Gregg Schroeder – Vice President Investor Relations & Corporate Development
Kenneth LeStrange – Chairman, President, CEO
Michael McGuire – CFO
Michael Angelina – Chief Actuary, Chief Risk Officer
David Cash – Chief Underwriting Officer
Ronald Bobman – Capital Return
Ian Gutterman – Adage Capital
Jay Cohen – Bank of America, Merrill Lynch
Endurance Specialty Holdings (ENH) Q4 2008 Earnings Call February 13, 2009 ET
Welcome to the Endurance Specialty Holdings fourth quarter and full year 2008 earnings results conference call. (Operator Instructions) I would now like to turn the call over to Gregg Schroeder, Vice President of Investor Relations and Corporate Development.
Welcome to our call. Hosting today's call will be Tim LeStrange, Chairman and President and Chief Executive Officer, Mike McGuire, Chief Financial Officer, David Cash, Chief Underwriting Officer and Mike Angelina, Chief Actuary and Chief Risk Officer.
Before turning the call over to Ken, I'd like to note that certain of the matters that will be discussed here today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties and a number of factors could cause actual results to differ materially from those contained in these forward-looking statements.
Forward-looking statements are sensitive to many factors including those identified in Endurance's annual report on Form 10-K and other documents on file with the SEC that could cause actual results to differ materially from those contained in forward-looking statements. Forward-looking statements speak only as of the day on which they are made and Endurance undertakes no obligation publicly to update or revise any forward-looking statement whether as a result of new information, future developments or otherwise.
I would now like to turn the call over to Ken LeStrange.
Good morning and welcome to our call. 2008 was a very turbulent year for the global economy, the financial system and the insurance industry. Despite the challenges we have experienced, Endurance has performed well against our strategic and financial goals.
Unlike years such as 2006 and 2007 when many companies performed well in a stable investment environment, and enjoyed benign natural catastrophe experience, the events of 2008 provided a demanding backdrop to assess Endurance's performance in underwriting, risk management, investments and preserving shareholder equity.
As I reflect on our performance during 2008, there are five achievements that highlight our strategy and approach to the business. First, we were successful in growing our business by 13.3% on a net written premium basis. Our growth was achieved through the acquisition of ARMtech and targeted expansion of our U.S. specialty insurance business.
We successfully integrated ARMtech during the year. As you know it was a challenging year for agriculture insurance and reinsurance. We experienced catastrophic flooding during the spring and extremely volatile commodity prices during the year.
Our new operation met these challenges, validated the quality of the organization we purchased and achieved a 95% combined ratio. The challenges experienced by the agriculture sector, also affirmed our strategic emphasis on insurance in this category of risk given the surprising competitive conditions we continue to see in agriculture reinsurance.
Second, we continued to manage a broad softening of the underwriting cycle during 2008 by reducing our exposure and attendant revenue in parts of the business no longer meeting our underwriting and return criteria as is evidenced by our 23% decline in reinsurance gross written premiums during the year.
Third, hurricanes Ike and Gustaf proved to be a significant catastrophic event for the industry. Endurance's original loss estimate has stood up well despite significant increases in estimates issued by modeling companies and some industry peers. This is not a coincidence.
This aspect of our performance is reflective of our risk management expertise and the portfolio management decisions we implemented over the last three years such as our emphases on personalized oriented catastrophe exposure and the decision several years ago to exit the offshore energy market due to its poor fundamentals.
In a year marked by Ike and Gustaf, frequent large property losses and the emergence of losses from the credit crisis, Endurance achieved a 93.5% combined ratio for the year, a result that demonstrates the strength and diversification of our core business. Endurance's seven year underwriting ratio for catastrophe reinsurance stands at 59.7% which compares favorably with the best performing companies in this business category.
Fourth, our investment portfolio performed well given the market volatility spawned by the credit crisis. The mark to market total return of the entire investment portfolio was minus 3.4% primarily the result of significantly wider credit spreads.
With our focus on downside risk management we were able to avoid many of the defaults of 2008. The portfolio ended the year with a triple A average quality and a 2.3 year duration. Our income statement results were impacted by $82 million in OTTI charges during the year and a decline of $111.6 million in the value of our alternative investments and high yield loan funds partially offset by $24.8 million in net realized gains.
