W R Berkley Corp (WRB) 2004 Q4 法說會逐字稿

Good day and welcome to today's W.R. Berkley Corporation fourth quarter 2004 earnings conference. On today's conference, 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, 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 31st, 2003 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. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. William R Berkley, CEO and Chairman of the Board. Please go ahead, sir.

Good morning. We were very pleased with our quarter and we think we've completed a terrific year. We have achieved almost all of the goals we set out the beginning of the year. And from our perception, we think the results indicate that our balance sheet is in strong position, that the managing of our enterprise with constant measurements of risk, as well as focusing on return are, in fact, well in place.

We're enthusiastic about our business. We're enthusiastic about where we stand. The only thing we're not enthusiastic about is that prices don't rise to the heavens. There is no question that the rate of price increases is no longer accelerating and, in fact, is decelerating. However, in our own price monitoring through the end of the year, the fourth quarter pricing levels still continue to increase. There are certain areas where we don't see any price increases and there are, in fact, decreases in some areas. But overall, we're really quite happy.

I think you have to understand that price increases can't go on forever and it wouldn't be appropriate for prices to go on forever, because in some areas, loss costs are declining with improvement in terms and conditions, tightening up of laws. The entire scenario for our business has improved dramatically, and we don't think that we're going to be able to drive returns much higher than the current levels. And candidly, we would be ecstatic if we could continue with returns like this for another 3, 4, 5 years. We certainly expect our returns to continue at this level through next year; although as we generate more capital, we need to find new opportunities to employ the capital or we have to manage that capital.

Before I start to talk about the business segments, I'm going to let gene Ballard, our Chief Financial Officer talk about the operating results of the Company, then I'm going to come back and talk about the individual business segments briefly and then take your questions. Gene?

Okay. Thank you. Well, as Bill said, we finished what was a terrific year with another outstanding quarter. Our operating income in the quarter was 114 million, that's up 43 percent from 79 million in the prior-year quarter and our operating income per share was $1.29, up 42 percent from $0.91 a year ago. The rise in our earnings is the result of strong growth in both investment income and underwriting profits, which were up 46 percent and 28 percent respectively in the fourth quarter.

Looking first at our income statement, you will see that we also finished with strong premium growth, our net premiums written were 1.1 billion in the fourth quarter. That's up 15 percent, over the prior year. Most of that growth was in our specialty segment, which had a 35 percent increase in net premiums in the fourth quarter. Specialties growth was primarily from our 4 excess and surplus lines companies, those would be Admiral, Nautilus, Vela, and our new company, Berkley Specialty Underwriters -- Underwriting Managers.

Premium growth rates for the regional and alternative markets were moderate by comparison, but still good at 7 percent and 4 percent respectively in the quarter. Reinsurance net premiums were down 1 percent in the fourth quarter and that, as we mentioned, in our last call, that's due to the end of our reinsurance relationship with AIG. Finally, international premiums are up 21 percent.

For all of 2004, our net premiums were 4.3 billion, up 16 percent over 2003, and in spite of the increasingly competitive marketplace, we -- our average prices for the direct business increased again in the fourth quarter by 6 percent, and that's about the same rate of increase that we have averaged for all of -- all of 2004. We also reported good improvement in our combined ratio in the fourth quarter. The overall combined was 89.9 percent, down 0.6 percentage points from the prior-year quarter. By segment, the combined ratios were 83.2 for regional 87.8 for specialty, 92.6 for alternative markets, 98.8 for reinsurance, and 106.6 for international.

For international, which as you know is our small -- one of our smaller segments, but the segment includes some savings products that have a negative impact on the combined ratios since there's less premiums for that business and more of the revenues are in the form of investment income. But if you look at the international segment, just for the P&C business alone, it's actually a 90.7 percent combined.

The overall loss ratio decreased by 1.2 percentage points to 61.4 in the fourth quarter, due mostly to improvements in both our specialty and regional business. As usual, our storm losses were modest in the fourth quarter of 2 million this year, 2004, compared to 3 million in 2003. And there was also minimal change in our estimate of hurricane losses from the third quarter.

