IPC Holdings, Ltd. Q3 2008 Earnings Call Transcript

Oct.24.08 | About: IPC Holdings (IPCR)

IPC Holdings, Ltd. (IPC) Q3 2008 Earnings Call October 24, 2008 8:30 AM ET

Executives

James Bryce – President, CEO

John Weale – Executive Vice President, CFO

Analysts

Joshua Shanker – Citigroup

Susan Spivak – Wachovia

Jay Cohen – Merrill Lynch

Richard Diamond – Revolve Capital

Doug Mewhirter – RBC Capital Markets

Ron Bobman – Capital Returns

Jay Cohen – Merrill Lynch

Operator

Welcome to the IPC Holdings, Ltd. third quarter 2008 conference call. My name is Shawn Symons, Senior Vice President and Controller of IPC and with me this morning are James Bryce, President and CEO and John Weale, Executive Vice President and CFO.

During our discussions this morning we may make forward-looking statements and while these statements represent our best current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. As always, we recommend that you refer to our public filings including our annual report on Form 10-K for the year ended December 31, 2007 and our soon to be issued Form 10-Q for more details on the risk factors.

And now, I'll hand over to Jim Bryce who will talk about the third quarter earnings.

James Bryce

Good morning ladies and gentlemen. The third quarter is unique in that it is our peak risk period in terms of North American wind aggregates which are the largest exposures to our committed capital. The various predictions of an active wind season from some of the specialists were validated by the 11 PCS cat events which culminated in the hurricanes of Dolly, Gustaf and Ike making landfall in the quarter.

Third quarter losses totaled $11.5 billion as reported by PCS and current estimates have the cumulative number including losses both on and offshore running as high as $18.5 billion plus. This total would rival the third quarter losses of 2001 and could make this third quarter of '08 the equivalent of possibly the second or third worst quarter in the history of PCS. The third quarter of 2001 obviously included the tragedy of the loss event of 9/11.

The underwriting actions taken by IPC re post the events of 2004 and KRW in 2005 have demonstrated a dramatic impact in limiting our involvement in the loss events in this quarter. We had no marine and no offshore energy exposures which has substantially limited our loss events in the third quarter. We are basically looking at a break even quarter from underwriting and a 50% combined ratio for the nine months of 2008.

Production on the quarter appears to be up due to the reinstatement premiums but was actually down on base premiums primarily due to program restructuring at the first of July 2008. New business was virtually offset by business not renewed. However, market conditions are still quite healthy for property catastrophe business.

Weakening balance sheets in some instances byproducts of the sub prime situation created some increase in CAT requirements as reported in the previous quarter's earnings call. This in turn, created some buying spikes for national and Florida driven carriers which resulted in the brief surge and price in demand in the quarter.

Outside the U.S. there are continuing signs of weakening for renewals at mid year. In general, rates remain flat on U.S. business and on non-U.S. business flat to down in the single digit range at mid year.

Loss activity in the quarter was in line with the predicted higher number of loss events and as previously stated, the third quarter could come in as a record for the second or third most active quarter in the history of PCS.

The 2008 non-U.S. renewals will begin to be discussed in Baden Baden next week and will be coinciding with the PCR conference in Scottsdale, again next week. These conferences will give us a much clearer indication of renewal conditions for the 2009 year. I do believe that capital investments and not just rate increases will be the major topics of discussions in both of these conferences.

It is expected that current levels of capital will be much less at 11/2009 than at 11/2008. As such, demand and supply is expected to be out of balance and consequential pressure on pricing is expected to increase between now and year end. In addition, one does not know what is in store for events in the fourth quarter or from mother nature or from further financial hurricanes.

The current wild fires in California which are tragic will also have an impact on renewals but at this point in time, it is too early to measure. On that note I will now hand over to John Weale. John will give us some comments on the financials.

John Weale

I'm going to give some brief remarks regarding some of the financial aspects of our third quarter 2008 results focusing particularly on the investment portfolio. Given the tumultuous events in the financial markets during September and subsequently, I'm going to focus those comments on those aspects of our balance sheet and income statement.

As mentioned in the press release our losses on investments came from the three main segments of our investment portfolio, of the total loss, $108.5 million in the third quarter of 2008. $59.2 million resulted from declines in our fixed income portfolio. This included a loss of $9.7 million from Lehman Brothers securities including $0.1 million realized from the sale of $1.5 million par value in July.

