Argo Group International Holdings Ltd (NASDAQ:AGII)
Bank of America Merrill Lynch Insurance Conference
February 13, 2013 04:05 pm ET
Mark Watson – Chief Executive Officer
Jay Bullock – Chief Financial Officer
Argo is a first time presenter at our conference. I’ve known Argo CEO Mark Watson for sometime. I’ve observed a dramatic change at the company since he is in the role of CEO in 2000. Now at the time Argo is called Argonaut back then it was essentially one line of business. It was a workers comp company and now it’s divested far broader than that. I’m sure Mark will outline many of the changes that have occurred and where the company is and going forward, as I turn it over to Mark.
Thank you, Jay and good afternoon everyone. I actually did want to spend a little bit of time today kind of talking about our company and how we have evolved over the last 12 years. I’ll start by just giving you all a profile of what the company is like today if I cam get. Okay.
I’m technological challenged. Here we go. All right, here we go. I’m sure that I may say a few things about the future so well we all can read that slide. Okay. So let me talk a little bit about Argo. As Jay said we were originally called Argonaut. We’ve actually been around for over 60 years and a little over 10 years ago we started working on evolving our company to become much more of a specialty underwriter.
We’re certainly not the only specialist in the insurance business, but I really like to be the platform that we have. We have four different operating segments I’ll talk about them in a little bit. They give us a very broad footprint in the markets where we operate. We are one of the largest excess and surplus lines underwriters in the U.S. and have been for about a half a decade now although the company has been around for over 20 years.
We have a pretty large trading platform in Bermuda both insurance and reinsurance and also we have one of the larger syndicates at Lloyds with the stand capacity of 350 million pounds sterling. Having been around a long time we have pretty strong relationships with our distribution platform whether its retailers, wholesalers or Lloyds brokers. We are very focused on being an underwriting organization and originating risk for ourselves with our business partners and reinsurers and we are rated A by AM Best.
Just to kind of take you through the evolution of our company over the last 12 years or so, there is a lot going on the slide but I think it really tells a pretty interesting story. You can see by looking at the red that that was the original part of Argonaut Insurance Company, but we referred to this risk management business, the majority of it was Jason Workers compensation insurance and most of that was in California, most of that was in the construction business.
And for that of you all that will remember in the late 90s that was actually which you didn’t want to do. And 30 of 32 insurance companies based in California say we were one of two to survive. We kind of got the company going. We started a number of specialty businesses in 2001. We acquired our E&S Company in 2001. The E&S business is that dark blue. And the retail businesses that we either had or started was a light blue and you can see it growing along with our E&S business from 2002 to 2006 pretty nicely and you’ll notice the red goes away in 2005. We finally sold the comp for the risk management business at the end of 2005.
Some might say that was kind of when we should have stayed then because rates were so robust but as you now know they went right back down a few years later, so I think we’re much better served where we are. You’ll also note that in 2008, there is a couple of other colors that show up, purple and green. The green is our international insurance business and reinsurance business.
We have a reinsurance business that we’ve started in Bermuda in 2007 and then we have a number of retail insurance businesses in the Middle East and Latin America mainly in Brazil. We acquired the Lloyd syndicate in 2008. Syndicate 1200, we acquired it half way through the year which is why you see a such a different in premium written between 2008 and 2009. And then you’ll notice a fairly substantial contraction between ’09 and ’10 and that was getting our CAT portfolio right size which we spend the last couple of years doing.
It was still a challenging year in 2011 because we did have a fair amount of international CAT exposure and of course there were number of events then. Just a couple of other things that I think you’ll see on the slide and you’ll see in other parts of my presentation. You’ll notice that our E&S business the largest part peaks in 2007 and then declined modestly and then that decline accelerates through 2011.
If you were to look at insurance market pricing in the U.S. I think you find that pricing kind of follows that same curve and so now that we’ve seen pricing begin to improve although modestly in the U.S. we’ve been growing our E&S business. We’ve grown only slightly our commercial specialty business that the retail part in the U.S. and actually I think it’ll shrink but I’ll talk more about that in a minute for 2013 I think it’ll shrink a little bit.
