Montpelier Re Holdings Q3 2008 Earnings Call Transcript

| About: Montpelier Re (MRH)

Montpelier Re Holdings (NYSE:MRH)

Q3 2008 Earnings Call

October 24, 2008 8:00 am ET


Jonathan Kim - General Counsel and Secretary

Chris Harris - President and Chief Executive Officer

David Sinnott - Chief Underwriting Officer

Mike Paquette - Chief Financial Officer


Matthew Heimermann - JP Morgan Securities

Rohan Pai - Banc of America

Amanda Lynam - Goldman Sachs



Greetings ladies and gentlemen. Welcome to the Montpelier Re Holdings Limited third quarter 2008 conference call. (Operator Instructions) it now my pleasure to introduce your host, Mr. Jonathan Kim, General Counsel and Secretary of Montpelier Re. You may begin.

Jonathan Kim

Thank you. Welcome to Montpelier Re's third quarter 2008 earnings conference call. A press release setting out our results, together with a detailed financial supplement have been posted to the company's website at This call is being webcast live and will be available for replay until November 24, 2008. Our speakers today are our President and CEO, Chris Harris; David Sinnott, our Chief Underwriting Officer; and Mike Paquette, our Chef Financial Officer. Chris and dividend will give their commentary on the quarter, and then Mike will present an overview of financial results. We will then be pleased to take your questions.

During our discussion this morning, we may make forwardlooking statements. Any such statements are based on the company's current plans, estimates, and expectations. Actual results could differ materially from those projected in any forwardlooking statements as a result of certain risk factors disclosed previously and from time to time in Montpelier's filings with the U.S. Securities and Exchange Commission. The company undertakes no obligation to publicly update or revise any forwardlooking statements whether as a result of new information, future events, or otherwise. I would now like to turn the proceedings over the Chris.

Chris Harris

Good morning. One of the advantages of stubbornness is that you never need to change your opinion. We could adopt a stubborn approach, ignore the impact of widespread investment losses, weakening insurance and reinsurance balance sheet, ignore the impact of Ike and Gustav, causing $15 billion plus of insured losses, ignore the impact of trapped collateral and likely reduced reinsurance capacity from the capital markets, and assume the price of risk continues its yeartodate downward slide across virtually all lines. We actually see all of these factors either directly reducing the supply of capital or arguing for higher return hurdles.

Based on discussions with a variety of feeding companies, we also expect to see increased demand for reinsurance, driven by several sources, including weaker capital adequacy positions and shrinking risk tolerances. As a result, we have become more optimistic in our outlook for 2009 since last quarter as we expect to see increased opportunities for all of our underwriting platforms. Within the U.S. operations specifically, we may benefit from potential clients expanding their list of insurance and reinsurance partners in order to lessen concentration risk.

We remain comfortable with our current capital level. However, in our internal assessment, the pendulum has shifted from heavily in favor of share buyback to a more neutral capital management position. We will monitor the upcoming renewal season closely. If underwriting opportunities emerge above our current expectations, we will consider deploying our contingent capital.

A couple of specific comments on this quarter. While it is disappointing to suffer a loss in any quarter, both our underwriting and investment portfolios held up well in challenging times. As regards to the $130 million net financial impact from Ike and Gustav, which is in line with our earlier preannouncement, we expect 90% to 95% of the net impact from Ike. The Ike estimate includes a total loss on our $52 million [TWEA] net line. Further, we expect the loss to be concentrated in our property CAT bucket, among personal and small commercial line writers. I will remind listeners that we do not write any offshore treaty exposures.

The quarter benefited from $23 million of prior year reserve releases, twothirds of the release was due to reductions in our estimate for specific prior year CAT events, namely the hurricanes of 2005 and the 2007 European losses.

One last item, last night we announced that we had received approval from Lloyd's for the establishment of our own wholly owned managing agent. Montpelier Underwriting Agencies Limited will assume the management of Montpelier Syndicate 5151 for the 2009 underwriting year of account with effect from January 1, 2009.

Our organic twostage approach to entry into the Lloyd's market has delivered a complete Lloyd's franchise, one which is integrated from inception into the Montpelier group, risk management, and underwriting philosophy at a fraction of the cost of an outright acquisition. The formation of our own managing agency represents the latest step in a series of strategic initiatives we began in mid2006.

We now have operations in four countries, employing three different insurance licenses. This broader platform should allow us to take greater advantage of the opportunities that we believe will increasingly present themselves. With that, I will turn it over to David.

