美國再保險集團 (RGA) 2003 Q2 法說會逐字稿

Good day and welcome to the Reinsurance Group of America's second quarter conference call.

Today's call is being recorded.

At this time I would like to introduce the President and Chief Executive Officer, Mr. Greig Woodring and Executive Vice President and Chief Financial Officer, Mr. Jack Lay.

Please go ahead, Mr. Lay.

Thank you and good morning.

Welcome to everyone to RGA second quarter 2003 conference call.

I will turn the call over to Greig Woodring our CEO in just a minute.

David Atkinson, our COO is also with us this morning.

Greig will comment on our results and then we will respond to questions from our participants.

As a reminder during the call we plan to discuss certain subjects that will contain forward-looking statements including expected financial performance, future transactions and industry trends.

You are cautioned that actual results could differ materially from expected results.

Additional detailed information concerning a number of factors that could cause those actual results to differ materially from expected results is readily available in our most recent annual report and 10-K for the year ended December 31, 2002.

With that I will turn it over to Greig for his comments regarding the second quarter results.

Good morning and thank you for joining us.

We are pleased once again to report strong results for RGA.

During the course of this call, we will focus our comments on results from operating income on both a pretax and after tax basis which under the SEC's new regulation G is considered a non-GAAP financial measure.

We believe this measure better reflects our ongoing profitability since it eliminates the net affect of realized capital gains and losses which can be volatile from period to period and are discontinued operations which are no longer a part of our ongoing business initiative.

Please refer to the text of our press release for the reconciliations of operating income to net income.

Operating income for the quarter totaled $41.2 million or 22% above the second quarter 2002 total of $33.9 million.

On a per share basis our operating income was 82 cents per diluted share.

This represents a 21% increase over the prior year result of 68 cents per diluted share.

Net income for the quarter totaled $42.6 million or 85 cents per share, per diluted share. 52% increase over the prior year amount.

Consolidated net premiums increased 25% for the quarter and 21% for the first six months.

A stated objective is to increase premium year-over-year by at least 15% so those results are very strong.

Premium close have been strong this year primarily due to continuing growth in international operations.

In terms of our individual operating segments starting with U.S. operations, our largest segment pretax operating income was $55.7 million compared with $43 million in the prior year, that's a 30% increase.

Strong results were driven by our largest sub segment the traditional mortality business consistent with the first quarter we experienced favorable mortality compared with expectations.

As we pointed out before, mortality results can fluctuate from quarter to quarter.

Premiums in the U.S. increased 12% in the prior year -- from the prior year quarter on a year-to-date basis premiums are up about 9%.

We expect premium growth rate for the year to be at least 10% and feel that we are on track in that regard.

The U.S. asset intensive business reported strong results for the quarter.

We did not execute any new significant annuity treaties during the quarter but added approximately $145 million of net deposits on existing treaties.

Activity in the U.S. life reinsurance marketplace continues to be strong.

Additionally the competitive landscape continues to evolve due to a number of factors including continued expected consolidation in the reinsurance industry.

Turning now to Canada.

The Canadian operation experienced slightly adverse mortality.

Pretax operating income totaled $9.6 million compared with $10 million in the prior period quarter.

Premiums increased about 18% to approximately $52 million.

Year-to-date pretax operating income totals $20.5 million.

Up from $18.9 million in 2002.

Primary operating subsidiary in Canada was recently assigned a AA minor financial strength rating from Standard & Poors that reflects the strong position in the Canadian life reinsurance market and its strong contribution to consolidated results of RGA.

Regarding our international operations, we saw solid top and bottom line results for both -- in the quarter for Asia Pacific and for Europe and South Africa.

Premiums for the international segment increased 79% to $149.6 million.

Much of this growth emanates from our UK operation as well as a from a few sites in Asia Pacific.

Pretax operating income nearly tripled from $2.9 million in the prior year quarter to $8.5 million in the current quarter.

Although we continue to build scale in these operations results remain more volatile than our mature operations in North America.

We continue to be pleased with the progress we are making in these markets.

Net realized capital gains for the quarter totaled $4 million on a pretax basis due primarily to sales in the Canada portfolio to reduce concentration to certain issuers.

On a gross basis right down to credit impairment for the quarter totaled $3.1 million a significant improvement over the prior quarter amount of $8.8 million.

