W R Berkley Corp (WRB) 2003 Q3 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the W.R. Berkley third-quarter earnings conference call. At this time I would like to inform you that all participants are in a listen-only mode. At the request of the company we will open up the conference for questions and answers after the presentation. The speaker's remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words including without limitation believes, expects, or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates, or expectations contemplated by us will in fact be achieved. Please refer to our annual report on form 10-K for the year ended December 31, 2002 and our other filings made with the SEC for a description of the business environment in which we operate and the important factors that may materially affect our results. W.R. Berkley Corporation is not under any obligation and expressly disclaims any such obligation to update or alter its forward-looking statements whether as a result of new information, future events, or otherwise. I would now like to turn the call over to Mr. William R. Berkley, Chairman of the Board and Chief Executive Officer.

Good morning. We were quite pleased with our quarter and I will try to run through a few of the highlights and talk about our operating units and let Gene talk about the financials and then talk briefly about where we see the industry. And then I will open it up for questions. We were really pleased. The numbers have come a long way over the past several years. We were still able to grow at 37 percent for the quarter, not quite as fast as in some prior periods, but still price increases that averaged about 20 percent, maybe a little bit more than that. We are starting to see some volume increases that made up the difference. Business overall is excellent; the returns we're generating in the current accident year are the best we have probably ever seen. Some segments of our business are better than we would have anticipated. Overall, while price increases are declining, they are still substantially higher than loss cost increases. We get loss cost increases of the magnitude of probably between four and six percent on an annualized basis. And our price increases for our regional business are probably averaging between 8 and 10 percent. Price increases on our specialty business are anywhere from 12 to 18 percent at the moment.

The reinsurance area prices are still stronger than that by a substantial margin and the strongest part of our business, probably our excess workers comp, and our facultative reinsurance area. We look at our businesses today and say our returns are adequate to even more than what we consider adequate, and with prices still going up significantly higher than loss costs, we are quite optimistic. Obviously the key factor for our increasing earnings going forward will be interest rates and how and when we invest our short-term portfolio. With basically 1.2 billion plus, probably 1.3 billion of cash, cash equivalents, and probably another several hundred million dollars in the shorter end of the yield curve, that is an important issue. Cash of $420 million for the quarter, we would expect the next five quarters to certainly reflect the numbers that are similar to that so that gives us 1.5 billion or $2 billion of cash flow over the next five quarters along with the current cash. And how we invest that is a real determinant of our ongoing earnings. We have a view that is longer than many of our competitors, and we're prepared to sit and suffer with the relatively poor short-term returns until we see interest rates getting to where we think they are attractive. That is a costly piece of the puzzle at the moment. Let me try and (technical difficulty) our business sections, one at a time just to give you an overview. Specialty business had an excellent quarter. We're quite pleased with their combined ratio, where things are. Prices are still increasing. It is less a continuous increase in pricing then it has been, but we will guess that prices for the balance of the year will continue to increase, let's just say anywhere from 12 to 18 percent, with probably 12 to 15 percent for next year.

The Alternative Market, strong segment, big service section. Lots of opportunities. The business is expanding. That includes our California comp, as well as North Carolina comp and servicing businesses, our third party administration business, Berkley Risk and our excess workers compensation business. Strong price increases there, especially in excess comp but frankly it’s really needed. Loss costs are growing faster there than most areas of the business, as medical costs drive up the exposure in excess comp and overall medical costs are bigger loss cost factor, so that this is an area where our service business is going to get the benefit of those higher costs because more people will look for alternatives and prices do need to go up.

We're still pretty optimistic, and feel little that will change be a dramatic improvement in that area of the business. We're very pleased with the reinsurance business. We had a GAAP underwriting profit volume is strong, especially in the facultative area. We see little that is going to happen that is going to change that. More and more people are leaving the casualty facultative business. For our point of view that is a real plus. We may be the last man standing, but it generates lots of opportunities. That business now represents probably half of our total reinsurance unit.

