丘博保險集團 (CB) 2006 Q3 法說會逐字稿

Good day and welcome to ACE Limited's 2006 third quarter 2006 earnings conference call. Today's call is being recorded. [OPERATOR INSTRUCTIONS] For opening remarks and introductions, I would like to turn the call over to Ms. Helen Wilson, Director of Investor Relations. Please go ahead.

Thank you. And welcome to the ACE limited September 30, 2006, third quarter earnings conference call. Our report today will contain forward-looking statements such as statements relating to our financial outlook and guidance, business strategy and practices, growth prospects, competition, pricing, and market conditions, renewals, exposures, losses, and reserves, reinsurance leverage, and licensing. Actual results may differ materially. Please refer to our most recent SEC filings as well as our earnings press release and financial supplement which are available on our website for more information on factors that could affect the forward-looking statements.

I would also like to remind you that this conference call and its content and any tape, broadcast, or publication by ACE Limited are the sole copyrighted property of ACE Limited and may not be copied, taped, rebroadcast, or published in whole or in part without the expressed written consent of ACE Limited. This call is being webcast live and will be available for replay for one month. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material developments. Now I would like to introduce our speakers. First we have, Evan Greenberg, President and Chief Executive Officer; followed by Phil Bancroft, Chief Financial Officer. Then we'll take your questions. Also with us to assist with your questions are several members of our management team. Now, it's my pleasure to turn the call over to Evan.

Thank you, Helen. Good morning. As you can see from the numbers, we had another excellent quarter. After-tax operating income was 652 million, or $1.96 a share, growth in both P&C underwriting and investment income contributed to this result. Book value grew by over $1 billion in the quarter, or $3.14 per share, as a result of both strong earnings and the mark to market effect of declining interest rates and a favorable equity market. Our ROE year to date stands at about 18%.

Our P&C combined ratio was 85.7 Lack of major cats in the quarter obviously contributed to these results, adding about $0.30 to our after tax earnings per share and benefiting the combined ratio by a little over 4 points. As you can see, even before the positive effect of the lack of major cat activity, it was an excellent quarter and Phil will provide a bit more detail. We are frankly, experiencing the other side of volatility, the positive side. As you know, catastrophe related risk by its nature is volatile. The previous two years we demonstrated our internal risk management capabilities in the face of negative volatility stemming from record cat activity. In this quarter, in fact, the entire year, we're again experiencing the impact of that volatility, this time it's resulting in a positive contribution to earnings.

While it should go without saying, this year's light cat activity and Atlantic wind related in particular does not change our view of cat risk, nor our appetite for this class. In our judgment that would be foolish. I'm not going to speak much about the market conditions. I've addressed this the last few quarters. I went into great detail on our last call. Conditions fundamentally remain the same. Pricing for cat exposed business, particularly in peak zones, remains firm. I believe current market conditions for cat related risk will continue into '07 and, in fact, I expect international cat exposed pricing to firm somewhat as well particularly in peak zones. However, that depends on the behavior of a few large reinsurers.

The fundamentals driving the market for cat remain the same and I don't see signs of that changing. Notably the new cat models, lack of capital and capacity in peak areas, rating agency vigilance, and cat reinsurance capacity. As for noncat business, there's no real change, either. Rates continue to soften around the world at roughly the same pace we have been experiencing throughout the year. With the competitive environment varying, of course, by territory and class of business. Terms and conditions are, for the most part, holding. Renewals in the main have been orderly, disciplined, and rates are adequate.

New business pricing tends to be more aggressive and at times undisciplined. There are numerous examples of new business coming to market where the pricing in our judgment is inadequate. The industry is positioned for an excellent year barring major fourth quarter cat events. This means substantial growth in the capital base of the industry which in turn may fuel further softening in non cat related areas in '07. And I see no signs at this time leading me to believe that this will turn into an undisciplined free for all. On the other hand, there isn't a whole lot of room to reduce pricing and still earn a reasonable ROE.

I want to touch briefly on our growth and revenue. Our growth in earned premiums picked up in line with the guidance we gave you last quarter. Our written growth in each of our segments, particularly after adjusting for reinstatement premiums paid in the third quarter last year, is consistent with market conditions. Adjusting for reinstatement premium our insurance business net written grew 4% in the quarter, while our reinsurance business was down 20%. And that is mainly due to our decision to nonrenew one account for underwriting reasons.

We continue to find pockets of opportunity for profitable growth in our insurance businesses, particularly in our short-tail lines, specialty casualty, and A&H classes. At the same time there are areas of our business that are flat or shrinking given competition and our drive to maintain underwriting discipline. With that said, we expect relatively strong written premium growth in our insurance segments in the fourth quarter.

