Argo Group International Holdings Ltd (ARGO) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter, 2009, Argo Group International Holdings, Ltd. conference call. My name is Ann and I will be your coordinator for today's call. (Operator Instructions)

I would now like to turn the presentation over to Mr. Michael Russell, Director of Investor Relations. Please proceed sir.

Thank you, Ann. Good morning everyone. Welcome to Argo Group's conference call for the first quarter, 2009. With me today is Mark Watson, Chief Executive Officer, and Jay Bullock, Chief Financial Officer. We are pleased to have the opportunity to review the company's results for the quarter as well as provide management's prospective on the business. No earnings guidance will be provided in this call. Before I begin, I would like to say we look forward to meeting you or seeing you again at two upcoming conferences in New York -- the Oppenheimer Insurance CEO Summit on June 2nd and the Fox-Pitt Kelton Cochran Caronia Waller MidCap Bank and Insurance Conference on June 17 and 18. We hope you will take advantage of the opportunity to sign up for one-on-one meetings with Argo management at both of these conferences. I would like to remind you this conference call is being recorded and all participants are in listen-only mode. Following management's opening remarks, the operator will provide instructions on how you may queue in to ask questions.

Let me remind everyone that as a result of this conference call, Argo Group management may make comments that reflect their intentions, beliefs, expectations for the future. Such forward-looking statements are qualified by the inherent risks and uncertainties surrounding future expectations, generally and may materially differ from actual future results involving any one or more such statements. Argo Group undertakes no obligation to publicly update forward-looking statements as a result of events or developments subsequent to this conference call. For a more detailed discussion of such risks and uncertainties, please see Argo Group's filings with the SEC. With that, I would like to introduce Mark Watson, Chief Executive Officer of Argo Group. Mark?

Thank you, Mike, and hello, everyone. We appreciate that you've taken time to join us today. I will lead off the call with some general comments regarding our first quarter results and investment portfolio and balance sheet, as well as touch on a few other items in our businesses. After my opening remarks, our CFO, Jay Bullock, will provide additional details on our first quarter financial results. After Jay's comments, we'll open the call for your questions.

Let me just talk about the quarter. Typically the first quarter is fairly uneventful, although it was a somewhat quieter quarter overall we continued to make substantial progress on a number of fronts. Regarding our financial results, all of our business segments produced solid underwriting returns in this environment, as we maintained a disciplined underwriting posture in a marketplace that remains largely competitive. Casualty rates in most of our businesses stabilized, while property rates, particularly in the property cat market, showed market improvements. While our international specialty segments results were positive and improved over the previous quarter, we still have some work to do to get our Lloyds business operating to its full potential.

I'm pleased to report that Argo Group produced profitable bottom line results despite the financial market's continued impact on our investment portfolio. While net income lagged last year's first quarter, pretax operating income improved 8% and total revenue was up over 43%. As the financial markets stabilized, we believe more of the company's top line growth will fall to the bottom line. Another positive trend specific to Argo Group is the benefits we continue to see from having a broad international specialty platform. It provides us with maximum flexibility to take advantage of opportunities that appear. We see a large variety of risks and we have a variety of options on which to write those, which we believe will be profitable. For instance, reinsurance appears to be at the leading edge of a hardening market. Our reinsurance unit was able to take advantage of that and had a particularly good quarter, producing a combined ratio of 57, which in effect offset our lower than anticipated results in the international specialty segment as we continue to reunderwriting our Lloyds book of business.

Let me just go through a few highlights of each segment in a bit more detail. First, let me start with our excess and surplus line segment, which produced a reasonable result in the first quarter, as our hit rate on renewal business continued to be good. However, we continued to see a significant decline in new business submissions, which is consistent with what is being reported across our peer group. Because most of our insureds are small businesses, we're mindful of the impact this slower economy has on our ENS client base. Many of our insureds are small start-up businesses, which are closing their doors and the reality is there just aren't too many new businesses being formed right now, which is a lot of our business. We also believe that the ENS market continues to be affected by competition from standard market carriers, which is still creating pressure on rates and lower volumes of activity coming through the wholesale market. We were encouraged; however, by a moderation of rate declines as a leveling off could indicate the market is nearing the bottom for the smaller risks we insure.

