丘博保險集團 (CB) 2006 Q4 法說會逐字稿

Good day, everyone, and welcome to the ACE Limited's fourth 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, ma'am.

Thank you and welcome to the ACE Limited December 31, 2006 fourth quarter and year-end 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 legislative impact. 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 Web site for information on factors that could affect the forward-looking statements.

I'd 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 or rebroadcast or published in whole or in part without the express 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'd like to introduce our speakers. First, we have Evan Greenberg, President and Chief Executive Officer, followed by Phil Bancroft, our Chief Financial Officer. Then we'll take your questions. Also with us to assist with your questions are several members of our management team.

And now it's my pleasure to turn the call over to Evan.

Good morning.

As you can see from the numbers, we had an excellent quarter which contributed to what we believe was an outstanding year. After-tax operating income for the quarter again set a record $643 million, or $1.92 per share.

For the full-year we recorded after-tax operating income of over $2.3 billion, or $7.05 per share. Book value growth was 21% and tangible book grew 27%. Our ROE was 18.5, and this speaks, in our judgment, to an efficient use of capital.

Our quality of earnings was excellent. We had a combined ratio for the year of 88.1 and so pretax underwriting income made up 52% of net income before tax while investment income contributed the balance powered by an invested asset that now stands at over $37 billion.

Our invested asset to equity leverage stands at 2.6 times, speaking to our future ability to grow book value and contribute towards a reasonable ROE.

Again, speaking about the year, our underlying earning power was excellent An absence of CATS obviously contributed to the year's result. But even adjusted for this by assuming we had CATS equal to the amount projected in our original '06 guidance, we earned approximately $2 billion after-tax. And let's remember, we had a $90 million AG settlement expense during the year.

I'd like to touch on a few items briefly, our growth in the quarter, current market environment at January 1, and finally a word about our Latin America business.

P&C net written premiums were up almost 9% in the quarter while full-year growth was closer to 2%. In the quarter we wrote one particularly large risk management account and adjusting for this transaction, our overall P&C net written premium growth rate was about 4% and our North American P&C net written premium growth was 5%.

I believe the adjusted growth rate is in line with our stated objective to maintain underwriting discipline in the face of a softening market. We are in that part of the cycle where revenue growth in many classes is more for vanity than a reasonable underwriting profit, and as I've said repeatedly, we will not play that game.

On the other hand, we've become a large global player with a broad and expanding product offering and geographic reach that is serving the needs of a larger and larger customer universe.

Market conditions at January 1 were broadly in line with our expectations. With the growth of the industry capital base on the back of record results, P&C markets continued to soften globally, and the rate of decline has accelerated moderately, particularly in non-CAT property and casualty-related lines.

As I said on the previous call, new business pricing is softer than renewal pricing. We are monitoring this closely since for most classes, renewal prices are adequate. There's not much room, or in some cases, no room to move prices down.

This is a broad statement and the facts vary by line, by country, and even within countries such as the U.S. by region. I should remind you that we will, if necessary, eliminate classes or portions of classes.

On the other hand, submissions for business are way up in a number of areas and this allows us to be more selective in the business we chose to write.

We are comfortable with the financial guidance we have given for '07 and our first quarter is developing right in line with our expectations. I expect we'll continue to grow tangible book value at a reasonable clip during '07.

On another subject, I just returned from Latin America where I visited our businesses in Brazil and Mexico. Latin America receives a lot of negative press these days, particularly because of Mr. Chavez, but it is a big continent and most of the region is not following in his political footsteps.

Brazil and Mexico have enjoyed moderate economic growth and low inflation along with a relative political stability for almost a decade now. These are large markets with a growing private sector and middle class.

As with Asia, our business is doing very well in these markets. We are an established specialty commercial P&C writer and we have a large A&H business focused on serving that growing middle class. Along with certain other countries in the region, we see significant opportunities to continue to expand our business.

We completed a small acquisition in Peru during December, and this provides us an opportunity to expand our A&H and credit life presence in that market. This is a relatively small but highly profitable opportunity.