Finally, as you know, we continue to expand and diversify our company by product, distribution, and territory. In line with the latter, we expect to receive notification shortly on two new licenses. P&C license in Vietnam and a life license in Russia. In fact, we were just notified yesterday by the Vietnamese government that we will receive our nonlife license before the end of the year, and I believe we're one of only two companies that will have both a life and nonlife license in Vietnam. This is all part of our strategy to continue to increase our presence in developing markets where the middle class and business sector are expanding and will expand for decades to come. With that, let me turn the call over to Phil Bancroft, then we'll come back to take your questions.

Thank you, Evan. Good morning. We had a very good quarter. Our balance sheet continues to get stronger, measured on the growth in our tangible book value, the size and quality of our invested asset portfolio, the increases in our reserves and our reduced reinsurance, recoverable, and debt leverage. Our tangible book value grew by 1.93 billion, or 11.9% for the quarter. For the year our tangible book value has grown 19%. Our third quarter operating cash flow was very strong at 1.3 billion and our cash and invested assets grew 1.16 billion to 36 billion. The change in this balance included increases for operating cash flow and approximately 500 million of appreciation in value offset by 300 million of debt repayments and an approximate 500 million reduction from the sale of the three runoff insurance companies.

Our portfolio continues to have an average credit quality of AA, and our duration remains short at three years. During the quarter, our reinsurance leverage, or our recoverables over shareholders equity decreased to 109%. This is down from 217% at the beginning of 2003, as we continue to grow our book value and manage this asset. Our debt to total capital has dropped to its lowest level since 1999 and now stands at 13.4%. During the quarter our net reserves increased 614 million before a reduction of approximately 500 million from the sale of the three subsidiaries. Our net reserves were reduced during the quarter by 110 million as a result of 2005 storm payments. Net loss reserves increased 2 billion year to date before reduction for the payment of prior year cat losses of 400 million and the sale of the subsidiaries. I have a few points on our earnings.

First, they were affected by prior period development of 25 million after-tax which resulted primarily from an increase in our after tax loss for 2005 storms. Our losses were also affected by the release of reserves for the 2006 accident year, the current accident year, due to better than expected performance to date on property and other short-tail lines. After tax this release was $0.20 per share. Our administrative expenses increased 14.6% over last year's third quarter. You may remember I mentioned last year that our administrative expenses were reduced by the release of an accrual in the North American segment. Adjusted for this $16 million item the administrative expense increase would have been 9%.

Now turning to our guidance. We have two changes. First, we had projected our combined ratio would be at up the upper end of the 88 to 90 range. We now believe we'll be at the low end. This includes the first quarter's AG settlement of 80 million. We now believe that our investment income will be approximately 1.575 billion, and all other guidance remains the same. With that I will turn the call back over to Helen.

Thank you, Phil. At this point we'll be happy to take your questions.

[OPERATOR INSTRUCTIONS] We'll take our first question from Mark Lane from William Blair.

Just a quick numbers question, Phil. The guidance for the combined ratio, does that include any sort of cat load for the fourth quarter?

We have approximately 80 million in cats for the fourth quarter in our estimate.

Okay. And Evan, can you provide your opinion on the Berkshire Equitas transaction and what you think that means or signals, if anything, about the environment for A&E exposure, particularly going into year end with your study -- your ground-up study that's going to be completed?

I'm just laughing because how you link the two things.

They could be completely unrelated.

Yes. I'd like to answer them unrelated, because I can't really divine that linkage there. Look, I don't think that -- we're still getting the details on the Berkshire transaction. We know about what you know, and so my sense of it is is obviously they wouldn't buy a loss. And, you know, in their judgment, I think they think it will run off with a positive return. From an ACE perspective, we have an exposure to Equitas and this perfects the counterparty credit quality to a far greater degree and puts back stock. Equitas has always been a tough reinsurer and I expect that Berkshire will run this in a professional way. As you know, we already have a relationship with them on the Brandywine, where they are in a position of adjudicating claims now for us. So I view it as neutral to a net positive for ACE.

As far as our own study, let me just, I know this is on the minds of a number of people, we conduct our internal review every year. We're in the middle of doing that right now. The external review is done every two years. That's going on right now. It's premature really for me to comment on it. It's a couple of weeks away from concluding, and if there's any -- if there's any news that comes out of it, as a result of the completion of the studies, we'll let you all know early. We'll let you know by mid-December.

