Kestrel Group Ltd (KG) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Maiden Holdings Second Quarter 2015 Earnings Conference Call. (Operator Instructions.) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Noah Fields, VP of IR. Sir, you may begin.

Good morning, and thank you for joining us today for Maiden's second quarter 2015 earnings conference call. Presenting on the call today we have Art Raschbaum, Maiden's Chief Executive Officer, along with Karen Schmitt, our Chief Financial Officer. Also in attendance today is Pat Haveron, President of Maiden Reinsurance Limited.

Before we begin, I would like to note that the information presented here today contains projections or other forward-looking statements regarding future events or the future financial performance of the Company. These statements are based on current expectations and future events, and are subject to a number of risks and uncertainties that could cause actual results to differ materially from these expectations. We refer you to the documents the Company files from time to time with the Securities and Exchange Commission, specifically the Company's Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q.

Some of our discussions about the Company's performance today will include reference to both non-GAAP financial measures and information that reconciles those measures to GAAP, as well as certain operating metrics, and may be found in our filings with the SEC and in our news release located on Maiden's Investor Relations website. Please also note that, unless otherwise stated, all references to common share data in today's discussions are on a diluted share basis, and comparative comments will refer to Maiden's results in the second quarter of 2015 relative to the corresponding period in 2014.

Finally, certain reclassifications have been made for 2014 to conform to the 2015 presentation, and have no impact on net income and total equity previously reported.

I will now turn the call over to Art.

Thank you, Noah. Good morning. Welcome, and thank you for joining us today.

For the second quarter of 2015, Maiden reported operating earnings attributable to common shareholders of $28 million and diluted operating earnings per share of $0.37, similar to the same period last year. During the quarter, investment income grew significantly from the first quarter as we put much of our accumulated cash to work while continued revenue growth remained strong at 16.4%.

Despite adverse development in the US underwriting portfolio of our diversified segment, results this quarter demonstrate the resiliency of Maiden's lower volatility, highly efficient business model, and strong balance sheet. Maiden's operating return on equity was 12.2% compared with 13% operating return on equity reported in the second quarter last year. Importantly, continued growth in invested assets and a focused on improved underwriting performance should further benefit operating returns and earnings in the future.

Looking for a moment at the first six months of the year, we posted an operating return on equity of 12.1% compared to 12.6% in the first half of last year, and operating earnings per share were $0.71 in the first six months of 2016 compared to $0.70 in the first six months of last year.

Focusing on premium production for the quarter, overall, gross premiums written increased 20% while net written premiums grew 16%. AmTrust business drove the increase in premiums, with net premiums written increasing 30% as we continue to benefit primarily from the impact of the Tower acquisition and continued organic growth. While we expect the growth rate from the Tower acquisition to moderate, we believe that AmTrust continues to have strong opportunities to profitably expand their business.

In the diversified segment, net premiums written fell 15%, reflecting the impact of the acquisition of a large US client. Going forward, the Company's new parent will not require quota share support. As we've indicated in the past, it's not unusual to work with our clients to develop capital support solutions that become unnecessary as their balance sheets build or, as in this case, they merge with the larger company. Even with this customer loss, year-to-date US net written premiums have grown slightly.

We continue to benefit from expansion of existing client relationships and disciplined additions of new clients as we maintain our focus on serving the needs of regional insurers. And within this portfolio, our focus remains on expanding the highest margin segments that we underwrite today.

Internationally, the continued influence of a weak euro adversely impacted our international insurance services, or IIS business revenues. As you may remember, this is a highly differentiated business serving the branded consumer insurance needs of automotive manufacturers. In addition to receiving service fees as a reinsurer, Maiden partners with insurers to deliver high quality insurance products.

Notwithstanding the euro impact, we expect further growth in the IIS business to be driven by new business opportunities in the auto OEM space with new partnerships coming online. We've been successful in the quarter, adding several new auto OEM relationships and are in active discussions with several additional prospects. Furthermore, our strategy to expand our auto OEM payment protection insurance, or PPI opportunities, is well underway. All these opportunities should drive expansion of IIS revenue and earnings toward the end of 2015, but more meaningfully in 2016 and beyond.

Separately, and also in Europe, we're very pleased with market reaction to our differentiated capital solutions business model. As you may recall, in addition to offering collateralized reinsurance solutions, we're working along with our main majority owned subsidiary, Insurance Regulatory Capital.