So I think what you see at the end of 2012 was a pretty balanced portfolio and I’ll talk more about that as I kind of go ahead. So if you look at the 2012 numbers and then look in the top left hand box, you’ll kind of see that same spread between our two U.S. businesses and then our non-U.S. businesses. The doughnut on the top right just breaks it down by product and then by geography. So you’ll see there is more underwriting, a fair amount of risk outside the U.S. now although to be fair a fair amount of the business underwritten by us in Bermuda and London as U.S. side is risk.
It’s either property CAT or it’s large corporate accounts some of their insurance program are property or liability is placed in the worldwide marketplace. You’ll also see that we’re primary still an insurance company, not a reinsurance company.
So let me talk about our business strategy for a minute and it’s been pretty much the same thing for the last 12 years. We’re not trying to be all things and all people, we truly are trying to evolve to a special underwriter and I think we’re well on our way to getting there. When you look at all the products that we have and the businesses that we’re in, we’re very focused on making sure that we understand a marketplace that we’re in that we have the ability to underwrite an account differentiate ourselves.
Sometimes we differentiate ourselves through our claims organization or our lost control or risk management operations or in some cases it’s our ability to really leverage the relationship that we have with our distribution partners but in every case, we’re looking for a way to differentiate ourselves instead of just being in the marketplace. I think we have the right amount of capital to run our business. Having said that, right now in the markets that we’re in and where our share price is, to the extent that we have excess capital we’ve been managing our capital and repatriating it a fair amount of it back to our shareholders. And I think we’ve done a very good job over the last few years of hiring some very good people into our company.
And at the end of the day, our single biggest asset other than financial capital is intellectual capital. And our goal of course is to grow book value per share. And if you look at how we’ve done over the last 10 years, we’ve been able to our grow our book value per share at the compound and annual rate of 10%. You’ll notice a little bit of lumpiness in 2008 and 2011. 2008 of course was the beginning of the financial crisis as well as so many hurricanes now I kind of forget but the one that hit Texas in 2008. Thank you. Hurricane Ike, and of course there were more hurricanes and other natural disasters than we can count in 2011 and so we lost a few percentage points of book value per share there.
The line graph you see tracks our price relative to both value and it just marks the high point each year and you’ll notice that we kind of peaked in 2006 kind of about the timing we peaked the growth in our U.S. business and a lot of that decline you’ll see is not so much a function of share price decline but rather growth and book value per share over that period of time. I’ll come back to this again.
So just to kind of put some more numbers up to look at, we were able to grow all four of our business segments this last year as I mentioned commercial, special group, commercial specialty, the retail business in the U.S. grew modestly. We saw fairly substantial growth both as a syndicate and international specialty. I would not expect the syndicate to grow at that same rate in 2013, I think we kind of right sized our portfolio there.
I would expect our international insurance business to grow pretty significantly mainly because of the new business we’re writing in Brazil.
Let me talk about each one of our business segments for a few minutes in particular. Kind of the most – the biggest and most longest standing is the E&S business while excuse me, we showed our earnings going back to 2006 as I mentioned earlier, we’ve actually had our E&S business now since 2001. And again you’ll see kind of that premium decline but it’s starting to grow now.
We tend to focus unlike many of our competitors on smaller accounts in the E&S space. And while they tend to have a higher acquisition costs or expense ratio, the volatility tends to be less and over a market cycle they tend to generate a better margin.
You’ll see that our combined ratio has moved up in backed down at peak in 2009 at a 99.6% in this last year came in at 91.9% not too dissimilar from where we were in 2006 and 2007 and if you actually backed up the slide a few more years, you would see a fairly consistent combined ratios for our business. We’ve kind of moved some parts of our portfolio with it over the last few years as the market environment has changed and now that we’re starting to see modest rate increases mainly in the mid single-digits, it’s allowing us to get contraction and start growing again and also having I think optimized our portfolio we know exactly where we want to grow.
The majority of our business is underwritten through wholesales. We do write our professional lines of business on both a wholesale and direct basis through retail agents in the U.S. and you can kind of see the split in that doughnut on the top left hand corner and you’ll see that we’re primarily a casualty driven business as opposed to property. And that’s a fairly predominant scene throughout the group as the exception of the reinsurance business in the U.S.
So let me talk about our retail business in the U.S. which we mainly call commercial specialty. We have a number of businesses here that trade under different brands. We have a mining operation that we call Rockwood and it’s one of the largest insurers of mining operators in the United States mainly co-mines so with the current administration of Washington perhaps we may come under a little pressure for growth but so far we’ve been doing pretty well last year, I think it was actually a record year for in terms of premium growth and underwriting in Rockwood.