Okay. And I don't know if I missed this, Phil, but what are your plans for providing '07 guidance?

We'll probably do in that mid-December.

Separately from everything else?

Yes, we'll take our plans to the Board and have them approved before we release our guidance.

We typically do it in mid-December, Mark.

Appreciate it. Thanks.

You're welcome.

We'll go next to Paul Newsome from A.G. Edwards.

I was wondering if you could talk a little bit about what you'd like to do in the future with the balance sheet in terms of leverage across all the spectrums, whether it be the recoverables or the asbestos exposure, or if you have any specific plans to focus on any aspect of the balance sheet in the near future?

I don't think there's any aspect at this moment in time that we're focused on in particular except to continue to grow our book value. Our recoverables leverage will continue to decline, I believe just naturally over time that we continue -- obviously we manage our counter party exposures pretty rigorously, as I think anybody should. It's a big part of your balance sheet. And in that regard, we continue to look for opportunities where we can reduce reinsurance leverage. But beyond that, I think, as we grow our book value, our leverage will continue to decrease, and I think that just gives us added flexibility of strong balance sheet for the future. We have only two assets. The balance sheet and people.

Great. Thank you.

We'll go next to Brian Meredith with UBS Securities.

Good morning.

Good morning, Brian.

Couple quick questions here for you. Phil, just a quick numbers question. I was a little confused about. The North American operations earn premium balance? It just seemed a little high in the quarter. Was there anything unusual going on?

Well, we had reinstatements, and we also had -- you may remember last quarter I talked about the change in the way we were going to recognize our revenue for crop hail. That has a tendency to move premium forward -- later in the year. So those two items had an effect on the premium.

But that will affect both written and earned, right?

Yes it did.

Okay. I'll follow-up the end on that one. The second question, Evan, back on Equitas just for a second, given that Berkshire now has taken that over, does it have any impact on what your bad debt allowance is for your Brandywine reinsurance recoverables?

I don't know at this moment in time. I can't -- logically you'd say it won't have a negative.

Positive impact.

Yes, I know. That's part of our total review of reserves right now in Brandywine. Part of it is the bad debt reserve. That's a couple of weeks away from my giving you a definitive answer, but on the score sheet it should only have a positive. We need to see some detail around it.

Great. Lastly on that one reinsurance contract, was that a commutation in the quarter is that why it had a significant impact, and what impact would it have on written premium going forward?

No it was a written premium event. We non renewed it. There was no commutation. We non renewed it and we non renewed it for underwriting reasons. It was plainly our decision.

So it will have an impact in the next couple of quarters, at least on a year over year basis?

Well, not on written. We took it all in the quarter.

Oh, you did? Okay. Great. Thank you.

You're welcome.

We'll go next to David Small from Bear Stearns.

Hi, good morning. Evan, in the past you had indicated you were looking to reduce your aggregate wind exposures by 40%. How far along are you in doing that, and maybe if you could help us understand on a model basis how much your wind exposure is down.

First of all, it was in -- remember, so you keep this in mind, it was on the insurance business, not necessarily ACE overall, because our reinsurance business we didn't see the same need for level of reduction. But in our insurance businesses, as I've been saying all year, we've been right on track with our reductions, and in line with our expectations, and as we plug them into the new models, the 6.0 model, it comes out as we've expected it to come out. So we're in good shape with that reduction and the management of our overall exposure.

Okay. Then just two other questions maybe. On the reinsurance side, I know there was the one piece of business you didn't renew. But are you seeing -- we've heard on other calls so far, a competitive casualty reinsurance environment. Could you maybe comment on that and opportunities you see?

Sure. I don't expect our reinsurance business to be declining at a rate of 20% going forward. That's unless conditions go to hell, but I don't see that. What do I see? I see the -- not much different than the primary side. I see discipline on obviously the cat business. It's quite firm. And as I said, if the behavior of a couple of reinsurers is rational, then I'd expect that to spread even a little more on the international side. The property risk side is staying -- is holding up pretty well, and the casualty side, we're seeing prices drift down. We're seeing some on the margin, competition around seeding commissions, and that's varying by territory. So there is -- we are seeing some pressure on that. But it's not irrational or dramatic at this time.

Then if I could just ask you one last question on the insurance book, could you maybe just give us a little more color on where you are seeing the opportunities to find new business?

Yes. First of all, it really is a different world. The U.K. and Australia are clearly the most competitive places we see. I'm going to work my way back to the U.S. Continental Europe is pretty stable, and we're growing both our property and casual business and our A&H business there. In Asia, because -- as I said, the Australian market very competitive. The balance of southeast Asia is pretty competitive, too, in P&C, but we're getting dramatic growth in our A&H business. Latin America, we're growing in both P&C and in A&H right now and substantial growth in the A&H.