The favorable trend in our paid losses continued with a 35.6 percent paid loss ratio for the fourth quarter and a 33.0 percent paid loss ratio for the full year. We're now in our third year with a paid loss ratio below 50 percent. And, based on the duration of our reserves, we're somewhat surprised, but very pleased that this paid loss ratio has remained in the mid-30s for as long as it has. And we do expect to see that ratio begin to rise in 2005.

In the meantime, our net loss reserves continued to grow at a rate much higher than the earned premium growth, increasing 277 million in the fourth quarter and 1.2 billion or 35 percent for the full year. On an accident year basis, we're estimating that the 2004 accident year loss ratio is at a 56 percent. Our year-end actuarial analysis indicates that 2003 and 2004 accident year loss ratios are somewhat better than our initial loss picks. And at the same time, we have increased reserves for certain earlier accident years and that's added approximately 7 points to the calendar-year loss ratio for 2004.

Our overall expense ratio was 28.5 percent, up 0.6 percentage points from the prior-year quarter. The increase is mostly due to the better loss experienced for our regional business and our Lloyd's reinsurance in the fourth quarter and that -- which led to higher profit commission accruals. Our non-risk bearing business revenues increased 2 percent to 25 million and the pretax profits on that service fee business increased 63 percent to 5.5 million.

Investment income was up 82 million in the fourth quarter, that's up 46 percent from a year ago. The growth in earnings there is mostly due to the increased invested assets, which increased 1.9 billion during the year, including 500 million in the fourth quarter. The quarterly -- the fourth quarter investment income also benefited from a decrease in interest credited to reinsurance fund held accounts of approximately 8 million.

And in spite of the difficult interest rate environment, the annualized yield on the overall portfolio was 4.2 percent in the fourth quarter of '04, exactly where it was in the fourth quarter of '03. For the full year, the yield was 4.1 percent in '04 compared to 4.6 percent in '03. At the end of the year, our total invested assets were 8.3 billion, about 7.3 billion of that's invested in cash and fixed income securities, which have an average duration of 3.5 years, down from just over 4 years at the beginning of 2004. The remaining billion is invested in equity securities, including about 400 million in arbitrage trades.

The arbitrage account had its best quarter in the past 2 years with an average annualized yield of 6.2 percent in the fourth quarter of this year, for 2004, up from 1.5 percent in the prior-year quarter. With the benefit of tax exempt investments, the overall effective tax rate was 31.0 percent in the fourth quarter of '04, the same as it was in the prior year, and that adds up to a quarterly net income of 116 million or $1.31 per share, which is an annualized return on beginning of the year equity of 27.6 percent. Finally, our stockholders equity increased 25 percent during the year to 2.1 billion at December 31st, which is a book value per share of $25.03.

Thanks, Gene. Let me try and give you just a couple of highlights of each of our segments, talk about a couple of other things, and then we'll take questions. I think that -- the first thing I should try to get across, we have consistently had a somewhat different view about many things than many of our competitors. And the reason is because we are not a company that does business across the board in the same way. And when I talk about the pieces of our business, they don't do things exactly like everyone else. We have our own way, our own style, and that overlaps with everyone else, and it's very similar. But it's not quite the same and we think that allows us to deliver different results.

Our business strategy, our business model is constantly changing. Sometimes it's a small adjustment, and sometimes it's a large adjustment. But it's constantly adjusting. With the focus on getting it as close to just right as possible. That's not just focusing on the best underwriting, it's not just working on the best claims, it's finding the best lawyers for subrogation. It's finding out about how we can optimize the outcome of our short-term investment portfolio. It's looking at every piece of our insurance business model and working and seeing, how do we do that? It's discarding anything that can't give us a minimum of a 15 percent after-tax return. So as that process continues, we're building a model that's going to, by necessity, end up on each of our operating units looking a little different than everyone else looks.

Let me talk about each of our pieces now briefly. Our specialty business had a great year. A great year because our base businesses, Admiral, Nautilus, Carolina, all did exceptionally well, achieving their goals, moving ahead, in a very cautious way, and we've added a couple of pieces with Berkley Specialty Underwriting Managers where we did a renewal rights deal with Gulf. We added another piece, sports and entertainment that came with us. That will gave us a great start for '05 and it gave us some business in '04.