Finally, we're pleased that the ENS -- that our ENS operation experienced favorable prior year's loss development of $3.4 million in the first quarter, primarily out of the mid -- the middle decade accident years. We talked about commercial specialty, which was a bright spot in the first quarter, performing to a 91 combined ratio with slightly positive favorable development of approximately $300,000. Production for the various businesses within commercial specialty was positive relative to what we saw in other areas of the market and overall I would say that we've now seen a flattening of rates and were encouraged that in some businesses, we could actually get some small rate increases. Premiums for commercial specialty were down quarter over quarter largely due to one large account that we chose not to renew during the period. For our reinsurance segment, we're very pleased with the first quarter results. Given Argo Re's strategy of writing risks at a higher attachment points, we were able to avoid many of the larger losses that others experienced during the quarter. Argo Re's losses related to Hurricane Ike developed favorably and were in fact redundant in the first quarter when many of its competitors were not so fortunate.

I was particularly pleased that in only its second year of operation, Argo Re has been able to be more selective than the risks it insured over the prior year. Additionally Argo Re saw rate increases in all of its core lines between 5 and 15%, as well as increases in all the regions where it writes business. Finally, in our international specialty segment, while the quarter was positive for Heritage, results were disappointing relative to where we believe this business has the potential to perform over the long-term. Positive strides continue to be made in repositioning our Lloyds book of business, as we've shed some of the business that is not core to Heritage. We also are seeing an opportunity in 2009 to write an equal volume of business and of better quality than in 2008. Those opportunities have translated into rate increases, the effects of which should be realized in quarters to come. Historically, Heritage's casualty lines have been a very stable book of business and the new lines we are bringing on appear to be opportunistic from market perspective. One of those lines is Argo Financial Products, our non-US professional liability business, which is entering the market at a time when there is significant market dislocation. We believe these and other repositioning efforts we have underway will strengthen Heritage's position in the Lloyds marketplace and we should begin seeing the benefits in the second half of this year.

Let me move on to our balance sheet. Although the financial markets continue to experience volatility, the overall impact to our $4.1 billion investment portfolio was relatively modest. The results for the quarter continue to reflect our conservative investment philosophy. We will continue to manage the portfolio largely dominated by high investment grade fixed income securities, with a small allocation of equities. Jay will provide more color on the first quarter numbers in a few minutes. Our balance sheet remains strong. We have the capital resources necessary to execute our business plan for 2009 and I'm pleased that the book value per share of our company grew more than 2% in the first quarter, which puts it ahead of its balance at the beginning of 2008.

In early March, we announced the renewal and expansion of our revolving credit facility, another sign of our balance sheet strength, as many CFOs and treasurers would tell you, completing this task in the current banking environment is a difficult process at best. I would like to congratulate Jay and his finance team for the tremendous effort and accomplishment in getting this done. Just a couple of other notable events, last week we announced the appointment of [Julian Anoyse] as the new CEO of Heritage. We're extremely pleased Julian will be joining our executive team and bringing his wealth of business experience and success to Argo Group. Julian is a respected industry professional with more than 20 years in the property and casualty sector. Julian will be coming to us from CNA Europe, where he served as president and CEO. He drove the successful turn around of CNA's European business through expense management, operational reorganization and strong branding, prior to joining CNA, Julian held senior roles with AIG Europe and Chubb Insurance Company of Europe . Julian's excellent leadership skills and proven management ability, we have full -- given Julian's -- given his experience, we have full confidence in his ability to lead Heritage through its next phase of growth and development.

Just a couple more comments. During our last conference call, we announced the appointment of [Nigel Mortimer] to head up Argo Re's mew;u established casualty and professional risk business. It became fully functional on April 1 with the infrastructure that we needed put in place. And we're pleased so far with the reception our excess casualty business has received in the reinsurance marketplace and look forward to reporting on its progress in next quarter's call. Lastly, I'll conclude my prepared remarks by commenting on another positive development that cannot be overlooked. During the first quarter, we settled several significant asbestos claims. The settlements included not only our largest single asbestos claim, but also the last large and potentially volatile group of claims remaining on our balance sheet. I should say that we know of. The settlement of these claims is a satisfying achievement in the company's evolution away from its embattled A&E legacy and is a reflection of just how far we've come as a business. Now I'll turn the call over to Jay, who will review our financial results and then open the call up for other questions.

