W R Berkley Corp (WRB) 2014 Q2 法說會逐字稿

Good day, and welcome to WR Berkley Corporation's second-quarter 2014 earnings conference call. Today's conference is being recorded.

The speaker's remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words including without limitation, believes, expect, or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates or expectations contemplated by us will in fact be achieved.

Please refer to our annual report on Form 10-K for the year ended December 31, 2013, 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. WR Berkley Corporation is not under any obligation, and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.

I would now like to turn the call over to Mr. William R. Berkley. Please go ahead, sir.

Thank you. Good morning.

We were very pleased with our quarter. We think it continues to demonstrate our capacity to generate returns in excess of 15%, and we expect that will continue through the year.

Rob Berkley is now going to talk about operating results, and then we will go over to Gene, who will talk about our financial results. And then, I will come back on and give you a general overview. So Rob?

Thank you. Good morning, everyone.

Market conditions during the second quarter remained somewhat of a mixed bag, not dissimilar to what we have seen over the past few quarters. The level of competition continues to vary greatly by territory, product line, and even down to classes within product line. The domestic insurance -- in the domestic insurance market, the casualty lines continue to be amongst the most promising, workers compensation in particular continues to be a bright point. Having said that, we would caution people not to paint with too broad of a brush, this can very much vary based on regions.

Property market in general is somewhat flattish. Having said that, cat exposed property remains under a growing pressure. Our speculation is this may be a result of the east increasing amount of property cat capacity that is available on the reinsurance market, and where the pricing for that reinsurance capacity has gone over in the past 12, 18, 24 months.

Professional lines continue to vary greatly. In particular, the excess public D&O and professional liability for large law firms is under a good deal of pressure. Having said that, by and large, the professional market is somewhat flattish, also not dissimilar from the property market, but there are a few product lines where there are opportunities to grow the business.

Consistent with our comments in the past, commercial auto remains an area of concern from our perspective in the domestic insurance market. We believe this continues to be an area that is poised for a hardening.

On the international insurance front, again it varies greatly by territory. Having said this, the UK and Europe overall remains exceptionally competitive. Additionally, the Canadian insurance market as well as the Brazilian market remains flavors of the day.

The global reinsurance market is a part of the industry that gives us the greatest reason for pause. There continues to be a lack of balance between supply and demand. Many participants appear to have an unquenchable thirst for premiums, which seems to be addressed through eroding underwriting discipline.

In regards to the Company, net written premium for the quarter was approximately $1.49 billion. This is an increase of 11% when compared with the corresponding period last year. This result was led by our domestic insurance segment, which grew at a rate of approximately 16%. 4 of the 16 points of growth was associated with rate, with the balance coming from exposure.

On the other hand, our global reinsurance segments net written premium was down 17%. This is primarily a result of market conditions, and our colleagues exercising the appropriate level of discipline. We applaud this behavior.

Loss ratio for the quarter was at 61.2%. This includes $40 million of cat-related losses. While this level of cat activity is modestly above what we had expected, generally speaking, this type of cat activity is not unusual for us in the second quarter, due to severe consecutive storms.

The expense ratio continued to move in the right direction, coming in at a 33.2%. This represents an improvement of more than 0.5 point when compared to second quarter of 2013. This progress is a result of many people's efforts, in particular our colleagues in the reinsurance segment. We expect this overall trend to continue, though on occasion we may need to take one step back in order to take two forward.

When you put all the pieces together, the Company achieved a combined of a 94.4%, which is more than 2 points of improvement when compared to the same period last year. While others are going to be going into some level of detail with regard to our balance sheet, I would offer the comment that we remain very comfortable with our aggregate loss reserves. This is demonstrated, not only by the $24 million of net positive development we had in the quarter, but also the fact that this is the 30th quarter in a row of net positive reserve development.