Vela Insurance, which was a start-up a few years ago has grown a lot and is building its specialty niche too. And the entire specialty business is moving ahead, gaining and improving its market position. We're exceptionally pleased with how they have done. Our start-up Berkley Medical has continued to expand and build a database and an information focused underwriting style that really adds value to the customers. So we've got a number of new pieces there that will be building volume in the future, and didn't get great returns last year necessarily, but they did good returns on their way to great returns.

Now, regional business -- our regional business is not, again, like everyone else's standard market business. Our regional business is a group of standard market specialties. So we write grain elevator business, grain dealer business, farm business, in Iowa. We write fishermen and lumber dealers and loggers in Maine. And we have those kinds of niches in every territory that we operate.

We write standard market, middle market business throughout our territory. And our small surety business, which is locally generated surety business which we have reorganized within the regional companies, is giving us a new impetus for expanded business and expanded opportunity. The regional business continues to generate absolutely fabulous returns, bigger units, great management, and continues to do just extraordinarily well.

The alternative market business is a business that's really focused -- it started to be focused on self-insureds, and we started where we managed assigned risk plans for states. We managed self-insureds, we managed tribal nations business, and we did reinsurance for self-insurance workers' compensation. That business expanded, really focusing on workers' compensation to preferred employers, which was a start-up, I think in 1998 of workers' compensation in California, where we acquired Key Risk, which started as, again, a third-party administrator business in North Carolina, but, in fact, expanded to include an insurance company also.

So that business, while it is not growing as rapidly as some of the others in the current environment, we don't expect it necessarily to, has built a solid base. We expect we'll grow; although, again, not quite as rapidly as some of the others, and it is less cyclical business. So that business, we're pleased with. It's had a great year. Great returns. And we expect that will continue through this year.

The growth, both in the regional business and the alternative market business will probably not be as great as in the specialty business for this year. Primarily because we haven't invested as much in new ventures and start-ups as we have in the specialty business.

The international business continues to do well in our Argentine business. We're pleased with how it's going, and that continues to build. Our business in Berkley Europe continues to build the business that we started up about 18 months ago, and we're pleased, we're 80 percent owners. Our partners in London Kiln are 20 percent owners. As an aside, we're extremely pleased with our relationship with Kiln. They have done especially well.

And finally, our reinsurance division. Our reinsurance division has gone through lots of turmoil and lots of reevaluation. We're really pleased with the great progress they have made. We think we have a first-class business. Berkley Underwriting Partners continues to write business on a program basis. We're retaining more of the business. We think there continues to be opportunities in the middle size program area where we can make good underwriting profitability and still manage the business well.

Facultative ReSources, we think it's the outstanding facultative reinsurer, we started the Company almost 20 years ago, 19 years ago. It was doing terrific. AIG was a major part of that business, as AIG was facing issues of extended exposures. They wanted to change their relationship with us, as to loss reserves and so forth, and we at first thought we had an agreement with them, we then evolved not to have an agreement and we mutually agreed, at least at the moment, we would not continue to do business on a facultative basis with them and that's what caused the decline in facultative business. We're sorry, AIG was a good customer, but we believe we have to be continued in control of our balance sheet and our financial statements and the agreement AIG suggested would have put that under question.

We have BF Re, which is a company we started from scratch, it's a direct facultative writer. It's an excellent group of people they've started from scratch and they are doing quite well. We're pleased with their results. It works only on a direct basis and we expect they will continue to grow and gain market share.

And finally, how we started the reinsurance business Signet Star. Signet Star has repositioned their enterprise, has rebuilt the business. They have effectively built the focus on companies that need and want reinsurance and want those who have a relationship culture, and that is what we do. We're looking for companies that need our capital, that want a relationship. Where they're willing to let us make a profit over the long run. It's the relationship culture that once existed at some of the big directs, but as they have gotten more and more pressure to be transactionally oriented also, it's something we think offers a good opportunity.