And driven by emerging capital needs that are created with the implementation of risk-based regulatory capital requirements, or Solvency II, we're actively entertaining a number of opportunities to provide blended capital solutions. Today we occupy a very unique position in the capital solutions market, with both collateralized reinsurance and subordinated debt products.

Maiden's combined ratio increased in the second quarter to 99.2%, up from 98%. The AmTrust segment performed well, with a combined ratio of 95.2% for the quarter, an improvement versus 95.7%, largely reflecting changes in business mix. We continue to benefit significantly from their profitable growth.

The diversified reinsurance segment posted a combined ratio of 104.1%, higher than the 97.7% recorded in the second quarter last year, and primarily due to adverse development in Maiden's US excess commercial auto liability reinsurance book. Although we've seen more modest impacts in the past several quarters, Maiden experienced a significant increase in client reported case reserve increases in the quarter.

While we're completing a comprehensive review of all outstanding commercial auto excess accounts to further determine the source of this activity, we've reacted prudently and swiftly from a claims, actuarial, and underwriting perspective. As you may be aware, other participants in the US commercial auto insurance industry have also similarly been experiencing elevated loss activity over the past several quarters. In Maiden's case, activity in the quarter was largely isolated within our excess commercial auto portfolio, where we've seen a greater issue with severity rather than frequency.

Notwithstanding the performance of the excess commercial auto portfolio, the balance of the US underwriting portfolio performed within expectation for the quarter. In our Bermuda underwritten IIS European auto portfolio, results have improved from the last quarter. You may recall that we experienced some large loss activity in our German and UK auto insurance portfolio in the first quarter. Performance returned to target levels this quarter.

Across Maiden, we remain committed to maintaining underwriting discipline while leveraging our significant competitive advantages to grow our business profitably. Notwithstanding the adverse impact in the quarter, we're confident in our ability to strengthen returns and expand our business, going forward.

I would now like to turn the call over to our Chief Financial Officer, Karen Schmitt, to review the second quarter in greater detail. Karen?

Thank you, Art, and good morning. As Noah said earlier, unless otherwise stated, all references to common share data are on a diluted share basis, and comparative comments will refer to Maiden's results in the second quarter of 2015 relative to the corresponding period in 2014.

Maiden reported second quarter 2015 net operating earnings of $28 million, or $0.37 per diluted common share, which were each essentially equivalent to the comparative period. Net income attributable to common shareholders was $21 million, or $0.27 per diluted common share compared to $26 million, or $0.34 per diluted common share in the second quarter of 2014.

The main driver of the difference in the net income this quarter versus last year was the foreign exchange loss of $5.3 million this quarter versus almost a $1 million gain in the second quarter of last year. This loss offset a portion of the foreign exchange gain from the first quarter as weakening in both the euro and British pound during the first quarter partially reversed, causing the non-operating foreign exchange loss during the quarter. Losses from our runoff operations were also smaller in the second quarter of 2015 versus the second quarter of 2014.

Gross premiums written in the second quarter of 2015 increased 20% to $674 million from $560 million. Net premiums written totaled $630 million in the second quarter of 2015, an increase of 16%. The diversified reinsurance segment's net premiums written totaled $145 million. Within the diversified segment, the US business premium volume was impacted by a single large customer that was acquired, but US premiums are still up on a year-on-year basis.

Premium levels in the international business were again negatively impacted by foreign exchange movements resulting from the strong US dollar and are down significantly, but are expected to produce strong growth in subsequent quarters due to the in-process initiatives Art mentioned. In the AmTrust reinsurance segment, net premiums written increased 30% to $485 million, reflecting continued business growth resulting from AmTrust's acquisition of the Tower Group business, as well as organic growth.

Net premiums earned of $609 million increased 15%. In the diversified segment, net premiums earned decreased 9% to $185 million. The AmTrust reinsurance segment earned premiums were up 31% to $425 million.

The combined ratio totaled 99.2% in the second quarter of 2015 compared with 98%. The diversified reinsurance segment's combined ratio was 104.1% in the second quarter of 2015, up from 97.7%. The higher diversified reinsurance segment combined ratio was due to adverse development in US excess of loss commercial auto business concentrated in the 2011 to 2013 underwriting years.

We have been focusing on this line in recent quarters and continue to evaluate the higher level of reported losses by our cedents. A comprehensive review of all accounts with significant commercial auto exposures is ongoing and will be completed during the third quarter. The small redundancies in other lines of business provided a modest offset to the commercial auto development, with total net adverse development of $14 million recognized in the quarter.

