Argo Group International Holdings Ltd (ARGO) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, welcome to the second quarter 2012 Argo Group International Holdings, Ltd. earnings conference call. (Operator Instructions). With that, I would now like to turn the conference over to your host for today, Mr. Matthew Coyle, Head of Investor Relations. Please, go ahead sir.

Thank you, Keith and good morning, everyone. Welcome to Argo Group's second 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'll open up the call for your questions.

I'd like to remind everyone before we begin, that 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 inherit risks 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 see 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 the time to join us today. Let me take a few moments to share with you my thoughts on the quarter, after which, Jay Bullock, our Chief Financial Officer, will provide you with additional detail on this quarter's financial results, and then we'll take your questions.

For the Group, we reported $17.9 million of pre tax operating incomein the quarter, versus $2.6 million for the same period last year. What's notable compared to a year ago, is that three of our four segments, including our Lloyd's syndicate, reported an underwriting profit. The only segment that didn't, was Commercial Specialty, which was profitable on a current accident year basis, excluding CAT. But unprofitable in total, due to an adverse loss development, which I'll talk about momentarily.

Overall, I'm encouraged by the positive achievements we've made on a number of fronts this quarter. First, we were able to achieve rate increases on almost every class of business where we thought we needed it, and that was most, by the way. Where we could not achieve rates, we chose to get off the risk, and that was most notable in our U.S. retail business at Argo Insurance. Second, we continued growing our top line for the fourth straight quarter, with gross written premium increasing 16.6 % year-over-year.

While part of this came from rate increases, it also came from growing our platform, particularly in our Excess and Surplus Lines segment, as well as, our operations in Brazil. I think we're well on our way to getting back that business on the right trajectory, and we expect to see that the positive growth reflected in earned premium over the next quarter or two, from our E&S segment.

I have to say, I'm really encouraged to see that in addition to the recent the positive changes in our rating environment, this positive momentum is based on the actions we've taken over the past two years that are now flowing through to the financial statements. And it's been a lot of really hard work from our E&S team, and I'm very appreciative for all their work.

Third, as I mentioned up front, our syndicate at Lloyd's generated an underwriting profit for the quarter. The positive momentum that the syndicate indicates that our previous portfoliooptimization actions are finally taking hold. Lastly, our book value per shareincreased for the first six months of the year, by 5.6% to $58.74 in a very choppy investment environment. That's 1.4% above our first quarter book value per share of $57.91, which had [equipped] our previous high water mark of $57.82 at the end of 2010.

As for the environment in general, I think things are still very challenging, but I'm pretty optimistic. While we are seeing the same level of rate increases as our competitors,when you take into account expected loss cost trends and the massive decline in investment yields, we still need to be very focused on rates, given those environmental factors.

What I really get excited about, is the positive changes that we've made within our Company, environment not withstanding. I can sum that up withbetter portfolio management, better risk selection, better people selection and better execution than a year ago. In short, I believe that even though we see some environmental improvement, that we will continue improving given those changes internally.

Now let me briefly recap how each of our business segments performed in the quarter, before I turn the call over to Jay. I have already mentioned our Excess and Surplus Lines segment, where our gross written premiums were up 9.2% in the quarter, due to strong growth in our core Casualty, Property and Environmental businesses. Submission activity was up 17.2%, our renewal retentionimproved 5 points, as compared to the same period a year ago. Which to me, was a really big deal.

In addition, this quarter marks the fifth consecutive quarter that E&S achieved a positive rate increase, particularly on those lines of business where we needed it the most. This quarter's strong combined ratio of 88.6%, includes 12.6% of favorable prior year loss development, primarily due to favorable loss trends in our liability book of business.

In our Commercial Specialty segment, gross written premiums were up 5.1% in the quarter, as compared to the same period a year ago. Premium gains in the quarter primarily reflect an increase in our Surety, State Funds, and Rockwood businesses, partially offset by targeted reductions in our Argo Insurance business, as certain accounts did not meet our underwriting standards, which I alluded to earlier.

