but the board, the board doesn't have--there is no, there is no great reason for the board to stop listening to offers, if and when they come.

Yes.

And potential transactions, I guess I'd point you to our previous disclosures for what I'm sure was a very long list of possible transactions. But there is any kind of business combination, a merger, a sale, a change in business strategy, understandably the board has sort of thrown all options open as being available.

Okay.

Thanks.

Mr. Radke, I will turn the call back over to you.

Okay. Thank you, everyone for participating. We appreciate it. We will talk to you next quarter. Thank you.

Once again, that does conclude today's conference. Thank you for you participation and have a nice day.