The treaty business is continuing to do well, with price increases in the 20 to 30 percent area and we expect those results overall will prove -- it is the area where we will have strong price increases for next year, and we are quite optimistic that that segment of our business will show continued improvement. The star performer from a combined ratio point of view is the regional insurance business. The business is growing. Prices are still moving up. They are really on roll at this point in time, with focus on improving their market position and determined to stick to underwriting goals of profitability. We sit and look at 86.5 combined ratio and couldn't be happier the returns there are well above our targeted returns. And we really think that business is performing extremely well. We have stepped out of what we call the plain vanilla day-to-day automatic kinds of businesses, personal lines small box and are focusing on what we call the middle market, which most of our larger competitors used to call the small commercial risks, things in the 10,000 to $100,000 range is the core of that business. And while we do some things that are larger and smaller, that is where we focus. For most of our competitors, they would consider even $100,000 small business.

The international business delivered an excellent return for the year for the nine months rather. We have seen a great improvement in our business in Argentina, and there the results have been outstanding as we have actually moved away from our life business there almost entirely, it is purely Property-Casualty business and the life and savings business in Asia is starting to improve, so we are pleased that we're making great progress there. Overall there is little we can say. With a 22.2 percent annualized return for the quarter, we don't think we are going to do a lot better than that without investment returns getting significantly higher. We do think there is some room for improvement in our GAAP combined ratio, but overall we are pretty pleased. I'm going to let Gene talk about the numbers.

Thank you, Bill. As Bill said, third quarter was an especially strong quarter for us in terms of both our revenue growth and our net earnings. Total revenues increased 43 percent over the prior year quarter to 916 million and net operating income increased 77 percent to 74 million. Net operating income per share rose to 84 cents from 54 cents in the prior year quarter. I just want to make a couple points on the 2002 number, if you are comparing them to last year's earnings release.

First, the earnings-per-share reflect a 3 for 2 common stock split that we completed in August of 2003. And second, as we have mentioned a couple times before, we did change the way we report Lloyd's premiums and expenses in the fourth quarter of last year. And as a result, the third quarter 2002 numbers were restated to reflect that change. All five of our business segments reported another quarter of significant growth in net premiums written. Overall net premiums increased 37 percent to 940 million. Premiums for Specialty Insurance, our largest business segment, increased 44 percent to 350 million, and that increase reflects strong growth for our excess and surplus business and also includes 21 million from our new specialty company in the UK that started writing business on July 1.

Premiums for the regional segment increased 16 percent to 232 million, with each of the four regional companies reporting double-digit premium growth in the quarter. Reinsurance premiums increased 48 percent 213 million. The composition of those premiums was 41 percent treaty, 35 percent facultative and 24 percent Lloyd's business. Alternative Markets premiums increased 43 percent to 128 million, and that includes approximately 42 million of primary California workers compensation business and international premiums increased 26 percent to 17 million.

Underwriting profits were up 175 percent to 70 million this year from 25 million in the prior year quarter. That is the result of 47 percent increase in earned premium and a 4 point decrease in the combined ratio, which was 91.7 for the quarter. The loss ratio decreased 1 point to 63.8 and the expense ratio decreased almost 3 points to 27.9 percent. Weather-related losses for the regional companies including hurricane Isabel were 14 million in the third quarter this year, compared with 12 million in last year's third quarter. Combined ratio was under 100 for all five business segments. That includes the combined ratio of 98 for reinsurance, 96 for Alternative Markets, 91 for international, 90 for specialty, and as Bill talked about, 86.5 for regional. Paid losses continue to be well below both industry norms and our own historic averages. A ratio of paid losses to earned premiums was 36 percent in the quarter, and that is down from 69 percent for all of 2001 and 52 percent for full year 2002. Net loss reserves increased 231 million in the quarter and have now increased 613 million or 26 percent year-to-date. Additions to loss reserves in the quarter included approximately 60 million in addition to prior year reserves.

