W R Berkley Corp (WRB) 2003 Q4 法說會逐字稿

Good afternoon, and welcome, ladies and gentlemen, to the W.R. Berkley fourth quarter earnings conference call. At this time, I'd like to inform you that this conference is being recorded, and that all participants are on a listen-only mode. At the request of the company, we will open up the conference for questions and answers after the presentation. The speakers' 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, beliefs, expects, or estimates.

We caution that you 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 Berkley, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you.

Well, we had great fourth quarter and a great year. We were very pleased with the outcome of our year and with the fourth quarter. Business continues to be strong across the board, and the underwriting record of our companies continues to improve month in and month out. The numbers do speak for themselves for all intents and purposes. There are some things that I think require a little bit of explanation, and Gene is going to also talk about some of the numbers in detail.

I do think that I should point out just a couple of issues. Number one, when you get to an underwriting break-even, or underwriting profitability, more modest improvement in pricing generates substantial improvements in returns. So if you look at our business today, at roughly a 90% combined ratio, every point that our combined ratio improves in excess of loss cost increases results in effectively a 10% improvement in profitability over the entire cycle the premium is earned. So we wouldn't expect prices to increase nearly as much as they have in the past, and even though that's the case, they can drive our profitability enormously.

An example might be price increases of 10%, loss costs going up by 7%; that would be a 3% net increase in your aggregate profitability on a 10% basis generating something approaching a 30% increase in profitability by the time the entire amount of premium is earned. So there's a lot of people talking about the end of the cycle. It's really not something we see. We are primarily a casualty company. Casual prices are still increasing faster than loss costs.

We expect that to continue at least through this year, and our own expectations are certainly through the beginning of next year, and recognize there's five quarters subsequent to the time you write the policy that that improved pricing is earned premium. Thus, we expect earnings to continue to increase at least through 2006. We're very optimistic at this point in time. While property pricing is generally flat to down, especially on large risks, in the middle market pricing on property risks, I would say is more flat than down. Casualty lines, big stuff, still strong pricing, tough reinsurance marketplace, and lots of opportunities.

There are people coming into the business. There are new competitors all the time, but it's a huge market, and the amount of new and inexperienced capital entering the marketplace is relatively small. That's not to say that there aren't blips on the radar screen where things are out there that you don't like. But when you're at a fundamental level with 10-plus points of underwriting profitability, things you don't like are okay. Profitability and return on capital is great.

I'm going to let Gene go through the numbers then I'm going to try and go through each of the segments of our business in a general way and then answer questions. So, Gene, why don't you take over the numbers.

Okay. Thank you, Bill.

As you said, it was another record quarter for us and a record year in terms of both our premiums and our earnings. For the full year, our net premiums written increased approximately $1 billion from 2.7 billion in 2002, to almost 3.7 billion in 2003. Our after-tax operating earnings, that's excluding realized gains, were up 77% to 284 million, or $3.26 per share. And when you include realized gains, our net earnings for all of 2003 were 337 million, which is a 25% return on our beginning of the year equity of 1.3 billion. This earnings improvement in 2003 was driven by significantly higher underwriting profits, primarily as a result of further price increases during the year. Our overall underwriting profits for the year increased 170% from 104 million in 2002, to 279 million in 2003.

For the fourth quarter, our net operating income, again, excluding realized gains, was 91 cents per share compared with 64 cents per share in the fourth quarter of 2002. Net premiums written increased 22% in the fourth quarter to 963 million, with all of our business segments reporting double-digit premium growth. For our largest segment, specialty lines, net premiums increased 18% to 338 million. That includes strong growth in our E&S lines which were up 22%, and also includes approximately 22 million of net premiums written from our new specialty company in the U.K..

For the alternative market segment, net premiums were up 42% to 127 million. That growth was led by our California Workers' Comp company which grew 89% in the quarter to 55 million. Reinsurance premiums increased 17% in the quarter to 226 million. Those reinsurance premiums include facultative reinsurance, which was up 94% to 93 million, Lloyd's Reinsurance, which was up 29% to 52 million, and our regular treaty business which was down 2% to 81 million.

All four of our regional companies continue to show strong growth with an overall increase of 27% to 256 million, and premiums for our international business were 17 million, an increase of 19% over the prior year quarter. The overall combined ratio in the quarter was 90.5% which was a decrease of almost 3.5 points from the prior year quarter. The loss ratio decreased 2 points to 62.6, and the expense ratio decreased almost one and a half points to 28.0. Paid losses for the quarter were 320 million, which was a 7% decrease from the prior year quarter, even though earned premiums were up 29% over the same period. That's a paid loss ratio of 36% of earned premiums for the fourth quarter and 37% for the full year.

