W R Berkley Corp (WRB) 2007 Q3 法說會逐字稿

Good day and welcome to the W.R. Berkley third quarter 2007 earnings conference. Today's call is being recorded. The speakers' remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by use of forward-looking 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 end December 31, 2006 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. At this time, I'd like to turn the call over to Mr. W.R. Berkley, Chief Executive Officer and Chairman of the Board. Please go ahead, sir.

Good morning, everyone. It is sunny here in Bermuda. We're having a nice day. I was pleased to report our earnings. We had a good quarter, pretty much in line with our expectations.

I think that the only surprising thing for the quarter that we saw was that our reinsurance business has gotten more competitive than we anticipated more quickly, basically with more limit being offered without change in price. And more people wanting to retain the business they had heretofore bought reinsurance to protect themselves on.

It is an interesting proposition to think that people are buying reinsurance, or rather not buying reinsurance at the point in time when their primary prices are going down. We are pretty pleased with the consequence of that which is less reinsurance, which is the most leveraged part of our business. So while we are disappointed to have that volume go down, we are satisfied that that is good economic news for our reinsurance operation.

Overall business continues to be satisfactory, not as robust as we like. There continues to be opportunities here and there in the United States and around the world that we are trying to find ways to take advantage of. None of those opportunities are easy. None of them come without their risks and uncertainties. But they still are there and over time we think there will be ways to create enormous value for our shareholders. So before I go on, let me let Gene Ballard go through the financials, and then I'll come back and go through the various operating units. Gene?

Thank you, Bill. Our third quarter net operating income was $180 million, that is up 4% from $173 million in the third quarter 2006. Our operating income per share was $0.93 and that is up 8% as a result of the higher earnings as well as the impact of recent share repurchases. We repurchased 9.7 million shares in the third quarter at an average price of $29.98 and have repurchased a total of 12 million shares in the first nine months of 2007 at an average price of $30.44.

Our third quarter net premiums written decreased 6% to $1.132 billion. About two-thirds of the decrease was from our reinsurance business with the remainder from the specialty segment. For the reinsurance business, as Bill said, increased competition as well as higher seeing Company retentions led to an overall decline of 25% for the quarter.

For the specialty segment, the continued slowdown in construction activity, as well as general pricing levels contributed to a 7% decline in premiums. For the reinsurance and alternative markets premiums were flat as price declines were offset by new business. And for the international segment, premiums were up 10%.

Our overall combined ratio was 88.5% for the quarter. The combined ratio was unchanged from the prior year with a 1.2 percentage point decline in the loss ratio exactly offset by a 1.2 percentage point increase in the expense ratio. The increase in the expense ratio to 28.4% reflects the impact of a 3% increase in commissions, including contingent commissions, and other underwriting expenses.

The combined ratios by segment were specialty, 84.6%; regional 90.6%; alternative markets, 83.5%; reinsurance, 95.4%; and international, 96.5%. The 10-point increase in the alternative markets combined ratio reflects less favorable reserve development in the quarter, as well as higher discount amortization for our excess worker's compensation loss reserves. The eight-point improvement in the reinsurance loss ratio was primarily due to higher underwriting profits from our participation in business underwritten at Lloyd's.

Overall our loss has benefited by approximately $20 million of favorable reserve development in the third quarter, and that compares with $6 million of unfavorable reserve development in the prior year quarter. Our paid loss ratio was 39.7% in the quarter, and our paid to incurred ratio was just 66%.

In spite of a 5% decline in year to date premiums, net loss reserves were up by over $650 million for the first nine months, including almost $400 million of additional IB&R. Net investment income was $166 million. That's up 14% from the prior year period. The average annualized yield was unchanged at 5.2%. The arbitrage account which was $845 million at quarter end had an annualized yield of 10.2% this quarter compared with 7.7% in the prior year period.

When compared to the second quarter of this year, our investment earnings from two external fund managers were down about $6 million due to a modest impact from the market conditions in August and September. Invested assets were $12.9 billion at September 30. That's up $900 million from the beginning of the year. The increase was, again, driven by strong operating cash flow which was almost $500 million in the quarter and over $1.1 billion for the first nine months. The average duration for the overall portfolio was 3.6 years and our after tax unrealized gains were $105 million at September 30.