Losses on sales totaled $6 million and gains on sales totaled $13.2 million.

Overall yield on the portfolio for the quarter was 6.67% consistent with the first quarter, actually.

In conclusion, we were very pleased with the results for the second quarter and the first half of 2003.

We remain bullish on the life reinsurance market domestically and abroad.

At the beginning of the year we provided full year operating earnings guidance of $2.95 to $3.15 per share and we obviously got a strong start toward that sort of result and will continue to grow the value of the enterprise as best we can.

With that, we will now take any questions you may have.

Thank you.Today's question and answer session will be conducted electronically.

If you would like to ask a question please do so by pressing the asterix or star key followed by the digit 1 on your touch-tone telephone.

If you are using a speaker phone today, we ask that you please make sure that your mute function is off to allow your signal to reach our equipment.

We will proceed in the order that you signal us.

We will take as many questions as time permits.

Once again that is star 1 to signal your question or comment.

Our first question today will come from Nigel Dally from Morgan Stanley.

Great.

Thank you.

A couple of questions.

First with regards to consolidation seem to be a simple properties up for sale.

I was wondering what your appetite is for criteria in participating in consolidation in the industry.

Second, with interest rates doesn't seem to having a big impact on your results.

Is there something you're concerned about?

Perhaps also if you can talk about your exposure to mortgage backed securities?

And lastly just on capital.

How quickly you are running through your capital and just a bit of an update on when you may need additional capital.

I will take the first one of those series of questions, Nigel.

On consolidation, there are a number of properties for sale.

We expect even more to come on the market.

Ironically enough it's a market where demand remains high and the number of competitors for other reasons than purely the reinsurance market has to do with their parents or impacts from outside of the market are shrinking.

And we will take a look at -- we intend to take a look at any properties that do come for sale.

We have not been successful in finding our price on any of these in the past, but we continue to look and if the right circumstance comes up, we will be very interested in those situations actually.

Is there a maximum size which you are looking at which you would be interested in?

Or are you looking at all potential properties?

Well I think we would look at all of them.

Obviously the size and the difficulty in implementing a transaction would weigh into our consideration of how active we would be in pursuing something.

We would potentially look at any size, we don't feel constrained in that regard.

In terms of interest rates, interest rates for us are one of the components of profit obviously and when they go up, we make more money, when they go down, we make less money.

We have been under pressure for the last couple of years where our portfolio yield has been dropping and that's been something we have had to fight off as a head wind.

It's not nearly as important as mortality for our results but it does have an impact.

We essentially saw in the second quarter interest rates at about the same level we have seen them or our yield at about the same level we have seen it.

So it's sort of a no effect from the interest rates that changed this quarter.

On mortgage backed securities --

I can respond to that.

Nigel, we have about $800 million or so in asset backed securities.

The majority of which are mortgage backed securities.

In terms of your last question on capital, we continually reassess our capital position.

We have been stating all year and I think we still state today that we have enough capital for this year, absent some large transaction or something that might occur during the last six months of this year.

So we probably are looking at least to the end of the year as having enough capital to continue operating at the same growth rates we have been.

And looking forward in terms of raising additional capital next year, any estimate on the magnitude of the potential capital raised in the form of capital?

It's a little too early to call that one, I think.

Thanks.

Moving next to Vanessa Wilson representing Deutsche Banc.

Thank you.

Greig, could you talk a little bit more about the properties for sale so we can understand the supply/demand fundamentals in the market.

What do you think are driving these properties for sale?

Have they had poor results?

Is the parent company deciding to be more focused on the primary businesses?

And to the extent there's been maybe problems elsewhere and they need to raise capital, just so we can have a better feel for.

I think -- first of all, in the U.S. market there are a couple of properties for sale right now.

Both situations it's because the parent has decided that they want to raise capital or reallocate their capital to more align with what they consider their core strength.

Ithas nothing to do with the life reinsurance business therein producing terrible results.

There are a couple international situations where they are part of a property casualty combined unit that has caused problems over the years and they have difficulties in terms of their existing capital position.

More due to the property casualty than the life business and this is something that they can jettison and raise capital and redeploy it.

Okay.

And in the U.S. properties are these operations underperforming for that parent company?