Thanks, Mark. Let me go over and add some additional detail around the first quarter's financial results. And after that, we'll take your questions. While the first quarter of 2009 saw a continuation of volatility in the capital markets and highly competitive operating environment, there were signs of progress. We saw a stabilization in improvement in the value of our investment portfolio, which continued subsequent to quarter end, and in many of our lines of business, we see signs of rates firming. With our performance in the quarter and the return to more normal values for much of our investment portfolio, we now have regained all of the ground lost on book value per share to last year's storm activity and market volatility. Our book value per share at $45.16 now exceeds the level recorded at the beginning of 2008. Our top line continued to increase during the quarter with net written premiums up 48% over the same period last year, largely a result of the additional premium from our international specialty segment. Net of this increase, our core US businesses reflect the declines related to the competitive environment offset by modest growth in our reinsurance segment, largely as a result of better pricing-- a better pricing environment.

Net investment income was up slightly for the quarter, reflective of an increase in our invested asset base year-over-year. Offset by the significant decline in rates on the shortest part of the yield curve. This decline impacted primarily the operating return in our international specialty and reinsurance segments, where we maintain short duration portfolios to match the corresponding short duration liabilities. For the quarter, we recognized $11.8 million of realized losses, which included other than temporary impairment writedowns of $14.2 million, primarily from our portfolio of equity securities and from the writedown of one large fixed income position. These writedowns were partially offset by net gains of $2.3 million from sales of various fixed income and equity securities. It is important to note that the OTTI charges taken in the quarter have in most cases been recognized through the balance sheet as adjustments to market value in prior periods.

We review our investments that have an unrealized loss at the end of each quarter and consider factors such as credit rating, the length of time the security has ben in an unrealized loss position, the magnitude of the loss and other items in deciding whether to accord an OTTI writedown. For our fixed income securities, the most significant factor considered is credit rating. For the equity portfolio, the magnitude of the decline in value in time are given most consideration. As such, if current market conditions persist, we expect to recognize additional OTT writedowns in the future from our equity positions, although it is important again to note that our book value already reflects the current market value of all of our investments and thus already reflects future writedowns. In addition to underwriting income, we earned fee income in our international specialty segment through profit commission derived from management of third party capital on our underwriting syndicates at Lloyds and through our commercial specialty segment. For the quarter, fee income was $0.2 million versus $1.3 million for the same period last year. Fee income in the international specialty segment was reduced to reflect revised expectations with respect to the recent year syndicate results. We expect fee income to be a modest contributor to income for the balance of the year.

Turning to the underwriting results for the quarter, we saw solid performance from our business segments and experienced continued positive results from prior accident years. For the first quarter of 2009, our loss ratio was 59.2% versus 60.2% for the same period last year. Overall, the prior year reserved and element was favorable by approximately $1 million for the quarter. We continued to experience favorable development in our E&S segment, recognizing $3.4 million in the quarter, mostly from the 2005 and 2006 accident year casualty lines. Our reinsurance segment experienced favorable development of $2.8 million, with $1.7 million of that coming from a decrease to Hurricane Ike loss estimates. In the run off segments, as Mark mentioned, we settled a large group of claims related primarily to one insured in the quarter, which should act to reduce our potential future volatility. Additionally, we recognize favorable development for the PXE runoff -- legacy runoff.

For the runoff segment as a whole, the net of the large claim settlement and the PX refavorable development amounted to a $5 million adverse development for the quarter. As we have discussed before, the expense ratio remains a focus. While the ratio in the quarter was influenced to some degree by the mix of business in our international specialty segment and by the addition of new personnel in the reinsurance segment, we believe there is room for continued improvement. With the excess casualty team up and running, revenue will-- their revenue will more than absorb this cost. We are actively working to identify areas of efficiency throughout the organization, even as we expect to see growth through the addition of new talented underwriting teams. Finally, the tax provision in the quarter is the result of a slightly disproportionate contribution in the quarter from our Bermuda-based reinsurance segment and from the tax exempt portion of the investment portfolio held in our US investment portfolio. In addition, the income from Argo US entities was lower as the majority of the OTTI charge in the quarter was attributable to the US portfolio.

