Argo Group International Holdings Ltd (ARGO) 2014 Q1 法說會逐字稿

Good morning, and welcome to the Argo Group first quarter earnings 2014 conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Susan Spivak, Senior Vice President of Investor Relations. Please go ahead.

Thank you, and good morning. Welcome to Argo Group's conference call for the first quarter 2014 results. Last night, we issued a press release on earnings which is available in the investor section of our website at www.argolimited.com. With me on the call today is Mark Watson, Chief Executive Officer; and Jay Bullock, Chief Financial Officer.

We are pleased to review the Company's results for the quarter, as well as provide you with management's perspective on the business. As the operator mentioned, this conference call is being recorded. Following management's opening remarks, you will receive instructions on how to queue in to ask questions.

As a result of this conference call, Argo Group management may make comments that reflect their intentions, beliefs and expectations for the future. Such forward-looking statements are qualified by 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.

With that, I am pleased to turn the call over to Mark Watson, Chief Executive Officer of Argo Group.

Thank you, Susan. Good morning everyone, and welcome to Argo Group's first quarter 2014 earnings conference call. I'll briefly share my thoughts regarding the highlights from the quarter after which Jay Bullock, our CFO, will add some color to the financial results. We look forward to responding to any questions you may have during the Q&A portion.

Overall 2014 is off to a strong start as we reported solid results in the quarter with net income up over 20% from the prior year. First quarter consolidated gross written premium was up with $463 million, an increase of 5.7% over the 2013 first quarter. We began the year with the same strategy that has been our focus for the last several years that of maintaining underwriting discipline while strategically growing our most profitable businesses.

Having said that, our E&S, Syndicate and International Specialty businesses all experienced growth in the quarter. And our Commercial Specialty business, while flat for the quarter, continues to make solid contributions from businesses like mining and surety while making tangible progress returning underperforming businesses to profitability.

For the Group we posted a combined ratio of 95.5% for the first quarter 2014, which is a 4 point improvement from 99.4% in the first quarter of 2013. At March 31st our book value per share was $60.29, up 2.3% from $58.96 at December 31, 2013, and continuing into our 12th year, a track record of growth and book value per share in excess of 10%, inclusive of dividends.

As evidence of their confidence in our businesses the Board of Directors increased the quarterly dividend by 20% to $0.18 per share yesterday. During the quarter we repurchased 165,000 shares of stock at an average price of $45.37 for a total value of $7.5 million, and subsequent to the quarter end we have continued to be active in the market for our stock repurchasing another $3.2 million worth of our shares at an average price of just under $46. As I have said in the past, we think our franchise is undervalued and view share repurchases at a discount to book value as a great investment. Capital management has been a key part of our strategy, and over the last six years we have returned more than $330 million of capital to shareholders. And we will continue to invest in our stock at these prices and return capital to shareholders while, importantly, also staying focused on ways to build the Argo franchise which still remains our main priority.

Let me briefly comment on each of our operating segments before turning the call over to Jay to discuss our financials in more detail. Our Excess and Surplus Line segment saw growth in premium of 9.7% in the first quarter with most of that growth coming from mature higher margin businesses. We continue to drive rate increases through the book with an average for the quarter of almost 2%, which is up 50 basis points from the average increase on the overall portfolio in 2013. That overall number masks larger increases in certain lines where rate increases were quite substantial.

For the quarter we posted an improvement in the combined ratio to 89.4% from 95.6% in the first quarter 2013 and this year's results included nearly $4 million of weather-related losses from the extreme cold this winter. Also prior year development continues to have a positive impact on our results in E&S as well. Jay will go through a little bit more of the results in just a minute, but let me just say that our E&S team is really doing a fantastic job of executing right now.

As mentioned, for our Commercial Specialty business overall premium was flat in the quarter. We saw benefits from new product initiatives and strong renewal retention at Argo Insurance in addition to stronger production and commercial programs as well as Rockwood our mining business. We are also pleased that our underwriting initiatives continue to improve performance in our financial results. Rate increases across the segment were 4.5% overall with higher increases in those lines that needed it the most. The segment's combined ratio was 101.5% in the first quarter of this year compared to 98.6% a year ago reflecting large property losses and cat losses resulting from winter storms in the current accident year. So while the results are not quite as good this quarter relative to a year ago, I actually think Commercial Specialty is in much better shape today and a mile apart from where it was two years ago.

For International Specialty gross written premiums were up 6.4% in the first quarter driven by our operations in Bermuda and emerging markets business in Brazil. Our Excess Casualty business was up slightly year-over-year and achieved risk adjusted rate increases for the quarter. Our professional lines book had a strong start to the year as well.

