Odyssey Re Holdings Corp. Q3 2008 Earnings Call Transcript

Executives

Don Smith – SVP, General Counsel and Corporate Secretary

Andy Barnard – President and CEO

Scott Donovan – EVP and CFO

Analysts

Doug Miehm – RBC Capital Markets

Susan Spivak – Wachovia

Josh Shanker – Citi

Odyssey Re Holdings Corp. (ORH) Q3 2008 Earnings Call Transcript October 31, 2008 10:00 AM ET

Operator

Good morning and welcome, ladies and gentlemen to the Odyssey Re Holdings Corporation’s third quarter 2008 conference call. At this time, I would like to inform you that this conference call is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation.

I will now turn the conference over to Don Smith, General Counsel and Corporate Secretary. Please go ahead, sir.

Don Smith

Thank you. Good morning. Odyssey Re's results will be discussed this morning by our President and our Chief Executive Officer, Andy Barnard; and by Scott Donovan, Executive Vice President and Chief Financial Officer of the company.

The following discussion may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Some of these statements may relate to risks and uncertainties. Actual results may be materially different from those contained in or suggested by such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's filings with the Securities and Exchange Commission.

Now, Andy Barnard will open the discussion. Andy?

Andy Barnard

Thank you, Don. Good morning, everyone. As we all know the world has changed considerably since the last quarter. I don’t think there is any need to recite the ever expanding litany of financial debacles. I would like merely to state that in our corner of the world the property, casualty insurance and reinsurance sector it is clear that much more matters than a narrow focus on operating earnings. Reaching for yield to enhance operating performance has been revealed as a costly practice, and at some companies' utterly destructive of value.

We at Odyssey have been fortunate to have the benefit of an asset management team that has combined a vigilant conservative approach with keen insight into where opportunities lie. As a result, we have produced another solid quarter of net income book value growth, despite a small operating loss generated by large catastrophe events.

In the quarter, book value per share has risen almost 3% and year-to-date we were up 13%. On the underwriting front, our results were heavily impacted by hurricane Ike. While some characteristics of this storm were unusual; its cause to Odyssey is well within our risk tolerance. At 2.9% of equity on an after-tax basis, it also positions us at the lower end of the scale amongst our competitors, consistent with our experience in prior catastrophes.

Our premiums in the quarter held fairly steady between the reinstatement premiums triggered by Ike and residual benefit of foreign currency translation. We largely offset the continued shrinkage in our US casualty reinsurance book. As the currency situation dramatically turned in the opposite direction during the quarter, particularly with respect to the Euro and Pound, we could expect downward pressure going forward on our non-dollar denominated premium volume.

During the third quarter we closed our acquisition of the Crop USA platform, now re-branded Hudson Crop, through which we will continue and expand our involvement in the multi peril crop insurance business. We also launched and [ph] staffed Hudson environmental products to leverage our experience in the environmental liability field, and we have beefed up the staff in our Hudson financial products in preparation for increased opportunity in the directors and officers' liability line. All of these developments in our US insurance division will position us advantageously as the market turns.

Of course at this juncture, there was a great deal of talk about the arrival of a hard market. Certainly, rational expectations would lead one to conclude the price of capacity should go up. Fortunately, our industry is not renowned for its rationality. Our current view is that we will experience a gradual tightening of market conditions that will pickup pace during the course of 2009, as the ramifications of the financial crisis play out.

To the extent financial markets don’t experience a significant recovery by year-end, financial statements released in February and March are going to reflect continued erosion of the industry's capital base. Which all things being equal, lend more urgency to the need for better pricing of risk. With our global well-diversified platform and solid financial base we are very strongly positioned to benefit from improved conditions. We have a well-developed franchise in the US and international reinsurance markets that has the capacity to grow significantly if conditions warrant. While we are currently seeing upticks in submission activity particularly in our individual risk business, we are not yet writing measurably more business as the pricing environment is still competitive.

So to sum things up, Odyssey remains committed to disciplined opportunistic underwriting combined with long term value investing while there are no assurances that our record of success will continue undiminished into the future. Since 2001 we have compounded book value at about 20% rate. By that measure prior to this year, we were entrenched among the best performing companies. After recent events, we believe our track record will be more favorably differentiated, and over time this record of performance will be reflected in the price of our shares.