Now let me turn to the balance sheet and I'll begin with our investment portfolio. At March 31, 2009, our investment portfolio was approximately $4.1 billion, an increase of roughly $60 million since the end of 2008, the majority of the growth was the result of positive cash flow in the business. Although the equity and fixed income markets continued to be volatile in the quarter, the market value of our portfolio improved approximately $6 million from year end. While equities continue to be particularly challenged in the quarter, most of our fixed income allocation showed price improvement. A $14 million decline in our equities portfolio was more than offset by a $20 million improvement in our fixed income portfolio. We made no significant allocation changes from year end positions, but saw opportunities to invest new money in the quarter in sectors with particularly attractive returns. At the end of March 2009, the fixed income portfolio duration was 2.8 years with an average credit quality of double-A plus and the tax equivalent yield was 4.1% for the quarter.

The second largest line item on the asset side of the balance sheet is our reinsurance receivables, which had a balance at quarter end of 1.2 billion, down slightly from year end. The top 10 reinsurers comprised approximately 50% of this balance and we're all rated A or higher by AM Best Finally, I would like to comment on the capital structure before we open it up for questions. Argo Group ended the quarter with $1.8 billion in total cash capital, split between $1.4 billion of book equity and slightly over $400 million of debt comprised of $300 million of trust preferred securities and $125 million of senior debt. As mentioned during the quarter, we renewed and expanded our revolving credit facility to $100 million. The new facility allows for borrowings by various Argo Group companies in multiple currencies. We feel we are properly positioned to support our business for the balance of the year and take advantage of other attractive opportunities that may present themselves. Operator, that concludes our prepared remarks and we're now ready to take your questions.

Okay, thank you. (Operator Instructions) And the first question comes from Bijan Moazami with FBR Capital Please proceed.

Good morning everyone. Jay, I was wondering if you could comment on the tax rate, was there anything you packed into tax rate than what we should be expecting going forward? And also, if you guys can comment a little bit about the president's plan that was announced on Monday, would that have an impact on your tax status in Bermuda.

Sure. I'll take the tax rate quickly. As I said in my remarks, that's really the explanation. Slightly disproportionate to prior quarters, larger contribution from the Bermuda-based business, which obviously in Bermuda has a zero tax rate and then the contribution in the US from our municipal portfolio and the fact that the OTTI charge in the quarter was all related to the US business.

So if you strip out the OTTI charge, you get back to a slightly more normal tax rate, but lower than you would expect as a run rate. I think if you backed out the OTTI effect, you would probably get closer to a high teens. If you have a proportionate impact in future quarters from the Bermuda-based businesses, I would expect to see low to mid-20s.

All right.

And, Mark, do you want to comment on the government?

Yes, well, I'm not sure what's going to happen, but I think given the way we're organized, it's -- while we're paying attention to it, I don't think it's necessarily going to affect how we run our business.

Okay. Very quickly, your reserve releases would have been around $6 million if you would have not settled that asbestos case. I just wanted to clarify that.

Slightly higher than that, but that's in the range.

Okay. So the reserve would have been very similar to what you had last year, if not for that one case.

That's correct.

Okay, and one last question, Mark, how much appetite do you have for reinsurance business, given that property reinsurance pricing is the strongest out there as compared to the casualty market?

Well, just because it's the strongest doesn't mean it's as strong as we would like to see it. And when I say we, I'm referring to Andrew Carrier, who runs Argo Re. He spent -- he's spending this year, or he and his team are spending this year really looking at how they have got their portfolio positioned and while they think there are more opportunities than a year ago, they don't believe that the prices are right to take significantly more risk on the balance sheet. So we've intentionally decided not to do that this year. If rates move up next year, then I think we'll look at writing more business in 2010.

Thank you.

And the next question comes from the line of Mark Lane with William Blair & Company. Please proceed.

Thank you. Good morning.

Good morning.

Just a couple questions. One on expenses, I think last quarter you stated that the goal was to keep the non-acquisition expenses, or the operating expenses kind of flat this year versus and kind of lower the expense ratio by growing into it. What sort of progress have you made there so far?