And speaking about opportunity, you read recently about the property sidecar we launched with Marsh. This was put together to help Marsh meet the needs of their large corporate clients. While just launched, we're already seeing a lot of activity that should help to meet market demand.

I'd like to make a comment on the recent legislative action in Florida. In my opinion, this is shortsighted and politically motivated.

It will prove to be short-term expedient and over any reasonable period of time, it will prove to be economic unsound and irresponsible putting the state economy and its citizens in a very vulnerable position. At this point, we believe the action's direct impact on ACE will be relatively minor.

In summary, we are in excellent shape. We've begun the new year financially and operationally strong, disciplined, focused, and restless to execute.

With that, I'll turn the call over to Phil.

Thank you, Evan. Good morning.

We had another very good quarter. Our earnings were strong and our balance sheet has continued to strengthen.

For the year, our tangible book value increased $2.4 billion. Our operating cash flow was $4.1 billion, and our cash in invested assets grew by 15%.

For the year, the mark-to-market affect increased the value of our vested assets by an additional $240 million, despite a rise in global bond yields throughout the year. This resulted from the portfolio's overall diversification and relatively short duration. Our duration is currently at 3.3 years and the overall credit quality remains high at AA.

During the year our reinsurance recoverable leverage, or our recoverables over shareholder's equity, dropped to 102%. Our reserves for unpaid losses and loss adjustment expenses continued to increase.

For the year, our net loss reserves increased approximately $1.5 billion, even after payment of prior year CAT losses of approximately $700 million, and the reduction of approximately $500 million from the sale of the three reinsurance runoff subsidiaries in the third quarter.

I have a few points on our fourth quarter earnings. First, earnings were affected by adverse prior period development of $14 million after-tax and by the release of loss reserves for the current accident year of $30 million after-tax due to better than expected performance on property and other short tail lines. In addition, our CAT losses were lower than our forecast by approximately $55 million after-tax.

In the quarter, our total expenses increased 9% over last year's fourth quarter. I mentioned last year that our expensed benefited from the release of a $25 million accrual in the North American segment.

In addition, this quarter included an accrual of $9 million of investigative-related expenses. Adjusted for these items, the normalized increase in our P&C expenses was 4%.

Now I'll turn the call back over to Helen.

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

[OPERATOR INSTRUCTIONS] Our first question is from Joshua Shanker from Citigroup.

Good morning, everyone. Great quarter.

Thank you.

In terms of the $14 million you spoke about in prior year unfavorable development, is there any way that you can go into detail about the vintage of how that's going from the prior years, '97, '02, versus the more recent accident years?

I would say that there's no systemic issue. It's resulted from a series of studies that were done in the quarter and there's nothing to point to. I mean the number's relatively small.

You'll see pluses and minuses in various segments and within those segments there's pluses and minuses. So I really don't think there's a trend to speak of.

Yes, there's no trend. The 14 was, in our judgment, it's just noise.

Absolutely. But in thinking about the '03, '04, '05 years compared to those prior years, is there net favorable from the more recent years and not unfavorable from the previous years?

Not much movement, really, among years in the quarter. So I would say, no, you wouldn't see a clear trend like that.

Okay. It was just -- it was really more case-specific than it was on a book of business. There were just a couple of cases that are older cases that required a reserve adjustment.

Additionally, in terms of the commentary about new business obviously not being priced as well as renewal business, is this broadly speaking through all of your competitors, or not without naming names, are there some competitors particularly who are causing this to happen?

By line of business, by territory, there's always one or two competitors who've discovered a pot of knowledge that the rest of us, that seems to escape the rest of us and their appetite is voracious within that line. So it really varies all over the lot. There's not any one consistently but there's always one or two outliers, and they're there.

And then finally, any thoughts on large opportunities in life going forward? I know it's something you've thought about in previous quarters and opined on. Any thoughts on development there?