Or view to be performing attractively so that they will be a source of capital?

Everything is relative in that sort of a comment.

It's hard for me to assess, but my sense is that they are probably doing okay.

I don't think that they are considered bad performers and they are trying to get rid of bad properties.

At the same time, I'm not sure they are wildly a part of their core either.

We lean more on the source of capital side?

I think so.

And then the other thing I want to, Jack, could you just follow up on Nigel's question on the mortgage backed security.

You told how much you have.

Are they prepaying in the current low interest rate environment so we can expect yield next year as the prepayments slow?

There is some prepayment but it hasn't been dramatic.

A lot of that relates to the traunches that we have.

I think in terms of the broader investment portfolio I would expect and therefore you should expect, that we will have some compression in our interest yields, our investment yields over the next couple of quarters unless there is a dramatic change in the interest rate environment.

So we would expect something closer to 6 1/2% for instance, for the entire year yield compared to 6.75% where we were in the second quarter.

Just lastly, Greg, on your guidance, you were saying you are expecting 10% premium growth for the U.S. for the year.

Did I get that correct?

Yes.

We were expecting at least 10% and we made that statement because we fell short of that in the first quarter.

A lot of that has anomalous reporting things of that sort do affect our quarter-to-quarter comparisons.

We do expect that number to be over 10% for the year as a whole.

That's it for me.

Thank you so much.

We'll move next to Jeff Schuman with KBW.

Good morning.

Jack, I was wondering if we could follow up a little bit on the interest rate comment.

If you could help us differentiate between the fact that the portfolio yield may come down on the one hand versus whether that actually means margin compression.

Obviously, if you put new business on the books today, you're investing at lower yields, that doesn't necessarily mean -- hopefully doesn't mean corporate margins are coming down.

Should we or should we not expect that yield compression actually means margin compression next year?

Well, that's a good question.

I would suggest that part of it -- part of our investment yield obliviously relates to the asset intensive portfolio and that's really a spread business that we try to manage the spread as opposed to simply managing one side of the equation.

My comment in terms of perhaps a 25 basis point reduction in the overall yield, I think you should presume that sort of yield reduction with respect to our mortality business.

And so that would have an impact on our ongoing earnings.

Not a dramatic impact, but some impact.

Some of that would relate to existing business and could not be offset?

Well, yeah.

Think of it like this.

The part that relates to our spread business is offset in most respects because there's also crediting and rates on the other side.

Okay.

And then with respect to the mortality business, as you write new business today, are you offsetting lower yields in new business pricing?

Yes, we would be.

Clearly, if we make 6 3/4% versus 6 1/2%, we make more money.

Okay.

And then I may have missed your earlier comment on Canada.

I apologize.

What should we think of as being kind of the trajectory from here?

You did actually have strong premium growth there.

You do have a problem treaty.

Should we think about sort of flat earnings for awhile?

Can we start to build from here?

What should we expect from Canada?

We are expecting that earnings will go up in Canada.

It's been a very strong performer historically for us.

It is a smaller block obviously than the U.S. block by a considerable amount just because of the nature of the size of the market.

And it does bounce around there for a little bit more.

The results historically have been very consistent in Canada around a very strong high performing level.

We are at the point where we are expecting a little bit of growth out of Canada in the coming quarters.

Growth in the top line but also in the bottom line?

Yes.

Okay.

Thank you.

Tanya Lewandowski with A.G.

Edwards will take our next question.

Hi.

Good morning.

Just wanted to get a little bit of an update from the discontinued accident and health segment.

If you could just tell us if there have been any changes here and again remind us of the expected time frame for that runoff.

There really was very little change in really in the first half of the year.

The runoff continues to be sort of very modest at this point in terms of information flow or new things coming up.

The business has a tail on it of say 7 or 8 years.

We expect this sort of to wind up in terms of activity in 2005, 2006 era.

The biggest things that will remain will be some arbitrations that we are currently involved with.

So we will keep you posted.

We don't expect anything to happen this year on those items.

Okay.

Then one last question.

In terms of the possibly raising capital next year, what type of capital would you expect or what sort of mix do you think would be the most likely scenario.

This is Jack.

One scenario would have part of that capital raising being either pure equity or some hybrid that's close to equity for ratings purposes perhaps combined with additional leverage with term debt of some sort.