During the fourth quarter our net loss reserves increased by 569 million, including approximately 50 million of additions to prior year reserves. For all of 2003, our net loss reserves increased by 1.2 billion, or 51% to just over 3.5 billion at December 31st, 2003. The reserve increase in both the fourth quarter and the full year that I just mentioned include, approximately 300 million that resulted from the commutation of a large reinsurance contract at the end of the year.

Effective December 31st, 2003, we commuted an aggregate reinsurance agreement that had been in place since 2001. The commutation had no impact on fourth quarter earnings. However, as a result of taking back loss reserves ceded under the contract, our net loss reserve position increased by approximately 300 million. Over the three years that this contract was in place, we ceded premiums of approximately 308 million: 56 million in 2001, 138 million in 2002, and 115 million in 2003.

This was a fund-held contract whereby we kept the premiums in a fund-held account. Upon commutation the balance in the fund-held account reverted back to us. This will have a positive impact on our investment income next year since we will no longer be crediting interest on the funds-held account to the reinsurer. The contract was completely commuted and settled, and there are no further obligations from either party. Most of the coverages under this contract will not be replaced in 2004.

Turning back to our other businesses, our nonrisk-bearing business service fees increased 7% in the fourth quarter to 25 million, while profits were unchanged at 3.5 million. And for the full year service fee, revenues increased 18% to 102 million with pretax profits up 15% to 19 million. Our investment income increased 11% in the fourth quarter to 56 million as a result of the significant increase in invested assets over the past year. Total invested assets increased 1.8 billion, or 39% during the year, to 6.5 billion at December 31, 2003.

Our operating cash flow was over 1.5 billion for the year, including 427 million for the fourth quarter. At the end of the year, our cash holdings were 1.4 billion or 22% of total investments. Tax exempt securities were 26% of the total, taxable fixed income securities 40%, Arbitrage investments 5%, and other equities in private investments 7%.

At December 31, 2003 the average duration of the portfolio was 4.1 years. The annualized pretax yield on the overall portfolio was 4.2% in the quarter compared to 5.4% in the prior year quarter. The decrease reflects the impact of lower interest rates generally and the effect of a greater portion of our portfolio invested in cash and tax-exempt securities. The annualized yield on the Arbitrage portfolio was 1.5% in the fourth quarter and 2.7% for the full year. Net unrealized gains before taxes were 202 million at year end, compared with 178 million at the beginning of the year. There were no impairment charges in the fourth quarter, and impairment charges were less than 500,000 for the full year of 2003.

Our income tax expense was 43 million in the quarter, which is an overall effective tax rate of 32%. The effective tax rate increased from 29% in the prior year quarter, primarily as a result of the higher level of underwriting profits and realized gains which are taxed at the full 35% tax rate. Finally, at December 31st, 2003, our stockholders' equity was 1.683 billion, or $20.14 per share. Our book value per share increased 25% from the beginning of the year, and our estimate of statutory surplus at December 31st, '03, is 1.9 billion. That represents a premium to surplus ratio of approximately 2 to 1.

Thank you.

Well, as I said, we were really pleased with the year. We were pleased with the year for a lot of reasons. And by the way, one of the things Gene mentioned when he talked about the Chubb Treaty is that it would have a positive impact on investment income next year. His referral to next year was this year, 2004. It was next year in terms of Chubb. And we would expect that the positive impact from the elimination of Chubb will be a plus of roughly $15 million in after-tax investment income, maybe a shave more than that in 2004.

Before I talk about all the things we have, I think it's very important that people recognize what we don't have. We don't have asbestos; we don't have any reinsurance recovery problems; we have no impairments in our investment portfolio, we don't have reserve issues; we have no derivatives that we worry about; and we don't have to rely upon the reinsurance markets for us to operate our business. By and large, virtually all our business is written in a manner that allows us to keep it.

I'll try and quickly go through the pieces of our company that I think -- to give you a better idea of where we stand. Our specialty business, mainly E&S business, has been excellent. Now it represents about a little over 1.4 billion of our total premium income. The combined ratio is under 90 and improving. That's one of the places where we're likely to see a significant improvement in the combined ratio for calendar '04. We're extremely pleased with how that business is going. It's been able to grow, and we're very enthusiastic. Both '02 and '03 were excellent years, but the business really grew in '03, and we continue to see price increases in excess of loss costs and some level of growth.

Our alternative market business, excellent. Represents about 550 -- 560 million of our premiums. Loss ratio in the low 90s. It's an excellent piece of our business. It's really, as much as service business as it is a risk-bearing business. There are lots of service fees, although they're not built into that combined ratio. It generates roughly $20 million a year of profits from service revenues, which in the aggregate total about $100 million.