From a balance sheet perspective, our unrealized loss position at year end 2008 stood at $172.5 million. Our demeanor towards risk in our investment portfolio remains cautious as is reflected by our 2.3 year duration and our increase to over $1 billion in cash and cash equivalents. In the short run we are sacrificing some investment income in return for enhancing our liquidity and to position our portfolio for more stable and better opportunities ahead.
Fifth, 2008 validated the efficacy of our capital management strategy. In response to softening market conditions in 2008 we repurchased 4.6 million shares of our common stock and equivalents and returned $58.7 million to our shareholders through our ordinary dividend.
Actions we took in 2007 specifically the establishment of our contingent equity transaction and the restructuring and extension of our credit facility through 2012 have enhanced our capital structure and significantly improved our financial flexibility.
Endurance's operating income was $60 million in the quarter and $198 million for the full year, representing an operating ROE of 8.5%. Our book value ended the year at $33.06 per share and year over year our change in book value plus dividends paid represent a decline of 2.8%.
While in absolute terms our results this year are not up to the level we have posted in recent years, on a relative basis our performance compares well with results reported by other insurers and reinsurers.
As I look at our performance from conception through the end of the 2008, we have generated a 14% operating ROE while growing book value nearly 76% when we add back dividends. Given the catastrophic events we and the industry have experienced over our first seven years, these results are proof that we are delivering shareholder value.
I will now turn the call over Mike McGuire who will cover our fourth quarter and full year results in more detail.
Good morning everyone. For the fourth quarter, Endurance earned net income of $16.9 million and $0.22 per diluted common share. For the full year, Endurance earned $98.6 million and $1.32 per diluted common share.
Operating income which excludes realized investment and foreign exchange gains and losses for the fourth quarter of 2008 was $60 million and $0.94 per diluted common share and $198 million and $2.91 per diluted common share for the full year. Our combined ratio is 83.5% in the fourth quarter and 93.5% for the full year of 2008.
Both our segments generated underwriting income for the quarter and full year despite significant catastrophe loss activity in our Reinsurance segment and a challenging year for our agriculture Insurance business. The combined ratio for the full year 2008 was impacted by 8.6 points of losses from hurricanes Ike and Gustaf. Our initial loss estimates for these storms have held up very well.
Our fourth quarter results included $41 million or 9.5 points of favorable prior year reserve development from our long tail and other specialty lines including agriculture Insurance. The current quarter's combined ratio was also favorably impacted by $17.7 million or 4.1 percentage points of favorable currency reserve development due to lower than expected short tail claim emergence from the first nine months of 2008.
Our full year results included $157 million or 8.9 points of favorable prior year reserve development split fairly evenly between the short and long tail lines in both segments.
Moving on to premiums, the fourth quarter is generally our lightest premium quarter in both segments. In the fourth quarter, our net premiums declined about $35 million or 16% to $181.1 million. Within our Insurance segment, the most notable decline was in our workers compensation line which decreased $28 million as we continued to pull back from the California Workers Compensation Market.
Our agriculture Insurance line was also down about $16 million primarily due to timing differences. Partially offset in the declines are professional, property and casualty insurance lines experience growth from our expanded underwriting platform, increased retentions and from opportunities created by the stress currently being experienced by several large competitors.
Declines in our Reinsurance segment were led by reductions in casualty and property lines due to some contract renewals that were extended into 2009 and from the absence of positive premium adjustments in the current year.
For the full year, net premiums written were $1.78 billion, an increase of approximately 13% driven by the growth in agriculture Insurance following the acquisition of ARMtech in late 2007. Net written premium growth was also achieved in property, casualty and professional lines in our Insurance segment as we continue to build out our U.S. Insurance business and increase net retentions.
Partially offsetting this growth were declines in Reinsurance as we did not renew accounts throughout the year that did not meet our return requirements and we saw smaller positive premium adjustments year over year. David will provide more details on our premiums and market conditions later on the call.
Turning to 2009, I want to highlight a few items that will impact our top line. First, with respect to our agriculture Insurance line of business, it should be noted that premiums very directly with changes in commodity prices. Current prices for spring crops are 20% to 25% lower than the base prices from 2008.
Although we are optimistic that we will be able to grow our policy count, premiums will likely be lower in 2009. It is important to note that although revenues may be down; expected loss ratios should not be affected.
Second, during the first quarter of 2008, we had approximately $25 million of net written premiums in our agriculture Insurance line that results from non recurring adjustments related to the 2007 year.