At Argo Re premium was relatively flat compared with a year ago. Here we realized the benefit of new business opportunities and expanded lines which helped offset rate reductions of 8% to 9% on the overall reinsurance portfolio. I won't belabor the point of new competition because we are seeing the same thing as others in the market, but remember we buy far more reinsurance than we sell which has inured to our benefit again this quarter. Having said that, the segment's combined ratio improved to 84.1% in the first quarter compared to 89.6% in the first quarter of last year.

Finally the results for Syndicate 1200 continued to show steady progress over the last two years. Gross written premiums were up 6% in the 2014 first quarter compared to a year ago. Growth was primarily driven by opportunities in our property division reflecting strong renewal retentions and new business initiatives. On an underwriting basis the combined ratio improved to 86.7% from 93.3% last year helped in part by prior year positive reserve development of close to $9 million for the segment, a far cry from our financial results of 2010.

Moving to the investment portfolio. The performance was broadly in line with our expectations. During the quarter, Argo's portfolio achieved a total return of just about 1%. Our investment grade bond portfolio modestly trailed comparable indices due to our conservative positioning with regard to duration and a 31 point basis point rally in the U.S. 10-year Treasury. At quarter end the duration of our fixed maturities was 2.7 years down from 2.8 years at December 31, 2013.

We have also chosen to maintain fairly high cash balances. We believe a defensive posture continues to be appropriate given market pressures on interest rates as we wait for them to normalize. Net investment income was $23.3 million in the first quarter. Our normalized book yield continues to compress given that market yields are below the portfolio book yield. The degree of yield compression should slow as rates rise and we fund new investments and ramp up existing investments and certain strategies that generate meaningful income. Investment income in the second half of the year should benefit from these strategies.

As mentioned last quarter, the focus continues to be on total return versus net income and of course what I really care about is growth in book value per share. Having said that, we continue adding uncorrelated alternative strategies which continue to enhance and diversify our portfolio. In the first quarter we had $4 million in realized gains from our alternative strategies. The same capital would have most likely contributed $1.5 million in net investment income if it was not invested in alternatives. We believing that building a low correlated portfolio with proven risk adjusted return managers will maximize shareholder value in the long return, and as I have mentioned before it is the long run that is our focus.

So in summary we are off to a very good start. Our first quarter results demonstrate our focus on driving efficiency and improving performance through our platforms. The underwriting environment is increasingly more challenging but with our focus on specialty niches we are producing improved and more consistent results that should generate stable returns for our shareholders. With that, I will turn the call over to our Chief Financial Officer, Jay Bullock.

Thanks, Mark, and good morning everyone. I will take everyone through some additional detail on the financials and then open it up for questions.

This quarter's results represent a continued validation of our efforts to increase underwriting income, grow our most profitable business lines and achieve scale in some of our newer businesses. In fact we saw an increase in underwriting income at the Group level from $1.9 million in the prior year's quarter to $14.5 million in the current quarter. I am optimistic these trends will continue.

First a few comments on the income statement. You will note the growth in gross written premiums and the growth in net earned premium were similar at between 6% and 7%. Net written premium however was down slightly in the period. This was a function of three things. First, the latest version of our Loma Re series of transactions is now accounted for as ceded premium rather than other reinsurance-related expense. Second, a change in the accounting for certain outwards reinsurance contracts. And finally, an increase in our state funds business whereby we are providing fronting capacity and hence ceding more of the gross written premium. None of these has an impact on the ultimate earnings pattern of our business.

In the quarter we reported $11.1 million of net realized gains. In addition to the return on the strategies Mark mentioned, the largest contributors to the net gain were from our equity portfolio gains and certain private equity investments. On the loss side away from our current accident year we experienced overall favorable reserve development in the quarter, representing our 12th consecutive quarter of overall positive reserve development.

Total prior year development for the Group was $8.9 million in the quarter, and the largest components of this release were continued strong results out of prior years in our Excess & Surplus Lines business from contract and casualty lines and positive development out of several lines in Syndicate 1200 offset in part by a movement in reserves in the runoff unit related to increased medical costs on older accident years and our former risk management unit. The table in the press release provides a full year breakdown.

For the first quarter of 2014 the effective tax rate for the group was 5.8%. The reduction of this number was largely a function of a greater proportion of income related to our Bermuda entities and to the impact of a tax credit in our U.K. operation that is the result of foreign exchange movements in the period.

Turning briefly to the balance sheet. The sum of investments in cash increased by approximately $31 million in the quarter, a reflection of positive cash flow from recent growth in the business. For the quarter cash flow from operations was just over $40 million. And we ended the quarter with a pre-tax unrealized gain position of $251 million down slightly from $253 million at yearend 2013.

Finally on the balance sheet of additional note in the quarter was the decline in reinsurance recoverables and gross loss reserves. This decline was a function of the completion of the reinsurance to close process on the 2009 and prior accident years on Syndicate 1200. These balances had formerly been carried on our balance sheet reflecting the original nature of the transaction structured as a whole account quota share.