So, overall, couldn't be more pleased. We think that our business is in great shape. And we think that '05 will result in really terrific returns and we're not at all uncomfortable with anyone's earnings forecast that's out on the Street at the moment.

Okay, Layla, if you want to take questions, that would be fine.

Thank you. And we'll take our first question from Mike Grasher with Piper Jaffray.

Good morning. Just wanted to follow up with your outlook beyond, I guess '05. I think in the past 2 quarters on this conference call, you kind of paused and looked back and sort of felt like it was '87, '88, where you still had 2 or 3 solid years ahead of you. Has that sort of been extended because things have kind of been held at bay here in terms of the pricing environment, and then also on the other side where loss costs have also stayed lower?

I think really, you have to keep in mind that the pricing cycle was fine through '92, and so you really -- while things turned down modestly in '88, I think that '05 is going to probably sort of look like '88, and I think you will probably have at least 2 or 3 more outstanding return years available. I think one of the things that -- the most surprising thing of the year, Mike, that happens is everybody swallowed those hurricane losses and didn't even wink. There was no -- no movement, no nothing on $30-plus billion of losses. But I think that we'll have to see how the industry moves along.

I'm reasonably optimistic that we have -- certainly, that '06 and '07 will be certainly fine years. Will we get 25 percent return years? Well, it's hard to be that optimistic, only because experience has said that that's not what happens. But, I think they will be excellent return years.

Understood. And then your comment about finding ways to invest that excess capital that you are generating, are there opportunities out there or is it somewhat difficult finding those opportunities?

Well, I'll quote a rating agency that we were complaining to that we deserved a higher rating. And they said, "We know that you're either going to buy stock back, pay dividends or find the things to do with the capital because you're not going to keep any excess capital." Right now we see -- we would tell you our opportunities or potential opportunities. As you move down towards the riskier or less certain part of the improving cycle, new opportunities become less attractive.

So, there's not a huge amount of time left where you're going to find things to buy that offer good opportunities. But even if the most difficult times, on occasion, opportunities come up. Where this year we should swing the balance of having more capital than we need without any new renewal rights transaction or without any acquisitions. We will end '05 with more capital than we need. So that's sort of where we look at the world right now, based on our forecasts.

Okay. Thanks. Congratulations on the nice quarter.

Thank you.

And we'll take our next question from Charles Gates with Credit Suisse First Boston.

Hi, good morning.

Good morning, Charlie. How are you?

Good thank you. And yourself? One question. How much premium were you talking about specific to the AIG program?

I -- I don't know, but it was -- it was a big -- it was a big number.

So that was the largest reason why the -- those premiums --

That was the only reason -- you're talking about for the reinsurance division?

Yes, sir.

It was the only reason in the reinsurance division, volume was down.

Was that a situation where you wanted collateral.

It was a situation where it wasn't only a situation of collateral, it was an issue of who established loss reserves. It was a series of other things that ultimately in the world of transparency, we're writing facultative business, risk-by-risk business and we set reserves on a risk-by-risk basis. AIG, because of their size and the scope of their business, establishes class reserves. I don't -- I don't find what AIG did was being wrong at all. If I were in their position, I perfectly understand their position. I think that they probably chose the wrong person because I think our financial segments are probably as strong or stronger than anyone in the business.

But I think that -- I think that AIG has a complicated problem and that is they built their business as a gross lines underwriter, that's they rely on the reinsurance marketplace. When you rely on the reinsurance marketplace, in a world where reinsurers frequently don't perform -- I shouldn't say frequently -- on occasion don't perform, you need to do things to help ensure your position. I was sorry that we couldn't reach a more amicable solution, but that's how it is. We're not going to ever put ourselves in a position where anyone else can direct us as to reserves, when they come down, what they come down. It's just not something we're going to do.

Could you speak to how you see the excess and surplus lines business evolving in 2005? And maybe compare and contrast what it is to date, versus 12 months ago?