Third, at the end of February, we will be completing our exit from the California Workers Compensation business. As a result, we do not expect to write any significant workers compensation insurance premiums going forward.
Fourth, we have just completed the sale of our U.K. property insurance book of business in a renewal rights transaction. In 2008 this unit wrote approximately $39 million of net written premiums which we will not write in 2009.
Our investment results in the quarter were impacted by the broadly negative performance of the credit and equity markets. Net investment income was a negative $4.6 million and it was driven by mark to market adjustments on our alternative investments and bank loan funds which declined 18.3% in the quarter and accounted for $62 million of losses.
Although reinvestment yields were lower particularly on our short term investment and cash holdings, our fixed income portfolio continues to generate solid investment income. During the fourth quarter the net after tax unrealized loss position on our fixed income portfolio grew by approximately $28 million primarily due to widening credit spreads.
Our investment portfolio continues to hold an average credit rating of AAA and the underlying credits continue to perform well. To date our portfolio has weathered the credit crisis very well with negligible levels of credit defaults.
We have conservatively recognized $42 million of other than temporary impairments or OTTI losses in the quarter and $82 million for the full year. The vast majority of these impairment losses were due to widening credit spreads as opposed to actual credit defaults or through impairments.
As you can see from our balance sheet, our cash and short term investment position has increased significantly since the third quarter. We are currently maintaining a defensive posture on our portfolio and investing portfolio and operating cash flows in very short, high quality investments and thus lowering our duration into 2.3 years.
Although in the short term this portfolio positioning will result in lower yields, we believe this will provide us with greater flexibility and auctionality to take advantage of opportunities throughout 2009 and will reduce further future portfolio volatility.
One last item impacting net income during the quarter was foreign exchange losses of $40.7 million. Although significant from an income statement point of view, these losses were largely offset by $38.1 million of currency related gains on investments that were recorded in unrealized gains and losses in the equity section of the balance sheet.
In our global operations, we seek to achieve a balance in our foreign currency assets and liabilities to minimize our economic exposure to currency fluctuations and these results indicate we are achieving that goal.
We ended the fourth quarter strongly capitalized with total shareholders equity of $2.2 billion and total capital of $2.8 billion, both down about $62 million from the end of the third quarter. During the fourth quarter, we repurchased nearly 700,000 shares for $18.1 million and for the full year 2008 we repurchased 4.6 million shares for a cost of $152.7 million.
As a result of the continued uncertainty and distress in the capital markets, and an expectation of improving underwriting conditions, we have currency suspended our share repurchase program.
For the year, our operating return on equity was 8.5%. Our diluted book value per share ended the year at $33.06 which excluding $1.00 per share of dividends we paid, was down $0.99 or 2.8% in the year.
We believe this modest decline stands out as a solid performance in a year that significantly tested the underwriting, investment and capital management capabilities of our industry and the broader financial services sector.
I will now turn the call over to Mike Angelina.
Good morning everyone. Our combined ratio for the fourth quarter of 2008 was 83.5% and 93.5% for the full year. Our loss ratio for the current accident year was 73% which translates into a 102.4% combine ratio for the full year of 2008, and this includes 8.6 points from hurricanes Ike and Gustaf.
The 2008 accident year combined ratio for our Insurance segment was 104.3% and for the Reinsurance segment was 101.3%. The Reinsurance segment loss ratio includes approximately 16 points due to hurricanes Ike and Gustaf.
Our 2008 loss ratio is about 15 points higher than our current view of accident year 2007 or seven points higher after removing the effects of Ike and Gustaf. This is consistent with industry loss ratio trends and is driven by a few factors.
First, an increase of five loss ratio points, particularly due to the higher proportion of agricultural Insurance business which we booked at a 95% combined ratio for the full year 2008. Also, a decrease of approximately five loss ratio points principally as a result of the restructuring of third party reinsurance arrangements from proportional to excess of loss for the property lines of business in our Insurance segment and from accident year improvements in the professional liability lines; and lastly, an increase of five additional loss ratio points due to rate level softening in most of our lines of business.
With regards to the pricing environment for the full year 2008, our overall rate monitoring indicated a decrease in pricing across most of our lines of business of 5% to 10%. However, for January 1 pricing, we saw an increase of approximately 4% across the book of business with terms and conditions being more mixed as certain lines, especially in the insurance segment saw improvement.