So with that I will turn the call over to Scott Donovan, Odyssey's Chief Financial Officer. Scott?

Scott Donovan

Thank you, Andy, and good morning. Our third quarter results are highlighted by pretax income of $186 million resulting in after-tax income of $121 million. During the quarter our book value per share increased by 2.9% or $1.17 per share to $41.78 per share. Over the last 12 months our book value per share has increased 27%. After-tax operating loss for the third quarter was $6.4 million or $0.10 per share, compared to operating income of $55.2 million or $0.77 per share in the third quarter of 2007.

Our operating earnings declined due to reduced underwriting income, which was impacted by increased cat activity primarily related Hurricane Ike, and lower investment income in the quarter. Net income for the quarter was $121 million or $0.96 per share, compared to net income of $112 million or $1.57 per share in the third quarter of last year.

The increase in net income was the result of higher realized gains partially offset by reductions in underwriting and investment income. Net income this quarter included a foreign exchange net loss of $12 million after-tax principally resulting from the weakening of the Euro and the Pound Sterling versus the US Dollar. This loss was comprised of an operating gain of $5 million or $0.07 per share, which was more than offset by foreign exchange and investment realized losses of $17 million or $0.28 per share.

Looking at premium activity for the third quarter 2008, compared to 2007, gross premiums written were $657 million for the quarter, an increase of 3%, both insurance and reinsurance contributed to the increase. Gross premiums written increased in the Americas, EuroAsia, and US insurance divisions partially offset by a decrease in the London market division. The increase of 4% in the Americas division was due to reinstatement premiums related to catastrophe losses. The gross premium increase of 7% in the EuroAsia division was mostly due to foreign exchange rate movements and a modification to our premium estimation process.

Excluding in the impact of exchange rate movements, reinstatement premium and modification to our premium estimation process, consolidated gross premiums written would have declined nearly 4%. In terms of premiums composition, 47% of our gross premium was derived from non-U.S. markets, compared to 46% in the third quarter of 2007. Regarding product mix, 51% of our business in the quarter was in casualty lines, 41% was in property, and 8% was in marine, aviation, surety and other specialty classes. Insurance as a percentage of our business volume was 36%, which is basically unchanged from a year ago.

For the quarter, our combined ratio was 113%, versus 97.8% in the third quarter of 2007. Included in the combined ratio for the quarter was $133 million or 24.3 points of current year cat losses. These losses include $120 million for Hurricanes Ike and Gustav, and an additional provision for the first quarter snowstorms in China of $6 million. For the quarter, loss development was favorable at $3.4 million or 0.6 points versus unfavorable development of $31 million or 5.6 points in the third quarter of 2007.

Looking at our four operating divisions; In the Americas, we experienced an increase of 4% in gross premiums written during the quarter, compared to last year. Excluding reinstatement premiums gross premiums would have decreased 3% during the quarter. Casualty gross premiums declined by $17 million or 15%, while property grew by $16 million or 33%. The Americas combined ratio for the quarter was 158%, which included 52.1 points of current year cat losses, primarily related to Hurricanes Ike and Gustav, and 11.9 points from adverse loss development principally related to an increase in asbestos reserves of $15 million.

We continue to reserve current year D&O at higher levels in expectation of increased loss activity associated with the ongoing turmoil in the financial sector.

In EuroAsia, our gross premiums written for the quarter increased by 7%, primarily due to favorable foreign exchange rate movements of $16 million and a system revision in the premium estimation process by contributed $11 million.

On a constant exchange basis and without the change in the premium estimation process, which I had no effect on our premium, EuroAsia's gross premiums written, would have declined 12%. The combined ratio for the quarter was 86.6%, which included 5.2 points from current year catastrophe losses and 2 points from favorable loss development mainly related to reserve releases on property business.

For the London market division, gross premiums written decreased 4% for the quarter, compared to the third quarter of 2007. The decrease primarily relates to our reinsurance business, which is facing competitive market conditions in most of its business lines.

Net premiums written declined by 9% during the quarter, primarily due to increased utilization of reinsurance in the syndicate, as a result net retention decrease to 84.8% from 89.8% in the London market division. London market had a combined ratio of 90.9% for the third quarter, which included 5.6 points of favorable loss development mostly related to reserve releases on property and other short-tail lines of business.