$9.2 million came from Morgan Stanley securities including $1.8 million which was realized from the sales of $16.8 million par value in August and September. $4.3 million from Goldman Sachs securities including $.01 million realized in a $5 million par value sale in August and $3.0 million from Wachovia Securities including $1 million realized in a $5 million par value sale in September. The balance of the loss arose from widening credit spreads which impacted the debt securities of many financial institutions.

Net losses from our equity portfolio totaled $32.8 million. Of this amount, $21.8 million was derived from our investment in a global equity fund and $7.5 million from a North American equity fund.

On September 12, 2008, we redeemed a $62 million investment in a futures fund which sought to replicate the performance of the S&P 500. This resulted in a very small loss in the quarter but represented a small gain in comparison to cost.

We incurred an unrealized loss of $18.3 million from our investment in a funded hedge fund in the third quarter 2008, most of which arose from movement in the month of September. Although we typically report the net asset value of the fund one month in arrears, given extraordinary events towards the end of the quarter, we have used an estimate of performance in the month of September as provided by the fund manager.

During the quarter we made a small allocation to mortgage backed securities. At September 30, 2008 this represented 5.8% of our total fixed maturity portfolio and 4.4% of our total investment portfolio. The decision to invest in this had been made much earlier in the year with the strategy being to focus predominantly on agency pass through securities. The purpose of this allocation is to provide greater diversification to the overall fixed maturity portfolio.

However, with the difficulties faced by the government sponsored agencies several months ago, we chose to defer funding that allocation until July and August 2008. Since that time, the allocation has performed as we hoped and at September 30, 2008 had generated a small gain of $1.8 million.

At the end of September 2008, our unrealized gains and losses were as follows; a net loss of $36.7 million from our fixed maturity portfolio, a net gain of $1.8 million from our mortgage backed securities portfolio, a net gain of $30.3 million from our equity investments and a net loss of $17.4 million from our investments in funded hedge funds.

We benefited from strong net operating cash flow in the third quarter 2008 of $92.5 million compared to the $87.7 million generated in the third quarter of 2007. We also generated $17.9 from net purchases of [inaudible] in our investment portfolio during the third quarter of 2008. During the same period we used $113 million to pay dividends and to buy back shares.

This effectively completed our share repurchase authorization as provided by our Board of Directors back in February of this year. Given both the physical and financial hurricanes that occurred during the third quarter of 2008 and the impact they have had on shareholder equity, there are no plans to authorize any further repurchases at this time.

Fully diluted book value per common share was $33.41 at September 30, 2008. Hopefully from next quarter on, many of you will find the calculation of the diluted number of shares a lot easier to estimate because of November 15, 2008 the conversion of our mandatory convertible preferred shares will take place.

On October 22, the Board of Directors declared a quarterly dividend of $0.22 per common share. This amount will be paid on November 28, 2008 to shareholders of record on November 13, 2008. In addition, the Board also declared final preferred dividends of $47.5781 per preferred share payable on November 15, 2008 to shareholders of record on November 3, 2008.

On that note, I'm now going to hand back to Jim who will open the Q&A session.

James Bryce

Operator, I'll now take any questions which we may have from the audience.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joshua Shanker – Citigroup.

Joshua Shanker – Citigroup

You have $70 billion of hurricane, $12 billion, $13 billion, something to that affect maybe those numbers will be higher. Reflecting on what you've learned about 2005, did the changes you made to your book and the changes the industry made causes that this type of storm season impacts you in the way that you believe your protection should be bought and the way that you should take losses?

James Bryce

The 2004 year was really the year of the frequency and that had us take a second look at both aggregate covers and second and third loss event covers. The 2005 events really showed us the extreme severity we would get primarily with Katrina but also to a lesser degree with Rita and Wilma.

As a result of that, we substantially increased pricing. Retentions went up dramatically. I believe we said that previous to '05 events in the $2.5 billion to $3 billion range would impact programs following events of '04 and '05. For national accounts, we're really looking in the area of $7.5 billion to $8 billion to affect national programs.

In terms of the loss events of this year, it pretty much fell in line with the retentions on the small to medium events or primarily on the retentions of our clients, impacting their income statements and to a lesser degree, balance sheets.

So yes it did fall in line with what we expected. We also took the posture of not doing offshore energy and marine because obviously in places especially like the Gulf, they all do correlate in the same loss event.

Joshua Shanker – Citigroup

In talking to your customers, have you found any sense that it didn't go quite as well as they had thought? They felt that they were expecting to get more protection than they actually received or is this the outcome they expected as well?

James Bryce

I don't think anyone envisioned the financial hurricanes. I think most of our clients are now looking at weakened balance sheets so it's not really what they anticipated in terms of the natural catastrophes. But the combination natural catastrophes and the financial events, and I guess in this quarter it was very unusual that both our fixed income and the equities were all down in addition to the financial hurricane.