In the quarter, Commercial Specialties current accident year combined ratio excluding CATs, was 98.6% or almost 4% better than the same period last year. We actually believe this is a good indicator of this segment's underlying profitability. However, the adverse loss development I mentioned earlier, was a real drag on this segments results for the quarter.

We experienced some of this last quarter, as you'll recall, and most of it stems from our US -- mainly from Argo Insurance. You'll recall that two years ago, we merged the former Great Central which was based in Peoria, Illinois, into our Grocer's business based in Portland, Oregon, and re-branded those businesses as Argo Insurance.

In hindsight, we overloaded our merged claim staff, which lead to many claims not perhaps getting as much attention as they deserved. During an extensive review by our team during the past few months, from other parts of the group, we decided that we should increase our loss reserves by $11 million, to take some case reserve increases into consideration. We also took a hard look at where we're willing to write business going forward.

And while the businesses performing well in the current accident year, we're in the process of evaluating potential changes to our business model in order to focus on the lines of business in geographic regions where we know we have the experience and expertise to be profitable on an ongoing basis. In short, I think that means you'll see continued premium reduction, from the Argo Insurance part of Commercial Specialty, for the remainder of this year, and perhaps into the first quarter of next year.

Turning to our International Specialty segment, gross written premiums were up 34% in the quarter, as compared to the same period a year ago. The increase reflects approximately $13 million of new premium from our start up operations, primarily Brazil, but also Dubai, and to a lesser extent, parts of Continental Europe.

We also had growth in our Short-Tail Property book due to rate increases and new business opportunities. International Specialty also had another good quarter of underwriting results, as there were no significant catastrophe losses in the period. Their combined ratio for the quarter was 71.1%, which includes $3 million of favorable prior year loss development, primarily on Short-Tail business.

In Syndicate 1200, where our Lloyd's segment is, gross written premiums were up 23.7% in the quarter, as our share of the syndicate increased year-over-year and many of the initiatives, that were put in place in 2011 to re-balance and grow the business, are starting to take shape.

We also achieved rate increases on our Property book, in the mid single-digit range. In terms of underwriting, Syndicate 1200 reported an underwriting profit this quarter, as evidenced by a combined ratio of 98.9%. There were no catastrophe losses for the quarter of any appreciable size, and the results included favorable prior year loss development of $1.9 million across multiple lines of business. I'll now turn the call over to Jay Bullock, our CFO.

Thanks, Mark and good morning, everyone. As Mark mentioned, with three of our four businesses performing as expected in a very reduced level of catastrophe activity in a period, it's good to be headed in the right direction. We are encouraged by the organic growth in segments such as, Syndicate 1200 and E&S, and as Mark said, we feel the momentum is as much a result of the effort of the teams there, as it is of market conditions.

We believe the platform we have in place will allow us to capitalize on current and future market opportunities. Now let me point out a few things in the financial results and then we'll open up the call for your questions.

As outlined in our press release, we reported after tax income of $24 million for the quarter, compared to $21.6 million for the same period a year ago. That translates into earnings per share of $0.92, versus $0.78 per share in the prior period. Current period results include $2.7 million of realized capital losses, and $9.8 million of gains for movements in foreign currencies. After tax net operating income per share was $0.55, versus $0.08 in the prior period.

As Mark discussed, gross and net written premiums, as well as earned premiums, all were up significantly in the quarter through six months. Through six months gross and net and written premiums were up 15.4%, and 11.6% as compared to the same period a year ago. Each of our business segments contributed to those results. The difference in growth rates between gross and net written premiums, largely reflects the timing of the recognition of certain reinsurance contracts.

Our catastrophe losses in the quarter were modest, despite once again, a pretty active spring storm season in the U.S. For the quarter, we incurred a loss of $3.9 million, versus $31.9 million for the same period a year ago.

Catastrophe losses in the quarter reflect U.S. storm activity, primarily in our Commercial Specialty and Excess and Surplus Line segments. On another positive note, the losses we incurred in 2011 in relation to natural catastrophes, were in total, stable for the quarter.

