W R Berkley Corp (WRB) 2005 Q1 法說會逐字稿

Good day and welcome to today's W.R. Berkley Corporation first quarter 2005 earning's 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 10K for the year ended December 31, 2004 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 due to events or otherwise.

Today's conference is being recorded. At this time, I would like to turn the call over to Mr. William R. Berkeley, CEO and Chairman of the Board. Please go ahead, sir.

Good morning. We were quite pleased with our quarter. We think the start of the year met our expectations, in general business continues to be excellent while we don't have pricing power in every segment of our business, in a number of segments we still do have that ability. The area that's obviously the most competitive pricing wise is the area that lends itself to larger risks and property risks not the sweet spot for us where we were middle market commercial casualty business that represents probably somewhere between 85 and 90% of our total premium. We think we still will be able to continue with modest price increases in a number of areas.

Unfortunately, however, we do not expect those price increases to exceed inflation rates and, in fact, they may not keep up with inflation rates as the year progresses. As our premium is earned for the balance of the year, you will see an increasing reflection of prior year price increases, so overall, the earned premium levels will show improvement and, for that reason, we expect our returns in '05 and at least in the first half of '06 to continue approaching the levels of last year. With pricing relatively flat on newly written premium in the aggregate, you'll see, in all likelihood, returns in the second half of '06. Starting to flatten out. We think we'll still be able to deliver returns in '06 of over 20%, but clearly the increasing returns we've seen for the past several years are not likely to continue. We've been able to deliver returns averaging over 15% for over 20 years, and clearly we think '06 and '07 probably will continue being comfortably above average, but the returns we've had in '04 we expect in '05 are going to be hard to maintain, both because of the profitability and the size of our capital account.

One of the cornerstones of what we'll have to do going forward is manage our capital account as it reflects the opportunities we see in the business. I think that effectively manage the enterprise when the time comes that we cease to see opportunities, which clearly is not the case at the present time, we'll have to apply our resources to managing our capital account as appropriate. Looking ahead, we think that our pay to loss ratio maintaining 36% and keeping it that low level for such an extended period of time is a really good sign that the real results of our current businesses are excellent and our caution in examining these changing trends will help carry us through going forward. I'm going to let Gene talk a little about the numbers and then I'll come back and talk about a couple of areas of the business that are particularly exciting and then take questions. Gene?

Thanks, Bill. As Bill said we started 2005 with another outstanding quarter. Our operating income was 121 million which was an increase of 25% from 97 million earned in the prior year quarter. After reflecting the three for two stock split earlier this month our operating income per share was $0.91, that's up 23% from $0.74 a year ago. That rise in our earnings was a result of strong growth in investment income and underwriting profits which were up 31% and 21% respectively in the first quarter.

Our overall net premiums written were 1.2 billion in the quarter, up 9% over the prior year quarter. Most of that growth was in the specialty segment, which had a 20% increase in net premiums in the first quarter and specialties growth was primarily again, from our four excess and surplus lines companies Admiral, Nautilus, Vella, and our new ENS company Berkley Specialty Underwriting Managers. Premium growth for our other primary segments were also good with a regional segment up 8% and the alternative markets in in international segments each up 7%. As Bill said, average prices for the direct business on an overall basis were essentially unchanged when compared with the first quarter of 2004.

Reinsurance premiums were down 3% in the first quarter, as we previously mentioned we ended our reinsurance relationship with AIG during the second quarter of last year and that accounts for all of the drop in reinsurance business. In fact, our nonAIG reinsurance premiums were up 24% in the quarter primarily as a result of strong growth in our direct facultative company BF Re and our program reinsurance unit Berkley Underwriter Partners. The overall combined ratio was 89.2% which is an improvement of 1 percentage point from the prior year quarter. The combined ratios by business segment were 84% for regional, 87 for specialty, 89 for alternative markets, 95 for international, and 100 for reinsurance.

The overall loss ratio decreased by 1.4 percentage points to 61.7 due to lower loss ratios for specialty, regional, and alternative market segments. As usual our storm losses were modest in the first quarter, just 2 million in 2005, compared with 4 million in the first quarter of 2004. The paid loss ratio still performing well below historical norms at 36%. Unchanged from where it was in the first quarter of 2004. We increase our net loss reserves by 263 million, or 5% in the quarter to just under 5 billion in March 31, 2005. That includes additions to prior year reserves of approximately 30 million or about 0.5% of the beginning of the year reserves.

