Argo Group International Holdings Ltd (ARGO) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2012 Argo Group International Holdings earnings conference call. My name is Jeremy and I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of the conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Mr. Matt Coyle. Sir, you may proceed.

Take you, operator, and good morning, everyone. Welcome to Argo Group's first-quarter 2012 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 that this conference call is being recorded, and that Argo Group management may make comments that reflects their intentions, beliefs, and expectations for the future. Such forward-looking statements are qualified by the inherent risk and uncertainties surrounding future expectations, 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 be Argo Group's filing with the SEC. Now, ladies and gentlemen, it's my pleasure to turn the call over to Mark Watson.

Thank you, Matt, and good morning everyone. We appreciate you taking time to join us today. After my remarks, Jay Bullock, our CFO, will provide you with additional detail about this quarter's financial results, and then we will take your questions. Let me take a few moments to share with you my thoughts on the quarter. First, the return to a more normal level-of-loss activity in the quarter gives us the opportunity to highlight the progress we've made in many of our business units over the past year. Second, we continue to see market conditions improving in varying degrees across our platform.

That said, with investment opportunities offering little return, there is still room and need for rate increases. Third, business flow is increasing, not simply in new ventures, but in many of our more mature businesses. In some cases, encouragingly, this flow appears to be from improved levels of economic activity. We believe these are positive indicators that market conditions are headed in the right direction. Finally, I'm pleased to report that our new ventures, most notably in Brazil, are off to a strong start. I look forward to sharing more about -- with you about our progress in these markets in the future.

For the group, we reported $28.1 million of pretax income in the quarter. That is a much better result than the same period last year. The absence of major CATS in the quarter was a significant factor, but that's only part of the story. The operating result, coupled with strong gains and asset values, lead to growth in book value per share of 4.2%, which puts us back above our high-water mark at year end 2010. Gross written premiums for the quarter increased 13.9% over the same period a year ago, from $348 million to roughly $396 million. This is the third consecutive quarter in which we've achieved top-line growth, proof to me that our strategy to expand the platform and return to intelligent growth is working.

We saw growth in two of our four segments, and are executing this strategy in a market of improving conditions. And one of the other three remained flat. Where we saw declines, they were in line with our stated strategy to reduce the platform's exposure to recent volatility, given the lack of market reaction in certain international property markets. The fact that we are experiencing growth across several parts of our platform, in many cases by expanding what we are establishing in a local presence, gives me comfort that the premium growth is sustainable. This should continue as long as market conditions continue their current trends.

Now let me briefly recap how each of our business segments performed in the quarter. Premium in our Excess & Surplus Line segment was essentially flat in the quarter, as competition and the effects of the shift in product offerings over the past 18 months continues to have an impact. That said, the business remains very profitable as indicated by this quarter's combined ratio of 91.5%. Included in the quarter's result was 9.7 points of favorable, prior-year loss development, as favorable trends continue to impact the bottom line. While we feel this is a good quarterly result, we recognize the future profitability of this segment will largely be dependent on our ability to gain adequate rate. With that in mind, this is the third consecutive quarter that rates on our renewal book have been positive. Finally, new initiatives in the edition of underwriting talents should help us advance this business in 2012, and beyond.

In our Commercial Specialty segment, gross written premiums were up 13.4% in the quarter, as compared to the same period a year ago. This increase primarily reflects double-digit premium growth from our public entity business, Rockwood, which is our mining business, and Argo Surety, due to a combination of improved retention, new business opportunities, and rate increases across most business units. We are pleased with the improving fundamentals of the business, but nevertheless, are disappointed with our combined ratio of 107.4% in the quarter, which includes approximately 5.6 points of unfavorable prior-year reserve development on liability claims. In addition, this segment incurred the brunt of the CAT losses we incurred in the quarter from US storm activity, adding another 2.9 points to the loss ratio. The good news, however, is that absent this above average catastrophe result, our underlying accident-year combined ratio of 98.9% is a 3.0 -- sorry -- it's a 3 point improvement over the same quarter of last year. We think that's a much better indicator of the direction in which we are headed.

In our International Specialty segment, gross written premiums were down 14.3% in the quarter. If you recall last quarter, we discussed our decision to reduce our exposure to inadequately priced international property CAT risks. The result in the quarter reflects the execution of that decision. When we could add rate, we increased our stake, otherwise, we declined the risk. We were also able to achieve rate increases on US property CAT exposures for both January renewals and April renewals. In conjunction with our actions to rebalance exposures in our property CAT portfolio, we made progress in our startup operations, producing over $9 million in premium in the quarter. The result of a relatively benign catastrophe activity, offset by the investment in our new ventures, led to a combined ratio of 89.6% in the quarter. And we expect to improve on this result as we achieve scale in our new business operations and as our strategy to reposition parts of the segment continue.