Our US insurance division gross premiums written increased 3% in the quarter. We experienced increases in several programs, which were partially offset by continued reduction in our Healthcare segment. Net premiums written declined during the quarter, largely due to reduce medical malpractice book coupled with increased utilization of reinsurance as well as lower personal auto premiums. The net retention ratio declined to 68% from 78.1% in 2007. The divisions combined ratio of 79.2% for the quarter included 6.5 points marine catastrophe losses due to hurricane Ike, and favorable loss development of 17.9 points, principally attributable to reserve releases from our healthcare business.

Net investment income, net of expenses for the third quarter was $62.5 million pretax, which represents a decrease of 27.7%, compared to the third quarter of 2007. The decrease is mainly attributable to lower interest rate environment impacting our larger cash and short-term positions and lower income from our equity investees. Overall our portfolio yield decline to 3.12% from 4.152% in the year-ago quarter.

Net and investment realized gains in the quarter were $197 million pretax or $2.7 per share after-tax, compared to 88 million pretax or $0.80 per share after-tax in the third quarter of 2007. The quarter included gains of $187 million from equity total return swaps, $144 million from credit default swaps, and 23 million from foreign exchange forward contracts, partially offset by other then temporary impairments of $61.2 million recorded on fixed income and equity investments.

As of September 30th, 2008, the carrying value of the remaining CDS portfolio was $145 million with a notional amount of $2.5 billion. The average term to maturity was 2.7 years. As a reminder, the credit default swaps maybe extremely volatile. Their market value, and liquidity may vary dramatically; either up or down in short periods, and their ultimate value will therefore only be known upon their disposition.

Operating cash flow for the quarter was $115 million, compared to $49 million in the third quarter 2007. The main components of the increased were reduction of gross losses paid largely attributable to the Gulf litigation settlement in the third quarter of 2007, and an increase in investment of $25 million due to timing our receives.

Our balance sheet and financial flexibility are strong and will permit us to take advantage of opportunities that will arrive as a result of the current crises in the financial markets. Our total capital amounted to approximately $3.1 billion at September 2008 with debt representing less than 16% of total capital, which is well within our acceptable levels.

Our senior notes mature in 2013 to 2021 and our preferred stock is perpetual. We hold the comfortable cushion over our capital require to maintain our current ratings. Our liquidity is also at a very healthy level, as cash in short-term investments, which consist primarily of US treasury bills were approximately $2.3 billion or 29% of the invested assets.

Additionally, longer-term US treasury securities represent $2.5 billion or 31% of invested assets. Our liquidity is augmented by a $200 million credit facility, the terms of which were disclosed in our public fillings, this facility expires in July of 2012. Total invested assets in cash were $8 billion at September30th, 2008, an increase of 3% over year-end 2007. Invested assets to common shareholders equity currently stand at 3.2 to 1 in our investment portfolio now equals $133.15 per share.

Equities including equity investees were $1.1 billion representing 14% of the portfolio. Additionally, we have short decisions through equity index total returns swaps, which is served as well as in economic hedge during this unprecedented times. Do you want to advise that we have reduced notional way of our equity hedges as of September 30th the notional value was approximately $1 billion, compare today’s approximate value of $785 million.

The positions that were closed during October generated realized gains. Our fixed income portfolio, valued at $4.2 billion as of September30th, includes US government securities of $2.5 billion foreign government securities of $966 million and tax exim bonds of $575 million. 91% of the fixed income portfolio was rated AAA with a minimal amount of securities rated below investment grade. At the end of that quarter our after-tax unrealized loss position was $15 million a decrease of $31 million, the change was primarily attributable to a reduction value of our common stock portfolio, partially offset by unrealized gains in our fixed income portfolio.

We revalued the investment portfolio as of Friday October 24th roughly speaking – I am sorry, as of last Friday October 24th broadly speaking excluding in the impact from foreign it was minimal change in value.

Finally, with respect to capital management, during the quarter we repurchased to approximately 3.8 million shares of common stock or 5.9% of our outstanding shares of June 30th, 2008, at a cost of approximately $141 million. The total amount shares purchased since the inception of our repurchase program in 2007 is 12.1 million shares at cost of $446 million, which equates to an average purchase price of $36.79 per share.

I will now turn the call over to Larry for your questions.

Question-and-Answer Session

Operator

Thank you sir. (Operator instructions) Our first question comes from Doug Miehm with RBC Capital Markets.