David Sinnott

Underwriting conditions remain challenging during the quarter, though we managed to renew the majority of our business at acceptable terms and continue to attract new opportunities to our Lloyd's and U.S. platforms. The impact of Hurricanes Ike and Gustav, while together a significant financial event, is in line with expectations and underscores the validity of our catastrophe management policy.

For the majority of classes underwritten by Montpelier Re, pricing continued to trend downward in the third quarter, albeit at a reduced rate. For the underwriting year to date for all regions in all segments of our operations, the premium weighted renewal price index for both property catastrophe and property specialty is down 9%. Other specialty has declined 11%. And casualty is down 8%.

Property catastrophe renewals at July 1 benefited from a tightening end supply of nationwide and Florida exposed wind capacity and less favorable terms available for outward retrocession protection.

Additionally, pricing for several large European catastrophe placements recently transacted at October 1, bell weathers for our January 1 international renewals with stable year to year. The trend towards rate stabilization in our direct and facultative excess book mentioned last quarter is more pronounced now, owing to a full recognition of risk losses in the first quarter of 2008 and to initial indications of a market dislocation in this space.

Other specialty lines remain competitive during the quarter. We continue to reduce our exposure to personal accident and workers' compensation excess of loss programs as the catastrophe and terrorism capacities require therein are more efficiently utilized in property lines, given current price levels.

Aviation reinsurance and retrocession have declined by 11% yeartodate, but may get a lift from anticipated increases in primary rates.

In casualty reinsurance, we continue to see a general relaxation in terms and conditions in medical malpractice and other specialty casualty lines. This deterioration has resulted in the further shrinkage of income in this class. While we do not see any evidence of immediate tightening, we were keeping a watchful eye on developments in light of current market upheaval and may commit additional resources to these areas if market opportunities warrant.

Casualty insurance, written on an excess and surplus line basis for MUSIC and a programs division of our U.S. agency operations is less prone to the cyclicality associated with reinsurance book. These operations are now fully resourced and will begin to contribute more significantly to our revenue growth in the near future.

Total gross written premiums for the third quarter was $103 million as compared with $128 million in the prior year, a decline of 20%. In addition to price declines, income for the quarter was negatively impacted by our decision to non-renew certain inwards retrocession treaties written in our property catastrophe segment in the third quarter of 2007, which capacity was effectively redeployed to expanded lines on Floridaspecific business in the previous quarter. Additionally, we registered a negative variance of approximately $8 million, attributable to certain nonrecurring items.

Looking forward to the fourth quarter and into 2009, we believe the stage is set for significantly improved trading conditions across our underwriting portfolio. From a demand perspective, the cumulative impact on primary carriers’ balance sheets of asset impairment and outside natural catastrophe losses in the U.S. during the first nine months of 2008 will result in a heightened level of scrutiny on security ratings and increased demand for traditional reinsurance.

At the same time, we also believe the current turmoil in financial markets will limit capital flows into the reinsurance sector, which coupled with an upward shift in demand will result in tighter terms and conditions.

In this market environment, we think Montpelier Re will be well positioned to achieve a more optimal utilization of its catastrophe exposed aggregate and take advantage additional opportunities through Syndicate 5151 and our U.S. agency operations.

At this point, I will now turn the discussion over the Mike Paquette, who will comment on the financials.

Mike Paquette

Our third quarter 2008 results were driven by sizable losses from both major storm activity and a meltdown of the worldwide financial market. Fully converted book value per share decreased $1.63 during the quarter to $16.61, an 8.5% decline considering our dividends and the resulting comprehensive loss for the period was $142 million or $1.69 per share.

Our operating loss for the third quarter of 2008 was $55 million, or $0.65 per share versus operating income of $78 million or $0.82 per share a year ago. The loss ratio for the third quarter of 2008 was 120% which includes $152 million of net losses or 113 points from Hurricanes Ike and Gustav. When considering the resulting reinstatement premiums and reductions in variable compensation, the net financial impact from those 2008 storms was approximately $130 million.

Also included in the current result was $23 million or 17 points of prior year favorable developments.

Gross and net premiums written during the third quarter of 2008 were down about 20% from a year ago as premiums from our new operations did not fully offset reductions experienced in Bermuda. Net premiums earned were essentially flat quarter to quarter, although the current period includes $8 million of reinstatements versus $4 million a year ago.

As our new operations continue to ramp up in the coming quarters, premiums will begin to earn more heavily through the income statements.