In our Lloyd's segment, which is Syndicate 1200, gross written premiums were up significantly in the quarter as our share of the Syndicate increased year-over-year, and many of the initiatives we put in place in 2011 to rebalance and grow the business are starting to take shape. Most notable is the increase from our expanded casualty effort and the launch of our Specialty business, made up of space, aviation and marine, which began to show results in the second half of last year. These lines are providing diversification to the portfolio, which should help produce volatility in the business. And while the operating profit for the segment in the quarter was modest, it is evidence that we are headed in the right direction. In future quarters, we believe the rate increases we are achieving across the book, combined with past underwriting efforts, will allow Argo to achieve an attractive return in this segment, as well.

Right now I'd like to turn the call over to Jay, and let Jay get into the numbers more. After we take your questions, I will have a few more comments. Jay?

Thanks, Mark. Good morning, everyone. As Mark mentioned, it's good to get a more stable quarter in the books and begin to see the results from the efforts of the past couple of years take shape. While I am reminded that there remains substantial room for improvement, I'm encouraged by the positive signs in all of our businesses. Let me add a little additional color on the financial results, and then we will open the call for your questions. As outlined in our press release, we reported pre-tax income of $28.1 million for the quarter. This compares to a pre-tax loss of $96.7 million for the same period a year ago. Current-period results include $13.1 million of realized gains and $2.9 million of losses from movement in foreign currencies. After-tax net income was $19.6 million for the quarter, versus a net loss of $94.1 million for the same period a year ago.

As Mark had previously discussed, gross written premiums were up significantly in the quarter. Net written premiums were actually down 1.3% in the quarter, largely reflecting the effects of the structure of the reinsurance program at Syndicate 1200. The ratio of ceded-to-gross written premium will moderate over the next three quarters, as this affect is spread over subsequent periods. And we expect it to be roughly in line with last year. We were obviously pleased to see the return to a more normal quarter of catastrophe activity. And while it was not a loss free quarter for the industry, we incurred a modest loss of $4 million versus $113 million for the same period a year ago. Losses in the quarter reflect storm activity, primarily in our Commercial Specialty, and to a lesser extent, in our International Specialty segments.

Overall prior-year loss development was favorable in the quarter. We recorded $3.3 million of favorable development, versus $4.7 million of unfavorable development, for the same period a year ago. Movement in the quarter was driven by favorable development in our Excess & Surplus Line segment, of approximately $9.3 million, coming mainly from our core casualty business. Partially offset by unfavorable development of approximately $4.6 million in portions of our Commercials Speciality segment, mainly from the general liability lines in our grocery and public entity businesses. The balance was represented by small increases and decreases in other lines, including a negligible movement in prior catastrophe provisions. All in, our loss ratio for the quarter was 61.3%, versus 104.7% for the same period a year ago.

The expense ratio was up in the quarter, primarily a function of our investment in new ventures. Our investment in initiatives to reorganize some of our support functions at the Company, and the development of a new technology -- a new information technology platform, that will allow us not only to reduce costs in the future through scale, but also makes us much more responsive to new opportunities in the marketplace. As we begin to see the new ventures generate revenue, we expect the expense ratio will improve throughout the year. The tax provision in the quarter was impacted by gains generated largely in the US, and by the release of prior-year reserves in the US as well.

Turning to investments; the size of our investment portfolio, including cash, was essentially flat in the quarter, as the continued pay-down of last year's catastrophe losses offset the growth experienced in our operating business. That said, we saw a slight improvement in income from the fourth quarter, as efforts to reposition the portfolio -- a portion of the portfolio into well diversified, yet higher-yielding, assets over the past 18 months, have begun to have a modest impact. Overall yield declines in the past few years led to a decline from $33.4 million in the prior-year quarter. Realized gains in the quarter of $13.1 million include $5.4 million of gains from our core fixed-income portfolio, with the balance coming from other long-term strategic investments. Certain of these investments are in the form of shares held in equity strategies, which by their structure will generate realized gains and periods of positive performance and losses in pullback, as opposed to investment income. Gains reported in the quarter included approximately $4 million from such strategies.

Fixed income portfolio, which represent 85% of our invested assets, has an average rating of AA minus, and an effective duration of three years. At the end of the quarter, unrealized gains in the portfolio were $280 million, up $48 million from year end. Our total capital position ended the quarter just below $1.9 billion. In the quarter we adopted new accounting guidance for the recognition of deferred acquisition costs, which have the net effect of reducing retained earnings by $16 million in the quarter. Book value has been restated for year-end 2011 to reflect retrospective adoption. This had a negligible effect on prior-period earnings. Taking this change into account, book value per share increased 4.2% to $57.91 in the quarter, from $55.60 at December 31, 2011.