I wanted to point out, you will notice we added two lines to our income statement that we call, two accounts that we call revenues from wholly-owned investees and expenses from wholly-owned investees. These are revenues and expenses from two recent investments in which we have a controlling interest and which, therefore, are consolidated for financial reporting purposes. The companies that we invested in are in the business of selling and servicing aircraft through fixed-based operations.

Also as we previously announced, we closed on the purchase of American Mining Insurance Company on October 4 and we will begin reporting their results in the fourth quarter. Finally, our overall tax rate for the quarter was 29.6%, and our after tax net income was $180 million. That gives us an annualized return on equity of 21.6% for the quarter and a book value per share at September 30 of $19.19.

Thank you, Gene. Let me just quickly run through a few highlights and then answer questions. I will go through by area. Our specialty area, as would be expected, was impacted by the softening market prices. Prices are down year-over-year roughly 7%. A little more, actually. They are about 1% greater decline in the current year-over-year than the prior quarter's year-over-year. Volume is down there. And while the business and our pricing disciplines remain good, our reserves are strong and we are happy with the business.

What you see at this point in the cycle is the standard markets come in and take away the easiest to find, easiest marks in the specialty area and move them over to the standard market at huge price discounts. Something we might write at $100 they might write at $50. They think it is a great premium because it might be an increase over what they would use as a standard market rate, but for us in the surplus lines business, it is a huge decrease. That is the first business that leaves the specialty area and we are seeing that in a significant way.

As to our regional business, it continues to do well. Very slight increase in premium volume. Lots of loyalty, terrific focus on service, both to the agents and the insureds. A real understanding out in the field that this is a partnership with our distribution and a focus on providing outstanding service. Great claims handling. That is really paying off and that business is really having a lot of stickiness and the combined ratio is holding up. Very slight deterioration. We are really pleased.

Alternative market business, the business is doing well. The volume is better than it looks because in fact in that area, California comp is down, and the rest of the business is up. So you are seeing one offset the other. While the volume is up for the group, it is really made up by California comp being slightly down still and the rest of the business being up.

The combined ratio for that group, in fact, while it appears to be less robust, in fact, this is really fine. The reason it was so exceptional in the comparable period was because of reserve releases from the California comp where the numbers just were astonishing. We are pleased with that business continues to do very well.

Reinsurance business is interesting. We are seeing across the board on both the [facultative] and the treaty business, fewer people buying. We are seeing a number of people decide that they would rather keep the business. It is interesting, if you manage this business right, your customers help insure you optimize your profitability because you do not write as much business as the market gets softer. So losing business, that is highly leveraged in return as prices go down is not the worst thing in the world.

One never likes to see volume disappear. We really would much prefer customers who perceive this as a long-term relationship, but that is just not how it is at the moment in many areas of the business, so customers are leaving.

Our business at Lloyd's that is within the reinsurance area has continued to do well. With a lack of catastrophic activity, that business has given us great returns.

Our international business, which is primarily Argentina and London continues to do well. We are pleased with it. The business in Argentina is performing exceptionally well, although we still always worry about the environment in Argentina. It is not as stable as we like it. When we go down there it looks calm and stable, but we have gone through some difficult times there. Our management is used to dealing with that uncertainty and has done an outstanding job.

In London, extremely competitive environment. People are out there, and real marginal underwriting profitability at the moment. We expect the business to remain such that we will have an adequate return but it is a competitive market. Certainly, it is as competitive or even more so than casualty business in the U.S.

Overall, we -- our investment portfolio continues to be conservatively focused. We don't see any real problems there. Our investments in what I would call areas that can be subject to the current financial crises that we are seeing arise are very small and we are quite optimistic that that investment income will continue to deliver great returns.

Bottom line, our pricing seems to be holding up better than I would have expected. Average price declines are 5% year-over-year. I would have thought they would be worse. But recognize that that is on the business we retain, which is 80% to 90% of our business. But on the business we lose, the price declines are substantially higher. So we cannot think that is a pure indication of the market.