In North America, as we have been saying all along, as ACE has broadened out its reach across the country, we are driving our presence more and more into that second and third tier brokerage distribution and our growth in specialty casualty related products, and large account and middle account and even smaller account property, we are growing. Our marine business is growing. And that's the areas that we're predominantly seeing our growth. Our risk management business right now has been -- large account business has been fairly flat. As you can imagine, prices are more competitive the bigger the premium, generally. That's when they're chasing volume.

Okay. Thanks very much for the answers.

You're welcome.

And we'll go next to Jay Cohen with Merrill Lynch.

Good morning, Jay.

Good morning. One numbers question, one bigger picture question. The numbers question, Phil, I just want to revisit this issue of earned premium in North America. The number was just over 1.5 billion. I look at the net written over the past four or five quarters and all those numbers are actually below the 1.5. So mathematically, I'm not sure exactly what's happening.

Well, as I said, there's two things that are happening. One is that we had reinstatement premiums in the year-ago third quarter, right, so that had the effect of depressing the premium in North America. The second thing we had was the adjustment for crop hail, as I said. We changed the revenue recognition pattern to move it later in the year to match the exposure period better. So those two things are changing what appears to be the rate of growth.

One is in deflating last year's number, which is the reinstatement. One is inflating this year's year on year comparison, the crop.

It's not so much the comparison to last year, it's simply--?

Are you looking at net to gross?

I'm looking at net earned relative to the written. Typically the written would drive the earned obviously, and just the number looks too high relative to what you have written.

The crop had a big impact on the earned growth. Okay? So the way it comes through, it earns more quickly than a typical written. So you could have a written and earned dollar for dollar in crop.

Oh, okay.

Okay.

That's helpful. Thank you.

What's also driving the net to gross. When someone asks that question, what's driving it down, is the crop hail again because there's a big session to the to the U.S. Government.

Got you. That's helpful.

You got it.

Secondly--.

It will straighten itself out for next year. It's year-on-year comparison this year.

Okay. The other question I had, it seems as if the environment is probably getting better for acquisitions. Your capital flexibility is better, other balance sheets are probably cleaner than they've been in a long time. What's your appetite for acquisitions at this point?

Well, look, we're -- we have been acquisitive in the past in our history. Here's where it fits in. We won't make acquisitions for acquisitions sake and just for the sake of size. That's not our strategy. But we do have a clear strategy of where we want to grow our business in terms of product, in terms of kind of customer, and in terms of territory. And types of businesses potentially beyond commercial P&C. And so where acquisitions fit in is really in relation to that strategy, and do we grow greenfield, are we better off -- or are we better off to make an acquisition, and then from there it's opportunistic. It has to be the right property of the right quality that brings value and makes our company better. And it's got to be at a price that we think is accretive to shareholders.

Are you seeing more opportunities that might meet hurdles?

What we've looked at so far, we get in line, but we just don't kiss a lot of girls because it seems to -- it seems that so far the prices are beyond what we'll -- what we think is the right price to pay.

Great. Thanks, Evan.

We'll go next to Josh Smith from [TIAA-CREF].

Thanks. Just a quick clarification on the numbers that Phil had out there for the net development. You said 25 million adverse from 2005 storms?

It was 25 million after tax was the total development, and that was one of the important things in there is the -- is the development from the storms.

Do you have the breakdown pretax on storm development for 2005 versus favorable development?

Yes, for cat development pretax we had 41 million. After tax, we had 25 million. And for the non cat positive development, we had both pre and after tax benefit of 25 million. So you'll see in our supplement the pretax number is 16, the after tax is 25.

Right. And the 6 million of cats was for this year after cats.

The current accident year.

Thanks a lot.

We'll go next to Tom Cholnoky from Goldman Sachs.

I guess on this whole issue of reserve development, Evan, obviously a lot of the newer Bermuda companies, and even some of the older ones, have been releasing reserves at a much more significant rate than you have. I guess that raises the question of, A, were you just much more refined in the way that you initially established those reserves, and therefore we really shouldn't expect to see much development, or is it that your book of business is such that you need more time to assess the reserves that you put on your books during the very strong pricing in the early 2000s?

