Argo Group International Holdings Ltd (ARGO) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Argo Group International earnings conference call. My name is Veronica, and I will be your operator for today. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. (Operator Instructions). As a remind they are conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Michael Russell, Director of Investor Relations. Please proceed.

Thank you, Veronica, and good morning. Welcome to Argo Group's conference call for the first quarter of 2010. On the call today is Mark Watson, Chief Executive Officer, and Jay Bullock, Chief Financial Officer. We are pleased to review with you the Company's results for the quarter as well as provide management's perspective on the business. Before we begin I would like to mention we will be participating in the Oppenheimer Insurance CEO Summit on June 8th and the [McCory] Small and Midcap Conference on June 15. Should you be attending one of these conferences, we invite you to sign up for one-on-one meetings with Argo Group management.

I would like to remind you this call is being recorded and participants are currently in listen-only mode. Following management's opening remarks, the operator will provide instructions on how you may queue in to ask questions.

As a result of this conference, Argo Group management may make comments that reflect their intentions, beliefs and 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 of 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. And with that I would like to introduce Mark Watson, CEO of Argo Group. Mark?

Thank you, Mike,and hello, everyone. We appreciate you taking the time to join us today. In a moment our CFO, Jay Bullock, will provide you with financial details on our first quarter, and then we will take your questions.

In a three month period with considerable catastrophic loss activity we remained profitable, reporting earnings per share of $0.67 and operating earnings per share was of $0.32. Our book value per share reached another record high, up 2.8% from December 31 and finishing at $53.81, and continuing a trend of sequential growth in quarterly book value per share. For the 12 months ended March 31, 2010, our book value her share increased by 19.2%.

All things considered, first quarters are generally uneventful, but as I'm sure you are aware, this one was quite the opposite. The industry responded to major catastrophic losses in both hemispheres. Our first quarter results were affected by some of these events primarily in our international specialty and reinsurance segments and largely from the Chilean earthquake. From a risk standpoint total capital exposed to first quarter catastrophes was less than 2% of year-end shareholder equity. We estimated pretax losses for first quarter cats, net of reinstatement premiums, at two thousand -- excuse me -- at $29 million. $21.6 million of this amount was attributable to the a quake in Chile, and I will touch on that segment impact in a moment.

Let me talk about capital first. One can conclude that the severity of catastrophes seen in the first quarter of 2010 might have a meaningful impact on the industry's available resources and underwriting capacity, yet we continue to be in the position generating capital at our Company, albeit modestly. This position results from risk management, our investment portfolio and a deliberate entrenchment from market environment that is worse today than a year ago.

Last year at this time things looked a little different. Opportunities appeared attractive due to the impact of financial markets and industry events from late 2008. Unfortunately, as we moved into the second half of 2009 and on the back of financial market recovery, favorable trends in rate and terms and conditions began to reverse themselves, and in some instances that happened quite rapidly. Since that reversal we have been operating in an industry flush with capital and confronting fierce competition from companies either building or protecting market share.

Let's talk about what is going on with the topline for a minute. We believe that shrinking our topline is a sound strategy during this stage of the cycle, and if you will recall from some of our previous quarters, we have said that we will shrink the topline for margin and specifically reduce our property exposure in the Lloyd's syndicate. This doesn't mean that we are standing by idly waiting for the market to turn. Rather we are evaluating and developing opportunities in new geographic markets and continuing to recruit top talent to the organization, like Lou Levinson, who recently -- we recently introduced as President of our E&S segment.

Internally we are streamlining our infrastructure and reducing expenses. While the effects of these efforts may not be immediately invisible, we believe it will produce benefits for customers, partners and shareholders in the near team, and position us well for the eventual market improvement.

As part of our capital deployment strategy last quarter our Board reinstated a quarterly cash dividend of $0.12 per share. This morning we announced another $0.12 dividend payment for shareholders of record on June 1. Additionally, during the quarter Argo Group purchased approximately $30 million of its common stock at market prices, and we are pleased to be in a position to repatriate a portion of the capital directly to the shareholders through both dividends and the buyback of stock.

Let me go through each one of the segments in a little bit of detail, and Jay will hit some of the financial metrics in his remarks as well. Why don't we start with the Reinsurance segment, which continues to perform well. And I would say it, kind of as designed, Argo Re's portfolio responded to the catastrophic events in the first quarter, particularly the Chilean earthquake, where we had losses $6.5 million net of reinstatement premiums. No other cat event had a material impact on the segment's results in the quarter. And as you may recall Argo Re's book responded just as after Hurricane Ike. Overall the reinsurance segment in the first quarter produced underwriting income of $6.5 million, for a combined ratio of 73.9.