Okay, great.

Thank you.

We'll move next to Al Capra with Putnam Lovell.

Good morning.

I was just hoping to flush out the whole supply demand issue a little bit.

I think what I am hearing from you is that you are seeing significant activity and momentum on the life reinsurance side and what we heard from Manual Life yesterday, a retro session air (ph), is that they are seeing a lot of large block opportunities which in turn tells me there might be a capacity crunch on the reinsurance side.

Could you just address this?

Is it a situation whereby the life -- the primary life companies are seeding more risk or shedding more blocks of business or is the capacity crunch in reinsurance just solely a function of the consolidation taking place?

I suspect there is a little bit of both of that.

There have been a number of blocks out on the market this year.

That's been a pretty steady activity over the last several years, and it could well be who is involved in what changes from time to time.

But the block activity has been well sporadic, more or less continuous over the last several years.

There are fewer life reinsurers and there are fewer people bidding on many of these block situations.

Okay.

Thanks.

I would like to remind our audience if you have a question or comment for our presenters, please signal at this time by pressing star 1 on your touch-tone telephone.

Once again that is star 1 to signal.

We will take a question now from Liz Werner from Sandler O'Neill.

Good morning.

I had a couple of questions.

I was wondering if you could follow up a bit on the demand in the U.S. and I was wondering if you are seeing any difference or changes in life reinsurance demand from the small and mid-size direct writers and if you are, is it coming for any particular product type?

Secondly, I want to know if you are making any changes in your investment strategy with regards to either asset class, allocation or duration in response to the low interest rate environment.

In terms of the demand, the demand continues to be very strong.

A lot of it is driven by pure outsourcing of mortality, some of it is driven by Triple X reserve requirements.

Others illustration, regulations.

There are a lot of pressures forcing companies to reinsure more rather than less.

New business was reinsured at a clip over 60% last year.

We don't expect that to grow very much more, but we don't expect it to shrink either.

We don't really see people pulling back their quota share programs into high retention programs at all.

Smaller and mid-size companies I think, they may have relatively more need to reinsure all of their Triple X type business or anything that requires additional strength.

But generally speaking they have been doing that for some time.

And we just see an environment where there is continued high strong demand.

A lot of reinsurance activity and fewer number of reinsurers to compete for it.

On the investment strategy side, Greig?

I can handle that.

In terms of the investment strategy, the general answer is, no.

We typically don't change our investment strategy in any meaningful way.

We do it only subtly over long periods of time.

So the answer is no.

Now in more detail, it doesn't mean we won't consider around the fringes some other asset classes that we feel are underrepresented in.

In terms of duration and primary asset classes we don't expect any significant changes.

Great.

Thank you.

Our next question comes from Michelle Giordano with JP Morgan.

Good morning.

I was wondering if you could address the results in the international operations in more detail, specifically, these are great results.

Was there anything that was unsustainable here and where would you consider to be a normal level of earnings for the international segment?

I recognize there is a lot of new businesses going on here, new growth markets, but how much of the results that you reported this quarter might be unsustainable.

And then secondly, in the asset intensive area, was there anything unusual in the results this quarter that may not be sustainable there and did you add any new contracts on the fixed annuity side.

I apologize if you addressed that earlier.

I did get on the call late.

Internationally, I guess I wouldn't say there is anything at all unsustainable about the results.

As a matter of fact, they were pretty close to our internal plan, a little bit strong but not much.

And those are always hard to predict because they are new operations.

The reporting hasn't settled down even let alone the block of business being big enough to stabilize earnings as much as the North American piece has.

But we are getting very strong business out of a couple of markets such as the UK, Australia, Japan and Korea and that's driving the flows in these international businesses.

We have gotten to a size where we have overcome the fixed cost structure of setting up these operations and we should be moving from low profitability -- low number of profits to a higher number relatively rapidly.

So that's why you see something like a tripling in profits as being something that we expected to happen or close to it.

So we expect good things to happen on the international front in the future and this is nothing unusual particularly this quarter.

On the asset intensive side, in terms of the experience for the quarter, that business has grown enough that what you are seeing is again the results of a bigger size driving down more profits.

There wasn't anything unsustainable or unusual in the quarter.