Tom, I'm not going to compare nor speak about other companies. That's yours to do. You make your judgment about that. I can only judge about ACE's. And we wrote and grew a substantial casualty portfolio in the last few years. From '02 really forward. One thing that I would say is a watch word for us, I think anybody who has been in this business for a while knows, and that is you don't really have optimists run your casualty business. And you don't manage it with an optimistic eye. I've rarely seen casualty portfolios that run off positively. There's always surprises. We grew the book quickly. A lot of new business in a number of classes. We manage our company conservatively. Our reserves are adequate, and I wouldn't judge the early patterns.

I wouldn't give too much weight to the early patterns of development, even if we see the actual developing better than the expected. Some of this business has three to five-year tails, some of this business has seven to ten-year tails. And hardly going to declare victory early. The only comment I'll make compared to others, because I think you used the word Bermuda, we are probably more casualty oriented than most Bermuda players.

Okay. That's fair. Just another point of clarification on the reinsurance. You mentioned the non renewal of a large contract. If we were to back that out, what would reinsurance premium growth or decline have been?

It would have been flattish.

Okay. Great.

You're welcome.

We'll go next to Charles Gates from Credit Suisse.

Hi, good morning. Two questions. My first question, I believe, Evan, that you opined that large case more competitive than smaller case. Would you elaborate on that?

Well, I don't know what more to say except that when it is a bigger premium account, when the premium is larger, it will tend to be more competitive than when the insured's premium is smaller.

So that's like Fortune 500 as opposed to middle market? Would that be a correct analysis?

Yes, that would be correct. That's a generality, Charlie, so it does vary by class. If you're looking at tough primary risk transfer classes, rates, and in a tough category, rates could be quite firm. But if you're looking at something more benign, that's when you'll tend to see greater competition for a larger premium account.

My second and final question, I believe possibly in your introductory remarks you opined pricing drifting lower. What were you referring to specifically there?

When I said pricing drifting lower, are you referring to my view of going into '07 or current?

I think it's probably true in both instances.

The current rate of decline I said is about the same, and as I have said all year, you're seeing casualty pricing drifting down, you're seeing property pricing fairly firm, particularly in cat related, noncat you're seeing it drift down. And we're seeing it drift down at the same rates we had been seeing all year, and I went into great detail in the last call about that.

Is that 7 to 10% in casualty, or is it more?

It varies by class, by territory. Many of them are -- we have numerous classes where it's more like 0 to 5. And we have some where it's 7 to 10. Really varies.

Thank you.

You're welcome.

And we'll go next to Scott Frost from HSBC.

I wanted to follow-up on that balance sheet question. Are your ratings about where you want them to be or do you expect this improvement in leverage to result in maybe a low A on both sides, and would that be a more optimal rating for you?

Look, we can't make the rating agencies' decisions. They'll make their own decisions.

But is that a goal for you?

But, of course, all things being equal we'd always like a higher rating.

But that's not a stated goal for you in other words, right?

It's not a stated goal.

Thank you.

[OPERATOR INSTRUCTIONS] And we'll go next to Joshua Shanker from Citigroup.

My question regards the promise that you made about the new entrants potentially having a risk of pushing pricing down at the same time pricing is adequate. It seems like you're walking a pretty narrow line.

I didn't comment on new entrants.

In the beginning of the call you stated that on the one hand pricing is adequate, on the other hand there's not much room for individual insurers to push pricing down.

Right. Right. That's right.

Well, so -- so is adequate just merely adequate at this point, for generally speaking, among some lines, or is there sufficient ROE for what we would say is abject profitability?

I don't know how to say it more clearly to you, so I -- excuse me if I repeat myself. Pricing is adequate. When I say adequate, that's to meet our target hurdles. Pricing is drifting down, and I am -- what I am saying is there's not a lot of room in that pricing to follow it down and continue producing -- meeting your hurdle rate. That's as much as I'm really going to say about that.

Well, would ACE be getting some non renewed business at the point that it drifts down further?

We have been. We have been all year. We have been since last year. And we have been -- we have gone into very great detail about that. And continue to go into detail about that. I think that's why you see that our growth rates are pretty low, and we have some areas, as I said, that are shrinking, some areas that are expanding, and some areas that are flat, and that's all because we're maintaining underwriting discipline.

Besides property cat, is there anything out there that's exciting?

Yes. Our accident and health business is quite exciting. Our specialty casualty business is, particularly in the middle market areas are quite exciting. And I think I'd invite to you call Helen Wilson and get more detail on all this if you're interested.

Okay. Thank you.

You're welcome.

And at this time there are no further questions. I'd like to turn the conference back over to Ms. Helen Wilson for any additional or closing remarks.

Thank you everyone for your time and attention this morning, and good day.