As positive as these results are, reinsurance rates remain under pressure, and there are signs of accelerated market softening. Competition remains high, and the market has ample capacity, particularly as cedents feel more confidence in their balance sheets, retaining larger amounts of risk and consequently buying less reinsurance.

Our results in our excess casualty business, the other part of the Reinsurance segment, remains challenged by the slowed pace of global economic activity and the addition of competition from certain new and existing markets. Although I think we will find that the magnitude of the deep water horizon accident will be significant enough to move the casualty market over time.

Let me next talk about International Specialty. This is where the premium contraction was the most evident during the first quarter. It was primarily from the planned reduction in certain property classes, mainly our binder business that I talked about last quarter, and actually I have talked about it for the last few quarters. We have been underwriting our book of business and mainly derisking the portfolio, and that has come in the form of reduced premium, but we have in the process reduced our aggregates quite a bit. And also at the same time, the Lloyd's property business is becoming more competitive as well for all of the reasons that I have mentioned earlier. The loss for the Chilean earthquake in International Specialty was about $15 million for the quarter.

In the US let me talk about our Commercial Specialty segments first. Actually I think given the level of competition, and this is the part of the Company where we have the most competition with the admitted market, I think we did okay. We came in with a combined ratio of 99.1, as pricing narrowed our margins a bit. And we had some losses from the winter storm activity in the US to deal with as well, keeping in mind that last year we had very little storm activity impacting our Commercial Specialty segment.

For our Excess & Surplus Lines business we actually see more competition there than anywhere. Renewals and new business opportunities are down in most areas of the segment. The weak economy has all but eliminated the start ups of new ventures, and as a result new business activity has slowed dramatically for the wholesalers with whom we deal, as many carriers continue to expand their risk appetites and are extremely aggressive in capturing new business that once was insured in the Excess & Surplus Lines marketplace. Having said that, the E&S segment produced a combined ratio of about 100 in the first quarter on reduced premium. Having said that we did see your expense ratios stay flat, as we have been able to take nonacquisition expenses out of the Company's cost structure, and we intend to continue doing that for the remainder of the year.

And also, as I mentioned earlier, we recently welcomed Lou Levinson to Argo Group as President of our E&S segment in charge of overseeing the underwriting and business Colony, Argonaut Specialty and Argo Pro. Lou will be based in Argo Group's New York office, and Lou comes to us from ACE Westchester. I'm confident he will have a meaningful impact on our E&S business, and actually after a month in the job, he already has. We expect to see a number of initiatives that he has been working on in that time start to take hold, and I think you will see them in the second half of the financial results for 2010. And with that I will turn the call over to Jay.

Thanks, Mark. Let me add a few additional details on the quarter, and after that we will take your questions. Even as market conditions in both our underwriting and investment businesses remain quite challenging, we have been able to maintain our financial strength through tactical underwriting and capital management decisions.

In reaction to the current environment, net written premiums and earned premiums down 18% and 6% from the prior year's quarter respectively. Net income was also down from the prior year's quarter. Despite the reduction in the top and bottom lines, we were able to grow our book value per share by 2.8%. And at the conclusion of the quarter we can report a compound annual growth in our book value per share of 12.2% since the end of 2002.

Away from the reduction of the topline of three of our segments, our underwriting results were impacted by catastrophe losses in the quarter. Our combined ratio of 105% was impacted by 9 points from a series of events, most notable the Chilean earthquake, which resulted in losses of $21.6 million net of estimated rein statement premiums. By segment the $29.1 million of catastrophe losses were incurred as follows. International specialty, $18.7 million. Reinsurance, $6.5 million. Commercial Specialty, $3 million. And E&S, $1 million.

Overall prior year development was favorable by $11 million for the quarter, as we experienced favorable development for each of the four segments and for our Run-Off business. By segment the positive development was $1.4 million for E&S, $1.3 million for Commercial Specialty, $5.6 million for Reinsurance, $1.9 million from International specialty and $800,000 from the Run-Off book.

Our reported expenses remained essentially flat year-over-year. That said, the expense ratio in the quarter was impacted by the underlining of approximately $8.4 million of deferred acquisition cost as the to topline was declined. We continued the assimilation process for Argo International and invested in new underwriting teams, while at the same time reducing nonacquisition -- acquisition expenses period over period by approximately 6.5%. Maintaining our infrastructure in proportion to the business opportunity remains a priority for Argo.

With the strengthening or the value of the dollar relative to sterling and euro, during the quarter we reported a foreign currency gain of just under $7 million. This was balanced by an approximately equal decline in the value of our nondollar denominated assets. Finally our tax provision in the quarter was impacted by the proportion of income generated by our US businesses; the impact of the weakness in sterling, which created a taxable gain in our international specialty segment despite our reported US GAAP loss; and by just over a $1 million of tax incurred as a result of the movement of capital.