You know, our life business is a combination of life -- of specialty life reinsurance and then our life insurance business is predominantly growing in Asia and we'll have a bit more of a focus in Latin America as well. And it's all internally generated at this time.

We do keep our eyes open for potential opportunities in the acquisition area, but that's opportunistic and, you know, it's got to be the right thing at the right price at the right time and you've got to hit that tri-factor and so money is certainly not burning a hole in our pocket.

Very good. Thank you very much.

You're welcome.

And our next question's from Matthew Heimermann from JPMorgan.

Hi. Good morning, everyone.

Good morning, Matt.

A couple of questions.

First, just following up on your last comment that money's not burning a whole in your pocket. As you look at kind of your priorities for this year in terms of where you're investing, where you're not, what businesses are consuming capital, I guess where would you point to as businesses that are consuming capital versus, perhaps, businesses that are now funding investment opportunities in other areas?

Most of our businesses are funding. There aren't too many that are consuming. We have a couple of countries overseas where we have recently opened and it's modest, but they're not yet turning a profit.

Our life insurance business does not yet have earnings -- positive earnings visibility. It's producing modest losses. The balance of our businesses are producing reasonable ROEs.

So most of our businesses, all of our businesses are generators of capital. They are not consumers.

And as you know, we -- given market conditions, we have slowed down our build-out. Frankly, we've built it out, and so our investment and our growth in expense has slowed and will continue to slow through '07.

And I guess looking, based on that, I guess, at what point, or is there any particular point that you're waiting for where you would say, all these businesses are throwing off capital, we've got too much capital, we need to think about returning it, or maybe it does start to burn a hole in your pocket and you look at other things?

Well, you know, on the comment of burn a hole in your pocket, shareholders should barbecue me if it's simply impatience that leads us to make an irresponsible economic move. At that point, that means we have capital we don't know what to do with and the best thing we could do is give it back to the shareholders so that will never happen around here.

It will not break discipline. However, on the other side of the coin to answer your question, we're producing a decent ROE, which to me says, we have a good risk-adjusted return on that capital. We expect we will continue to have a decent ROE.

And we will not make a short-term decision if we see the ROE drift down, we're looking more over the medium-term at our capital needs and capital management. And part of that, obviously, we always will look at the potential of share buybacks or other techniques, but at the moment that's not something that as we look at it, that's in the cards.

And also remember, the rating agencies and others have a view of what's considered adequate capital. And capital requirements in this business have gone up dramatically during '06.

That's fair.

And I guess if you could just -- would you be willing to articulate what kind of a minimum ROE would be? At which point will you feel like risk-adjusted return starts to be inadequate?

The reason I won't do that is because you then have to put it in context of how you see the environment and your opportunities over the foreseeable future and so you can't simply judge it on the ROE you have at the moment. You also have to be looking forward at the environment. And so I have to say, like the Fed, we will not just set a target.

Fair enough. I tried. Have a good day. Thanks.

And our next question is from Josh Smith of TIAA-CREF.

Hi. Thanks for taking the call.

I had to hop in and out, but did you mention the impact of Kyrill or the California orange freeze?

The California orange freeze will not have an impact on us, that is, it's very minor. And Kyrill, we will have losses, as everyone will. It doesn't affect our guidance for '07 and we don't view it as affecting our first quarter results.

Okay. And then I had a question on reserves.

I mean most of your peers are releasing significant reserves at the past few years while you kind of haven't. Is there anything unique to your business that would account for this? I mean, does it take longer to season or were you just more aggressive in setting your initial picks?

No, you know, look, I can't comment [multiple speakers] -- I'm sorry?

Or is it that you just don't need them released?

You know, look, I can't speak about our peers, and I can't comment on how they establish their reserves, what their loss development looks like or any of that. I can only speak to our company.

And in our company, we have a rigorous process for establishing reserves, establishing loss picks, establishing reserves, and constantly testing the reserve development on prior accident years.