Our overall expense ratio was 27.5%, that's up 0.4 percentage points from the prior year, due primarily to slightly higher acquisition costs and in addition the reinsurance expense ratio was impacted by the decrease in the facultative AIG business which attracts a lower business ratio. Our net non -- excuse me, our non risk bearing service business revenues increased 7% to 30 million and the pre-tax profits on service fee business increased 5% to 6.1 million. Investment income was 90 million in the first quarter, up 31% from a year ago. Our average invested assets were 8.4 billion in the first quarter of 2005, which is nearly 2 billion higher than the average invested assets in the first quarter of 2004. The annualized yield on the overall portfolio was up slightly at 4.3% in the first quarter of '05 compared to 4.2 in the prior year quarter. Our total invested assets were 8.7 billion, about 7.7 billion or 90% of that was invested in cash and fixed income securities which have an average duration of 3.7 years. And the remaining billion was invested in equity securities including 420 million in the various arbitrage accounts.

The annualized yields on the equity portfolio including the arbitrage account was 7.4% in this quarter compared with 6.4% in the prior year quarter. After tax unrealized gains on investments decreased from 112 million at the beginning of the year to 50 million March at 31, primarily as a result of the increase in market interest rates. Our investment in tax exempt securities increased by 400 million during the quarter and that resulted in a decline in our effective tax rate to 30.3% from 31.7% in the prior year. All that adds up to quarterly net income of 121 million, of $0.91 per share and annualized return on beginning of the year equity of 22.9% and an ending book value per share of $17.10.

Thanks, Gene. I think that it's important to understand, we manage our business in a little bit different way than many of our competitors. We focus on return on capital. It's not a combined ratio that measures how we do. It's an indication of ROI profitability which is one factor. But it's return on capital we measure, and we try and look at the return on capital, by each piece of our business and examining it, we look at the risks that are implicit in every piece. Our specialty business has wide arrays of risk and generally it's terrific returns. We think that part of our business will be able to continue to grow in this environment.

There the challenge is not other specialty competitors most of whom are behaving in more responsible ways, but rather its standard markets who decide when things no longer are growing in their regular business, that they suddenly have become capable of underwriting specialty business in spite of the fact they've consistently proven otherwise. So, strength in business continues to grow, good opportunities, we're excited there. We think that there continues to be niches. For the most part, our competitors are acting pretty responsibly.

Our regional businesses have just a dramatic improvement over the past five years. Getting out of personalized refocusing and management of our business, fewer enterprises and a real focus on profitability and our relationship with our distribution channel has resulted in just a dramatic change. Huge decrease in loss ratio, lots of growth, returns on capital in the high 20s, approaching 30%. In fact, we hit 30% this quarter. We really just -- outstanding opportunities. Again, we have some national companies that our competitors, a few regionals. But there's still opportunities out there and that segment of the market is particularly focused on service and responsiveness. It's an opportunity for us to continue.

Our alternative market segment, which are focused on Worker's Compensation primarily, both writing the business directly through some of our pieces, excess business through midwestern quarters, or managing that other people's Worker's Compensation continues to find opportunities to grow, although various segments of the business are under attack in particular jurisdictions. California's clearly becoming more competitive than it was, on the other hand, lots of the foreign risk plans and self-insureds are becoming more conscious that it isn't just the dollars you pay for the services, it's the outcome of the services provided that's important. So, we find that segment of our business to be able to grow. And there are lots of opportunities there.

Our reinsurance business has been a greatly improving business, although the treaty business in all its improvements, has still had problems from the past. Late reporting losses from '97, '98, '99 where we wrote treaties and people along those three and four years ago told us they had reported all their losses, suddenly new ones developed last quarter. It's an astonishing thing. I think everyone participating in the treaty reinsurance business has found the standards of behavior for seasons seems to have disappeared and we've all been surprised at how late a number of companies have reported loss development. That aside, we continue to manage the business with substantial discipline. We're pleased with how we're doing. The fact that the business continues to do terrific and we're really quite pleased with the business.