The AmTrust reinsurance segment reported a combined ratio of 95.2% in the second quarter of 2015 compared to 95.7% in the second quarter of 2014. The improved combined ratio for the AmTrust reinsurance segment is largely due to the higher proportion of earned premium coming from AmTrust's very profitable worker's compensation business.

Overall for the quarter, net adverse development from operating segments added 2.3 points to the combined ratio. Included in our combined ratio is a non-operating loss from runoff operations of 0.3 points, as well as an operating expense ratio of 2.7%, the lowest quarterly ratio since 2009. This very efficient operating expense ratio provides an advantage in an increasingly competitive market.

In the second quarter, net investment income was a record $35 million, an increase of 25%. During the second quarter, two securities were called, which increased net investment income by almost $6 million. The average yield on the fixed income portfolio, excluding cash, is 3.4%, with an average duration of 5.1 years. The new money yield on fixed maturities in the second quarter was 2.74%, with an average duration of 6.2 years. Including cash, the average duration is 4.7 years versus an average duration of liabilities of 4.4 years.

Total investments increased to $3.8 billion compared to $3.5 billion at year-end 2014. Operating cash flow was $208 million during the quarter, up 127% compared to $92 million. Cash and cash equivalents were $309 million as of June 30 as compared to $641 million at the end of the prior quarter.

During the second quarter, we actively invested $769 million in high quality corporate bonds and government agency mortgage-backed securities compared to total purchases of $116 million during the first quarter. The quarter-end cash balance reflects our strong cash flow, including significant premiums received at the end of the quarter. As we continue to generate strong cash flow and invest new cash, our earnings run rate should continue to increase.

Total assets increased 10% to $5.7 billion at June 30, 2015 compared to $5.2 billion at year-end 2014. Shareholders' equity was $1.2 billion, down 1% compared to year-end 2014 due to unrealized losses in the investment portfolio during the quarter as higher interest rates caused lower mark to market valuations.

Book value per common share was $12.35 at June 30, 2015, or 3% lower than December 31, 2014, affected by the lower investment values. Total capital resources remained strong at $1.58 billion, a decrease of 1% since year-end.

I will now turn the call over to Art for some additional comments.

Thank you, Karen. I'd like to provide you with an update on market conditions, and then provide some closing thoughts. In our diversified segment, our IIS business in the UK is benefiting from improving primary motor rates, which, according to industry sources, have increased by approximately 5%. And this is the first significant increase in the UK since 2012. Rates remained stable in the German personal auto market, where the majority of our IIS business emanates.

In the US, the primary commercial lines insurance market is increasingly more competitive. Primary insurance rates across the board seem to be flattening for commercial lines in general. Despite that trend, other than the commercial auto segment, primary loss cost trends remain relatively benign.

Notwithstanding this broader trend in the AmTrust segment, we do see continued pricing strength in many of their niche markets. Within the reinsurance sector and our target market segment of lower severity business, competition is continuing to intensify. While we've been able to hold the majority of our renewal portfolio, new client development in this environment has been more challenging. That said, we've added several new customers and are in active discussions with a number of prospects.

We believe that clients and prospects still value differentiated solutions, and we remain confident in our ability to expand our portfolio in a disciplined manner. Importantly, we continue to experience growth from existing client relationships.

As we continue to work through the second half of the year, we remain focused on monitoring and working to mitigate the challenges we've seen in our US commercial auto liability portfolio. Importantly, there are a number of reasons for optimism, as our investment portfolio continues to benefit from an increasing base of invested assets. Efforts to win OEM business in Europe are gaining momentum, while the pipeline of opportunities for deals in our capital solutions business is also increasing.

Ahead of the fall conferences in Europe, we're in active discussions on a number of opportunities. And while capital solutions decisions ahead of Solvency II by companies continue to develop, we believe we're positioned to advance Maiden's business strategy as we enter this key period.

In the US, we've been successfully expanding established client relationships and are diligently pursuing new business relationships in a disciplined manner. Maiden's diverse lower volatility, non-catastrophe reinsurance model should continue to benefit from efficient capital utilization and growing premium levels in both of our business segments.

From a management perspective, we remain focused on providing excellent products and services to our customers while strengthening underwriting performance, with an eye on ultimately enhancing the value we deliver to our shareholders.

This concludes our prepared remarks.

Crystal, could you please open the line for Q&A?

(Operator instructions.) Randy Binner, FBR Capital.