Overall prior year loss development was favorable in the quarter, despite the provision we put up for Commercial Specialty, that Mark discussed. We reported $4.1 million offavorable development, versus $1.1 million offavorable development for the same period a year ago. The loss ratio in the quarter was 62.1%, versus 70.4%for the same period a year ago.

The expense ratio was up slightly in the quarter, due to our investment of new initiatives. Which include both our new underwriting operations, as well as, projects designed to reorganize some of our support functions and create an information technology platform, that will allow us not only to reduce costs in the future through scale, but also make us much more responsive to new opportunities in the marketplace.

As we begin to see these new adventures generate premium and projects come online, we expect to see improvement in the expense ratio. The foreign currency gain, which is reflected in the income statement for the three and six months, reflects the significant second quarter strengthening of the US dollar against pound sterling and the Euro, and the resulting decline in the value of contracts denominated in the latter currencies.

The modest tax provision of $1 million in the quarter, was impacted by profits generated in Bermuda and the lower effective tax rates associated with income earned in other countries. In addition, the provision is impacted by such things as, tax exempt interest in the U.S. and by currency impacts in other jurisdictions.

Turning to investments, the overall size of the portfolio, including cash, decreased slightly in the quarter reflecting a drop in the unrealized gains position of $14 million, as compared with the first quarter and the continued payout of prior year catastrophe losses. As a result, and in combination with lower investment yields, our net investment income this quarter was down $2.9 million, versus the same period last year, and $1.4 million as compared to the first quarter of 2012.

The book yield on the fixed income portfolio declined from a yield of 3.7% in the prior quarter, to 3.6%. In the quarter we incurred net realized losses of $2.7 million, which include mark-to-market adjustments on a global equity fund we hold, and foreign exchange movements on certain short-term investments, partially offset by realized gains from our core fixed income portfolio.

The fixed income portfolio this represents approximately 84% of our invested assets, has an average rating of AA minus, and a effective duration of three years. At the end of the quarter, pretax unrealized gains in the portfolio ere $265 million, up $33 million from year end.

Elsewhere on the balance sheet, our receivables declined reflecting our increased percentage participation on Syndicate 1200. Loss reserves were down, reflecting the continued payout of last year's higher level of catastrophe losses and unearned premium was up as a result of increased production. Our total capital position ended the quarter just below $1.9 billion, our book value per share increased 5.6%to $58.74 in the quarter, versus $55.60 at December 31.

In the quarter, we repurchased approximately 602,000 shares, for a cost of $17.4 million, and returned $3.1 million to shareholders in the form of common dividends. Year to date, we have repurchased $27.4 million or approximately 941,000 shares, and returned $6.2 million in dividends.

We've continued to measure the pace of share buybacks and at the third quarter, having completed approximately $6 million of additional repurchases since the end of the quarter. We will continue to balance the decision of return of capital against opportunities we see in front of us in the marketplace, and the compelling valuation of the stock. Operator, that concludes our prepared remarks, and we're ready to take questions.

(Operator Instructions). Your first question is from the line of Amit Kumar, Macquarie.

Thanks and congrats on the quarter. Maybe just starting, I guess in their reverse order, let's start with capital management. You said is $6 million done in Q3, does that mean that we should not anticipate any more buybacks for the remainder of the hurricane season? Maybe just refresh us, what your thought process is, for continuing to buyback, even in Q4, just based on where your stock price is?

Amit, this is Mark. I think Jay's point was meant to be, that we actually think we will keep buying back stock during the hurricane season, and throughout the fourth quarter as well. With our share price where it is, and given the volume restrictions we have, we're pretty comfortable continuing the pace of buybacks for the rest of the year.

I guess what I was trying to ask is how much you have remaining and would you reload?

The capacity under the authorization isn't really a constraint, because I think that we could get that reauthorized if we were too exhausted. I don't have the number handy, but I think we still have $75 million to $80 million of capacity under the existing authorization.

Yes. I don't think we'll run through that during this year.