We grew very quickly, we have a very large portion of our business is casualty and for anybody who's been in this business for any period of time, I think you understand that casualty is not a business that you view with optimistic eyes. We're in a risk business where at the time you write the business, you don't always know 100% of the risk you're assuming.

We will, with that all said, we believe we've established our reserves prudently and in my judgment conservatively.

Fair enough.

That's what it is.

Yes. One final thing.

On the Florida legislation you commented, I don't see it having a big direct impact on you, but it could have indirect effects if it forces carriers and reinsurers to chase business in other areas to make up for the loss premiums and so it could increase competition in the market. It also has the knock-on affect of reducing aggregates for just about everybody, so it actually could free up some capital.

Are you asking me a question?

Yes.

What's your question?

My question is, does that free up -- it goes back to the previous questions about capital, does that make it --

No.

It doesn't free up any more capital than otherwise would have happened?

No.

All right. Thanks.

Our next question is from Thomas Mitchell with Miller Tabak.

Aside from the fact that the quarter was so good, it's hard to see how you can do much better.

I guess the basic question is, how sensitive do you see your workers' comp line particularly the small case business, or small and medium accounts, to changes in the jobs outlook in the United States? I mean if we saw instead of 150,000 jobs a month growth going to zero, do you think that would affect your underwriting results?

You know, I don't think it would affect our underwriting results, not in any short-term period. Obviously, if the economy slows, the job growth slows, then the universe of insurable individuals for workers' comp slows down and so the natural growth rate would slow. But I don't see that.

I actually see driving workers' comp right now more micro industry-specific issues than I do the economy having the big affect at the moment. That's barring a recession.

And I might add, we see workers' comp getting more competitive. We see people underwriting to what we believe is not only north of 100, we believe, in some areas it's getting well over 100.

We write our workers' comp business in three areas. We write large risk management businesses where there's significant self-insured retentions and we write excess and do all the servicing. That business is doing quite well.

We write on the other side of the spectrum, a very small business workers' comp book that's written over with technology, predominantly over the Internet. And that business is doing well and we think it's still reasonably priced and we have growth in that business.

Then you have the middle market risk transfer workers' comp business. We don't like the pricing, we think it's overly competitive, and we are dramatically curtailing our writings in that segment right now. And if I was you, I'd be keeping my eye on more of those trends in that business than so much the job growth in the short-term.

Thank you.

You're welcome.

Our next question is from Charles Gates with Credit Suisse.

Hi. Good morning. I only have one question.

On the Chubb conference call last night, the Chief Operating Officer of Chubb at some length dwelled on the fact that he thought that the most competitive area of the commercial lines market today was, to quote him, large account and risk management programs.

Given what you said about the risk management large account that you put on the books during the fourth quarter, how would you speak to that?

First of all, Chubb is not a big writer of the large account risk management business.

He said that's the reason why they were not.

Well, they're really not in that market much, we don't see them so I don't know how they judge the market, frankly, if you're not in the market.

I do see is it more competitive. And our quote rate -- our business in that area has slowed down dramatically. Our growth in that business, excluding the one large account we wrote in the quarter, has -- it's virtually flat.

The number of quotes we've been making has gone down and our close ratio has gone down. However, that business is about service, it's about capacity you can provide on an excess basis, and we have an excellent capability in that area and a real franchise.

I would dare say we're probably number two or number one in that business in the country now. And so, Charlie, while I do see more competition in it I think, for us, it's a profitable venture and we're disciplined and we continue to write it.

Thank you.

You're welcome.

And our next question is from Brian Meredith with UBS.

Hey. Good morning. A couple quick questions. First, Phil.

Phil, was there any kind of a tax catch-up or anything in the quarter? The tax rate looked a little on the low side.

No, there's no catch-up. It just results from the normal allocation of our profit to taxable and nontaxable jurisdictions.

Okay. Excellent. And then, Evan, two quick ones here.

First one, Chubb is now providing supplemental commissions and I know it's largely for agents, but have y'all thought about any kind of a supplemental commission program at all?