Let me spend some time on Argo's investment income. Our investment income increased modestly from $32.4 million in Q4 2009 to $33.8 million in the first quarter of this year. We are pleased with the reversal of the trend in quarterly declines, and this reflects our efforts to improve returns without meaningfully increasing risks. The current reinvestment rates remain lower than our average rate of portfolio yield due to further declines in rates and the compression of credit spreads which continued through the first quarter of the year. We have chosen to keep the duration of the portfolios relatively short, with an overall duration of slightly over three years.

Argo's investment duration is just shorter than our expected liability duration. Along with very low global interest rates, valuations in most fixed income sectors remain fully priced on a historical basis. In addition, the challenges faced in the euro zone are additional cause for concern. Argo Group has no sovereign exposure to Greece, Portugal, Spain, Italy or Ireland, and we continue to position our investments conservatively, with an average credit quality of AA. We believe this conservative investment strategy allows us the flexibility to deploy our investment capital as valuations become more attractive relative to their risk.

Given the continued rally in both equity and fixed income markets, we realized approximately $14 million in net gains during the first quarter. The gains were largely in our fixed income portfolio and spread across all sectors. At the end of March, Argo's investment portfolio was approximately $4.3 billion invalue, a slight increase over the [area] in the area of 2009, and at the end of the quarter our unrealized gain position was approximately $176 million. This growth was experienced throughout the portfolio, as equity markets generated strong first quarter performance and most fixed income sectors continued their risk relative to 2009.

Finally a comment on the capital structure. We ended with approximately $2 billion of total capital, split between $1.6 billion of equity and $377 million in debt, of which $311 million are in the form of trust preferred securities. We recently renewed our revolving line of credit. The new agreement expanded the size of the facility from $100 million to $150 million and increased the term from one to three years. In addition, we added two new banks to the group. The revolver is available for supplemental liquidity needs, and we feel well positioned from a capital standpoint to support our business and take advantage of attractive opportunities that may present themselves. Operator, that concludes our prepared remarks, so we are ready to take questions.

(Operator Instructions). Your first question comes from the line of Scott Heleniak from RBC Capital Markets. Please proceed.

Good morning. I wonder if first you could talk about first International Specialty, how far you feel you are along in refocusing the book to far? And how quickly you expect to deploy some of that capital to some other areas? Just to touch on that a little bit.

We should finish derisking the binder business by the 1st of July, so we are just about finished. And we have a couple of underwriters who have -- we have either announced are coming on or just coming on to the syndicate in the second half of this year, so they will be writing. They won't write as much premium as we are letting off the books this year, but they will be getting going for next year. So we expect to see a decline in premium for this year, but I think when I -- when we look at the opportunities that we have for 2011, I think that we will be fully utilizing the capacity of the syndicate for 2011.

Okay. And so you said that essentially most of that, the business you are not renewing is property -- is pretty much all property? Is there --

It is all property. It is all cat exposed property in remote regions of the world where the margins look great right until an event happens, and then all of a sudden they don't look so good.

Okay. Also expectations for the expense ratios about 39% or so. What are your expectations on where that might end up for the year? I know you talked about some initiatives on getting expense ratio down, but where do you kind of see that heading over the next few quarters?

Let me go first, and then I will let Jay supplement my answer. Part of the expense ratio is a function of mix of business. A lot of that expense ratio is being driven by Argo International. In fact, most of it is. And so as we continue to move away from the binder business, recover holder business that has a higher acquisition cost, and as we reduce some of our personal accident books, which also has a high acquisition cost, you will see the expense ratios start to move down.

The second thing that will drive it will be the continued, what I'll call consolidation of our back offices, not only in the US but in the UK as well. And that is an ongoing process that probably still takes another year to finish. I don't know that we will see a lot of expense ratio improvement from that, because I suspect that the market is not going to improve in terms of competitiveness for the year. I would expect that we will continue to see our topline decline during the year. So any expense improvements we get are likely to keep the expense ratio fairly neutral as opposed to improving it. And as Jay was mentioning in his remarks, a lot of that expense ratio challenge is coming from the change in deferred acquisition costs as well.

Right. I don't really have anything more to add to that. I mean the -- take the $8 million off from a ratio standpoint, and that is kind of what the underlying numbers look like. But I think there is still more -- I think -- there will still be some additional back unwind, because we are coming -- the rate of decline is going to cause the back to reverse.

Yes, and I think that becomes even more clear when you look at our cash flow statements, which we will publish in the 10-Q in the next couple of days.

Okay. That makes sense. That's helpful. And then the only other question I had was reinsurance heading into July 1 renewals, do you expect your mix -- I don't know exactly how much you write, I don't think you write a whole lot or renew a whole lot at July, but what is your expectation for renewals there, given where pricing is I guess in Florida and the other places you would renew?