Hey, good morning, (multiple speakers). So, on investment income -- I'm just going to start with some income statement things. The net investment income was quite strong. Was there unusual one-timers in there, like bond prepayments, or anything that made that number higher than it otherwise would have been?

Well, we had call premiums of about $6 million, $5.9 million, during the quarter. And we've had those from time to time. We had none of them in the first quarter, but we did have some substantial call premiums also in the fourth quarter. So, they tend to be a little lumpy. I wouldn't call them necessarily one-time, but they're certainly not every quarter.

And then, did you cover on the script how much you have to invest still? Because I think that you had an excess balance from the -- staying away from the low rate environment in the first quarter, and then you're still generating a lot of free cash. So, are you fully invested, or do you still have excess cash to put into the portfolio?

We ended the quarter with a little over $300 million of cash, but we still have some more cash to invest. And some of that was we had pretty substantial balances paid at the end of the quarter. So, we'll continue to get that invested.

So, when you say $300 million cash, that's $300 million cash in general, or $300 million that kind of needs going to the portfolio? That's not just buffer?

Well, that's the total balance. I mean, we won't go down to zero. But, we did invest over $750 million during the quarter. So, we'll continue to invest the majority of that $300 million, and we also expect continued strong cash flow during the third quarter, as well.

Like, if you go back to this time three months ago when we were on the phone, and you guys had held off on investing, how much better in, like, basis points would you say that the new money investing environment is?

Well, we ended up at 2.74% I believe this quarter, and that was really a mix. I mean, we had some higher yielding maturities and some lower. I think we were in the 2.5%, or maybe even a little bit lower last quarter, so at least 25 basis points, and I think probably towards the end of that quarter, even better.

Yes, that's kind of a metric, Randy. If you think of where the 10-year treasury was, at its trough in that quarter, I think it was running 1.8%, or somewhere in that range, and now it's rebounded to 2.2% and higher. So, that's 40 basis points movement just in the risk free rate.

Understood. And then, on FX, just can you break out exactly how much in millions of dollars there was, how much headwind there was this quarter just for premiums?

Yes. I mean, for diversified this quarter was about $3 million, and it's probably about $4 million in the first half of the year. So, about $7 million year-to-date for diversified. And then AmTrust, then there was also an impact on AmTrust, as well.

How much was it on AmTrust?

AmTrust this quarter was $17 million.

Okay. I guess I'll leave it there. I'm sure people will hit on the case reserves, so I'll drop back in the queue. Thanks a lot.

Thank you.

Sure, thank you.

Ken Billingsley, Compass Point.

Morning, Ken.

Morning, Ken.

Hi, good morning. The first question I wanted to ask is regarding the M&A event with the customer. And last quarter, I know some of us had issues with the net premiums earned pattern versus what was written. And I know I made an adjustment, but it seemed a little off still this quarter on the diversified segment. Can you talk about how much premium written was pulled because of the M&A event?

Yes. I mean, it was a large account in the US. It was an account that was written on a loss [of occurring] basis, so written premium equaled earned premium. So, as that came out, it affected the earned immediately as opposed to some of -- there are other contracts where we may terminate, and they run off and we continue to have premium from them.

That was not the case with this one. And this was the account we mentioned last quarter that was restructured, and we essentially helped them work into this acquisition. So, I don't think we can give absolute numbers, but it was a decent size account for the US. That being said, on a year-to-date basis, the US is still modestly up from a written premium standpoint.

So, essentially, the pulling of this account would not have affected net premiums earned this quarter?

No, it definitely did affect net premiums earned this quarter.

Oh, [it did], definitely did, but definitely be based on the premiums written that you announced for this quarter, not from premiums written in prior quarters?

Well, I mean, the premiums written in the prior quarter and premiums written year-to-date are slightly up. But, in the US, contracts can be written on a risks-attaching basis or losses-occurring basis.

So, some of the contracts that are written do not immediately affect earned premium. They affect earned premium over time. This particular account, because of the way it was written, when it comes out of written, it comes out of earned immediately as opposed to writing it and then having it earn out over a couple of years. This one has the same impact on earned premiums as written premium, if that make sense.

Okay, it does.

Some of the business that replaced it actually will earn out over time as opposed to earning immediately.

Then, on the commercial auto issue, you said you're doing -- so you've gone in and initially taken a charge, but there's a review going on that'll be completed in the third quarter. So, first of all, I'm assuming can we expect further charges from this, or what specifically is being reviewed? And where do you see the direction of reserves going?