I think that it -- it's no different than any cycle. The E&S business will become more competitive as standard markets get into the business, and then standard markets do unbelievably stupid things. And it takes 3 or 4 or 5 years and then they lose more money doing this stuff than they do doing their own things and then they get out of the business, so you're going to have standard markets think they are brilliant and they are going to write contractors in California on a standard basis, and then they will find out that that was a mistake, but they're going to lose a lot of money between now and then.

I think it will become a -- it will come somewhat more competitive, but there's some E&S companies that are going to effectively go out of business, because they still haven't put enough reserves up and haven't dealt with their problems, so you probably have at least 3 or 4 E&S guys who are effectively going to just close up and go away. For those who are as strong as our companies are is in the marketplace, I think there will be plenty of opportunities.

If you were an analyst, how would you foresee companies that you think might fold in this business?

Charlie, that's why I decided to run a business instead of being an analyst, because I don't have to foresee them.

Okay. Final question. You can't harm me for asking, though. It was a good question.

Absolutely

The final question. Could you elaborate on why the alternative markets business had such -- go through the most important trends in that business, please.

Yes, the biggest problem in the alternative market business was our Midwest employers adverse development put up for increased medical cost inflation. That's a very, very long tail business. And it's a business where you can really get bitten if you are not constantly aware of those trend lines. It's a business with a liability duration of 17 years. So, that slight changes in your forecast for medical costs inflation has a big tail. So we -- we believe the alternative market business, all of which is workers' compensation related, effectively had to make an adjustment across the board to consider the fact that medical cost inflation seems to be moving to almost a level that is just out of hand.

And in part that's because of things the people perceive as good for patients, drug costs are much, much higher, the kinds of surgical techniques that are available are becoming more costly. People are requesting new surgeries to replace old surgeries, such as replacement vertebrae out of this new ceramic material and all of that stuff. So overall, it just means you just better totally reevaluate those medical costs. So it all of the adverse developments that took place in the alternative market, did that trend -- when I say all, it's probably an exaggeration, because my lawyer is shaking my head, there's a sign that says, nothing is ever all, Bill. Most of all is related to medical costs inflation.

Thank you.

And once again that's star one for questions. We'll take our next question from Mike Dion with Sandler O'Neill.

Good morning. Question on reserve development positive and/or negative during the quarter and, I guess for the full year. You had mentioned that '03 and '04 were developing favorably, but if there's any adverse reserve development, where was it and what lines? And then secondly, Bill, if you could just expand on your statement at the outset of the call where you said regional and alternative segments would probably return less in '05 than, for example, the specialty segment.

I don't think I said "return" I think I said they will grow less.

Okay.

Okay. I think they'll grow less because we -- frankly, we have invested a lot more money in new opportunities in those 2. I think that, as we said, roughly 7 percent reserve development, a big piece was in alternative markets because of medical. The other big piece was in the reinsurance area, treaty reinsurance continues to look ugly in the '98, '99, 2000 period. And on occasion, something here or now comes back from older years. Part of the problem is some of the people we reinsured have done such a bad job of keeping us informed that things come out of the blue that we never even knew about. So we're trying to keep up with that and every time we think that we're ahead of it, we find out that we're not.

But part of that development comes about because of the nature of the accounting process where we make our best estimates and if we're a little conservative for the current year, you end up that those reserves go up in prior years to be sure that your numbers are -- continue to reflect that conservatism. So we think our accident year numbers are going to prove to be quite -- quite conservative for '03 and '04, and we'll start to see a substantial diminishing level of adverse development.

Great.

But honestly, we couldn't imagine having a better return on capital than we had. In spite of that 7 percent -- the 7 points of development.

It was very strong. Congratulations.

Thank you.

And we'll take our next question from John Keefe of Ferris, Baker Watts.

Thank you. Bill, can you talk a little bit about your views in the directors and officers market with respect to attractiveness in 2005? And maybe where the competition or perhaps where you are seeing the most competition, the Bermuda markets, London or New York markets?

Well, I think, first of all, a lot of people were attracted to the business because, especially in the -- let's say the Fortune 1,000, because the big ticket items, especially, in the excess area, where prices just skyrocketed, and, a lot of people got into the business. The core to our D&O business are really smaller companies and we continue to do quite well there; although there's no doubt we will eventually get to the point where that becomes more competitive also.

