Argo Group International Holdings Ltd (ARGO) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2011 Argo Group International Holdings, Ltd. earnings conference call. My name is Stacy; I'll be your conference moderator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today to Mr. Matt Coyle, Vice President, Investor Relations; please proceed.

Thank you, operator; and good morning everyone. Welcome to Argo Group's fourth-quarter 2011 earnings conference call. Joining me today is Mark Watson, Chief Executive Officer and Jay Bullock, Chief Financial Officer. On today's call Mark and Jay will review the Company's financial results for the quarter, and afterwards we will open up the call for your questions.

I would like to remind everyone this conference call is being recorded, and that 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.

Now ladies and gentlemen, it is my pleasure to turn the call over to Mark Watson of the Argo Group.

Thank you, Matt; and good morning everyone. We appreciate you taking the time to join us today. After my remarks Jay Bullock, our Chief Financial Officer, will provide you with additional detail about this quarter's financial results, and then we'll take your questions.

Clearly, 2011 was a difficult year for us and for the industry as a whole in terms of catastrophe activity, and that was certainly reflected in our full-year results. We expected the outcome of each event and relative to our competitors, who were also exposed to international CATs, we performed relatively well. Rather than dwell on the obvious, I would like to take this time to share with you my thoughts on our business and market conditions.

In the quarter, we reported a modest pre-tax gain of $8.3 million for the Group as a whole. This result reflects $36.1 million of catastrophe losses, primarily related to the Thai floods. And, while this quarter was an improvement over the prior one, it was a far cry from where we'd like to be.

That said, we achieved two important milestones. Namely, receiving licenses for our new business ventures in Brazil and continental Europe, which we have been working on for quite some time. And, we also saw a number of positive trends that give us confidence in our strategy for the year ahead. I'll speak more about these when I address each segment in a minute.

In terms of our top line, gross written premiums for the quarter increased 18.3% from the same period a year ago. That is the second consecutive quarter in which our gross written premium has increased at a double-digit growth rate, and evidence to us the strategies we have put in place are beginning to work. For the second half of the year, gross written premium was up 15% year-over-year.

Turning to the market conditions, I'm still cautiously optimistic; but I'm more confident that we can execute our strategy for the year ahead based on the positive trends in the marketplace and what we are doing internally as well. As many of our peers have reported, we are seeing pockets of price improvement, ranging from low to mid-single-digit rate increases.

While we certainly view this as a positive trend, just keep in mind that with interest rates remaining at historically low levels, rates still need to improve given our long-term return objectives and current interest rates. That said -- or I should say current investment income. That said, we are encouraged by the positive momentum and are pleased with the business we have retained. We will continue to identify those opportunities that meet our long-term return goals as we grow the business to more appropriate levels.

Now I'll briefly recap how each of our business segments did for the quarter, and Jay will give you a bit more granularity in terms of the financials. Starting with our Excess and Surplus Line segment, gross written premiums were up 3.4% in the fourth quarter as compared to the third quarter of 2011 and up 1.3% from the same period a year ago. Also noteworthy is the fact that for the second consecutive quarter, rates increased slightly, and we recorded an underwriting profit with a combined ratio of 86.9% for the fourth quarter.

That may not seem significant, but we think it is real progress considering the state of the economy and the continued competitiveness of this market. Recall from previous discussions that we spent a lot of time in 2011 repositioning this segment with a focus on people, products, and improving distribution relationships; and that came off the back of the restructuring that we did at the end of 2010.

We believe the platform we built is among the best in the business and expect the positive trends in gross written premium and underwriting margin we achieved in the fourth quarter to carry over into 2012. For the year, the Excess and Surplus Lines business turned in a combined ratio of 95.7%.

In our Commercial Specialty segment gross written premiums were up 4.2% in the quarter, as compared to the same period a year ago. The increase primarily reflects higher workers' compensation premium at Rockwood, due to an increase in the demand for coal and natural gas, and new business production at Argo Surety.

Further, this is the third consecutive quarter in which our Commercial Specialty segment has achieved an increase in rates. We expect that these favorable trends will continue throughout 2012 as we roll out new products and programs, improve retention levels on desirable accounts, and increase rates.

In our International Specialty segment, gross written premiums were up 18.7% in the quarter, as compared to the same period a year ago. Our new office in Dubai, which was licensed in July, had good traction in terms of bound policies and premium written. We also experienced growth in our Excess Casualty and Professional Lines books.

In our Excess Casualty Program, pricing trends continued to be positive for most large energy accounts. Similarly, for Professional Liability, we saw rates firming in the E&O line.