I think it was a bit of a surprise for many of our clients in terms of the impact of not only the storms, and I guess in the first six months also the per risk losses, but all of that was really culminated with the financial hurricane. So it's pretty much a surprise to many of our clients.

Joshua Shanker – Citigroup

2004 and 2005 caused you and the industry to reevaluate how you think about CAT liability risk, not the industry but IPC in general, have the events of 2008 caused you to say, "Maybe we need to reevaluate how we do our asset risk", or in the end given the severity of this event, are you actually somewhat pleased with how the portfolio reacted?

John Weale

I think as Mr. Greenspan said yesterday, this is a 100 year event on the financial side. I think this is the first time in certainly close to 40 years that you've had a period where both equities and fixed income were both down so dramatically at the same time.

Our portfolio is structured to get the benefit of diversification in difficult times when typically it's either one asset class or another that gets hurt and that typically is offset by the performance of the other. I guess to that extent, yes, we are a little disappointed in the fact that both asset classes and of course hedge funds as well got hurt all at the same time. It's hopefully a very unusual period in financial history.

Operator

Your next question comes from Susan Spivak – Wachovia.

Susan Spivak – Wachovia

Could you remind us how much of your business comes from AIG and whether you're currently seeing an increase in demand from them or will there be an overall decrease on your portfolio given the events of the recent weaker, or whether it will matter because there will be so much increased demand regardless?

James Bryce

I think right now we're in the single digit percentage from AIG. They have substantially increased their retentions along with the entire market in the last few years so premium has been falling off even though rates have been going up. Demand is going to be taking off from virtually everyone. AIG is in the process of reorganizing, reevaluating exposures, really trying to measure what they need for the 1/1/2009 renewals.

I think it's still a bit early for them to be projecting what their needs are and obviously without their advice we can only guess, but I think there will be plenty of business out there at 1/1/2009.

Susan Spivak – Wachovia

Do you have any recent examples over the last couple of weeks where new programs have come into the market indicating what will be in January '09 or do you expect to see much more of that at PCI?

James Bryce

I'm seeing some renewals came in from October 1. Price levels are starting to move up. I guess there were some surprises with the brokers in London where renewal capacity which is almost taken as a given was not available in Lloyd's at October 1. That could cause some shock and awe in addition to not only the financial hurricanes but the fact that capacity is becoming a bit of a premium.

I think the discussions and meetings we've had with two of our employees in the U.K. last week, the discussions are really centering around our investments and all the insurers' investments. I guess the security issue respect to the balance sheet becoming very major points of consideration. Obviously we've got a very clean and transparent balance sheet so we can field those questions quite easily.

Susan Spivak – Wachovia

Recognizing that it is still so early with the world in flux, what would you expect to see in terms of the magnitude of rate increases in this type of environment come January?

James Bryce

I'm actually on my way to Baden Baden tomorrow, so I would think we're looking at double digit. The degree of double digit will really vary on supply/demand. I guess the fourth quarter in terms of financial wind storms, we've had a few of those already in October, and of course the wildfires in California. It's still pretty early to tell but most certainly supply and demand is going to be out of balance.

Susan Spivak – Wachovia

So we went from pressure to down rate to double digit increases.

James Bryce

At 1/1/2009.

Operator

Your next question comes from Jay Cohen – Merrill Lynch.

Jay Cohen – Merrill Lynch

Do you have the paid losses in the quarter?

John Weale

Paid loss net net paid claims in the quarter were $31.6 million.

Jay Cohen – Merrill Lynch

The exact number of share you bought back in the quarter and the average price.

John Weale

We bought 3.3 million shares during the quarter at an average price of $29.53.

Jay Cohen – Merrill Lynch

With Katrina, a lot of insurers walked away feeling quite surprised, and reinsurers about the ineffectiveness of some of the models and how wrong they were. Obviously that caused a major change in risk perception. Do you get a sense, are they any lessons to be learned from Ike for the industry? Anything surprising that the models didn't work or diversification didn't work. What are your views on that?

James Bryce

Of course the models primarily for onshore, no one to my knowledge has developed an offshore model that's very accurate and also marine is very difficult because of the fact that you've got these vessels constantly moving. I think that models give us an estimate, a direction of where we think the loss is going to end up, and we really rely on PCS which is the property claim service for the actual totaling of the claims as reported.

The thing that's surprising to me is the fact that the PCS numbers recorded to date is so small because in terms of Ike, it's recording a loss of only $8.1 billion for onshore. We're looking at almost double that figure of $14.5 billion.