Operator, that concludes our prepared remarks, and we are now ready to take questions.

Thank you. (Operator Instructions). Our first question comes from Bijan Moazami of Guggenheim. Please go ahead.

Good morning. Bijan Moazami, Guggenheim. In your Commercial Specialty Line you have many insurance companies. Could you qualify where you are having problem, where you are doing well in that segment, and what is your long-term strategic plan for the sum of those products?

I think the only part of the segment that I didn't reference in my remarks, Bijan, was Trident. Trident's premium was down slightly for the quarter. That is our public entity business. And we didn't see any adverse reserve development from Trident for the quarter. That doesn't mean we won't see any for the rest of the year, but I think we have got it going in the right direction right now. We will know for sure on the first of July because that is the big renewal date for public entities. Many of them buy their insurance on that day. But for the most part I think Commercial Specialty is now heading in the right direction, and our strategy is to keep on executing and staying focused on specific industries that we serve within that segment.

Okay. There was also a very nice decrease in the overall expense ratio. I missed some of the comments Jay made, but did the ceded reinsurance cost or ceded premium have an impact on the expense ratio?

Sorry, Bijan, if I got your question correctly. There were some changes in the period as to how we are ceding premiums. I think to answer your question most directly we have made some changes to our reinsurance buying and some of the nature of the structures around our reinsurance that should ultimately inure to the benefit of underwriting income, i.e., we are retaining more margins. So to the extent that means we are retaining more premium, yes, on a same-expense base it will have a modest impact. Most of the impact on the expense ratio however is really the result of the growth in the business we have seen over the last 18 months now really starting to come through the earned premium line.

The benefits I think we will see from the changes we are making to our reinsurance that I alluded to in my remarks are amounts that we will see flow through in the subsequent five or six quarters. It had very little impact in the first quarter. We will see more of that to come.

So overall 2.1 points have dropped in the expense ratio. Where should we be thinking about expenses when you add corporate overhead back to it?

The overall expense ratio includes the corporate expenses, Bijan.

I realize that, but in terms of the direction how much cost cuttings you have further to go before you get to some kind of a run rate expenses?

I think I can answer and I will -- I'll answer your question directly in a moment but let me answer it indirectly. We have been focused on getting 5 points of underwriting margin into the business, and we have been doing that through a combination of scale in the business and underwriting initiatives. I am not declaring victory and Mark isn't either, on that goal even though it was really close to 5 points of underwriting margin in the quarter. One quarter doesn't make a year. That said, I expect contributions to margin both from continued improvement in underwriting decisions and from the expense ratio. So I expect to see quarter-over-quarter to start moving down into the 38 range before the end of the year and by next year to be contributing another 100 basis points to the combined ratio.

All right. Thank you.

Our next question comes from Dan Farrell of Sterne, Agee. Please go ahead.

Good morning. I was wondering if you could talk a little bit about your view of rate versus loss trend. And I guess what I am trying to get at the overall rate seems to be slowing a little bit, but you are putting through larger amounts of rate increase in certain lines while others are not seeing as much and I am just wondering if you are getting more in areas that you need it and does that contribute to some continued loss ratio improvement across the book in your view?

I would say the improvement in the loss ratio has primarily been a function of risk selection over the last couple of years; that is first. Second, for the accounts that we deemed to be underperforming we have either eliminated them or added substantial rate to them, and if we couldn't get the rate, then we just didn't renew the account. In some cases we are talking about 10%, in some cases we are talking about 20%.

When you look at our average, our average increases are low but that is because we have still got some very high margin business that unfortunately our competitors have figured out there is still a little margin to give. But overall I am pleased with the level of rate increase we are getting when I look at where our portfolio is. To summarize, again I think the loss ratio improvement is first coming from the difference in portfolio composition today versus a couple of years ago. Second, it is followed by rate improvement.

That is very helpful. And then I was wondering if you could talk a little bit about the Syndicate business. That is an area in the past that you have talked about being able to continue to grow. And I was wondering looking forward if you could expand on that a little bit and talk about some of the lines and some of the areas where you might be growing off of a lower base to expand your overall platform there? Thank you.

The bulk of the Syndicate continues to be property risk. Over the last two years we have evolved that away from reinsurance and insurance to be exclusively insurance, and also we have evolved that away from a combination of both U.S. and non-U.S. risk to primarily U.S. risk. We think we are getting paid much better to focus on U.S. insurance and then we let Argo Re, the Bermuda company, mange the reinsurance portfolio for the Group. There are still some opportunities in property, but I think for the remainder of this year and the near term given the competitive nature of the property market I think we will continue our focus on some of our other specialty classes within the Syndicate. I think we see a lot of opportunities still in personal accident and marine to just name a couple.

Okay. Thank you very much.