We are pretty comfortable that things will continue and our returns look like they will be able to continue well in excess of our targeted minimum 15% through next year, and really as far out as we can see at the moment. With that, I'd be glad to answer any questions. Abraham?

Yes, sir. (OPERATOR INSTRUCTIONS) And we'll take our first question from Josh Shanker with Citigroup.

Good morning, everyone.

Good morning, Josh.

Three questions. The first one is you gave the hypothetical scenario where in the specialty line someone would price you down by about 50%.

I'm wondering, these large price cuts, how widespread are these examples of you seeing some cases fuel pricing down that dramatically? Two, given the share repurchase, I was wondering if there is some sort of anecdotal idea about when you come into the market for your own shares? And, three, given the, maybe what was taken out of context, you said in a previous conference call that you would not be a buyer of your own shares at this levels. I want to know what your own appetite is from that mentality at this point?

First, the issue, when I said I would not be a buyer of my own shares was two calls ago and it was taken out of context. It really revolved in part around the same question which was your second question that it is not in my shareholder's best interest for me to tell the world when and what price I'm going to buy my stock at.

We buy the stock when we think it is appropriate and it is a reasoned use of our capital for our shareholders. If the stock does not sell at that level, we will look at other ways to deploy our excess capital through dividends or whatever. But it's not that we have a price that we think we should tell the world when the stock gets to $30.04 or $28.91 that we're going to buy the stock. We do not really set a price like that and it surely would not be in anyone's interest for us to tell the world that anyway. Because we are interested in buying the stock as attractively as we think we can for the Company.

For the first question regarded how often you are seeing radical cuts in certain contracts and what not?

I understand the question. I think I was really referring particularly to areas that we are going back to the standard market. For example, nutrition stores that were really clearly specialty risks are now being picked up by standard markets as sort of a specialty retailer. And health chains where they only have exercise equipment and they do not do any of the other kinds of things, so they are now being picked up. As long as they do not have tanning salons alongside them.

What I call is people are so anxious to get business, as is everyone at the moment, that they are rationalizing away the reasons they were in the excess and surplus lines business originally, Josh. And then they are falling back to the standard lines market. Once they get in the standard lines market they are being what I call book underwritten.

They are looking up on page 93, column four, class 7, and that tells you the price and that price is often not at all related to what we in the NS business would assess the risk at. And it's more of an [iso] categorized risk. So the prices are down substantially. And I would not say it is a huge amount. But it is -- we are seeing that in the past six months for the first time in quite a while.

I appreciate the color. Thank you.

Thank you. We will now move on to the next question. We will take a question from Charlie Gates from Credit Suisse.

Hi, good morning. A couple of questions. My first question, Bill, if you were to look back in history, what period of time from a competitive standpoint is similar to where we are now?

How far back do I look?

30 years.

30 years is not very far, Charlie. I would guess that we are probably -- putting aside, you have to put aside Andrew, which sort of changed the pattern. I would say we are probably in '89, maybe '90 where clearly on an accident-year basis you are marginally profitable and heading down. All right? I think business written now for the best companies has underwriting profits, and for the average company, underwriting profits on an accident-year basis probably are not there.

All right. Second question, I think by most any definition, seemingly the industry is much over capitalized. What do you see as the outgrowth or implication of that?

Well, you know, I think a number of companies -- first of all you have to recognize, I think some things have changed. I think that we have Sarbanes-Oxley which is forcing people to be honest about their numbers. We have a lot more companies, new companies who are trying to find their place, but they cannot hide bad results. I think that we have no catastrophes of consequence this year so you have a lot of people who are over capitalized that still get no return.

I think that -- excuse me. I have to correct myself. A lot of people are over capitalized and still getting an okay return. I said no return and I apologize. There are no catastrophe losses, so they are getting an okay return even though they are way over capitalized with no cat losses.

So I think that at the moment everything looks okay. I think that as time evolves, new capital is going come in the business in a different way. I think it is going come in the business in a manner that it is temporary capital. It will come in as side cars and other vehicles where investors can put their money in and get it out. In spite of lots of promises, many of these people put their money in vehicles that they expect it to be liquidated or merged out and they get their money out and that has not happened.