While it continues to be evident that this is not a classic insurance cycle, we remain quite encouraged by the number of opportunities that we see before us to achieve attractive returns. We remain focused on trying to find the appropriate balance or the optimal balance, if you would like, between rate increase and exposure growth.

As we examine our policy or numbers, our confidence continues to grow in our ability to improve our results on a reported basis from here.

Thanks, Rob. Gene, you want to go through the numbers, please?

Okay. Thank you.

As you can see, we did have a very strong quarter with a 55% increase in net income to $180 million, and a 65% increase in net income per share to $1.35. I will start with just a few more details on underwriting.

As Rob said, we -- our premiums grew 11% to $1.5 billion. The increase was led by the domestic segment, which grew 16%, with workers comp up 26%, and other liability up 15%.

International premiums increased 10% in terms of US dollars, and by 20% in original currencies. And if you look at the growth in terms of original currency, it was primarily from business in Australia and Latin America. Reinsurance premiums' decline of 17% was due to a decline in treaty business in both the US and the Asia-Pacific region.

Our overall underwriting profits increased 82% to $80 million. Our reported loss ratio declined 1.6 points to 61.2%, and our accident year loss ratio before cats declined 1.5 points to 6%. The accident year improvement was led by the domestic segment, which improved 3 points, as earned price increases continue to outpace loss cost trends.

Cat losses of $40 million or 2.8 points, were compared with $34 million a year ago. This year we had cat losses from 12 named events in the quarter, the largest of which was a $9 million 15 storm event in late April. Favorable reserve development was $24 million, and resulted from reserve releases from the domestic segment that were partially offset by a modest increase in reserves for the international business.

The overall expense ratio of improvement was 6/10 to 32.2%. It reflected a decline in both our net commission ratio and our internal expense ratio, and was led by our reinsurance business, which improved by 3.5 points. That gives us an overall combined of 94.4%, an improvement of 2 points from a year ago.

Investment income was down 3% to $139 million, as a result of the decline in the annualized yield in our fixed income portfolio to 3.7% from 4% a year ago. This reflects a reduction in our average duration from 3.1 years at June 30, down from 3.3 years at March 31.

Earnings from investment funds in the arbitrage trading account were in line with the prior year quarter. Realized gains were $109 million, up from $33 million a year ago. The gains in 2014 included a gain of $85 million from the sale of an office building in London. Our realized gains for the first six months were $162 million, and for the last 3.5 years were $619 million, which is an average gain of $177 million per year.

Pretax unrealized gains also increased by $189 million from the beginning of the year to $586 million at June 30. The average credit rating of our portfolio remained unchanged at AA minus.

Corporate and other expenses were in line with the prior year, except for the foreign currency movements. We reported a modest loss of $2 million in the quarter for foreign currency movements, which is in line with our average gain or loss for a given quarter or any given quarter, but much less than last year's second quarter, which had a gain of $7 million.

Our effective income tax rate was 31.6% in the quarter, compared to the 27.5% a year ago. The tax rate was higher in 2014, because a greater portion of our pretax earnings were attributable to income that is taxed at 35%. That includes realized gains, as well as underwriting income.

The 2014 tax rate on operating income, that is before realized gains, was 29.2%. That gives us a net income of $180 million, an annualized return on equity of 16.6% for the quarter, and our book value per share is up 10.5% from the beginning of the year to $36.20 at June 30, 2014.

Thank you, Gene.

So we were quite pleased with the quarter. We continue to try and find investment opportunities that will give us gains or income to maintain the decline in the interest rate, or to offset rather the decline in interest rates, as the nature of our business being primarily casualty requires investment returns to achieve our 15% goal. Which means given the interest rates and given our desire not to extend the durations, which we think adds substantially to our balance sheet risk and the risk to our owners, and given our desire not to change the quality of our portfolio materially, we conclude the only alternative is to go for gains, that, while not as easy to model, offer some fairly predictable over an extended of time, gains.