For the insurance services businesses, fee revenues were up to 25.5 million in the quarter and 77 million year-to-date. That is a year-to-date increase of 22 percent and pretax profits were 5 million in the quarter and are up 20 percent year-to-date to 15.5 million. Investment income rose 7 percent in the third quarter to 51.7 million, as the increase in invested assets again more than offset a decline in average yields. Total invested assets increased 557 million in the quarter to just over 6 billion at September 30. The increase reflects over 400 million of operating cash flow and the proceeds from the sale of 150 million of senior notes in September.

The investment portfolio has now increased almost 1.4 billion from the beginning of the year. The composition of the portfolio is mostly unchanged from June 30. Our cash holdings are 1.2 billion, which is 20 percent of total investments. Tax-exempt municipals are 28 percent of the total. Taxable fixed-income securities 40 percent, arbitrage investments still at 5 percent, and the remaining 7 percent is made up of other equities including publicly traded REITs and private investments. The average duration was 4.6 years at December 30.

The annualized pretax yields on the overall portfolio was 4.4 percent in the quarter compared with 5.5 percent in the prior year quarter. The decrease, of course reflects the impact of lower interest rates generally and also the effect of having a greater portion of the portfolio invested in cash and tax-exempt securities. On an after-tax basis, the annualized yield was for 3.4 percent, compared with 4.1 percent in the prior year quarter. Unrealized gains before taxes were 191 million at September 30, and that compares with 178 million at the beginning of the year.

Income tax expense was 31 million and an overall effective tax rate of 28.4 percent. The effective tax rate decreased from 32.7 percent in the prior year quarter, primarily as a result of the higher level of tax-exempt securities. Net operating (technical difficulty) 74 million and operating income per share up 56 percent to 84 cents. On an annualized basis, the operating return on equity was 22.2 percent for the third quarter and is 20.4 percent for the first nine months. At the end of the quarter, stockholders equity was 1.578 billion or $18.96 per share. That is an increase in book value per share of 18 percent from the beginning of the year. We estimate that our statutory surplus was approximately 1.7 billion at September 30, which represents a premium to surplus ratio of right at 2 to 1.

Thank you, Eugene. Just to give you a quick overview of our view of the industry, we are pretty pleased. There are always people who are out there being aggressive, who are mispricing, in our view the business, who think they will get a bigger market share by cutting price. There are always people even in the hardest market who do that. We see players out there trying to get market share entering new markets. There are a couple of aggressive people in our regional standard markets and a couple in the specialty areas, but overall the market is pretty strong, pretty disciplined. Brokers are trying to talk down price. It's their jobs to get their customers the lowest price. Companies are trying to hold fast in their price in general or raise prices. Again, that is our job. The balance still seems to be toward increasing prices over less aggressive price increases than a year ago, or even six months ago. I think that you will find that there are areas like large property risks (indiscernible) where pricing has gotten softer in general and the casualty lines pricing is still up. Again, not as much as we'd like it, but we would expect more than 10 percent, less than 20 percent.

We are pretty optimistic that will continue through all of next year. At the moment it is on the higher end of that, but clearly getting softer. I think that there are some segments of the market that are very strong. There are still some segments of the market where there is no capacity at all. And there are a lot of companies in the marketplace, a lot of self insurance in the marketplace who still have extremely serious financial problems and have not grappled with those issues yet. Those are the people that give us opportunity. So with that, I would be glad to answer any questions that anybody has. Frank, if you would open up for questions?

(OPERATOR INSTRUCTIONS) Marco Pinzon of Smith Barney.

If I strip out underwriting expenses and insurance services expenses from your other operating expense line, I get to if I am doing the numbers right, I get to a corporate expense of around $8 million for the quarter, which seems well below the recent run rate, some 40 percent below the second quarter number. Can you tell us what is going on there and if this is a sustainable number going forward?

I can assure you we're not lowering the pay of people who are performing well. I think that you have a whole lot of accruals and chargebacks to companies as well as some unusual benefits that occur. It is not a number I would expect. I would rely on the number of prior quarters being the one that one should use going forward. This was a little unusual and some of those expenses just disappear as they get chargebacked to the operating units for things that have been done in the particular point in time. But it is an unusual looking number. I do not think you should rely on that 8 million dollars going forward.