So at the moment, I think, we are stuck with a lot more embedded capital than the industry needs. There will be some mergers. Mergers are hard. It means people giving up positions. It means a whole lot of different things happening. But I think mergers are inevitable. There will be more consolidation in the business. I think that is going to continue.

So I think that my forecast is next round of capital raising will come in on a short-term basis, side car type vehicles that a number of the newer entrants will have to consolidate, and a lot of people who have big amounts of capital but don't have any distribution relationships are going to have to have merger partners or find other ways of returning their capital.

All right. Was there an insurance aspect of the acquisition of the aviation company?

No. It was really just part of our investment portfolio. It was part of our private equity investment portfolio. It's a small investment. We are just buying some of these things with the view that it will go public or we'll spin it out to our shareholders or do something else. It is just a good return business that I coincidentally knew something about. Nothing in particular.

My final question, I think Gene made reference to two investment managers. Some issue with regard to those in the quarter, and I did not understand that?

The answer is we have a few outside investments in both the real estate and merger arbitrage business that are outside. And two of them gave us very low returns in the quarter just compared to what they had been giving us. That was the reason our investment income was not up as much as one might have expected.

Thank you.

Thank you. We will now move on to our next question from Michael Phillips with Stifel Nicolaus.

Thanks. Good morning. A couple of questions here. First, to try to get my hands around how you think about the margins put into your current business. The answer to your prior question that you just gave to Charlie on the industry, you said on an accident-year basis industry is still marginally profitable but, of course, heading down. How does the fact that your prior year business has been developing pretty well change the way you think about your current year when you set up your initial reserves?

I think that when we look at our current year, each successive year loss picks are based on prior year loss picks and the development of those prior year loss picks. Looking at combination of case and IB&R. It is not that we get smarter, we get older. And older let's you look more accurately what was happening before.

So, for instance, in our California comp, it was not that suddenly we had much better results, it was that we started to see the real results of the change in the law and the development and we felt confident in making changes. We effectively are just constantly looking back and trying to evaluate what should our current loss pick be, how do the prior years develop? And while we might not take down everything that was there in the prior years, we are constantly using that data to make the best pick we can in the current year given inflation and price changes.

So it is really a continuum of adjustments. And you try to get it as right as you can and the longer you have the better you are going to estimate. So if I know 2004 with a lot more accuracy, I am going to have a much better pick on 2007 because I built 2007 from 2004. So it is just a continuing process.

Okay. But it would not be incorrect to say that if we looked at margins in your current business, they have probably deteriorated from last year just given what's happened with rates? I mean I think that your loss trends in the casualty business have been pretty favorable, but with rates coming down it is probably safe to say that the margins are not quite what they were last year?

I think that our current year loss picks reflect that, our expectation of that deterioration. I think our loss picks are probably three or four points worse.

Okay. Good. And just real quickly on the breakout that you put on the income statement. The margins on that business, is that pretty stable?

I am sorry? What are you talking about?

On the wholly-owned stuff that you broke out on the income statement. Is the margin pretty stable?

Yes.

Okay. Good. That is all I have. Thank you.

Thank you. We will now take a question from Jay Cohen with Merrill Lynch.

Yes, two questions. The first is with the reinsurance business shrinking the most among your segments, I guess my assumption is that is one of the more capital intensive businesses and if that's the case does that essentially free up capital a little bit quicker?

You know, capital is primarily today is related as much to loss reserves as the volume of premium and it also has a longer tail. So just because you are writing less business, your reserves are not going down. In fact, even though we are writing less business, we are putting out more reserves. I would not expect that that is going happen.

I think we are very comfortably capitalized, and we have no problem basically looking at our earnings and saying what do we need to do with the earnings? We don't think we need to build up any new capital. To suggest that we are going to look at the new capital we generate and see what do we want to do with it, what do we need it, we don't think we need it to run our business per se unless opportunities change. But I don't think we think we should just pull out capital that is embedded in the business at the moment.

Okay. Next question, the higher commissions, was that simply a change in business mix, or did it relate to any strategic change you have made as far as commissions you are paying out?