And as I continue to say, this was a particularly good quarter. What we are hoping for is sort of $25 million or more a quarter, and we will be able to deliver on that from our ordinary portfolio. And we would expect that we will be able to continue that going forward, and that is still our objective.

The building we bought, we bought with the expectation of selling it, not to hold it for a long time, it was a good opportunity to sell. We have other real estate that we will own for very long time, and other real estate that we own with the goal of selling it. We continue to work hard to find alternative investments, and we believe we will be able to continue achieving the goals that we have set forth.

The basic business is more competitive than we would have expected, but as Rob mentioned, price increases still exceed loss cost trends. That is a good thing. It makes us want to grow and expand where we can.

That doesn't mean we are going to grow and expand everyplace. It means there are plenty of opportunities. You have to find them, and you have to find ways to take advantage of them.

So we think it will be an excellent year. We think we will achieve our 15% after-tax goal. And we are quite enthusiastic over the balance of this year, and we don't see anything that is going to change dramatically next year.

With that, Andrew, we are happy to take questions.

(Operator Instructions)

Amit Kumar from Macquarie.

Thanks, and good morning, and congrats on the quarter.

Thanks.

Just a few questions. So the first question relates to the discussion of domestic insurance, on pricing exceeding loss cost. Could you sort of help us understand how you expect the pricing versus loss cost delta to play out for the remainder of 2014, and at what point does it inflect?

This is Rob. Our view right now is that, we are probably getting give or take, around 200 basis points over loss costs, as being additive to margins if you will. I think trying to speculate exactly how it will unfold over the balance of the year, we will have to see. Having said that, our hope and beyond hope actually, expectation based on what we are seeing so far is, give or take where we see things now is not a bad indicator for where we see things over the next, call it six months.

Got it. I guess, the only other question I have is going back to the discussion on comp, and I know we discussed this in Q1, too. How we should we think about, I guess, that new business component versus the renewal business component in this unit? I guess, I am trying try to segregate out the impact of pricing versus areas where others might be withdrawing due to issues?

So your question is the growth that we are having, how much of it is driven by rate versus exposure? I am not sure that I -- ?

Yes. Yes, that's correct, and comp specifically.

Yes, honestly, it really varies by territory. There is certain areas of the market where we are very happy with the returns that we believe that we are achieving, and we are willing to accept rate increases that are very modest. And actually in some cases, we may be willing to accept rate that is -- are flat with expiring, because we are encouraged again, by what the return opportunities are.

Having said that, there are other parts of the country where from our perspective, you need a meaningful amount of additional rate to achieve those returns. When you look at our overall growth in comp, I think you would be fair to assume that it is some combination, but it is going to vary -- as far as exposure versus rate, but it is going to vary by territory.

Okay. That's all I have. Thanks for the answers.

Amit, one thing you might take note of --

Yes.

That surprised everyone, and that is medical costs last year went down for Medicaid, which was a real surprise to everyone. So when we talk about loss costs and trends and looking ahead, I think there is so many new variables with changes, it is a tough thing to predict for anyone out far ahead.

Got it. Thanks for that clarification.

Vinay Misquith from Evercore.

Hello, good morning.

Good morning, Vinay.

This is actually Max Zormelo on Vinay's line. My first question is on share buybacks. There is quite a pullback this quarter, and I am wondering if that is a function of the growth opportunities that you see in the market, or if it is just your stock price? Can you give us some color on that, please?

As we have always told people, we are opportunistic buyers of stock. It takes several things. Number one, it takes a price we are willing to pay, and number two, it takes availability of shares. Because the nature of our rules, we can't just drive the stock up, we have to buy in certain environments. So when the stock starts to move up, we are not in the marketplace, we can't be. We can't drive stock up. So we have to have availability on down ticks.

We can't buy in all kinds of issues with -- when we are in a blackout period. So after the end of the quarter, when actually there were some times we would have liked to buy, we couldn't buy it, because we were blacked out. So, no, we haven't changed our view. We still have an appetite to buy stock back, and no, it is, it looks more trendy than it is. It is just the way the opportunities fall out, given our judgments, and what the market does at any moment in time.