It's a business that we're very pleased with. It's mainly focused on self-insured Workers' Compensation, the excess reinsurance or self-insured Workers' Compensation, and a California Workers' Compensation company that we started five years ago that's really become one of the leading writers of small self-managed business. When I say "self-managed," is where owner-managed businesses with sort of 50 employees would be the typical.

Our reinsurance business, which is roughly a billion dollars of our premiums lead by our facultative business, which has had substantial rate increases -- we're very pleased with that business. It's been hugely profitable. That business is really exactly like our excess and surplus lines business except on a wholesale basis where we write, in essence, excess individual risk business, but we do it wholesale. We reinsure other companies on an individual risk basis.

Our treaty business has improved dramatically. We're very pleased with where we made in that. We've got a couple of specialty pieces there where we've provided capital to some Lloyd syndicates and to some other underwriting companies, and we're very pleased with how they've done. And then we have a small bit of business where we have specialty programs, but that's a declining piece of business, in the global sense, because we're becoming more and more selective and only interested in businesses where we can have a long-term relationship. There's lots of opportunities there, and our management understands that the long-term nature of that program business is relationships that are mutually rewarding and contractual, and ownership relationships that will fit that area.

Our regional business has just been fabulous. It's just performed incredibly well. It's at about -- just under a $1,200,000,000 of business this year with combined ratio in the mid 80s. We got out of the personal lines business. Real concentration on small commercial lines, middle-size commercial lines. We've built relationships with agents. We are not offering our products to every single agent in every state. We're selective in our distribution. We think that we're the distribution channel of choice for the particular areas of the business that we offer coverages in.

That business has continued to improve. Our relationships have continued to improve. And there, while we have to be price competitive, price competitive doesn't mean the lowest price. It means really great service. It means great claim service, prompt claims payment, and responsiveness to agents, and a reasonable price. I.e., you can't be 30% higher than your competitor, but if you're within 10% of your competitor, our agency plan sells the idea that we're going to be there year in and year out as we have been.

Our international business, which is a smaller part of our business, continues to generate profitability. Argentina has come back a long way with great results and great performance on behalf of our Argentine partners. In international, I might point out, is a partnership with Northwestern Mutual Life. Our businesses in the Philippines, while not as good as it was in the previous years, is profitable, and we've invested in expanding a life insurance sales business in this area in Hong Kong. We have, in our specialty business, I might add, expanded in an 80% owned venture inland to write casualty professional liability business in the U.K. marketplace.

So overall we look at all of our businesses. We're pleased. We've grown a lot. We would expect our growth to continue in the area of 20% for the year. We think we might do a little better, it might be a little worse. We think we'll be able to enhance profitability, and we would expect a return on capital to be somewhat more than the year we just finished. Our pretax -- our aftertax return was just under 22%, and we would expect to return on starting capital of at least 22% after tax.

There's nothing one can say except all the signs are positive. When you're making returns like this, you can't complain that margins are only increasing by 10%. Nothing could make me happier. We're very satisfied with the returns.

So with that, Frank, I'd be glad to answer any questions.

Thank you very much, sir. The question-and-answer session will begin at this time. If you're using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, press star 1 on your push button telephone. If you wish to withdraw that question, please press star 2. Your questions will be taken in the order that they are received. Please stand by for your first question, gentlemen. Our first question comes from Charlie Gates of Credit Suisse First Boston. Please state your question.

Good afternoon.

Hey, Charlie.

In your introductory remarks, Bill, you opined that you thought that earnings could increase through 2006.

Yes, sir.

Could you elaborate on that?

Sure. I think you have to recognize that earned premium comes in over five quarters, and my expectations are that prices through the first quarter, really through the second quarter of next year, will continue increasing modestly more than loss costs. So I think we have basically five or six quarters where price increases will extend past loss costs, and I don't think prices are going to fall out of bed. So I think as that continues -- I think the other driving forces, I expect investment income to increase fairly significantly. Our own model will tell you that we would say by the end of the year you'll have 100 basis point increase in rates, and by the end next year another 150. So 250 basis points. And when you plug that into our portfolio and our cash flow, that's a huge number, Charlie.

So those two things, and recognizing five quarters from the second quarter of next year take you through price increases in the third quarter of '06 and increasing investment income to me says that we think in all likelihood that's going to happen. I think the other piece you have to remember is, we've put up for prior years development this year, something just about $200 million. We think that that's gone, 50 million this quarter, give or take a little bit, and that ultimately, you know, means we'll do better. So we're pretty optimistic.