As a matter of fact, it was at least one small negative in the quarter that was overcome by the increased size of the operation.

And I think that you should expect that sort of result going forward as well.

Did you add any fixed annuity reinsurance contracts in the quarter?

We did not add any fixed annuity contracts, any new ones but we have got some flow and a couple open ones.

That was about $145 million.

Okay, great.

Thank you.

We do show a follow-up question from Vanessa Wilson with Deutsche Banc.

Jack, I wanted to follow-up with you on this point of pricing for low interest rates in the mortality business.

Is there a way that the pricing goes up to reflect the lower interest rates?

Or on new business this is just absorbed?

No.

On new business, we can certainly work in any kind of assumptions we want.

One thing to keep in mind, whenpricing new mortality business, the expectation on mortality kind of overwhelms the expectation on interest rates.

So think of it like this, we could build in a little change in interest rates that would have only a modest impact on our ultimate quote.

It's what we expect mortalities rates to do.

And I guess my sense is that the market is so intensely competitive for mortality risk that there might not be pricing power to build in anything for interest rates.

You are saying it's such a small part of the economics that it's fine?

We -- no, no.

We do reflect the current interest environment when we price new business.

Obviously, those quotes will be in place for 20 , 30 years and interest rate changes after 2003 we will pick profits on that block of business that's produced up or down from that point.

Thank you.

And we will take a question from Thomas Gallagher with CS First Boston.

Good morning.

Just a question on variable annuity reinsurance.

Knowing that capacity has been close to nonexistent there, is that a market that you are keeping your eye on at all?

Looking at pricing and is there a potential point at which you would either look to get in to the GMDB, GMIB or principal guarantee reinsurance business?

The problem that we had with that business is that it's very difficult to price the market risk.

It's not so much the mortality, we don't worry about the mortality at all.

In fact we would be happy to take pure mortality risk and have done so on VA-type situations but not get involved in the market risk.

It's too difficult for us to deal with.

So you haven't explored hedging alternatives?

We looked at it but we have never gotten comfortable.

Is it a capital issue?

No.

It's really a matter of the prices that we are being offered, being very inadequate to cover even -- and the risk being so large if everything went the wrong way that it was placed in a huge bet on situations falling within sort of 98%, 99% of the distribution.

Okay.

Thanks.

Before we take our next question, I would like to make a final reminder of our audience that if you have a question or comment please signal by pressing star 1 at this time.

We will return to Tanya Lewandowski with A.G.

Edwards for a follow-up question.

I was wondering, with so much discussion and focus on the interest rates, is there any way you could quantify the sensitivity of earnings interest rates?

I know it is relatively small, but is there anything that you could comment on in terms of so many basis point change and the yield that you would expect ,some sort of dollar amount associated with that?

If you look at our mortality block of business, ignore the spread business that Jack mentioned, just look at that business.

We expect positive cash flows every year.

And so we built up funds over time that are the result of all those years of accumulation.

And that fund is a couple 3 billion at this point and you can do your own math as to what a 1% or 1 basis point change in interest rate does to the $3 billion or so of funds that backs that mortality business.

Okay.

And then I guess kind of following up on the prior question with regard to guaranteed minimum death benefits, I know you’ve mentioned that if you could pull out the mortality risk and reinsure that on variable annuity products and stay out of the equity market risk portion of the product that you would look to do that.

Have you seen much of that in the market?

Or have you had the opportunity to bid on some of that business?

We have done that.

Some of those structures have been coming into the market in the last I would say 6 to 9 months now.

We have been taking a look at just reinsuring the mortality risk on a period to period basis without any market risk component.

Do you see that as potentially a growing portion of your business, I guess, if it makes economic sense for you?

Well, I guess so.

It would be some deals that we haven't done before like this and we have done a couple of these at this point.

There is a limited number of them that would come to market is my expectation.

Okay, thanks.

And at this time, Mr. Lay, I show there are no further questions in the queue.

I would like to return the conference to you for your closing remarks.

Thanks again to everyone who joined us this morning to the extent of any other questions or issues come up, feel free to give us a call here in St. Louis and with that we will end the call.

And this does conclude today's Reinsurance Group of America's second quarter conference call.

We do thank you for your participation and I hope that everyone has a wonderful afternoon.

If you are now welcome to disconnect.