Okay. That's helpful. Second, I have a couple of numbers ones. The tax rate, as you mentioned in the prepared remarks was higher, and I am just wondering what drove that? And also going forward, what should be the expected tax rate for the rest of the year?

It's too high. I can tell you that. Over to -- Gene?

Yes. So what drove it is, is a greater proportion of our taxable income in the quarter was -- more stuff is taxed at 35%. So the realized gains were up -- very large in the quarter, that's all 35%. And the underwriting is growing faster, the earnings from underwriting is growing faster than the earnings from investment income, that is taxed at 35%. So you see that trend when that happens.

One of the problems, if you could take the position of somebody who is trying to model this is, if you don't count the capital gains as income which is 35%, that raises the tax rate because it is so significant overall, probably by, at least 2 points, maybe 3. Because that is at a full 35%, whereas the non-capital gains probably is more like 28%. Do understand what I mean?

I understand. And I did take that into consideration, but I think it still comes up closer to 30%, right? ( Multiple Speakers)

I think it comes up to around 28.5%.

Okay. All right. Thanks for that. And then one more if I may, please -- (Multiple Speakers).

By the way, that's too high anyway, so --

The 28% is still too high, right?

28%, I think is 28.5%, but yes, it's too high, it's terrible. (Laughter).

But would you expect the full year to come at around the same rate?

I would expect on ordinary income, the full year will be around the same, maybe slightly lower, but not much.

Okay. Thanks for that. And then last one, the expense ratio in the reinsurance segment declined quite meaningfully this quarter. I am wondering if there is some one-time items in there?

No, I think that -- well, there may be a little bit of that, by and large it is a reasonable one rate to assume going forward. Having said that, obviously, if we try to expand the business or develop it in other territories, there could be some expenses associated with that. So long story short, if the business continues with the platform that it has today, I think what you saw is a reasonable run rate.

All right. Thank you.

Michael Nannizzi from Goldman Sachs.

Thank you. I just have one question on reinsurance and kind of the market conditions there. Are you looking to sort of take advantage of better terms and conditions in your reinsurance buying? It looks like the CD percentage didn't go up, but I am just trying to understand how we should think about that lever for you going forward? Thanks.

Mike, this is Rob. As it relates to -- from the perspective of us being a buyer of reinsurance --

Right.

Or receiving business, we are certainly aware of market conditions and what the market will bear. And there is always the tug-of-war between is, it that attractive and that compelling, the type of ceding commission you can get that it overwhelms what you believe is the underlying profitability of the business, and would you rather retain it?

And we buy more than 100 different programs, and we go through them one by one, and trying to examine, are we better off buying or are we better off retaining? Additionally, as we talked about I believe it was last quarter, we are examining in general, whether we should be buying the same amount to the same way going forward.

Got it. And then --

I think we could add a little bit to that, Michael, and say, that clearly we understand what is going on in the marketplace. And where our opportunities are appropriate, we will take advantage of it. But our own business is getting better. So you need -- you have to look at the changes in your own business vis-a-vis, the changes in terms and conditions.

Got you. Okay.

I will just add one quick point to that. The gross premiums for the quarter are up 10%, and the ceded premiums, the written premiums for the quarter are up 2%.

Right. Got it. Okay. That makes it sense. And then, I remember there was a time when we talked about startups and kind of the amount of premium growth coming from sort of the legacy businesses, and the sort of start ups. And I know, we haven't really talked about those for bit, but just trying to get an idea of the sort of geography of the written premium growth. Is -- how much of that is coming from the more established platforms, versus maybe some of these newer platforms that have scaled, or recently scaled or are still scaling?