Well, we're not growing into it because we haven't grown the business. In the US, our top line has continued to decline because of market competition, and our reinsurance operation in Bermuda has -- was about flat. So, one of the -- so the opportunity of growing into it hasn't happened so far and if that -- if the market doesn't change soon, Mark, then I think we'll be having to take a tougher view on expenses than we had anticipated three months ago or six months ago.

Well, what was the operating expense number during the quarter? Because you don't provide it separately.

The operating expense line in the quarter, I'll have to get that for you in a second, Mark.

Okay, and then on Heritage, so, using your words, repositioning, how long do you think the repositioning will take where you're comfortable with that business and if the market environment continues to move in the right direction, when could we see some growth in that segment?

In the second half of the year, which is what I think I alluded to earlier. Remember that be started -- we started -- I'm mainly talking about our-- a portion of our property business. We started reunderwriting that business in the fall of last year. We will be through reunderwriting that business in the summer, but 90% of it will be done by the end of June, so we're I think six weeks away from that. And so it takes time for written to become earned premium and therefore revenue, which is why I would suggest that I think that we start to see that in the second half of this year.

So what changes exactly are being made?

Types of risks that we're writing in our property portfolio, in terms of industry class and also attachment point on a particular risk.

Okay. Thank you.

Let me just answer that question, Mark. General expenses in the quarter were about $55 million for the quarter. Next question?

And the next question comes from the line of David Lewis with Raymond James. Please proceed.

Thank you. Good morning. Mark, lot of CEOs have been out talking about pricing trends. Some saying it's-- we're on the verge of an upswing, some saying that we're not seeing a whole lot. And I know everybody's in different lines and segments. But maybe if you could just talk through your different segments and seeing what-- give us a better, kind of drill-down of what you're seeing and maybe if there's material change in your policy retention levels.

Well, I think that, that we all would like to talk the market up, but talking doesn't necessarily change anything. The reality is that on the casualty side, rates, rates may be going up here and there, but for the most part, the optimism you hear is that rates are-- that the rate of decline has slowed and in some cases, has stabilized. But I haven't seen on the casualty side significant rate increases anywhere, in our portfolio, whether it's small commercial accounts in the US or outside the US through our Lloyds operation.

On the property side, the primary rates are increasing some. Cat exposed risks, particularly larger risks, and as I said in our reinsurance portfolio, are increasing more. And most insurance companies, including ourselves, are renewing their reinsurance programs right now for their cat exposed property business and my guess is that their reinsurance costs are going to go up more than the rate increases they are getting the, so that should drive more rate increase or their margins will compress. That includes us as well. And I don't know that the property rate increases are necessarily going to drive the casualty side, but I guess that's possible.

There's a little less capacity in the system this year than a year ago for all the reasons that we've talked about and eventually that will drive a higher rate. But I think that you're not -- you're not going to -- so far, there hasn't been a shock effect to drive rates up significantly quickly and perhaps what we're going to see this time is a slow rising of rates instead of a rapid rising of rates.

That's helpful. On the reinsurance side, I guess rates were up January 1 and most cat exposed property, anywhere from 8 to 12%. Do you think there's a material change as we come into the June renewals?

Well, I think that you're seeing a bit more rate increase in the June renewals than you did on January 1, which I think a lot of us predicted, so a lot of us tried to keep a little bit of powder dry on January 1 in anticipation of getting a little better rate increase now, and I think that we have. So on the next quarter's call, I'll be able to speak more imperially about that because it's all business being written as we speak.

That's helpful. And I know that your short term return on average equity target has kind of been 10%. Once we get over that hump we'll move to the next (inaudible) target, is that something you still believe is achievable if mother nature remains fairly normalized for 2009?

Yeah, absolutely. The first quarter on an operating basis, we had a return on average equity of just over 10%, so as long as the market continues to stay where it is or hopefully improve, then I believe we're on track to do that. The first quarter would suggest that.

Okay, and just final question probably for Jay, the year-ago gross premium written from the large nonrenewed account and the specialty commercial?

Yes.

What was the magnitude of that on a gross premium written basis?

It was about two-thirds of that reduction and the other reduction and as I said, that was a conscious nonrenewal on our part. The balance of the reduction came from a fronting-- piece of fronting business that we let go, again, not a high margin business. That segment from a margin standpoint was pretty stable in the quarter.

Great. Thank you very much.