As I mentioned earlier, late in the quarter we received regulatory approval to write business in both Brazil and in the EU. The licensing process in Brazil took longer than we anticipated, but we are now positioned with strong teams, products and systems in place. And we are one of only a few international insurance groups with a local company licensed to underwrite insurance in Brazil. We are very excited about the potential we see in that market, which you have heard me talk about in the past. I'll have more to say on that later in 2012.

We were also excited to receive our license late in the quarter from the authorities in Malta for our new business venture there. The business will be focused on underwriting Professional Lines business in key markets within continental Europe.

In terms of our property CAT reinsurance portfolio, that business remains a challenge, particularly for international exposures. For January 1 renewals we saw rates increase, particularly on loss-exposed business, but not of the magnitude we would have expected, given how low rates already were. So, we reduced our international exposure by 26% as of January 1. As a result, our portfolio is weighted more toward US risks, which we believe is the appropriate mix given the current risk-reward paradigm.

Overall, we feel good about International Specialty's mix of business and the opportunities we have created. We believe the actions we have taken will have a positive impact in 2012 on both gross written premium volumes and underwriting results.

In our Lloyd's segment, which is Syndicate 1200, gross written premiums were up significantly in the quarter, versus the prior year. The increase was primarily due to new business growth from our property casualty and specialty division. Remember that this compares with significant reductions in 2010.

For the January 1 renewals, our International Property Division experienced a similar reduction in property exposures, as did our International Specialty segment. Policy counts for renewal business were down 32%, as we declined to write inadequately priced international property risks. Also, approximately 90% of the renewed policies were bound at a reduced share.

In summary, I believe the steps we have taken and the initiatives we have put into place will now position Argo for long-term profitable growth. The volatility from our international property CAT portfolio is disappointing. But, as I previously discussed we have taken significant action to reduce our exposure prospectively until we think we can be adequately compensated for the risk.

I'm encouraged by the positive momentum in rates and our own growth in premium. More importantly, I'm proud of the platform we are building and look forward to talking with you about our success in future quarters.

In closing, I want to thank all of our employees, worldwide, for their efforts in making Argo a great and financially strong organization, and perhaps I'll say more about that after Q&A. Now, I'll turn the call over to Jay Bullock.

Thanks, Mark. Good morning, everyone. As Mark mentioned, it goes without saying that this was a challenging and disappointing year from a financial standpoint. That said, we feel good about the groundwork laid and the prospects for the years ahead. Let me take a few minutes to review the financial results, and then we'll open up the call for your questions.

As outlined in our press release, we reported a pre-tax income of $8.3 million for the quarter. This compares to pre-tax income of $18.3 million for the same period a year ago. The current period results include $11.5 million of realized capital gains and $7.6 million of gains from movements in foreign currencies.

Our tax rate remains somewhat out of sync with our results as we continue to generate income in the US from older accident years. After-tax net income for the quarter was $1.4 million, versus $12.8 million a year ago.

As Mark previously discussed, gross written premiums were up significantly in the quarter. Net written premiums were up 25.2% as well, while net earned premium was up only 1.2%. The difference in growth rates is simply a function of timing differences in those accounts.

During the quarter, we made the decision to change the accounting of the expense for the reinsurance we buy for Loma Re, the special purpose vehicle set up in June of 2011 to issue CAT bonds and provide reinsurance protection for Argo against certain events.

There is no financial impact from this change. However, for this quarter and forward the cost of the reinsurance protection will be recorded as other reinsurance related expense, rather than as a component of ceded earned premium.

The second transaction that we entered into in December will be recorded in a similar fashion. The change was driven by the remote possibility of excess recoveries from either of these structures. As the protection provided is a component of our reinsurance structure, we will report our loss, expense and combined ratios going forward by subtracting the costs from our earned premium, as we would the cost of any traditional reinsurance protection.

During the quarter, as Mark mentioned, we incurred storm and catastrophe losses net of reinstatement premiums of $36.1 million versus $16.6 million for the same period a year ago. Losses in the quarter reflect catastrophe activity related to the floods in Thailand of $27.5 million and an increase in loss estimates on events that occurred in the first nine months of 2011 largely related to US storm activity of approximately $8 million.

By segment, the losses in the quarter were as follows. Excess and Surplus Lines effectively had no CAT activity in the quarter, Commercial Specialty $1.5 million, International Specialty $18.3 million, and Syndicate 1200 $16.4 million. Year-to-date storm and catastrophe losses, net of estimated reinstatement premiums, were $207.8 million and $73.3 million for 2011 and 2010, respectively. In addition, as previously reported in the third quarter of 2011, we incurred approximately $10 million in losses related to aggregate reinsurance covers.