I think the commissions, partly we have contingencies for our standard market businesses. Then there is slight changes in business mix. But, the commissions were 3% of the base of commissions. So, it was not the -- it was not 3 percentage points higher. Gene's statement was a little confusing if you just listened to it. It was 3% of our standard commissions went up. So it was sort of a probably 0.4 of a percent increase in commissions. Most of that was contingencies because underwriting profits have been so good and we expect that there is probably pretty good embedded underwriting profits.

I guess, lastly, what is the rationale for growing the IB&R as much as you have when, in fact, your premiums are shrinking? I assume unit count is not growing?

No. Well, I asked the guys and the claims people and the presidents of each of our units and I ask all the senior vice presidents, many of whom I am looking at around this table now, and why are they low balling me, Jay? And I ask them that same question. And I ask the actuaries that.

And you know they tell me they gave me their best estimates of the numbers. And no one would want me to arbitrarily lower our reserves. So I just simply tell them that, you know, I don't like it. I think our reserves are probably erring more on the conservative side, but it is, in fact, the blended view of all of the people involved. It is not so conservative that I feel I cannot live with it.

It is on the conservative end of what I believe is reality. But we have a big amount of reserves and they -- we have had positive developments for the past few quarters and my expectation is that will continue. But the fact is that the worst thing for an insurance company that is decentralized to do is to go out and direct the people in the field to change their reserves.

So unless we cannot live with it that is just not where we are going to go to. There are occasions where that may be the case, but it is not how we want to run the business.

Great. Thank you.

I will now take our next question from Scott Heleniak with Ferris, Baker Watts.

Hi, good morning. Just a couple of quick questions. First of all, the California worker's comps, the latest reforms, does that really change your mind set on doing business out there? It was just passed, I guess, a couple of weeks ago, one way or the other?

We have restrained ourselves in California. We have kept the business to be something less than 5% of our overall total, recognize that things change in California. It is a political environment that is constantly changing. Sometimes good and sometimes bad. We think we have a terrific team of people there who understand the business.

Therefore, this is a business that provides us good opportunity. Just as we did not rush in to write all the business we could and make it a huge part of our Company, we are not going to run away. We are in there and we're pretty happy with our people. We think we understand how to make money there. We are not going change our view in California.

You do not think it will be that much more competitive than it is right now?

It may be more competitive, but we think the best people can still make money there.

Okay. And then the regional, I was just curious what areas you are seeing the growth there? You also talked about the sticky pricing. Is pricing off, is it sort of flat or is it off a few percentage points? I wonder if you might be able to comment on that?

I think that our overall pricing is down around 5% for the year, the rolling 12 months. And the regional business pricing is down about 4%. Specialty business pricing is down a little over 7%.

And you know, I think that -- the more you can get across the idea that your customers, that they are buying service and that one out of five, one out of 10 is going have a claim and they want to be sure they get the company that gives them the service when they are that one, you can sell that issue. When price differentials get to be more than 10% or 12% you are going to likely lose the business. At this point, we are still able to have -- retain a large percentage of our business. Our retention rates are 80% to 90% in general. A little lower than that in the specialty areas.

Okay. And then the start-ups in 2006, could you give the overview of what the premium volume is? What they did for the quarter, the third quarter?

About $35 million, I would still say behind where I thought, they have not really gotten the traction. A couple of them have gotten great traction, a couple of them have not. We have invested a lot of time and effort. We have a couple of people here who have actually gotten gray hair because of it.

And I think that we are working on getting that dealt with. I think we are seeing some real positive developments. The two start-ups we had this year, actually that we had in the middle of this year, actually are already in the quarter contributed about $4 million of business.

So that will be more significant in the fourth quarter. Still behind, slower start for the '06 ventures. Two are doing okay, two are sort of not up to where we thought. We think we are now on track with those two.

Do you think we are at the point of the cycle where there is enough opportunity and prices come down enough, if you do want to get into a somewhat new category, expand, is it easier to just buy someone or do you still prefer kind of starting up? I know you made the acquisition this quarter, but what are your thoughts on that?

We would always be happy to buy someone if we are able to. But that is determined by price, risk in reserves, and the quality of the people. I think there is almost always a risk in reserves.