You know, I have to tell you, I was stunned and it was ironic to me after all that the industry has gone through over the last two years to see that oh, there's no more PSAs, we have this new calculation and this new scheme for contingent commissions, and we consider that it's something very different and so therefore the attorney's general finds it acceptable and the industry overall can now reset the clock and go back to what they did under a different name.

I was just stunned by that. So what is the point? What have we gone through?

I don't like contingent commissions and we have no plans at this moment to be employing it in our brokerage business and we'll just wait and see what happens.

Okay. Great.

And then the last question, Evan, do the changes in the S&P capital model, or at least proposed changes, I guess, is that going to have any impact on your capital allocation decisions, pricing decisions, and what impact, if any, do you see it having on the industry pricing?

Well, you know, to the extent that people glue together return on capital with their underwriting shops and the underwriting decisions and that they translate an ROE to a combined ratio so that their underwriters understand with clarity this peg loss ratio and this pricing will derive this ROE, it should have an impact.

I'm not sure that most companies, in fact, manage it that closely. We try to, and can I tell you as capital requirements go up, that affects ROE and that tells you something about loss picks and combined ratio targets.

But for you, will it affect the relative attractiveness do you think of the business that you're writing? You know, looking at your allocation of capital, some longer tail lines maybe don't like quite as attractive after it goes through?

It's dynamic and we look at it line by line and we've already put it all through, an RO7 plan's already incorporated.

Excellent. Thank you.

You're welcome.

Our next question is from David Small with Bear Stearns.

Good morning.

Evan, you talked a little bit about this earlier, but could you just talk about your desire to do acquisitions? Is there a geography that you see opportunities or maybe if you see more opportunities potentially on P&C versus life?

You know, I'm a little agnostic on that. In the P&C side, you know, if we were, what's in our minds if we were going to make an acquisition it would likely be bolt-on size, smaller, targeted towards a territory or a line of business that would enhance our presence or enhance our capability.

And in that regard, because we're broad, it could fit many geographies or a number of different classes or lines and so, you know, we have our eyes open and we're looking in a methodical way.

One other question.

You mentioned earlier the market softening, but obviously depends on line of business and geography. Maybe could you just give us some sense of which geographies you think are weakening the fastest and don't have room for further softening and which lines of business, in the same question, are softening the fastest and don't have room for additional softening?

I'll answer part of that. The areas of the world that are softening the fastest in geography would be the U.K., Australia, and the United States. The areas of business that are softening the fastest is obviously non-CAT property and various casualty-related lines.

The casualty-related lines in the U.S., I see pricing is off between 4 and 7% on average whereas previously we would have said pricing was going down at around 3 to 5. And that's overall in casualty and it varies by line.

Some lines are at 6, some lines are at 10, some lines are at 3 or 4. But overall, that's what we see.

And on the international side -- and property, by the way, we see non-CAT property dropping between 5 to 15%, and it varies, you know, again, by type of property and the geography you're in. If you turned to somewhere like the U.K., there we see rates of more like 8 to 12% in the property areas and in the casualty areas between 5 and 8%. Does that give you a sense?

Yes, that does. Thank you very much.

You're welcome.

Our next question is from Marc Serafin with Morgan Stanley.

Hey. Good morning.

Evan, you spoke about how submissions were up substantially in your prepared remarks. Maybe you could give us a little bit of color as to the origination of those opportunities maybe by region, by line, and talk about how this matches up for the areas where you're willing to expand versus areas where you're looking to cut.

Yes, let's see if I give you a sense about that. Submissions in the U.S., let me take the U.S.

Submissions are up about 20% in the U.S. in the quarter. I'm giving you a fourth quarter statistic. While the amount of business that we're -- the bound business, that is, what we write, what we actually quote, is down 10%.

So the submissions are up, but we're more selective because our bound to quote is down by 10. Now that does vary. For instance, in overall casualty, our submissions are up 16% and our bound rates vary by line, but are dropping.