The other question I had was, you referred -- or Gene referred to the Chubb program. I didn't understand that reference.

Well, you know, he tried to explain a really complicated thing in a paragraph. So let me try and explain it, because I can really confuse everybody. We had a fund-held reinsurance treaty with Chubb. We put it together because we wanted to increase our retention, and we didn't want to find that we had a shock loss from a series of large losses when we increased our retention. So we created a reinsurance treaty that I sat down and negotiated with John Burger at Chubb, and we did it in a way that it was a longer term treaty, so in the event we had sudden losses in one year, they would be offset, so we accumulated premiums over a period of time until the aggregation of reserves built up enough that in any one quarter or one year, sudden losses wouldn't create a shock or a sudden loss to the system, and that was made a lot easier because we ended the year early because we grew so much that our aggregate premium made that increased retention not an issue at all.

So the end result of that is there was a big amount of withheld funds that accumulated investment income, and with that -- something in excess of $300 million, and with -- the important thing is, none of it had any impact on our net reported earnings. When we canceled, it had no impact on our earnings. And going forward in '04, the net impact will be between 3.5 and $4 million positive in net after-tax investment income.

Thank you.

Per quarter.

That was great. Thank you.

Thank you. Our next question comes from Jay Cohen of Merrill Lynch. Please state your question, sir.

Yeah, a number of questions. [Staying] with that topic, with the commutation, does it affect any other parts of the income statement going forward, the underwriting results at all?

No, not really. The only thing that will happen is you'll see that our net premium line, our net premium line will go up, so you'll see that our net premium line will go up faster than our gross premium line next year. That's the only impact, and investment income.

Right. Right. When you said -- you mentioned -- you threw out there 20% growth. I assume you meant net premiums written.

Yes, sir.

That includes, obviously, keeping a little bit more because of this commutation.

No, I wasn't counting this, actually.

Okay, so you're saying 20% for the full year, give or take a little bit?

Yes, sir.

Okay. When you define book value, you threw out there 22% after tax on beginning book. Are you looking at book value at--.

$20.14.

You're looking at reported book value?

Yes, sir. 1,682,000,000 --.

-- and 42 cents.

Well, we don't -- no -- $559.17.

The increase in interest rates that you mentioned, the 100 basis points, another 150, is that just your view of world? You think rates go up? Or is that -- we're going put money to use more effectively rather than just having it sit.

No, that's just my view of the world.

Okay.

We think we'll do better than that because we have such brilliant investment people.

And then lastly, the -- you mentioned that you had prior year development in the year, about 200 million.

Yes, sir.

Just doing the math, looks like about 5 points on the combined ratio.

That's a fair number. It's actually a little more than that because it's on earned premium of 3.2 million, so it's probably a little more than that, but okay.

So it looks like the accident year combined ratio in '03 would have been in the, quote, 86% range. The business you wrote in '03. Just taking it to 5 points.

That's a numerical analyst's view, yes. I can't argue with that conclusion.

Right. We're not going to use an 86 going forward, clearly, although academically, you could argue one might, but --

One could even argue it should be lower than that because the trend is in an improving direction still.

Yeah, but I can't have a model that has you guys earning $12 a share, so -- All right. Well, I've got to get back to my modeling and crunch some numbers here, but it looks like -- it just looks like you've got earnings leverage on both sides, the underwriting and, obviously, investment income with this added roughly 15 cents from the commutation, too.

Yes, sir.

All right. Thanks, Bill.

Our next question comes there Bill Wilt of Morgan Stanley. Please state your question.

Good afternoon. Let's see, a couple of numerical questions, or at least, I guess, just one. Gene, you had given the cash holdings at the end of the year. I missed that number.

Round number is just under a billion five, it was.

Billion five, okay, great. Wonder if you could comment, I guess both for Berkley and industry-wide trends, on the commercial auto sector. I know that's an important one for you. My sense has been that is -- that's a line of business where the -- that both turned earlier than other liability base lines, turned positively, and my sense has been that it's begun to slow down. Is that a fair characterization?

We, frankly, at this point don't really see that happening. We think rates will be up in line with loss costs, maybe a point more than loss costs, maybe a point less, but at this point we would tell you that every sign we see, and we saw maybe 20 of our biggest agents within the past month and met with them, and every sign we got was, no, that at this point in time, other than for the big fleet business where -- where price competition is getting there a little bit -- but at least in our marketplace, we're seeing prices still up slightly more than loss costs at this moment in the year.