We also have insured a number of small accounts in counties around the U.S. through a brand that we call Trident and that makes up about 28% of the portfolio. We also have an MGA within our organization that we call Alteris and that makes up a substantial amount of the premium volume but not so much on a net basis because the business tends to be brokered out to other markets. And then so we have maturity operation and the last is Argo Insurance. You may have heard me talk about on earnings calls some of the changes that we’ve been making within our commercial specialty segment and that’s where it is within Argo Insurance.
All of this business is distributed through retailers mainly independent agents while we do have partners sheds but some specialist retailers, we find that we actually get a better underwriting result with generalist independent agents because we really can help them bring value to their client, our policy holders whereas the specialist has a pretty good idea of the risk and is always trying to hammer us down. So, we try really hard to work with independent agents and we tend to get a much better result.
You’ll see that we’ve had pretty good underwriting margins in this business segment until the last couple of years. A lot of that has been CAT activity certainly in the most recent year 2012. And we’ve had an emergence of CAT activity, that’s a fancy way of saying that we had a whole lot of buildings burned down this last year beyond what we would expect. And it tends to move around from one year to the next. So, we’re making a few changes within the Argo Insurance portfolio but I think that we will have finished doing that through 2013.
Let me talk about the syndicate. When you look at the product mix, it’s a pretty broad diversified portfolio. It’s mainly driven by our direct and facultative property portfolio, almost all of which is US side risk again the large corporate clients as well as our liability business which tends to be which is non-U.S. business. So, some of that is director’s and officer’s liability but some of it is also general liability. It’s mainly European accounts and/or accounts in other commonwealth countries so think Australia as another example.
And we do have aerospace program, that’s underwritten from our Paris branch of the Syndicate and general aviation outside of the United States and then we have a more traditional Lloyds marine and energy portfolio underwritten from the syndicate as well.
You’ll notice the financial results are pretty lumpy. In both 2010 and ’11 we had a fair amount of CAT activity. I’ve mentioned before that we reenter written that portfolio and reduced some of our exposure. But our biggest challenge in 2011 is that there were so many different events that while we have plenty of reinsurance to protect our balance sheet it’s there to protect the capital not the earnings. And so, several events got right up to our attachment point but didn’t quite trigger it.
In 2013, we pulled back our portfolio a little bit but we have merged our property Cat program here with the one in the U.S. which has dropped our retention a fair amount. So I think we’re actually in a better place for 2013 and 2012, and actually I think that Cat load and – the amount of Cats that we had relative to our combined ratio from Hurricane Sandy was less than five points. So, actually it’s not to, for the group as a whole, so I’m pretty pleased now with where we have our Cat portfolio.
And actually if you look at the underwriting results for 2012, not withstanding the CAT activity, we generated a combined ratio of 96 and an underwriting profit on – an operating profit on a pre-tax basis of about $32 million.
Then the last part of our business we referred to is International Specialty. So, again this is where we have the Bermuda Reinsurance Company which only does property tax. This is where we have the excess casualty business in Bermuda as well as excess professional liability, most of that again large corporate accounts based in the U.S.
And then rounding out that is our Brazil operation which now accounts for 18% of the total and will probably grow to 25% in the coming year, I think that will be the biggest growth. I think of all those specialty classes that we talked about at the syndicate a minute ago, we tend to write those in Brazil as well, particularly, professional liability, energy, marine, and to a lesser extent construction or property risks.
I think of this as more of a long-term opportunity for the group, I don’t think we’ll make too much money in 2012 from the insurance part of this business but I think that this is worth some of our growth will come from in the future. Right now, the earnings levers are the syndicate, the U.S. businesses and the reinsurance business embedded here.
Like our other businesses, and well, like our retail business in the U.S. this is all retail driven but it tends to be some of the larger brokers unlike the U.S. where we tend to deal with independent agents. So, I think you’ll see the most growth coming here in 2013.
So, let me just talk about our fourth quarter for a minute. And as I mentioned earlier, we had a pretty big fire loss within commercial specialty and we also had hurricane Sandy. So we generated a small loss for the quarter but again for the year we generated a profit. And if you look at our full year results compared to a year ago, well, there is a fair amount of improvement. If you strip out the catch, which this slide doesn’t show, we were pretty close to generating an underwriting profit. And I think that that’s a good way to think about us going forward for 2013 and 2014.