Our international business, which is a joint venture with Northwestern Mutual Life. Small business in Argentina, but doing terrific, has gone through a extremely difficult time with just outstanding performance by the management and staff there in a very difficult environment. We couldn't be happier. Our business in the Philippines continues to perform -- the deposit life business continues to perform well. So overall, happy. We think good returns to great returns are going to be available to us for the foreseeable future certainly beyond 2006 and we continue to build the value at a substantial rate. So we're really enthusiastic about where things are. We think the riskiness in our business continues to diminish as we get greater strength and we'll be able to generate higher and higher returns in spite of what we perceive as diminished risk. With that I'll be glad to answer any questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question today will come from Charles Gates with CSFB.

Hi. Good morning.

Good morning, Charlie.

My first question, Bill, in your prepared remarks you made the comment we look for the returns in our business to flatten out in the second half of '06. Could you elaborate on what you mean by that?

Sure. Profitability comes from earned premium as opposed to written premium. When we talk about pricing, we talk about the newly written premium. So the pricing increases continued throughout all of '04. So through all of '05, those price increases will come into our earned premium. I think you'll still see some benefits for modest improvement in the first half of '05 as well a diminishment of the development. So I think you'll continue to see returns sort of in line with where we are now through the first half of '06, Charlie.

I would expect that as that flattening premium comes into effect, maybe even modestly declining premium and inflation starts to impact losses, I would expect our return on capital in the second half of '06 is going to probably be more like let's just say 20% than 23 and 24%. I think -- I'm pretty happy with our higher -- our capital is going to be up by 20 to 23%. If I can still deliver that kind of return, that still means my earnings are up pretty substantially per share. I am talking about return on capital and an increase in capital base. I'm reasonably optimistic. I don't think the business is going fall off a cliff. The most competitive areas that we think are out there are the property business and the jumbo risk business.

I know in your comments about the specialty business, you made reference or some reference to the E&S element. Could you elaborate on the competitive environment for excess and surplus volumes?

I think there's some segment of -- E&S business is a broad, broad area. I think that -- the fact is that I was asked a question this morning and that is what did I think the future was of property casualty business, or auto business, or homeowner's business, or commercial trucking business because clearly the person didn't differentiate it. I think when you have a broad brush E&S business for me to try and differentiate is really hard. I think that the -- there's some places such as products that are becoming somewhat more competitive and there are other places such as professional liability that are less competitive. I'd say overall the E&S business is flat. There are places that prices are better and there are places that prices are more competitive. I think it would be hard for me to give you a broad across the board response.

Thank you.

Our next question we'll hear from Stephan Petersen with Citadel.

Good morning. Bill, I was wondering if you might be able to provide us just a little bit more color with what was going on in reinsurance of the loss ratio, the 68.5%. How much of that would come from prior a year adverse development and maybe just a couple of quick comments on what's going on in the facultative market.

First of all, we don't give out adverse development by segment on our call. In general we don't. I think in a facultative market, the facultative market is, pricing is generally flat. I think people generally are purchasing less reinsurance because they're trying to increase their retentions because new business is harder to come by. I think the reinsurance business itself especially the treaty business, didn't have the kind of bounce that the rest of the industry had in 2003 and 2004. Profitability for the standard markets improved much more than for the reinsurance business. But I think a lot of people, in the treaty reinsurance business, are sitting back and saying -- we can't let prices erode, and people on the other side are trying to push hard for pricing benefits.

So, I think it's one of the areas that has the most, at least the treaty business, is having the most turmoil at the moment. I think prices generally are flattish. There's a lot of leverage. It's a long lever from that on standard market pricing. But I think the business is reasonably profitable currently on the treaty side. On the facultative side, the biggest buyer of facultative reinsurance has always been AIG. And we're not doing business with them, but the rest of our business continues to grow and pricing is I would say generally flat.

Would you say -- it sounds like it's still fairly rational on the facultative side.

Yes. And I think most of the treaty side is rational, also. There are exceptions. There are some big buyers, big treaty placements where they're attempting to get terms that aren't acceptable. But I think in general the reinsurance marketplace didn't benefit as much because they had a much, much worse development from prior years and therefore they didn't get to show as dramatic an improvement in their results, as their standard industry. So I think that the erosion and reinsurance pricing is not as great at the moment, although on the property side, I think prices have come down quite a bit.

Terrific. Thank you.

And next you'll hear from Erin Archer with Piper Jaffray. Good morning.

Congratulation on your new quarter.