So we should think more like --?

I would think that historically the number would be between 10 and 12 million.

Okay, great and then a second question is the combined ratio has been pretty consistent for the first three quarters of the year. You gave us a prior year reserve strengthening number of 60 million. Can you remind us what those numbers were for the first two quarters of the year, and can you tell us where the 60 million number actually falls within the various segments?

First of all, the first two quarters were a little less, but probably let’s just say 40, 50 million. And I think that the majority of it in the reinsurance area, and we do a different reserving strategy in our reinsurance area, and that is we evaluate our reserves in the reinsurance area treaty by treaty. So as we move along through the process, for several years now we have been effectively as we see development, late reports to an individual treaty, we have responded to that individual treaty. So I think that we are trying to be more conservative as time goes on to be sure that we don't have any surprises coming up and I think that that is really what you have seen, this continuous review. There are other developments here or there within that package, but the core driver is reinsurance, treaty business, where as we get an individual treaty that seems like it was late reporting, we try to respond.

Great, thank you very much.

Charles Gates of Credit Suisse First Boston.

Congratulations on a tremendous quarter. Two questions. The first question, what was the number equivalent to $60 million in the third quarter of 2002?

Honestly, Charlie, I don't know. Let me -- Eugene, you recall?

$175 million for the full year.

Let's just say assuming that even for the year it was probably 40 to $50 million number.

And those are all pre-tax numbers, is that correct, sir?

Yes, and everyone should understand that in managing insurance company, the one thing you want to do is you want to be constantly looking at your old years and trying to ensure that nothing comes up to surprise you. So you are constantly trying to evaluate old years and ensure that there is nothing surprising there, but what everyone should understand, putting up reserves for old years is one thing. Paying out claims is another, and you will note our pay our loss ratio, still continues to decline.

My second question, I might have misheard. I think you said that the pricing in the specialty areas up between 12 and 20 percent. Could you take that one step further? What do you see in excess and surplus lines, property and --?

First of all, we don't write a lot of property business. I would say the property business will probably be 112 percent price increases. It is the softest part of our total business. And there on the big risk we are effectively not getting the pricing going down and on the smaller risks we are probably having relatively modest price increases. I think things like the commercial transportation, their modest price increases on the lower end, we are probably seeing that price increases at Admiral overall have been substantially higher, although there is obviously you are going to see a change as year goes on. Monitor, which is our D&O, lawyers, price increases are probably towards 18 percent. And Nautilus is probably 12 or 14 percent. So it is a pretty wide range and things like Vela which does contractors business, price increases are in the '30s.

My third question, if you were to look for, if you were to wear your hat as an industry analyst and you were to look for losses for the industry as a result of the horrible fires in Southern California, I guess you would look at homeowners; you would look at the property portion of commercial multiple peril. Where else would you look?

I think depending on it, you may have business interruption exposures, because a lot of businesses are totally closed. You are also going to probably find auto coverage that this fire is jumping around. But the driving force is going to be commercial multiple peril. Some homeowners and some special risks, because some of these houses were built in areas where the only market was probably excess property. I think that it is hard to tell at the moment because how long this goes is going to be a big determine. Business interruption is a big uncertainty. If you started to see a large-scale segments of California be closed down for more than yesterday, our business in California was closed yesterday. You just can't get around. So I think that that is the wild card that is out there.

My final question, sir, if you were to go back to the 85, 86 cycle as a to some extent indicative of what is occurring now, would you go back to say the fall of 1986?

No, we are a little further along than that Charlie. I think we are in the beginning of 87, which could be the fall of 86, but we are now -- every month is not showing the same consistent price increases, and that is because here or there there are people who are competing. We are happy that we have been able to maintain price increases, but it is not as easy as it was. From our perspective when we look ahead, we think there is probably certainly through the middle of 2005 prices will continue to increase. One of the things you have to remember it is loss costs are going to tell you how good your price increases are, and right now you are in a 46 percent loss cost increase factor, so just to stay even with where you are you got to do that. It was 88 in that last cycle that was the turn, prices were still very adequate and you got great returns, but 88 was the year where prices did not go up as much as loss costs. But people were still able to generate -- the best companies could generate returns in the low 20s.