We are very confident in the management and reserve levels in the people at American Mining, and we thought it was a first class opportunity for what we think is a long-term industrial opportunity for us, which is why we bought American Mining.

So there we didn't see any of the normal risks we normally expect. On the other hand, most things that we see have substantial reserve exposures, lots of uncertainty, and they want a price far in excess of what would give us the kinds of return targets we have.

It is a more immediate positive, if you buy something. But in real economic terms, it is better to start up if you are able.

Okay. That is all my questions. Thanks.

Thank you. We'll now move on to our next question with Mike Grasher from Piper Jaffray.

Hi. This is actually Joe DiMarino. You may have already said this, but did you purchase any shares during the quarter?

We did say. During the third quarter we purchased 9.7 million shares.

7 million?

9.7 million.

12 million for the full year.

Thank you. And my other question is, you said on average you are seeing 5% price declines on retained business. But that it could be -- it was substantially lower on loss business. Can you give more color on the --

We cannot give you any statistics. We don't know. On the business we inquire about that we lose, we lose it for certainly more than 10% price differential.

Okay. Thank you.

Thank you. (OPERATOR INSTRUCTIONS) We will go Sam Hoffman with ADAR.

Good morning. Can you comment on the prospect for tax reform in Bermuda in terms of affiliated reinsurance, corporate inversions and any other options that are under consideration?

I will only comment as to what is already public and that is we are working with a coalition of other companies which consists of Liberty, Hartford, Travelers, Safeco, Ambac, MBIA, Hartford, Chubb, Berkshire Hathaway, Scottsdale Division of Nationwide, a number of others I have probably forgotten to get legislation to address the current status of the ability of foreign domiciled insurers who set up U.S. subsidiaries and then reinsure this business to low or no tax environments.

We are working diligently with people in Washington, and we are optimistic that we will succeed in getting legislation.

What do you see as the timing?

If the President can't forecast timing for legislation that he wants, how should I be able to do that?

Okay. Thank you.

(OPERATOR INSTRUCTIONS) And we'll now go back to Mr. Michael Phillips with Stifel Nicolaus.

Hey, thanks, just one quick follow-up on a numbers related item. I think you said last quarter that the reinsurance contract that you lost that was running off this quarter, this quarter the impact was about $40 million, is that correct?

For the third quarter it was about $30 million.

$30 million in this quarter?

Yes, third quarter, right.

Okay. Thank you.

Yes. Thank you. We will now move on to the next question. We do have a question from Charlie Gates with Credit Suisse.

Can one of you speak to the approximate size of the investment in subprime mortgages?

It is virtually none. I think we have $20 million in Alt-A and I think that is it. I think one of our companies, one of our investor companies had roughly $20 million, of which we have sort of a 10% piece. So a couple of million. But, Charlie, the answer is for all intents and purposes, it is none.

Second question, do you have a guesstimate as to what the off-balance sheet asset specific to the Greenwich property might be?

You mean how much our building is worth, Charlie?

Yes, sir, relative to what you paid for it.

It is probably worth more than $100 million above our cost.

My final question --

Is that a promise?

(laughter) Yes, sir. At this time. Do you see any implications for Company of the horrible fires in California?

For us, none. Should not be much. If there is exposure, it is going to be -- it should be de minimis exposure. I really cannot imagine that there will any --- there will be none that we go out there and write other than -- that we know of.

By that, I mean, could we have $5 million or $10 million or $20 million or $30 million, it surely is possible. But nothing that would have any consequential financial impact on the Company. And it would because -- I don't want to give you a more precise number. Because we think we know, we might miss one building that's on some schedule of some something, but as far as we know it's virtually nothing.

Thank you.

(OPERATOR INSTRUCTIONS) Mr. Berkley, it appears there are no further questions at this time.

Okay, thank you all very much. We continue to be optimistic about being able to generate the kinds of returns we've seen. While it's always a challenging environment, we continue to believe that next year will offer us great opportunities to continue to do well and substantially exceed our targeted returns. So with that, thank you all very much. Have a great day.

Thank you. That does conclude today's conference call. We thank you very much for your participation. Have a great day.