Yes, I would say that, if you think of the activity in the quarter, we saw an elevated level of reported additional reserves on, for the most part, existing cases. So, clients that may have looked favorably initially on their position on a particular claim now feel less favorable and have increased their reserves.

What was unique about the quarter was that we saw a lot of this activity in that quarter, probably historic levels. And so, that causes us to kind of question what catalyst drove that. We've assumed that it's all development, that it's all coming through and reflecting an adverse view. The thing that you don't know is whether in some cases clients might be changing process to try to get to, let's say, full development faster to recognize kind of the ultimate quicker.

So, our review process will be to really try to understand the source of it. Our assumption in establishing the reserve was not that this is an acceleration. We essentially assumed it was all real and to be developed.

So, what we want to understand is really kind of what is the catalyst, are there any elements that we're missing. Equally important, we want to make sure that we're influencing forward pricing on our business to reflect those effects as well. But, I think it's premature to say that this is either excess development or not enough. We feel pretty good about our reserve position based on what we saw in the quarter, and obviously we'll see what the next quarter brings in terms of development. As we said, we're not unique in that respect, but I do think we're reacting as fast as we see the information.

And if I recall correctly, you said this was more of a severity issue, not a frequency issue, from 2013?

It's actually from sort of 2011 to 2013. Those three years seem to be the focal years. And it really there -- for the most part, they're claims that have been noticed to us for quite some time, and clients are sending us notices, increasing their reserves based on their assessment of their ultimate liability.

And where is the severity specifically coming from? I mean, is it from a [damaged, bodily, where, this] on the liability side? Where specifically is the severity increasing?

It's all on the liability side, and a fair amount of this is coming from commercial trucking.

And as the cases are settling, is it things that are going to court, or has there been some kind of shift?

Because we're excess, most of these end up being litigated claims. So, most of the claims that hit the excess layers are likely litigated.

It really is -- when claims professionals look at individual claims, they monitor and follow them. There may be certain facts that develop that cause them to feel that their liability is growing, and so they'll adjust their case reserves, and that's what we monitor and react to. We also do audits of our clients to see how their reserving process is developing as well, and so we kind of take the [accumulative] effect of those activities and react.

And just last question on just this topic here for me, is -- are more of these going to claims than maybe what you expected? And is it one or two customers, or is it broad-based across all of your customers?

It's more broad-based. I wouldn't say it's every customer, but it's certainly more than a handful. I think when we've talked in the last couple of quarters, we've seen significantly smaller movements. I think we're talking in the range of $2 million and $3 million in the last couple of quarters. So, this is much more significant. And this is from more than one or two customers, but it's certainly not the entire universe of commercial auto that we write.

But is it a percentage of claims going to litigation much higher, or is it just the size of the settlement?

I think it's more the size. We're not seeing -- I mean, the frequency was already established and defined. So, these aren't -- for the most part, these aren't new claims coming in. They're just higher reserve estimates for outstanding claims. And the majority of these are still open and still in trial process or settlement discussions, so it's a sort of interim evaluation of case reserves.

Great. So, moving on, this I guess is somewhat connected. So, AmTrust was asked would they be interested in giving any commercial auto, given the problems there, and they seem to move in when there are issues. And if they were to expand in the commercial auto, would that fall under your existing contract, it would just flow into business that you would accept from them? Or would this be something that you would have to approve?

No, it would flow into the existing contract. And frankly, we're writing commercial auto today. It reflects what we're seeing in kind of the information. In fact, some of these accounts that have been involved, we've taken rate action on renewal. In a couple of cases, we've insisted on stronger rates, and the client has chosen to sort of accept a different rate structure from a competitor. And that's fine. That'll happen, but we want to be disciplined about this process.

So, the important thing for us is not just to get the reserve right, but also get the pricing right prospectively, and we think we are reacting effectively. I do think, and I think there have been a variety of customers that are reacting to this as well and raising rates, and so I think that we look at client rating activity to make sure that we're comfortable that the pricing that we have reflects their pricing activity, but also what we believe the needed loss costs are. So, we wouldn't shy away from AmTrust increasing their position in the space.

Great. Thanks for taking my questions.

You're welcome. Thank you.

Thank you. And I'm showing no further questions from our phone lines. I would now like to turn the call back over to Noah Fields for any closing remarks.

Thank you very much to everyone for joining us today. We look forward to speaking with you in the future, and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day.