I think it's something that, the models are getting better over time, but we've got to remember they give us a reasonable range, but they'll never give us an exact answer.

Operator

Your next question comes from Richard Diamond – Revolve Capital

Richard Diamond – Revolve Capital

Looking at the long term forecast with the reduction of the number of hedge funds and their capacity, if they leave the reinsurance business what difference would that make to long term pricing?

James Bryce

The hedge funds have got two things. They've go the funding on an ongoing capacity and the fact that they're going to have to leave collateral up for the outstanding liabilities for not only the '08 but prior years. I think if we see dramatic reduction in the hedge fund capacity, there's going to be quite a dramatic shortage of capacity.

I think the thing that would be very interesting is what a shortage of capacity would do to the financial strength up-gradings of many of our clients because we have clients that use model to model, usually recalibrate after major events. I think if hedge funds disappeared, pricing would probably dramatically increase almost to the extent of what we saw post Andrew back in 1993.

I can't envision that the hedge funds will completely disappear. Of course, we also have the fact that the CAP bonds which have been around for awhile are also a rather attractive investment. I think capacity will diminish. Prices will go up. But I don't think we're going to see a dramatic disappearance of any of the capital providers.

Richard Diamond – Revolve Capital

If there was a significant withdrawal from hedge funds from reinsurance could it be a 20% or 30% driver medium term?

James Bryce

I would say that's probably not a bad guess. That's really what we saw post Andrew and what we saw post Katrina. The amount of capital loss not just from the catastrophes but from the financial events, it's very similar in terms of what's happened to the balance sheets.

Operator

Your next question comes from Doug Mewhirter – RBC Capital Markets.

Doug Mewhirter – RBC Capital Markets

It looks like it's going to be a sellers market come January. How does that weave in with your new tighter risk management? It seems that you reduced a lot of your aggregate coverage. It seems like you went up the tower a little bit. If someone approaches you and says, "I need to buy a much lower retention", are you going to be willing to go back down the tower a bit or are you still going to be somewhat restrained and let some other person fill in under you and you would just take a higher rate to stay where you are?

James Bryce

We really don't believe in trading dollars. A 50 online, one in 100, you could most certainly almost guarantee that you're going to have a loss. As you're signing the slip, I tell the underwriters, 'You probably should be signing the check at the same time for the loss statement."

We're going to stay at the current levels. Prices will be moving up, it's just a question of how much.

Doug Mewhirter – RBC Capital Markets

If you converted your mandatory preferreds today, what would the exchange ratio be?

John Weale

It would be one to one. It has to be average price over the last 20 days, and if it's below 26, 25 which is where we've been now for at least a week, and certainly the assessment period or the period during which the conversion price is calculated is in effect. So I would say right now, we're definitely going to be going at one to one. We will be converting nine million shares and that bares a dramatic increase in the share price between now and November 11.

Operator

Your next question comes from Ron Bobman – Capital Returns.

Ron Bobman – Capital Returns

Is the company issuing nine million shares at $26, $25? Is that the way to think about the accounting impact?

John Weale

We're just issuing shares. There's no financial impact. There's no change to our balance sheet other than the number of shares outstanding. There's no money changing hands here. The funds were received back in November 2005. It was just a question of what the final number of shares we were going to issue was going to be.

Up until September it was going to be somewhere between seven and a half million shares and eight and a half million shares. Clearly with the decline in the share price over the past couple of weeks, it's now it will definitely be the maximum number which is nine million.

Ron Bobman – Capital Returns

On the equity account, we'll have a movement from convertible preferred outstanding just to common equity, right?

John Weale

Correct.

Ron Bobman – Capital Returns

I think I'm right in assuming that no one leaves Baden Baden on the client side with signed contracts but I assume that your clients and buyers, do they leave there with a hand shake and an understanding that the reinsurer will be playing in a certain size at a certain level at a certain rate, or is that even beyond the degree of discussion and informal commitment that's provided by reinsurers. With such a world of flux, I'm trying to understand what exactly the buyers walk away from the event with.

James Bryce

Baden Baden PCI usually is the beginning of the negotiating process for pricing. This year clients are going to want to get indications and commitments as soon as possible and quite frankly, reinsurers including ourselves are not going to be in any rush to commit until January 1, '09.

I think the conversations with two of our employees this week in the U.K. will really center around the balance sheet. They want to get a comfort level on the transparency and the composition of assets. After that comfort level is achieved, then they'll start to talk about pricing.