In the quarter we repurchased approximately 340,000 shares for $10 million and returned $3.2 million to shareholders in the form of common dividends. We have continued the measured pace of share buybacks into the second quarter, having completed an additional $8 million of repurchases since the end of the quarter. We continue to balance the decision on return of capital against the opportunities we see in front of us in the marketplace and a compelling evaluation of our stock. Operator, that concludes our prepared remarks, and we are ready to take questions.

(Operator Instructions) Randy Binner, FBR.

Quick question, just on the reserve development in Commercial Specialty. It sounds like that was litigation driven. So my question is, do you expect there to be a tail on that liability activity because of the litigation, or do you think it's a relatively contained matter that you saw developing with the reserves? In particular, what accident years were effected there?

I don't think it's just litigation driven. There is always some litigation in the liability portfolio. There are a few dozen accounts that we are looking at in particular that are -- that drove the movement by a few million dollars. We will see how that goes over the next couple of quarters, but I think that's a -- I don't think we will see much more there. Jay, you may have something else you want to add.

Obviously, we think we have -- we hope we've put up adequate provision. We continue to look at it. There's been an underwriting effort ongoing for the last quarter and this quarter to identify those accounts where we've been having some issues, and we hope that addresses it.

It's recent accident-year, right? Because it's generic liability stuff, like slip and fall, so I'm imagining it's '11 accident-year or '10 accident-year, is that right?

It is in the more recent accident years.

I think it may go back to '09 and '08, as well. It's not just last year.

And then one on capital, if I can. Mark, the buybacks are extremely creative at this level where the stock is trading. There was some of that activity in the quarter, but it sounds like you are getting more comfortable that there is going to be real market opportunities going forward. Just want to get the latest on where you are on that trade-off between preserving your capital for the market and letting the opportunity go by to buy the stock so far below book value.

I don't think my point of view is any different today than it was on our call last quarter, when we were going through year-end results. There is more opportunity; as we generate income, we are generating capital. So, we are out buying -- one of the challenges we have at the moment is that the average daily trading volume has gone down a bit over the last couple of years. So, it's a little more challenging to actually buy the stock today than it was two years ago. We are not really pulling back, too much, in our buybacks right now because of the future. I think we have an adequate amount of capital. I think we all kind of wonder what we should be doing during the storm season. We are not quite there yet. But, I think you should look for us to continue buying back a reasonable amount of stock for the remainder of the year, including the third quarter.

Doug [Mewhirter], RBC Capital.

I just had actually two questions. First, on the investment side, Jay. Are you doing anything with your fixed income portfolio, in terms of trying to salvage what yield or investment income you can? Are you moving out on the duration at all? Have you shifted around? It looks like your average rating hasn't moved a whole lot. I was just wondering what your strategy is right now.

We still have not materially moved out the duration, just because we still don't see the value in that. That said, we have moved small amounts of the portfolio into slightly higher-yielding opportunities.

So we changed asset class, more than we've changed duration.

Exactly. And some of that would be included -- I think I commented that 85% of our portfolio is what we would consider to be our core fixed income. Some of those allocations would be into that other 15%. Think of allocations-to-asset classes in the $50 million to $100 million range, with the goal being to retain quite a diversification of the portfolio. We are seeing a bit of a pickup in investment income and so some of those strategies starting to take hold.

Right, but we are not seeing quite as much pickup as we might otherwise, because some of the gains from the other asset classes are -- well, they are coming in the form of gains, as opposed to investment income.

Okay, that makes sense. My second and final question is -- it sounds like a numbers question, but I think it's more of conceptual -- I think it's hard to put a number on it. I was looking at your reinsurance expense, which I think mostly accrues to the catastrophe bonds that you issued, the [charge] of the catastrophe bonds. It looks like -- and actually, first, the numbers question is, it looks about -- a little less than $7 million a quarter, is any of that front-loaded, or is that -- would I expect to continue on until the bond matures?

And the conceptual follow-up of that is, I'm trying -- given that is a real cost, it either adds to expense or comes out of earned premiums, however you want to look at it. Where do you see the benefit showing back up? Is that a lower tail to, maybe, the catastrophe season's loss ratio? Do you pay -- Is there less traditional reinsurance expense? I am just trying to dig a little further into that.