Overall prior-year loss development was favorable in the quarter. For the quarter we recorded $10.8 million versus $9.1 million of favorable development for the same period a year ago. This was most pronounced in our Excess and Surplus Line segment where we saw net favorable development of approximately $16 million, driven primarily by continued redundancies in the core casualty business. Year-to-date for the Group, we reported $11.7 million of favorable prior year reserve development, net of premiums and losses.

Our expense ratio improved very slightly in the quarter. This reflects continued efficiency improvements, partially offset by our investment in new initiatives, designed both to drive the top line and further streamline the infrastructure of the organization. A tremendous amount of effort has gone into work on all aspects of our infrastructure in 2011, designed to make Argo a more agile, responsive, and efficient organization in the future.

Turning to investments, lower reinvestment rates and a slight decline in fixed income producing assets impacted the quarter's result, as net investment income declined to $29.5 million from $33.1 million in the prior-year quarter. The decline was down only slightly from $30 million recorded in the third quarter.

While the decline year-over-year is disappointing, it reflects the logical result of our decision to keep the duration of the portfolio shorter, coming out of the market turmoil of 2008 and 2009. Throughout the last two years, we have been deploying discrete amounts of the portfolio into new asset classes, which we believe will have greater yield and appreciation characteristics, but which don't have a material impact on the diversification or quality of the portfolio.

The fixed income portfolio, which represents approximately 85% of our invested assets, has an average rating of AA minus and an effective duration of 3.1 years. As you are aware, September 30 of last year represented a low point in that year for asset values. In the fourth quarter markets recovered, and as a result, we saw an increase of $46 million on a pre-tax basis and the value of our portfolio in the quarter to $232 million from $186 million in the third quarter of 2011.

In terms of capitalization, we ended the quarter with $1.9 billion of capital, with no change to the amount or structure of our debt capital. Book value per share at the end of the quarter was $56.21 versus $54.84 at September 30, an increase of 2.5% in the quarter; however, down from $58.41 at the beginning of the year representing a decline of 3.8% for the year.

In the quarter, we repurchased approximately 427,000 shares for $12.5 million. For the full year, we repurchased $49.3 million of our stock and returned $13.1 million to shareholders in the form of common dividends. Operator, that concludes our prepared remarks, and we are ready to take questions.

(Operator Instructions) Randy Binner, FBR.

I guess I just go to pricing right away; and Mark, your comments were more optimistic than I think they had been previously. And, more in line with how a lot of P&C executives I think are seeing pricing turn. I would be curious get a little bit more elaboration on what you are seeing out there, in particular anecdotal signs that insurers are backing away from certain lines, submission activity. Just like to hear more about what you are seeing across the segments?

Well, there are a range of things -- the range of data points that I'll give you from the last quarter to this quarter that in the aggregate make me feel a little bit more positive. We are starting to see rate increases month-over-month consistently, whereas it was sporadic earlier in 2011. And, 2012 is off to a good start. It's still single-digits for the most part, but it's more consistent.

Second, when I look at what's going on with our insurance property portfolio in London, for the month of January, we and the market as a whole, were up pretty close to 10%, if not 10%, on rate. I think I mentioned in my remarks that perhaps we might like to see a bit more than that, given some of the CAT activity, but most of our -- with the action that we took on January 1 coming off a lot of international risk that's much more skewed towards the US, where I think pricing was more adequate to begin with.

I also think that many of our competitors who write admitted products in the US are starting to see the same thing they did 10 years ago, and the market cycle before that. Which is when you expand coverage and don't price for it, eventually the losses start to catch up, and I think we are seeing a bit of that.

Has our submission activity increased? Yes, it has. Some of that, I think, is a bit of admitted business coming back into the US. But I think also, it's us doing a better job of executing our distribution platform.

I would expect in 2012 for the business that, for some of the business that's migrated to the admitted markets in the US, to come back to the E&S marketplace. I don't see that changing rapidly, Randy, but I do think it will happen over the course of 2012; and we are seeing the signs of it already.

And then the last thing I would say is, part of my sanguine remarks over the last year or so have been a recognition, at least by our company, that for our casualty portfolios, which is the majority of our company, with these rate increases, our underwriting margin is starting to look better.

And, it is starting to be more comparable with our accident year margins in -- maybe not quite as good as 2004, 2005 or 2006, but it is starting to move in that direction, but investment yields were substantially higher then. So if yields stay down, then we need even more underwriting margin to get an acceptable return on capital. And, my concern has been whether or not the industry, as a whole, has that same point of view and is willing to move pricing more, in order to get back to a double-digit return.