(Operator Instructions) And the next question comes from the line of Amit Kumar with FPK. Please proceed.

Thanks. I guess just going back to the discussion on Heritage. If I go back and look at what they wrote in '07-08, it was roughly a 260 to $270 million book. I'm trying to think of $184 million coming in Q1. What is the -- seasonality with this book?

Amit, I'm not sure the first numbers that you -- where those numbers came from. The total book for the syndicate, and this is gross of acquisition costs, has been roughly a $700 million book for the last couple of years. We've had 54% of that last year. We've got 60 something percent of that some year. Because of some accounting peculiarities the gross written premium includes some of our capital partners on that account. So if I adjust for that and try to work backwards to a 600 to $700 million book, obviously it's declined somewhat because of exchange rates, you see about 30% of the business being written in the first quarter.

Okay. That's, that's helpful. And in terms of (inaudible) underwriting, how much will that impact these premiums going forward?

Well, in neither this quarter, last quarter, or in the fourth quarter did we see premium change significantly as a result. It's more, it's more just a function of trading one risk for another. So right now we're not trying to grow the book, nor are we trying to shrink it. We're just trying to reallocate the capacity that we're putting out. So premium is staying flat. Having said that, the average rate that we're getting today is 15% more than a year ago and the average exposure that we have today is about 15% less than a year ago.

Okay. That's helpful. And I guess just one other question on your reinsurance writings. Is it -- for 2009, I think it's still -- is it fair to say that overall premiums would be, in the $100 million-plus range expectation, or could that number go up meaningfully if rates continue to go up?

I, I think that the $100 million mark is probably the right way to look at our book for this year.

Okay. That's very helpful. Thanks so much.

And the next question comes from the line of Scott [Heleniak]-- with RBC Capital Markets. Please proceed.

Hi, thanks, good morning. Just had a quick question, wondering if you can talk about what kind of progress you're making on the search for the new head of ENS, sort of that process. And then on last call, you mentioned trying to get some teams of underwriters. What kind of progress you are making there and if you could expect to make some announcements in the next couple quarters there.

We have a few more people announcements coming, some of them internal, some of them maybe external. The largest-- , the largest thing that we have going on right now is our search for the head of our US operations, and while we have interviewed and met with a number of candidates for the ENS position, I am more focused on trying to get the head of US position filled first and I think we're pretty close to getting that done. But as soon as I say that, something will happen. So we'll wait and see. We do have other people that have been joining the company since our last call.

We haven't -- we don't announce everyone that joins the company. We've had probably half a dozen senior underwriting folks come over since the last call and we tend to announce those intermittently, but not everybody gets a press release when they come

Sure. Okay. And then, the-- since naming the new CEO at Heritage, does this change any plans refocusing the book there, do you still expect to have that done by the end of June? And any different directions since the new appointment at all versus what you said a couple months ago?

No. The new CEO doesn't change our middle to long-term strategy. It actually helps us execute that strategy better to get somebody like Julian on board. But for the short-- for the short-term, his focus will be making sure that what we have on the books at Lloyds today is what we think it is and we'll be looking to leverage that operation first before we do anything else.

Okay. Thanks.

Ladies and gentlemen, this concludes today's question and answer session. I would now like to turn the call over to Mr. Mark Watson for closing remarks.

Thank you very much. In summary, I would just like to make a few points quickly. Our diversified international specialty platform is producing additional market opportunities, better positioning us to compete for business in the converging specialty marketplace, and attracting some of the market's top talent to Argo Group. We produced solid profitable results in the first quarter by maintaining underwriting discipline across our segments. Casualty rates have stabilized to improve slightly, while property and property cat rates have improved considerably. The ENS segment produced good hit ratios on renewal, but new business submissions are down as competition continues from standard market carriers. Commercial specialty saw pockets of rate improvements and produced solid underwriting margins.

Our reinsurance segment produced outstanding results and reported favorable development in redundancies related to Hurricane Ike. International specialty is seeing opportunities to write better quality business in 2009 and as it repositions its book of business for the long-term. Our balance sheet and investment portfolio remains strong and we have the necessary capital to execute our 2009 business plan and finally we settled several significant and potentially volatile asbestos claims with minimal impact on the quarter. And with that, operator, I'll conclude our call. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.