Oh, that's how -- that's what I was trying to get to, thanks. The other question I have is on the Commercial Specialty, and thanks for the color. Can you give us any additional color, in terms of how you think about this going forward? You talked about re-underwriting, changes in your business model, what other factors, I guess you could share with us, which should give us comfort that this is probably it, regarding this issue?

I think there are probably three things to focus on. One, and I mentioned this in my remarks earlier, we combined two operations into one. And perhaps we needed to keep more claim staff than we did, but what exacerbated that, was a couple of large accounts or programs that we had that drove a fair amount of claims frequency through the system, that's now abating. Okay?

So think of it as the snake trying to eat the proverbial rat, when you can see it kind of going through the snake. That sort of thing happened within the claims organization. I think that's pretty much taken care of now, in terms of how we're handling claims.

But, of course, whenever you change case reserves dramatically, it changes your ultimate loss reserves, because it's a mathematical exercise. I don't mean to sound cavalier, but it takes a couple of quarters for that to settle down. The only thing I can tell you for sure, was whatever number we put up was wrong. We either put up too much or not enough. But we won't know for another couple of quarters. I think we have a much better handle on where we are today than we did three months ago. We've done a lot of work since then.

As a respect to underwriting, that's a separate issue, it's not really loss driven. Some of it is, but I think it's more of a function of recognizing that there are certain types of accounts that we do really well in our retail business, and others that we're just competing on price. When we actually can collaborate with our policy holder and bring value to the table, whether it's our knowledge of the market, our knowledge of the insurance risk and our ability to help them manage their risk on the front end, or mitigate loss through our claims department on the back end, we achieve a better underwriting result for ourselves, and, of course, achieve a better result for our policy holder.

Where we're just issuing a policy and competing on price, we tend to not do so well. We don't do any worse than the market as a whole, but we're trying to not to beat the market. I think over the next nine months, you'll see us get off of accounts where we're not truly bringing that value-add that we think we are, and really getting back to our client-centric focus. So it's not a new approach, it's just going back and making sure that we really do have accounts on the book that are consistent with our longer term strategic goals.

Got it. That's actually very helpful. Just a final quick question. I've gotten some questions regarding fracking and the exposure, can you just sort of refresh us? Would that be included and where does Rockwood stand in regards to fracking?

Remember, that Rockwood is mainly insures coal mining operations. And to your point, we mainly provide workers compensation coverage to mining operators. Most of the fracking, if not all of the fracking exposure, is coming out of the oil and gas part of the energy industry.

So is it's not clear who will have exposure. Of course, it's not clear that we're going to have this huge challenge from fracking, but most of Rockwood's exposure is all coal mining, so they're really -- I don't want to say immune, but they don't have direct exposure because that's not what they're insuring.

Having said that, there are some oil field service contractors that we insure, that are involved in the Marcellus Shale Plain, not so much in the Eagleford Shale Plain down in Texas. But I think our exposure if any, should something arise in the future, is incidental. I would be fibbing if I didn't say that we weren't keeping a pretty vigilant eye on that, as respects future underwriting that we do in the energy space in Texas.

Got it. Thanks. That's all I have and good luck for the future.

Thank you.

(Operator Instructions). It looks like we have no other questions at this time.

All right. Then I'd like to just make a few concluding remarks. In summary, I just want to say that I feel really good about the direction in which the Company is heading right now. I'm very encouraged by the progress that we've made, particularly in our E&S business and at the Syndicate, and by the growth trends we're seeing across our businesses in terms of both rate and top line.

I think we've got a good handle on the issues in our Commercial Specialty segment, as we just got through talking about it, and I'm very confident the resources that we've got working on our Commercial Specialty segment will get us in the right direction quickly.

I'm also encouraged by the consecutive quarters of positive rate momentum we've achieved, and I look forward to that trend continuing. I'd like to thank you all, today for your time, and I look forward to talking to you about our progress at the end of the next quarter. Thank you, Operator, that concludes my remarks.

Thank you. Ladies and gentlemen, that will conclude today's conference. Thank you very much for joining us. You may now disconnect and everyone have a great day.