Net investment income for the third quarter of 2008 was $21 million versus $32 million a year ago. The decrease is the result of lower yields on lower float.

General and administrative expenses for the third quarter of 2008 were $18 million versus $23 million for the comparable 2007 period. The $5 million decrease in comprised of $6 million of increases in fixed expenses, which can be substantially explained by incremental costs incurred by our new operations, offset by an $11 million decrease in variable compensation.

Our consolidated investment return, net of fees and withholding tax for the third quarter of 2008, was minus 2.3%. The negative return stems specifically from a 1.2 percent loss on our fixed income portfolio, a 6.7% loss on our equity portfolio and the 7.6% loss on our alternative investment portfolio. In terms of investment positioning, our highly liquid fixed income portfolio has a duration of just 1.4 years and an average credit quality of AA plus.

At quarterend, 42% of our investment portfolio was invested in cash, U.S. government, and U.S. government agencies; 24% was invested in MBS and ABS securities; and 17% was invested in corporate bonds.

Our investment portfolio also includes equities and alternative investments which currently, in total, represent 15% of our total invested assets and 27% of our shareholders' equity.

Our financial supplement made available last night provides detailed disclosures on each of the components within our investment portfolio.

Our operating loss excludes $27 million of realized investment losses, $48 million of unrealized investments losses, and $13 million of foreign change losses which hedge certain of our reinsurance balances and activities.

We escaped nearly all of the equity investment bombs that exploded during the quarter, meaning Fannie Mae, Freddie Mac, AIG, WaMu, Wachovia. But we took a $17 million fixed maturity hit from the collapse of Lehman Brothers.

During the quarter, we terminated our securities lending program at a slight gain to our small unrealized loss position at yearend.

We have not repurchased any shares since our last call, but as a reminder, we did repurchase 673,000 shares in early July at an average price of $14.87. From a total capital perspective, we remain comfortable at our current level of 1.51 billion, which includes $89 million of contingent capital.

With my summary concluded, I now pass control of the meeting to the Operator for any questions you might have for us.

QuestionandAnswer Session


(Operator Instructions) Your first question is from Matthew Heimermann JP Morgan.

Matthew Heimermann JP Morgan

Couple questions. First, can you just talk to us about, you said Ike and Gustav were very consistent with how you were thinking about your exposure. Can you just remind us where you have the most amount of capital at risk today?

Chris Harris

I am not sure where to take that question.

Matthew Heimermann JP Morgan

I was just hoping you could remind us of where your biggest aggregates are sitting and what the underlying peril is there and then maybe contrast how big Texas wind or western gulf wind does compare with that.

Chris Harris

I will take a stab at that one. Although, I will comment in advance that's a bit difficult because that shifts over time. That's not something that's constant. In terms of U.S. exposure, we have noted this generally that the hurricane exposure is greater than the earthquake exposure in our portfolio currently. I don't think our peak spot would be materially different than most other people. Florida is an area where we would have a bit of an overweight. Texas, frankly, is an area where we have a bit of a concentration. I think it is important to talk about how our portfolio is made up. What's not in there is any offshore exposure. It tends to be concentrated most heavily among the personal lines insurance companies, some of the small commercial lines riders. They tend to make up the bulk of our exposure. We are left heavy in what I would call the retro space and the offshore marine space.

Matthew Heimermann JP Morgan

One of the things I have been struggling with is how to think about maybe PMLs the rate metric or not, but maybe PML relative to economic capital and how that may have changed end of 2007. I know the portfolio is different, but end of 2007 versus today or even June 30 versus today.

Chris Harris

Again, I think that's probably been relatively consistent, if anything. We talked about that a little bit on the call last quarter. Probably going into this wind season our risk profile would have a little less at July 1 than it was at January 1.

Matthew Heimermann JP Morgan

I guess one of the things I am trying to get at we're talking about capital being constrained, I am just trying to get a sense of with respect to in-force portfolios how even that is changing our company's books today before contemplating demand next year potentially.

Chris Harris

I am still struggling a little bit with the question. What exactly are you asking?

Matthew Heimermann JP Morgan

Presumably, you hold economic capital against all the liabilities you are assuming in our insurance business, correct?

Chris Harris

That's correct.

Matthew Heimermann JP Morgan

So to the extent that investments are part of your economical capital equation, and they have been declining, I am just curious as to how that leverage, I am assume there's some constraint on how much risk you can assume relative to your economic capital. I am just curious how that leverage ratio for lack of a better term, has changed end of third quarter relative to end of second quarter or even end of first quarter, yearend, excuse me. Sorry if it's poorly worded.