I think we're still in a state of flux in terms of the hedge fund capacity. I think there's a lot of moving pieces, so I think people will want to have reassurance that you're still around at January 1, '09, you still have capacity. As I mentioned before, this sudden withdrawal of renewal capacity took many of the brokers and clients by surprise at October 1.

I think we're probably going to see more of that and I think people at Baden Baden PCI will really be looking for some type of a comfort level that capacity is available. And by the way, we'll discuss the price later on as we get closer to the January 1 renewal and as we see better transparency on the balance sheets.

Ron Bobman – Capital Returns

What would you determine to be adequate pricing for this upcoming renewal season, wherever the market takes it to be, but is it at a level above or at what you consider adequate. How much more capacity do you see yourself capable and willing to write as compared to what you wrote for the trailing exposure period?

James Bryce

We're really setting our capacity as a percentage of our capital and we really have to see what our capital position is at the end of November, beginning of December. Right now we're looking at pretty much a level capacity so if we wanted to get something additional, we would have to explore something like a sidecar if that avenue would be available.

Ron Bobman – Capital Returns

I had a question about stock price relative to reported book value. Is there a stock price where the view changes on the buy back? So many things that up to this point have been inconceivable have occurred in the world so as it relates to stock pricing, I have to consider those to be a lot of those inconceivables to be conceivable. Is there a number or a level where that plan changes?

James Bryce

We don't really have a number. These are things that are discussed at every Board meeting, both the share price which obviously our success is enhancing that share price to levels above our book value. In terms of share buy backs we have not come up with a number.

John Weale

My comment at this point goes back to the first question you asked, and that's the amount of capacity we have available compared to the past 12 months. Clearly our capital position has taken a hit from the falling value of our investments, the unrealized losses. At this point in time if we were to undertake further share buy backs it would only reduce our capacity which would not be a sensible thing to do with expected market conditions from the next 12 months or longer.

We're anticipating a significant improvement in conditions and this is not really the time that we would continue to think about reducing our capacity. If anything, we're looking at the same level of capacity or more through possibly a sidecar or other forms of capacity.

Ron Bobman – Capital Returns

It sounds like from your comments and it sure looks like it from the world that this is not going to be a one step up in rate levels to only return six months later to '07 or early '08 or '06 levels. It looks like July of '09 is going to be higher than 1/1/09 and January '10 is going to be higher than January '09.

John Weale

I wouldn't like to predict as far as January 2010 renewals.

Ron Bobman – Capital Returns

You are making a bet by deploying all capacity at 1/1/2009 to that affect. You are making a bet with the capital.

John Weale

We do that every year.

Ron Bobman – Capital Returns

What's your personal view about personally buying stock, individually?

James Bryce

I'm going to look to get to that as soon as my window opens which I believe is next week.

Operator

Your next question comes from Jay Cohen – Merrill Lynch.

Jay Cohen – Merrill Lynch

The conversion of these convertibles, when you talk about diluted book value currently, you're already taking into account that conversion, is that correct?

John Weale

Correct.

Jay Cohen – Merrill Lynch

So your diluted book value per share doesn't change and your diluted EPS shouldn't change either.

John Weale

Correct. The only difference obviously would be the level of conversion because at September 30 our diluted book value per share is based on the level of conversion using September share prices. So at September 30 I would guess that the amount of dilution from the preferred was probably about eight million shares and the actual conversion at this point in time would appear to be more likely to be nine million shares.

There will be a slight additional level of dilution as a result of the change in our share price over the last three weeks.

Operator

You have a follow up question from Susan Spivak – Wachovia.

Susan Spivak – Wachovia

Help me better understand exactly what happened at Lloyd's with the renewal pricing and what the impact on the market that is.

James Bryce

It was a major program coming up for renewal October 1. Generally clients and brokers without getting advance warning assumed that renewal capacity is available because if it's not generally you'd be reading an AK or some kind of announcements. No announcements were made and when the renewal lines were due to be put down on the October 1 renewals, the brokers were advised by the underwriters that there was no capacity left for the year.

That caused in turn very nervous brokers to try to complete the covers which to my understanding, some of them were completed on short fall covers which are not in current terms paying a little bit more just to get the thing home. It's a little bit of a stress situation.

Susan Spivak – Wachovia

When was the last time you ever saw that occur in this market?

James Bryce

The last time was really in the '05 year with KRW. I guess before that it was 9/11 and before that it was post Andrew.

I think we've got a very full call today. I thank everyone for your interest in IPC. The comments on the share price make for a compelling reason to buy our shares. Hopefully that sentiment will be shared by many including employees and thank you very much for you good questions and your interest.

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