Thank you, sir. That was a tremendous answer.

Jay Cohen of Merrill Lynch.

Two unrelated questions. The prior year development, what years did that come from?

I would guess that you are talking about ‘98, ‘99, 2000.

But '01 and '02 I should get in touch?

To say we didn't touch, that is a very definitive statement and I can't answer you. I have not yet looked at those details, but the vast majority were '98, '99, 2000.

That makes sense. Second question, in your regional markets, how big a presence has Atlantic Mutual been? Obviously they got downgraded. It seems like another opportunity, but do you compete against them at all?

A little bit. Not a lot. They touch on our areas, I would guess, but it is probably -- I wouldn't as a major competitor.

Great, thanks.

Jeff Thompson of KBW, Inc.

First on the investment income can you give us a sense of what you are looking for and an opportunity to reinvest? What is going to trigger you to put more money?

First of all, we think interest rates are going to go higher. We think inflation driven by deficits are going to increase. We think the only thing holding things down at this point is every government in the world is wanting to generate more increased economic activity, and that means governments are trying to hold interest rates down. But with the deficits every place, we think inflation is sitting out there waiting to happen. When we -- we are looking for what we believe the opportunity is that the risk is worth the reward. A month and a half ago we invested a couple hundred million dollars in intermediate-term municipals because there was an aberration at that moment in time and it gave us an opportunity. We own a bunch of banks because the dividends were between 4 and 6 percent. We are purely opportunistic investors.

And just trying to get a sense as to when it might be put to work.

I would expect that we will take advantage of the municipal market more and more as our operating profits are such, and I think that we are certainly what we would expect interest rates to increase, but it will be the second half of next year before they increase dramatically.

Okay and on the $60 million charge for prior year, was there any charge in the quarter for reinsurance recoverables?

First of all, charge is the wrong word.

Right, (multiple speakers)

Increase in prior reserves. No, there was no reinsurance recoverable issue. And frankly we think implicitly within our reinsurance recoveries try to take that into consideration.

And final question, can you comment on your capital position, what your activity might be near-term?

I think that as we said before, if we do something, we might do up to probably $100 million equity type offering of some kind, we are pushing it off as long as we can and hopefully will be able to generate enough income for that not to happen, but that is where we stand at the moment.

Okay, thank you very much.

Bill Wilt of Morgan Stanley.

Let me check in on reinsurance, the growth in facultative. I know that has been an area of focus. Just looking for some color commentary and background, are the large players completely pulled away from casualty facultative? Is there any expectations that they will start to get back into that?

It’s not an easy business to enter. You need scale. We have scale. We think we are probably the largest we are certainly the largest factor in the broker market. I think that we are benefiting, as are a few other people who compete with us, to most people effectively withdrawing from the market. And I think that probably only three or four players in the broker market.

Okay, thanks. Second question, the combined ratio with the specialty and Alternative Markets jumped for the quarter. Is there any color you can to that sequentially?

I'm sorry?

Sequential quarter, as opposed to -- I'm just wondering if there's any color you could add to that?

Hold on. I do know what you are talking about the second -- combined ratio was -- let me just look at the numbers. I think that first of all, we had an arbitration that while it is not fully resolved, part of it is resolved and we elected to try and deal with part of that, that had an impact of probably three points compared to prior quarter. And in addition to that, the ordinary swings of how the business goes quarter to quarter with some large cases. I think the specialty business has a bit more volatility and we felt that we had the opportunity to deal with the potential arbitration, so that was the only single significant factor that was three points, roughly.

That's helpful. That was in the specialty segment, you said?

Yes, what was your other question?