On the other side of the coin, we have a middle -- and a lot of that submission activity is really being driven and to us is proxy for the affect we're making on penetrating the middle market for specialty classes of business. You know that's been part of our strategy and we've made the investment and that's what's paying off.

On the other side of the coin, you take an area like advantage, which is packages for the international exposure of small companies. Very good business for us.

Submissions were up 21% there and there our quote, our bound to quote is flat because the business is well priced, we like that business a lot and we're actually writing almost 45% of the business that we quote, whereas, again, on the casualty lines, it's more down in the teens to 20% that we bind what we quote. So it varies across the line.

Our medical business, the quotes are up, our submissions are up 20%, but the amount that we're writing, our bound, is down 15% because there's an area you want to be more selective. Does that give you a sense?

And if I took the risk management area, there the number of opportunities, the number of submissions was actually down 15% and the amount we wrote out of that was down roughly about 20% down.

Okay. And that's all North America?

That's all North America.

Okay. That's helpful. Any other color outside of the U.S. on that?

I don't have submission numbers for you for the international. However, in Asia, in Latin America, and in the continent of Europe our submission activity is not up as much, but it's well up in the double digits because it's the same theme as we've done in the U.S. to drive into the local markets.

While our bound business, bound to quote is dropping, and you can see that by the fact that we've really flattened out in our growth in ACE International.

Okay. Thanks.

You're welcome.

[OPERATOR INSTRUCTIONS] Our next question is from Steven Labbe with Langen McAlenney.

Hi. Steve Labbe with Langen McAlenney. A couple of questions.

One, just curious as to your initial thoughts or impressions on Senator Kerry's bill that was proposed in early, earlier this month, I think, or maybe it was the end of December, but I think it was early January?

And also, was wondering if you could talk about your political risk business as it pertains to what Mr. Chavez is doing down in South America these days?

Let me take that one first.

We have little to no political risk exposure in Venezuela or in any of the countries that are following Mr. Chavez. So I don't see -- that was on our radar screen a long time ago. We have in Latin America shortened the duration of policies we will put out in most countries and we're careful on the classes that we will entertain, it's classes that generate hard currency for the country.

On Mr. Kerry's bill, I'm not well familiar with it, but what I do know about Kerry's bill right now, it's not particularly just aimed at the insurance business, but I find it ironic that we want to promote more global trade and we want to promote more overseas investment by U.S. companies to go more global.

And on the other side of the coin, we have Congress promoting bills that will in essence discourage companies from doing more overseas. And I believe that's what that aims at.

Okay. Is it really out there to believe that to the extent something along these lines were to occur, changes in tax law were to occur, that it would impact the captive insurance industry in a significant way that might actually open business opportunities for you?

You know, I don't see that. And you know, more of the talk which I've been listening to and paying attention to and, frankly, trying to educate those in Congress is about the question of freedom of reinsurance, which is very important to any global insurer and not using reinsurance, tax law and reinsurance in some protective fashion and I think that's more of the crux of the issue.

The IRS right now, because there's a concern that people are gaming the tax system by going to lower tax jurisdictions, such as Bermuda, to write their business and so they're just using the U.S. subsidiaries they have as a front to take the business offshore.

The IRS right now has plenty of tools to handle that in transfer pricing and permanent establishment rules and so I don't know what problem they're really chasing to fix because if somebody is gaming it, as I say, there are tools to deal with that.

On the other side of the coin, companies such as ACE and U.S. companies who do business globally to manage capital efficiently need freedom of reinsurance. And the U.S., which is 40% of the world's insurance market should be encouraging that.

Okay. That's great. Thanks a lot.

You're welcome.

And that does conclude our question-and-answer session for today. At this time, I'd like to turn the conference back over to Ms. Helen Wilson for any additional or closing remarks.

Thank you for your time and attention this morning. We look forward to speaking with you again at the end of next quarter. Thank you. Good day.

That does conclude today's conference call. Thank you for your participation. You may now disconnect.