And it seems that there are no -- pardon me. Our next question comes from Ken Billingsley of Compass Point. Please go ahead.

Good morning. Just a couple of quick questions on the share repurchases. How much more do you have remaining on share repurchase authorization?

Ken, I don't have that number at my fingertips, but it is well over $100 million, so we have got more than enough capacity. And I would simply say that the Board has shown a willingness each time we have gotten close to exhausting a prior authorization to renew that authorization.

I apologize if you did mention this before, but in the runoff segment the reserve increase was about $5.5 million. Can you just speak where that was coming from?

The majority of it came from medical cost inflation on some quite old accident years. It is really less about, I say medical cost inflation, it is really more about mortality expectations. People are living longer. It is a fairly small population, and we took the opportunity in the quarter to put up a modest reserve for that.

And if you look at the reserves over the last 12 years, I forgot the exact number but we have had tens of millions of dollars of positive reserve decrease on that portfolio over the last 12 years. So this was a trend we have been looking at for a couple of quarters and thought we might just want to top up our reserves a little bit.

Very good. And then the last question I have and I know you talked about the difference between gross premiums and net premiums written, but could you give a little more clarification on the retention levels across all the segments are down and how we should be looking at that going forward? Because you are saying the gross is up and the net should stay up, but are we expecting that the net premiums written is going to continue to be negative?

I think the point Jay was making is that in the 2013 financial results the way that our cat bond that was in place at the time was structured, it wasn't ceded premium, whereas it was in 2014. So that accounts for part of it. In actuality there is a couple of variations, and Jay you can jump back into them, but we are actually retaining more risk now than we were before. Some of our programs where we don't keep much risk have grown, so that pushes the number a little bit as well.

Those are the three elements. The point I was making, Ken, is that the retention levels -- we have tweaked our retention levels every year for the last couple of years, and taken the opportunity probably in the last two years to begin to move those up because we have got a broader, more diversified portfolio. What you are seeing in Q1 shouldn't really be extrapolated into any sort of quarterly progression. It is anomalous is my point. And yes, that is sort of my point.

I would just add one more thing. While we should be taking more risk net as we can certainly handle the volatility, if reinsurance pricing continues to come down, as I said in my opening remarks we are more of a buyer than a seller of reinsurance then we may start buying again. But you can ask me about that later in the year.

Okay. Based on what you saying, is this something that maybe there is a seasonality factor in what we may see with retentions between net to gross maybe in the first quarter but normalized trends for the remaining part of the year?

Correct. I think if you went back and looked at the retention levels from last year, you might see a slight decrease but not a material decrease.

Very good. Congratulations on the quarter, and thank you.

Thank you, Ken.

Our next question comes from Amit Kumar of Macquarie. Please go ahead.

Thanks, and good morning. I just joined in, so I apologize if I missed any of these. Can you talk about the International Specialty growth? I think you might have alluded to that in the opening comments, but maybe expand on that and what the key drivers were.

I'm not sure that I have anything else to expand upon. We grew our Bermuda business slightly. As I said Argo Re was kind of flat. We had some new initiatives that pushed up premium, but rate increases declined premium and we continued to grow steadily in Brazil.

Got it. The second question I have is on the runoff book. Can you remind us how much capital is backing that?

That is not a number we have quantified very specifically, Bijan -- I'm sorry, Amit.

Bijan.

I'm sorry. I lost my train of thought. It is probably between $100 million and $150 million.

Okay. That is very helpful. I'm sorry?

Call it $150 million.

Got it. I guess the only other question I have is on the discussion on consolidation. Clearly you have seen the other discussions out in the marketplace. I just wanted to see if you had any updated thoughts as an acquirer or as an acquiree and has anything changed. I know your franchise, you've fixed some of the issues you might have seen in the past, so it seems like a cleaner franchise now. How should we think about that or has anything changed?

No, nothing has changed. I have been an investor and member of the Board of Directors of this Company for the last 15 years. I have been running it for the last 14. We have made a dozen acquisitions along the way, and I think we have taken what was a small regional franchise in the U.S. and turned it into an International Specialty company and we still have got a long way to go.

Are there any specific regions you feel could use that route or is it more organic in terms of growth from here?

Well, Bijan -- excuse me, Amit. We have always focused on organic growth but we have used M&A as a tool to supplement organic growth when we thought it could accelerate our market presence or add product to what we were already doing.

Got it. Thanks. This is Bijan Kumar signing off.

There are no additional questions. At this time, I would like to turn the conference back over to Mark Watson, CEO, for any closing remarks.

All right. I would like to thank everyone for dialing in this morning. I know it was a pretty busy morning and thanks for accommodating the change in our schedule. We look forward to talking to you at the end of the second quarter. And I think as I said we are off to a good start, and I am looking forward to telling you how we did for the first half of the year. Thank you very much for your time.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.