If you look at our balance sheet, the assets in our portfolio I think are pretty conservative. The average credit rating for a bond portfolio, it is AA minus. We’re sitting at a duration of 3.3 years and a book yield of 3.4. Obviously if interest rates stay low that’s going to continue to be challenging but I think we have a pretty balanced portfolio. Our fixed maturities, our fixed income portfolio is still about 73% of the total. But I think we have a pretty good balance depending upon what happens with interest rates over the next year or two.
So, when I think about our company, I think we’ve built a pretty good specialty underwriter, I think we have a pretty good platform, our challenge now is to actually put a little bit more premium through it and get back to our high water mark at 2009 and back to that $2 million mark.
I think that we’re in the right marketplaces I think we have the right products. I believe that we’ve got very good distribution relationships we have plenty of capital to execute our business plan. If you go back and look at our historic results, we have generated a 10% return on average over the last 10 years. I think we’re in a good place to continue doing that. And to the extent that we generate excess capital I think you’ll see us continuing to repatriate that back to our shareholders.
So, with that I’ll take your questions.
It sounds as if the opportunity to improve the ROE, some of it is uncertain businesses and growing those businesses. As you mentioned platform your distribution is the market. Are the market conditions acceptable to push through the kind of growth that you want to push through?
Yes, so if you look at how our core businesses have grown, we’ve been growing policy count or exposure kind of low single – low to mid single digits. But with our rate increase equal to that amount now we’re seeing 5%, 10% growth in our core business, where you’ve seen higher growth it’s because we’ve added a new product or added a new geography to our platform. Otherwise I think our growth has been pretty modest.
When you look at that change in written premium and think about the lag between written and earned, you’re just now starting to see the benefit of more earned premium coming through. You’re starting to see slightly lower loss picks but only a 100 to 200 basis points. But as we move up our premium volumes modestly it also drops the expense ratio a bit as well. So, if we grow 5% or 10%, with the product mix that we have today, I think we could see a 2 or 3 point improvement on the combined ratio. So, we’re not looking for huge growth.
And part of that growth is obviously priced which, one would suspect is in excess of claims installations, so it will underlying loss ratio improvement, some expense ratio improvement?
As far as capital goes, you said you would – is that – what’s the bigger issue, is it scale size, margins or is it the interest capital?
Well, actually I think it’s a combination of all three, as we re-underwritten our portfolio and tried to call the lesser performing parts of the business and focus more of our energy on the better performing parts, that improves margins. As we’re able to write more business in the aggregate that improves margin because the expense ratio improves.
But we probably have somewhere between $100 million and $200 million in excess capital depending on which model do you want to look at? It’s not clear to me how much of that is really excess given where it sits in our capital structure and also thinking about what may happen with interest rates, meaning if you see – if you see interest rates move up quickly then of course some of that – those capital gains go away a little bit. But then you’ll make that back up over time in investment income.
With the ROE have you talked about a specific goal and when you want to achieve that goal?
Market conditions remaining about where they are now, I think they were on a path to get to a run rate of an ROE of 10% by the end of next year, so, the end of 2014. Now, it’s hard to think about a goal higher than that if the risk free rate stays where it is.
You didn’t get the 10% your stock would do pretty well I would guess?
I’d be pretty happy, wouldn’t I. But you know, I’m looking at our business plan for this year and next year, and I’m thinking about our view of that a couple of years ago and it seems pretty far off but now it’s just right in the front of us and I think about how we’ve executed over that time and actually there is a lot more visibility to that today.
Any other questions for Mark?
Stand on what sort of infrastructure do you have in the country, what’s the sales platform you’re using etcetera?
Yeah. So, we’re one of the few international companies that has a local license to underwrite insurance in Brazil. So, we’re not doing reinsurance only insurance on a local basis. We have a team that’s based in Sau Paulo, they’re all from Brazil, they were all at some of the big name insurance companies that you will know all international companies. But they’ve all been in the marketplace for 10 to 30 years. The fellow who runs our business, his name is Pedro Perm, he ran the Zurich office for many years before coming to start our business in Brazil. Almost everything we do is through the larger brokers and some of the – the larger international brokers and the big regional brokers there in Brazil. But it’s all focused on specialty products not on general insurance.
I would like to thank everybody for listening to my presentation this afternoon.
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