There are some people out there who are being foolish. There is no answer for being foolish in this business other than patience, and then those people get sick and if you are lucky they die and if you are unlucky they take resources from other places and they live and maybe they get smart or maybe they continue losing money. We think that overall probably the -- one of the most competitive areas that we're in is the D&O area and we expanded a bit into some intermediate-sized companies and we're sort of back to the core business we have, which is the smaller market.

Thank you, Bill. Are the foolish players isolated to one of the geographic locales I mentioned, or would you say they were more spread out?

Look, you engaged looking for me to make your life easier?

Always.

Come on, I can't tell you that. It would be unfair of me to tell you that there are a number of publicly traded companies that are being foolish in this business, but I wouldn't want to even mention their names or initials.

Okay. Thanks, Bill.

And we'll take our next question come from Bill Wilt with Morgan Stanley.

Hey, good morning. 2 questions, first one a numbers question. Gene, you mentioned the accident year '04 loss ratio was 56 percent. Do you happen to have the initial tick in the current view of the accident year '03 loss ratio?

We don't have it right here with us, Bill.

Okay. I can follow up. Second one, if I could, Bill, if you could maybe reconcile 2 comments. You mentioned just a few minutes ago somewhat cautious, view, I guess on loss cost trends -- or medical cost trends, specifically in workers' comp. At the outset, broadly speaking it sounded like you had a fairly favorable view of loss cost trends broadly speaking maybe one of disinflation, are there other areas you could site where loss costs have been more favorable than you expected?

Well, I -- I think that they haven't developed at a rate greater than inflation, ie, social inflation. None of the -- the lost cost development has been at a relatively modest rate, probably less than inflation, except for medical. Frequency has also gone down a little bit. But I think that the frequency going down is in part a function of terms and conditions on our specialty businesses where we've got better terms and conditions, which effectively reduces the frequency of losses.

I think the medical is an issue that is less of an issue in the current year where we're reserving adequately. It's a looking back over the past years' reserves for those long-tailed pieces of business where you are trying to give an estimate, Bill, of what do you think looking ahead 10 or 15 years your medical cost inflation is? So, a change of even 1 percent of your expected, when you have such a long tail is a pretty significant development number.

Sure.

Now, overall, decline in frequency, especially in the specialty areas, where we've had a real improvement in terms and conditions, and no -- virtually no social inflation, so real inflation of costs has been equal to or less than the inflation levels.

That's helpful. I appreciate that.

And there appears to be no further questions at this time. I would like to turn the conference over to Mr. Berkley for additional or closing remarks.

I think just a couple of things that I should try and take a couple of people through, because we -- we've -- one of the things that is an enormous change in the insurance business, is the idea that getting reserves right is such an important element of managing your business, that conservative is not good, and optimistic is not good. Getting it right is good. And that's -- that's a huge process of education and how you impact and manage your enterprise and how you get people to come to the right conclusion establishing reserves.

It's a constantly evolving thing. And if you look at our macro basis reserves, and you started it the end of '02 and just adjusted our macro reserves are effectively up by about $2.4 billion since the end of '02, and if you adjust that for deficiencies, adjust it for inflation and policy count and change and retention, and all of that, you come up that on a macro basis it looks like our reserves are significantly redundant. That isn't the view of the people in the field. They look case by case, IB&R, whatever, and conclude that that's not the -- not the case. And in part, that is because of how they look at their business, looking backwards not forwards.

Over a period of time, that will work its way through the system. But as long as we're continuing to have such low paid loss ratio, we think we couldn't be happier where we are. We're building up a level of conservatism and as we go through an entire cycle of the business, this will work its way through over time. In the meantime, we think we'll have a number of years where we'll be able to deliver the outstanding kinds of returns that we expect.

So we're very pleased with the business. We're very optimistic about '05. And we're excited that we will continue to deliver the consistent returns that we have over the past several years. Thank you all very much. Have a great day.

And that does conclude today's teleconference. We do thank you for your participation.