So yes, I'm a little more positive this quarter than a quarter ago. I also like to talk about what we've done, not what we are doing. So, now the numbers are moving in the right direction, so I can talk about how we are doing not what we want to do.

That is fair; thank you for the comments. Just to clarify one of your last points, you get more of a sense that the other executives are getting it on low rates and that's finding its way into pricing?

They are starting to talk about it. Now, let's see if it happens. Because, of course, the market price is still the market price.

Ryan Byrnes, Macquarie.

Firstly, on the new Latin America operations and European build-out, what kind of premium growth or overall premiums should we be -- what are you guys looking to target in 2012?

We're not looking for a lot. We will write millions of dollars of premium and professional liability in Europe, given where the market is right now. It is not going to be tens of millions or hundreds of millions. We'll write a bit more in Brazil. Just getting -- it's really hard to gauge how much premium you can write, getting out of the box.

Having said that, on an annualized basis, if we could write somewhere between $30 million and $50 million in premium in Brazil in 2012, I'd be pleased. Now, of course, that will probably accelerate during the year, and then there is the lag between written and earned. So, I wouldn't expect it to begin making a P&L impact until the end of the year.

Okay, great. Then, obviously, with net written premium increasing again, where do you guys view capital management in that whole dynamic? Should we expect it to slow down going forward with premiums growing again?

I've always said that capital -- I've put capital into four categories. First, we need capital to support the risk that's already on the balance sheet. Second, we need capital to grow the businesses that we are already in, when the market is conducive to growth. Third, if we have strategic opportunities to grow the company through M&A, or I should say if we can use M&A to accelerate our strategic business plan, we will use capital to do so. And, if we don't think any one of the -- we've got a little capital left over, then we'll repatriate it.

Now, over the last two years, with our share price where it's been, I purposely said that I thought a better use of excess capital, or perhaps a little additional capital, not excess, would best be used to buy back stock, instead of making acquisitions because buying back stock has been so accretive. Clearly, it's still accretive right now. If we have plenty of runway to keep growing the company organically, I think we will continue to look at our share price and think about whether we want to buy back stock.

As we get a little closer to wind season, I suspect we will do the same thing we have in the past and others have done, which is take a cautious and optimistic view. We will continue to look at capital management as a tool for 2012, but we will certainly keep an eye on whether the top line can move up in a prudent way, more than what we have been talking about.

Okay great. Then just one quick clean-up question. Some re-insurers or insurers have put out their exposure to the Costa Concordia shipwreck. I wanted to see if you guys had any exposure to that or what your thoughts are on that?

We don't usually comment on whether we have exposure to any one policyholder. But we are also pretty good about announcing when events occur that everyone else has announced, and you might have noticed we didn't say anything about it.

Okay great, thank you.

(Operator Instructions) Mark Dwelle, RBC Capital Markets.

Let me start with a numbers-oriented question. Did you earn any reinstatement premiums in the quarter? Some fairly large jumps both in the Lloyd's and the International segment. I was wondering if there was any earned reinstatement premiums within those numbers?

There would be some reinstatement premium in the quarter, although not as significant as it was earlier in the year. When the reinstatement premium comes in, it's earned immediately. I'm just trying to put my hands on that number. But, that doesn't really reflect the -- it does reflect -- earned premium is impacted by that more in International Specialty than in --

Yes, I think for the -- I don't remember the exact number for the quarter, but for the year, I believe it was about $12 million.

Okay. Yes, I like to be able to back that number out of my numbers to look at the, I'll say the real run rate of the business, as compared to the amount that is specific to the events that might have happened in the quarter.

Mark, the total reinstatement income was about $1.9 million in the quarter.

Okay, thanks that's helpful. The second question is really, I guess it's a strategic question. I have seen your various announcements of hires in Dubai, Malta, Paris, wherever; I'm not doubting whether those are good people and so forth.

But, the question I would like to ask is, is this the most attractive strategy to try to penetrate markets where the Company really doesn't have a whole lot of market presence, as compared to trying to build out more completely the US market share, where, frankly, the track record has been very good. And, there would seem to be quite a lot of market opportunity in that market space?

If you look at where most of the premium growth will come from in 2012, the majority of it will come from the US, to your point. When you look at the, with the exception of Brazil which I'll come back to in a minute, when you look at the other places that we're doing business, we were already doing it before. We were just doing it remotely, from either the Syndicate in London, or the insurance operation in Bermuda. So, we are not adding product; we are just adding geography and trying to be a bit more local as more and more business is being placed locally.

We talked during the year about people that we hire, but we don't always put the place they are being hired. If I had just said to you look, we've hired two or three more professional liability underwriters, you might not think so much about it. To which you then might say okay, Watson; but now you are in a new geography, how does that change? Well, we are already there.