Chris Harris

I get where you are going. Clearly we did have some excess capital as would measure it against our internal economic model. Certainly we talked some of the stock repurchases and we did through the first seven months of this year. Clearly with some of the losses we suffered in Q3, both on the underwriting side and the investment side, that cushion has decreased a bit. I would say at this point, and I mentioned in the script, we are comfortable with our current capital level. We think we can absorb our existing portfolio within our current capital base and potentially have some capacity to expand.

Matthew Heimermann JP Morgan

I might follow up with Bill because I just would be curious. I am not asking the question from the standpoint that I am worried about your capital. I was just more curious to try to put in perspective how that may have changed. I will follow up after, thank you.


Your next question comes from Rohan Pai Banc of America.

Rohan Pai Banc of America

Following up on Matt's prior one, assuming we're in a capital constrained environment in 2009 and assuming that the property CAT model relies on having access to capital, do you think it will change the way you look at your risk profile in 2009? Would it be possible that you decide to lower peak exposures or something given the environment we're in? Or do you not anticipate any real change to the way you're doing your business?

Chris Harris

I think that's a balancing act that we always look at internally. As you pointed out, certainly in time of uncertainly, there is a greater premium on capital; and given current stock market valuations, to raise any capital would be prohibitively expensive.

Having said that, we have been operating well within our risk constraints because we didn't think conditions were at optimum. To the extent we see improvements in prices, we have left ourselves that cushion where I think that could work against the other point that you're making.

Rohan Pai Banc of America

Then the second question I have is you said your initial conversations with feeding companies seem to suggest increased demand. If you could just give us some color, these feeding companies, was it mostly the small, regional personal lines, the mutuals, that are demanding more or is it kind of across the board with even some of the larger national players looking to increase demand?

Chris Harris

I certainly would not name anybody by name. I would say we have talked to companies that fit in both of those groups. I don't know, David, if you want to add anything more to that.

David Sinnott

I think in terms of actual instances, we have yet to see a full manifestation of that. However, there is one small mutual company that is going to purchase substantially more reinsurance as a direct result of their asset situation. There is another national rider who just went into the marketplace with a very sizable earthquake protection which replaced some reinsurance that they had in a different form.

Just anecdotally, in conversations that we have with clients with prerenewal discussions, it's evident that they're very focused on this question of protecting themselves in what is amounting to a much more risk-averse environment. We will see more once we get into the negotiations at 1/1, but I think the early signs are that that demand will increase.

Chris Harris

It's no different than the question you posed to us in terms of potentially buying more reinsurance. Gives a competitor access to more capital for them and given how expensive capital is at the moment, we think that will cause some more people to look at the reinsurance market as another option.

David Sinnott

If you look at the vast majority of mutual companies and even some of the stock companies, don't have a lot of flexibility in terms of how they finance their operations. In this context, we believe that purchasing additional reinsurance is going to look like a very favorable option.

Rohan Pai Banc of America

That was helpful color. The last question, did you quantify the level of premiums written by your Lloyd's and U.S. on-shore platform?

Chris Harris

We didn't split that out. That will be in the 10Q that we put out, but for the quarter, I can say the nonBermuda operations were about 26% of the gross premium volume.

Rohan Pai Banc of America

Lastly, was any losses from Ike and Gustav incurred in these operations or was it all in Bermuda?

Chris Harris

The vast majority came from the Bermuda book.


Your next question comes from Amanda Lynam Goldman Sachs.

Amanda Lynam Goldman Sachs

I apologize, I picked up the line just a few minutes after you started. Would you please repeat the comments you were making about your contingent capital?

Chris Harris

I won't go back and actually reread the script, but what I did say was that to the extent we saw underwriting opportunities emerge above our current expectations, we would consider deploying the contingent capital. Certainly we will keep a very close eye what happens on the upcoming renewal season.

Mike Paquette

If I can add, we have not drawn on the contingent capital. But I did mention that the way we look at our total capital position is always inclusive of that available amount. And that amount right now is $1.51 billion including the contingent capital.


There are no further questions at this time. Mr. Kim, please proceed with your closing remarks.

Jonathan Kim

Thank you. That concludes the proceedings from the company's point of view. It only remains for me to thank you all very much for your participation and we hope you will join us again in our fourth quarter earnings call next year.


This concludes today's conference. Thank you for your participation.

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