Let me answer -- this is Mark. Let me answer the last question first and then I will let Jay go through the accounting. The CAT bonds cover tail risk, so they are really only covering really large events that don't happen very often, but when they do, they are pretty big. So, that does allow us to buy less traditional reinsurance coverage. Presumably, we are buying the CAT bond at a lower price than traditional reinsurance coverage. That's the reason for the trade. But, you're not going to see that much of a benefit in the loss ratio because that CAT bond is out there for a really big event, as opposed to more of the attritional events that tend to happen annually, anyway. Do you want to go through the accounting?

That is kind of a run rate, and so you have correctly pointed out it should be looked at as ceded premium. And I think that I would suggest, as I did in my comments, that the sum of the other reinsurance expense for the year, plus our traditional ceded premium, will roughly be equivalent to the ceded ratio -- I expect it will be equivalent to the ceded ratio from last year. And as Mark pointed out, that catastrophe -- those catastrophe covers are really what I would call capital protection, i.e., protecting the tail. So again, except in a scenario where there are extreme events, the benefit is that you've got protection against loss of capital.

(Operator Instructions) Ryan Burns, Macquarie.

I just wanted to get your thoughts as to -- as how we should view retentions? Especially in the International Specialty line as you look to grow kind of a new region as well as Syndicate 1200. Just wanted to get your view as how we should view retentions? Thanks.

So let me hit International Specialty first. Whenever we start new businesses, it doesn't really matter whether the-- let me rephrase that. Whenever we introduce a new product, whether it's in a new geography or an existing geography, we always tend to buy more reinsurance than we have on our incumbent portfolios. We do that for a couple of reasons. One, we like to get a little help in sharing the startup expense. More importantly, we want to manage volatility and keep it as low as possible. In the past, that has meant we have given up a fair amount of upside. But, on occasion, we've -- it's managed a bit of volatility to the downside. For the first two or three years that we get things going, we tend to buy a fair amount of reinsurance just to stabilize the business and get it going. We are taking that same approach with the new business initiatives we were talking about earlier in the call. Do you want to hit the other part?

The retentions inside of Syndicate 1200 really haven't changed. They vary by line of business, but they tend to be in the single millions -- low single [millions] of dollars on average. And then we have some business there, for example, some of our US liability business that has fairly low limits, very similar to what you'd see in our Excess & Surplus Lines business.

So, for our working layers, we continue to keep pretty low retentions. Our CAT cover for the D&F program came down slightly year-over-year, but otherwise, things have stayed -- have remained the same.

Quickly, my last question would be on just your general view on the E&S market. We've heard positive commentary from other E&S players recently. And actually your GPW was basically flat for the quarter. Just wanted to see how your submission uptake is coming in right now and just your general view on the market right now.

So I'm much more positive today on the E&S market than I was a year ago. Things are slightly starting to move in the right direction. I'm also positive, for our portfolio in particular, because we have finished some of the re-underwriting we did in a part of the Casualty portfolio. We've had year-over-year premium declines for over three years in a row, so to kind of finish the first quarter, flat we are happy with. I think we've kind of hit bottom and we are starting to move ahead in a positive direction of forward again. So, I would expect you would hear the same positive comments from us as respects E&S over the remainder of the year, assuming that the market conditions continue moving the way they are right now. So it's still low single digits, but that's a much better place than we were 18 months ago.

John Thomas, William Blair.

I was curious if the $6.9 million reinsurance expense is allocated to the segment expense, or loss, ratio?

There is a portion of it that sits in the Syndicate 1200 P&L. There's a portion of it that is held, as what I would consider to be a group cover, and not allocated. I would say approximately 25% is sitting in Syndicate 1200 and the balance -- that's not true. 25% is Syndicate 1200, approximately 25% is in International Specialty, and the balance would be in the group.

Okay. Then, for tax rate going forward, if the combined ratio is around 100%, is a 20% tax rate in line or is that too low going forward?

It really depends on where the -- it depends on where loss activity develops and depends on where we -- it depends on how the prior-year reserves develop. I think, from the view of a steady-state environment, that is still a good rate to use.

At this time, I'd like to hand the call back to your leaders for an any closing marks.

I would just like to say, in summary, that I feel pretty good about the direction of the company right now. The strategic initiatives we've undertaken in recent years to grow the business profitably are beginning to yield results that we can see. I'm also encouraged by the consecutive quarters of positive rate movement we have achieved. I look forward to that trend continuing and accelerating, and I'd like to thank everyone for their time today, and I will look forward to talking with you about our success in future quarters. Operator, with that, I will conclude our call. Thank you.

Thank you, sir. Tank you, ladies and gentlemen, for your participation in today's conference. This does conclude the presentation, and you may now disconnect.