I think of it more as a bit more paperwork. And it does increase, in the short run, our expenses. But it doesn't increase the underwriting execution risks because, as I said a second ago, we are already underwriting that risk. It is just that we're waiting for the wholesalers to bring it to us, and we'd like to do it more directly.

Now, the exception to everything I just said would be our business in Brazil. In the past, I have talked about where I thought we could grow our business prospectively, and I've always begun by talking about which industries we've focused in and the markets that we already operate, beginning with the United States.

And I have focused our underwriting attention and my remarks on the service economy, the energy industry, the technology industry, and more of the traditional E&S risks where we continue to expand our product portfolio modestly. But, I've also -- so, that is where the majority of our energy is going, and that is where the majority of the growth in premium will come from, prospectively.

Having said that, I have also suggested that I think there are certain economies in the world that would grow faster than the markets that we're already in. And equally important, insurance as a percent of GDP would be growing at a faster rate.

When I look at all of the opportunities for emerging markets or developing economies, I think that for our company, Brazil is the best opportunity for us. We are selling products that we are already familiar with in a market that we are culturally familiar with for other reasons, and look, it's easier to be a new market participant in a growing market as opposed to a shrinking market. So, that's the logic behind Brazil.

But, I think that our premium objectives are quite modest for 2012. We are much more focused on ramping our E&S business, should the market present itself, and also in the Syndicate. And, those are the two places where we have the best franchises and the most entrenched market positions. So, I think your question is a good one, but hopefully that answers it.

That's a very helpful clarification, and I agree with you entirely in terms of the Brazilian potential. It's definitely a dynamic market, and certainly one possessive of a lot of growth potential for everyone. I'll get back in the queue if I have anything else, thanks.

Ken Billingsley, BGB Securities.

Just wanted to follow-up on comments, Mark, that you made at the beginning regarding Brazil. Just clarify, can you just talk about the competitive advantage that you felt that you gained? I believe you commented that you are just one of a few international insurers that have an operating company there. Could you just clarify the statement you made at the beginning, and then talk about the competitive advantage you may have in the near term?

Sure. The point I was trying to make is when you look at some of the markets that we compete in, particularly the US and at Lloyd's, we are competing with 20 or 30 other underwriters for every risk. Perhaps that is an exaggeration for some risks, but I think that is probably true for the majority.

If you look at our international operations, they are very different than the US. In the US, we are focused on very small accounts, occasionally medium-sized risks. But, we measure premium in thousands of dollars and occasionally tens of thousands of dollars.

If you look at our operations in Bermuda, and much of what we do at the Syndicate, but not all, we are participating on very large risks, whether it's a general liability program or property program, where it's as much about capacity as underwriting expertise. And, you are looking at hundreds of millions of dollars, if not billions of dollars, in limit that are being put together.

There aren't that many companies that participate in that marketplace. And, the point I was trying to make about Brazil is that there are even fewer companies that are actually licensed to underwrite risk in Brazil that we compete against at an international level.

Doesn't mean there is not a very large and robust insurance market. But what we found, over the last few years, is that it's not quite as sophisticated as the markets that we trade in, and so hopefully we bring that level of sophistication to the Brazilian marketplace. I think that we won't write -- we'll write some large accounts there, but we'll also write medium-sized risk as well.

So, I think what we bring to the table is our knowledge of professional liability, of surety, of cargo and marine, and perhaps a few other classes of business over the next year or two.

At this time, I would like to turn the call back over to Mark Watson for closing remarks.

I would like to thank everyone for joining the call today. As I mentioned in my opening remarks, it's been a challenging quarter and a challenging year. It's hard to talk about positive trends, given the financial results of the year. So, please understand that we own those results, and we are, perhaps, as disappointed more than you are.

Having said that, we have made a lot of positive moves over the year. I would be surprised if the losses that occurred in 2011 from CATs happened again in 2012, or I should say, if the events did. But, as I mentioned in my opening remarks we have de-risked our portfolio, and on a pro forma basis, it is unlikely that the same set of losses would be incurred by us going forward in 2012. So, I think we've right-sized our CAT appetite.

I think that we have all of our businesses moving in the right direction. The business plans that we are operating against have been the same ones that we have been operating against for many years, although sometimes execution has been a challenge. I think we have very good people in place today, better than a year ago; and I'm looking forward to talking with you again at the end of the first quarter, where we can see how we did.

I would like to end by just thanking our employees again for all the hard work. It's been a tough year, and I'm very appreciative of everything that each one of our employees has done in the year.

Thank you, again.

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect, and have a great day.