Thank you.

I had several question but in particular I was wondering about the reserve editions. Now I know that you won't mention it by line, but could you tell us if that was a net number and if you released any reserves in the quarter?

Gene?

Yes, that is a net number. And so there were some accident years that, more recent active years are developing favorably and we had some overactive years that developed negatively. So that's a net of all that.

The accident years that are developing unfavorably are they still the '97 to 2002 years?

Yes. '97, 2001 primarily.

Okay. Then I had a quick question on reinsurance growth. Now, excluding AIG, could you mention the underlying growth. Do you think that's a --?

By and large reinsurance pricing is not improving. It's basically flat. And the growth in reinsurance is primarily because modest increases in two areas Berkley Underwriting Partners which is really a program business and there were added some programs people who were with companies that have left the business that are attractive to us and DFE which is direct facultative business which is something we got in a couple of years ago.

Okay.

Our historical reinsurance business, facultative resources business, star treaty business have not grown particularly.

Okay. Thanks. On the switching to net investment income could you talk about where on the yield curve you're investing new cash?

By and large our net cash position is still around, a little over $2 billion of what we call cash and short term which is we keep it about -- let's say between 700 million and $1 billion literally in less than 90-day money. And another billion to billion and a half that we trade within a less than two-year maturity opportunistically. So we have about between 2 and 2.25 billion, maybe as much as 2.5 billion of short-term money and the other pieces we're investing out sort of ten years on the yield curve in municipals.

Well, thank you so much and congratulations again on your quarter.

Thank you very much.

Next we'll move on to Jay Cohen with Merrill Lynch.

Good morning. Focusing on the regional business, I have heard some standard companies say that the claims frequency in that business is positive. It's not just personalized but kind of a small commercial side. What are you seeing from a claim standpoint in your regional business?

I think it's down somewhat. But I think that it's -- the business itself is better where we think that we're doing a better job. I think overall, though, the frequency is down somewhat -- it's been an improving trend for a few years. I think as people are more conscious though of loss prevention, risk management, you're seeing insureds who looked at insurance prices going up, said, hey, we need to do something. You have a lot of people paying attention to monitoring these kinds of issues and you find that there's an improvement.

Great. Thanks for the color.

[OPERATOR INSTRUCTIONS]

Jay, by the way, to be precise, overall planned counts is down 5% for the regional business.

[OPERATOR INSTRUCTIONS] Next we'll move on to Mike Dion with Sandler O'Neill.

Good morning. Bill, in your opening remarks you mentioned that you expected returns to be 20% over the next year and a half or so. Also mentioned that long-term returns are roughly averaging 15%. Can we use that as a rule of thumb as to when you might look to do some capital management, whether you increased dividend and/or share buy back when returns get around that 15% level?

First of all, I think that what I said is, our historic return over the past 20 years has been a 15% return on equity. I would hope that we wouldn't get down to 15%, and I think that the capital management is not going to be determined by returns. It's going to -- we're going to look at what we do with our capital when we start to generate more capital than we think we appropriately need on our balance sheet because we can't find opportunities to use it.

So, I hope I'm not going to sit and wait for my returns to go down. I'm going to sit and wait and say, do I continue to have opportunities to use my capital? We're growing at 10, maybe a little more percent this year. Generating improved capital position of something more than 20%. That means our net capital position is improving. We can have a cushion because we were clearly using right to the edge of our capital capacity up until now. But I think if that same situation were to arise next year, we'd have to consider what would we do with that excess capital we're generating? Be it dividends or buy backs.

But those would be the two areas you would look to if that situation arose?

Yes. I mean, obviously if we can find a wonderful company that was a better opportunity than buying back our own stork we'd look at it. But we haven't found many companies that we thought were as good as buying our own stock.

Okay. Fair enough. Thank you.

Jeff Thompson with KBW will have our next question.

Thanks. Bill, I have two questions. The first I guess focusing on the specialty, with rates fla what are you doing to grow that business 20%? Have your changed your commission program with agents. Are you changing the policy terms? Are the products better? Can you give us some color on that?