That was it, just the pickup and specialty in Alternative Markets, which sounds like --

Alternative Markets, we are taking a more cautious approach to our excess workers comp on medical cost inflation, and as you can imagine with such a longtail line, a couple points increase in your estimated development costs for excess medical costs has a significant impact. So we elected to be a little more cautious in our reserving and our excess compensation because of that anticipated higher loss cost due to medical inflation.

Sure, that is sensible. And on the topic of medical, I was curious to know if you could just comment on where the company is vis-a-vis -- I know you pursued growth or set the stage for growth in medical malpractice insurance and just was hoping to get an update on growth?

I think it is doing well. We run the business at a very actuarially generated away. I think that we will probably do 50 or $60 million in premium this year, maybe a little more, maybe a little less. But that is our expectation. For the most part we think that business is okay. But that is a business that we are managing in a very, very analytic, actuarial determined method and at this point we are happy, but we are not going to try and force the business to grow. Several of the big competitors in the business are having lots of troubles and lots of issues, and there are a couple of people who are in there trying to compete in an undisciplined fashion. But for the most part the brokers are being sane and excluding the (inaudible).

(OPERATOR INSTRUCTIONS) Michael Dion with Sandler O'Neill.

Bill, just as a follow-up to last question, I thought you had indicated on the second quarter conference call that you were slowing your growth a bit in the excess workers comp market, particularly in California. If you could just address that issue with your response to the last question, some of the rising medical costs you are seeing in that line, being more cautious on the reserve side?

I just think that we have to be careful about what goes on in excess comp because it is a very, very longtail line of business. It exposes you to a lot of reserve issues. Our excess comp business that we own for probably eight or nine years has been in existence for something more than 20 and they've been extremely good on maintaining adequate reserves. We do not want to find out that we have done the wrong thing, so we manage the business in a way that we think is cautious and conservative. And we do keep those reserves on a discounted basis, which means accuracy is even more important. So we are just trying to be careful both in not aggressively expanding the business in some places and by being sure that we are reserving in a more conservative way.

But the two areas of expansion are California and North Carolina? Is that what you said at the beginning of the call?

Those are the two states where we our primary workers --

No, the answer is we have within that Alternative Market segment a primary workers comp business in North Carolina and in California. As Preferred Employers is a primary workers comp company in California exclusively, and then Key Risk is a primary workers comp company primarily in North Carolina, but in Virginia and South Carolina as well as a couple other states. But mainly North Carolina. So that has nothing to do with the Alternative Market business.

Great. Okay, thank you.

John Keefe of Ferris, Baker Watts.

I have a couple of question. First can you give a comment on the Kiln operations? Secondly can you comment on the distinction between your casualty (inaudible) and that of others that seem to be blowing up with pretty routine regularity?

I think first Kiln continues to do extremely well. We are replaced with our relationship with Kiln. Kiln is a first-class underwriting organization with a culture of underwriting profits. We like the management. We like the leadership. We will be probably be cutting back our quarter (ph) share with them for next year as we mutually agree that it was 20 percent for two years and it will go back to between 5 and 10 percent for next year. They have had a great year and we couldn't be happier with the relationship. And I think that is where things stand at.

As to our facultative business, we have an extremely disciplined management team. Some might even say cantankerous. We cut our volume back in '98 and '99 dramatically. The volume went down probably 80 or 90 million down to $40 million over a period of a few years, and as prices started to move up, we expanded our volume dramatically. We had lack of underwriting profits probably in '99 and 2000 as they developed, but relatively modest numbers and not any disasters. But today our rate on line is back to the level that was in 1986, '87, and we are enthusiastic. We have a lot of confidence in the people leading that business and that confidence didn't come because we liked them. It came because they delivered tremendous results.

Thank you very much, Bill.

(OPERATOR INSTRUCTIONS) If there are no further questions, I will now turn the conference back to Mr. Berkley.

Thank you all very a much. We are certainly pleased with the quarter. We are real pleased with the return on capital and we would anticipate a great balance of the year and next year. Thanks.

Thank you, sir. Ladies and gentlemen, this concludes our conference for today. Thank you all for participating and have a great day. All participants may now disconnect.