Yes, most of the business that we have yet to renew for the property cat reinsurance book is US focused, and the majority of that is wind in Florida and other parts of the Gulf and the Atlantic seaboard. Given how much more ceding companies are taking on a net basis and -- while there is some additional capacity this year versus a year ago on the reinsurance side, the real change is just demand has dropped significantly. And so I think that we still have a chance to keep ourselves positioned on the programs where we want to be, but as cedents continue to increase their net retentions, that business gets a bit more volatile. Sorry, the part we end up reinsuring gets a bit more volatile, and whether or not we as an industry get the right price for that I think is going to be a real challenge between now and July 1. For our portfolio we don't have that much coming up, so I don't think we are that challenged, but you are asking the right question.

That's all I had. Thanks.

Ladies and gentlemen, (Operator Instructions). Your next question comes from the line of Amit Kumar from Macquarie. Please proceed.

Good morning, and congratulations on the quarter. Two quick questions. Can you talk about your exposure to the Transocean oil rig?

We -- it doesn't appear that we have any exposure from our property account, Amit. We do have -- we believe that we will have exposure from our excess casualty business underwritten out of Bermuda for some of the energy accounts, where we sit on some of their excess programs. But at this point it is pretty early -- too early to tell exactly what that is going to look like. We did not insurance Transocean and, of course, BP is self-insured.

And is there like a range in your mind as to what that number could be?

Well, that the point, based upon what we know today, I think it is millions of dollars and certainly not hundreds of millions of dollar.

Okay. That's very helpful. Moving on and then this is the final question. In terms of the capital position, obviously you have the buyback, you have the $0.12 dividend this morning. Could you talk about your capital position from this point onwards? How do you think about it? And once the ASR is done, what are the thoughts on a possible reload of that and maybe even increasing the dividend down the road?

Well, I think that we always have the option of increasing the dividend. As you have seen from what we have done in the past, when we thought we had capital we could repatriate we have done one-shot large dividends in the past, most recently in 2007. I think for now having the 12% -- excuse me, $0.12 dividend in each quarter is just fine. I think that if we are going to repatriate additional capital, it will probably be in the form of additional share buybacks. And I don't know that we would necessarily reload what we just did or what we are finishing as respects the accelerated share buyback, but probably we would do something similar to that.

Okay. That's all I have. Thanks so much.

Thank you.

(Operator Instructions). And your next question comes from the line of Bob Farnam from KBW. Please proceed.

Hi there, good morning. Did you have any losses related to the mine explosion in West Virginia.

We did. We had a small property loss out of the syndicate, and I think it is about a $1 million, Bob. But we didn't have any of the workers compensation exposure from our US companies. We weren't on the risk.

Okay. That was what I was wondering happened (inaudible - multiple speakers) --

We just happened to be on -- the syndicate happened to be on Massey Energy's global property program.

Okay. And you have given bits and pieces about what your growth expectations are by segment. Can you just kind of refresh? It sounded like the US ops was competitive and they're going to expect premium declines for the year. Is that accurate?

Yes, I would expect premium declines in the high single digit to low double digits quarter -- I mean year over year for each quarter. I think that we will continue to see a contraction in the topline -- sorry, we will see a contraction in the topline of Argo International -- sorry, our International Specialty segment in the second quarter as we continue derisking the binder business. But as I think I mentioned this in one of the other questions, and that is that should be done by the 1st of July. So I think we will see a temperament in the rate decline for the syndicate. The reason I hesitate is the property market is getting pretty competitive now, and so while the majority of our premium that is underwritten through the syndicate is property from our direct and facultative book, I think it is going to be challenged.

For the Reinsurance business, I think that with -- well, there is not that much to be written in the second half of the year. Most of it is written in the first half of the year, with the exception of July 1 business that is booked on July 1. I think the Transocean claim we were talking about a minute ago will start to move casualty rates later in the year as losses start to trickle through. But, I wouldn't see that straightaway.

So I think that our topline -- we would rather focus on margin right now than on market share, and I think that means continuing to plan for topline declines in the short run as some of the investments that we are making now come online towards the end of the year and next year. It is a little early to talk about next year, but I'm a lot more optimistic about next year than I am 2010.

Okay, very good. Thank you.

Ladies and gentlemen, there are no further questions. I will now hand the call over to Mr. Mark Watson for closing remarks. Please proceed, Mr. Watson.

Thank you, I appreciate everyone taking the time today to join us for the first quarter call. It has been a pretty choppy time for all of us in the marketplace, and we will remain focused and look forward to talking to you all at the end of the second quarter and report on our results and our progress then. Operator, that concludes my remarks, and thank you again.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.