Yes, at this stage, Mike, as you have referenced a moment ago, in the past, a lot of the growth was coming from the younger operations. While they remain meaningful contributors to the overall growth, more recently as market conditions have continued to improve, we have seen a greater contribution from the more mature businesses. So depending on how you define startups or younger businesses, versus more mature businesses and where one wants that to draw that line, we could try and break out percentages for you. But having said that, I think at this stage, once it was safe to assume that there is a notable contribution coming from both mature businesses as well as some of the younger ones.

Great. Thanks. And then just a last one if I can. On the workers comp book, is the growth been balanced between excess and primary, or has it been more of one or the other? I am just trying to sort of balance the growth that we have seen there, which would seem to be exposure growth, I think in reference to a prior question as well. How do we balance this sort of competitiveness that you are seeing, with the continued opportunity that you have found for growth there? Thank you.

Yes, the first part of the question, the lion's share of the growth is coming as the result of the primary comp, not the excess comp.

Okay.

And then, as far as what is driving the growth, it really varies by territory. There are some territories, where in order for us to be willing to write the business, we are looking for meaningful rate. There are other territories where quite frankly, we are very happy with the available margin and it is -- the growth is being driven by exposure.

Got it.

So it really can vary state to state, and then actually in some -- particularly in some of the larger states, it can vary by region within that state.

Got it. Great. Thank you so much.

Jay Cohen from Bank of America.

Yes, thank you. I am not sure I quite got this in the prepared comments, but I believe you said that the underlying loss ratio for the domestic business improved by about 3 points from the year earlier. Is that accurate?

Right.

I guess, Gene, then the follow-up or the question is, it looked like overall for the Company, the loss ratio got better by about 1.5 points, which would suggest, obviously, there is pressure elsewhere. We don't see the actual number yet, because we don't have the breakdown of the development, but where is that, where is the pressure coming from that is offsetting the improvement in the US?

Right. There is some increase quarter over quarter in the international (inaudible) year loss ratio, although it's very good, below 60%, but it is a little bit higher than it was a quarter ago. And reinsurance is -- not changed too much.

What is going on internationally? Is that just kind of one-off event, or is there real underlying pressure on the margin. Should we expect that to continue internationally?

Well, as I said, I think it's -- in terms of loss ratio is still pretty good. It's just slightly higher than what it was a quarter ago, so it's not a -- not something that is going to be a problem going forward.

Okay. Thank you.

Josh Shanker from Deutsche Bank.

Yes, good morning. My question revolves around the alternative investment portfolio. Historically, it has been fairly correlated with the prior quarter's market returns, and which were flat. It did have a very nice quarter in Q2 2014. I am wondering if composition has changed at all?

No, not really. (Multiple Speakers). I think that several -- one of our big alternative investment portfolios achieved their hurdle rates. So they got -- their carry dropped in, which for a quarter or two will reduce our returns, as they get their hurdle rate caught up.

So it is nothing really -- it is going along, and it is doing pretty well. And I think that for the year, it will be in line with our expectations. But that is the only thing that has changed in the alternative investment portfolio.

So just -- I am not still familiar with the accounting. So this quarter had a little extra, which might come out a little bit in the next couple quarters?

I'm sorry?

Because if they have received their carry, you are saying, it was a little bit higher here and might be -- ? (Multiple Speakers).

No, what I meant is we, that the alternative investments didn't do quite as well as they might have, because we had -- we accrued the carried interest over the next two quarters for one of our big alternative investments. So the quarter we just reported and the next quarter, will be impacted as we -- as a significant portion of our investment returns will go towards their carried interest. But that, that is the only change in our alternative investments that impact -- the alternative investments had an excellent quarter in the second, and we would expect the same in the third.

Okay. Thank you for the answers.

(Operator Instructions)

And I am seeing no other questioners in the queue at this time.

Okay. Thank you very much. Have a great day. We are quite happy about where things are going, and we see a great balance for the year. Thanks.

Ladies and gentlemen, thank you for your participation in today's conference. This now concludes the program, and you may all disconnect. Everyone, have a great day.