That's great. Is that a line where reinsurance capacity, the ebbs and -- comings and goings of reinsurance capacity can have a meaningful or --

We bind no reinsurance in that line of business other than crash cover exposures. It is a line that without reinsurance capacity new entrants will have a hard time going in, so a tight reinsurance market will keep that market a lot better for a bit longer. If the reinsurance market was to suddenly get real soft, that's the line that would start to change.

That's great. One other question on the regional segments. You obviously have done incredibly well this year. In your overview of the segments you commented, I want to do it justice -- I guess being a leader in the areas that you specialize in. Could you just add some color on that and contrast the business approach of products that Berkley has versus some of the other national competitors to differentiate?

I think that, Bill, what we really offer is prompt service and prompt claims payment. I mean, as I say, we were with all of our biggest agents just two weeks ago -- 110 agents to give us probably something more than a billion dollars of business. And the response -- and all of our senior people were there, people who run our businesses, people from here, and, you know, in an effort to be sure we know these people, all the people from our headquarters go out and talk to the agents.

And the kinds of responses we get is, you know, we had a problem. One of our guys needed a claim payment. He needed it tomorrow, and I called the president of the company, and the claims guy delivered a check that afternoon. I couldn't have gotten anybody else to deliver a check other than another regional company, and we don't have any more regional companies in our territory. They're all gone. So those are the kinds of things that really sell service, especially where companies have an attitude right now, in a tight market, that they don't need to give service. We try and have the attitude that even in a tight market, service is important.

I think that the kinds of things that we do is -- Acadia does lumber mills, Acadia does fisheries. And they know how to do them in the Northeast. Acadia can't do lumber mills in South Carolina, but they know how to do them in Maine. We do farm owners. We do farm store business. We do grain elevators in the Midwest. We've been doing it for 75 years. Those are the kinds of things that we do, but -- it's that expertise, but it's how we deliver the expertise, and how we deliver it consistently even in a market where we could be arrogant and we could be difficult. And the uniform view of the people we were with was that we're one of the few people that has behaved in the same positive way when we need them and when they need us, and I think that's really the story.

That makes sense. Very helpful. Appreciate that.

Thank you, Our next question comes from Mike Dion of Sandler O'Neill. Please state your question, sir.

Good afternoon. Couple of questions. First off, is there any line that you're underwriting right now that is currently not getting rate increases in excess of loss costs?

The answer is, I'm sure there is.

And would you elaborate on that at all?

I don't know what it is, but I'm sure there is. Just the nature, we do enough stuff that there's going to be something out there that we're not -- I think in general, that -- you know, there's nothing of great consequence that I can suggest. I think that there's some of our larger property risks that certainly we're having actually declines in pricing, Mike.

Interestingly enough, some coastal property in the Southeast. Some what we were -- where it was excess and surplus lines kind of property risk, we're finding a few people in there being a little more aggressive, and we're seeing price decreases there. Now, it's not a big piece of our business. It's probably 10 or $20 million of our business on a $4 billion book, but there we're seeing some people literally cutting prices. So it's not even price increase, it's price decreases of probably 10 or 15%. But in the casualty lines, we haven't seen any significant declines. Here and there, we're seeing a couple of standard line companies go back into the restaurant business or write some health food stores or some things like that, but not -- no line of business overall, no area over all.

Okay. Fair enough. And one follow-up. Given your 20% forecast for growth in '04, not including the commutation, do you expect that given the growth in book value that you'll be able to manage that within your current capital position?

Where we stand now, our book value grew by a shade over 25%. We would expect our book value to increase in the aggregate enough to deal with our growth. You're obviously -- you're on the cusp of where you are, and we've told the rating agencies that we understand we're on that cusp, and if we think we need to raise a little bit of capital, we will. At this moment in time we think we're okay.

Fair enough. Thank you.

I might add that we thought, four months ago, we didn't think we'd have as good a fourth quarter, especially with capital gains as we did have, and obviously, capital gains is the juice that gets you over the top.

Okay. Great.

Oh, and by the way, we did close out a couple of pieces of our portfolio in January that will generate substantial capital gains, that will help our capital position further.

So right now it looks pretty good but you're on the cusp, and you'll kind of play it by ear?

And our statutory surplus to writings is less than 2 to 1 from being over 2 to 1, so we're moving in the right direction.

Fair enough. Thank you.

As a reminder, ladies and gentlemen, should you have any further questions at this time, please press star 1 on your push button telephones. Gentlemen, please stand by for any further questions. If there are no further questions, I will now turn the conference back to Mr. Berkley.

Thank you all very much. It was a terrific year, as I said. We're really pleased, and we think that '04 is going to be a significantly better year. Have a great day. Thanks.

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