Well, I think first of all, we've got a couple new entities. We acquired the middle of last year the business from Gulf, Berkeley Specialty Underwriters. That's caring for part of it. In addition, we continually refine our reinsurance range so we retain more and more business. We have added a couple of programs in Vella for some particular areas to expand the business, Admiral added excess back two and a half years or I guess two years ago. That's really coming into its own. You're starting to see that developing. So I think it's a whole lot of pieces where we're adding things, where we've grown, where we've gotten teams of people who have come over to us. I don't think it's anything in particular. Certainly as far as I know, it's not that we're increasing commission. I hope not.

And then the second question, I guess, is a little philosophical but looking at the reinsurance market, I know they weren't the ones to lead the charge in this last cycle, raising rates. You mentioned they didn't get any benefit of the bounce like the primaries. I'm wondering what do you think the reinsurance market needs to do as we move into the next pricing cycle into the future to sort of benefit better from the changes in terms and conditions. Maybe what did they do wrong this time?

I think the real problem isn't the reinsurers. The problem is they weren't presented with very accurate data from receiving companies.

Was it out of their hands?

Well, we've spent a lot of time looking and -- of several hundred reinsurance clients our losses all came from relatively few. It's interesting. Other than one very large company, the rest were all relatively modest companies and they didn't seem to take much responsibility for accurately giving us their information. By accident, by plan, or by lack of knowledge, I don't have any idea.

I only know the information that we got when we made our decisions to underwrite the risk and the information that subsequently developed to be factual. Didn't match up very well. So, I think that the nature of the transaction which is of the utmost good faith is something that has dissipated. So the nature of the reinsurance transaction is going to have to change a bit. Maybe they'll become more retrospectively rated policies where if you give me this information and in fact the underwriting data proved faulty, we're going to adjust the pricing. I can't tell you the answer to that.

Okay. Thanks a lot.

[OPERATOR INSTRUCTIONS] Next we'll take a follow-up question from Charles Gates with CSFB.

Over the last six months, seemingly the most important issue that people didn't see with regard to investing in this group was the regulatory issue. What do you think that's going to be, say, over the next six months?

That was really nicely brought up, Charlie. I think that for most people who had various levels of peripheral involvement in this whole thing. I think becomes the conclusion. That there were a lot of things that weren't being done very well or very right. And while we may not agree with how they were handled by various kinds of regulators, the issues we shouldn't confuse are, they did find things that were being done that were wrong and whether we like or we don't like how they dealt with them, they didn't make the problems. We made the problems. We shouldn't forget that.

I think that a lot of people in the industry are trying to pay attention to that. I think clearly the big global brokers would like to know contingencies. I think, of course, they'd like there's no contingencies because they can't have them. So if they can't have them, they'd like no one to have them. I think contingencies are fine. As long as they're not related to an individual customer. And I think as long as the brokers understand that they have to let their customers brokers agents understand they have to tell their customers how they get paid. Transparency is the key.

I think the other thing is that Sarbanes-Oxley and all that goes along with it does put a burden on a company in the insurance business when even if you try to get your best estimate of your financial position, you're subject to many, many judgments. I think you're now being forced to try to be more accurate in a timely fashion. I think it's going to take real focus for our industry to get that way. As we improve. And I think we will. It will have a tendency -- this is really the answer to your question, I think. The thing I think that people will miss is, we are likely to have less amplitude in the cycles of our business and of shorter duration because people are going to be forced to recognize their state of finance more quickly because the consequences of holding your nose and closing your eyes are going to be severe. So, I think there are going to be some changes. The thing I think people probably are going to be surprised the most at is that you're going to probably see a change in that.

I think that would contribute to higher insurance stock prices.

Well, it'll also probably contribute to a few guys going bankrupt, which would also be all right.

What kind of companies would go bankrupt?

Oh, Charlie. That's what your job is.

Thank you.

It appears there are no further questions. Mr. Berkley I'd like to turn the conference back over to you for any additional or closing remarks, sir.

I was going to say, we are really pleased with the quarter. We're pleased with where the business is. We're happy about our position in the industry. We're really happy about most of our regular market competitors. There's generally a responsible tone to the market. There are a few idiots out there. Some of the biggest companies in the world are idiots, but you can't do anything about that. They can afford to lose a lot of money.

But for the most part, I think you're seeing a real responsible behavior and I'm especially pleased that that's the case about many of the companies in Bermuda. I was concerned. But, we think it's going to be a great year. Thank you very much. Have a great day.

That will conclude today's conference call. Thank you for your participation.