Our Fortune 1000 insurance business experienced high single digit price decreases during 2008 on which is a very large space for 88% of renewal premium. As you can see in our triangles which we published last night, this book is generated in section to date loss ratios in the low 60's with high levels of RB&R and has historic renewal rates in the 80% to 90% range. As David Cash will discuss more in detail later, this is an area where we have begun to see signs of market hardening.
In the onshore Reinsurance area, we saw mid single digit rate decreases for both property and casualty risk during 2008. However, the business we wrote during the year is still within an acceptable return range relative to the required capital.
It is also worth noting that the renewal premium comprised approximately 85% of our annual premium in this area and our January 1 pricing experienced single digit increases slightly improving terms and conditions with the market behaving rationally.
Lastly, the Bermuda based catastrophe Reinsurance lines saw low double digit price decreases in 2008 on what was also a larger renewal book. Even with the impact of Ike and Gustaf, this book was able to generate a profit for the accident year, illustrating that even within the business unit's diversification matters. The market conditions since January 1 have improved as we are generally seeing better rates and terms and conditions.
Turning to our loss reserves, in the fourth quarter of 2008 our loss reserves across all prior periods which include the first nine months of the 2008 accident year developed favorably into total by $58.7 million split evenly between the Insurance and the Reinsurance segments.
Approximately $17.7 million of this favorable development is attributable to accident year 2008 arising from our short tail lines of business as the actual loss experience was less than expected for the premiums earned in the first nine months of the year.
It is worth noting that for the short tail lines of business, excluding our provision for Ike and Gustaf, our carried ID&R level for the 2008 accident year is $157 million. The remaining $41 million of favorable development observed this quarter arises from accident years 2007 and prior.
The development is split between Insurance and the Reinsurance segment and is driven by our long tail lines of business. The favorable development in the long tail insurance segment of $17.9 million arose largely from our Bermuda based health care liability lines as claims activity was below expectations.
The remaining favorable loss development of $21.6 million from accident years 2007 and prior arose predominantly from two sources; the California Workers Compensation business that we wrote as a reinsure, and the directors and officers liability line of business. For both lines, you can look at our triangles and get better visibility into how we have reserved these businesses.
To date the book loss ratio for long tail line in our Reinsurance segment is about 63% across all accident years, or within a point of our initially priced loss ratio.
Consistent with last year, we released global loss triangles last night with our year end results. The triangles and the supporting exhibits are presented on an accident year basis and expand our segment level information to highlight differences that exist in broad reserving classes.
We are committed to being at the forefront of our industry and transparency and disclosure and enterprise risk management, and we feel providing this level of detail in a timely manner, allows you to analyze and fully appreciate the strength of our balance sheet. You will note that the exhibits also show in greater detail, the drivers of our year to date favorable loss development of $155 million which is split between the Insurance and Reinsurance segments and our long tail and short tail and other specialty exposures.
We also published our value at risk service of January 1 in the financial supplement last night. Reviewing this curve, you should note that in addition to our small capital base, our curve has shifted to the left due to lower expected levels of revenue and investment returns. However, our one in 100 year loss expectation remains within our tolerance level and currently stands at approximately 22.6% of our shareholders equity.
Our value at risk curve incorporates a more favorable view of market conditions for many lines as well as a change in the mix of business. The loading for catastrophes is approximately 12% which is consistent with last year and assumes no favorable or adverse development from reserves.
As we look at our current and our prior value at risk curves, we see the benefits of having a balanced and diversified portfolio both within our business units and across the enterprise as a whole. Our curve reflects our balanced underwriting portfolio which is comprised in almost equal parts of agriculture insurance, catastrophe reinsurance, Fortune 1000 insurance, working layer reinsurance and our onshore specialty insurance businesses.
These areas which for the most part are non correlating also provide a nice mix between Insurance and Reinsurance, long tail and short tail exposures, distributions of limits and attachment points, customer segmentation and distribution channels. As we continue to expand our international Reinsurance footprint, we expect further geographic diversification.
When we couple this underwriting and catastrophe portfolio as evidenced in our value at risk curve with a strong reserve base, conservative investment portfolio and actual liquidity, we feel that we are in a strong position relative to the risks in our portfolio from both an economic capital and a rating agency capital point of view.
I would now like to turn the call over to David Cash.
Good morning everyone. For my portion of the call, I will provide you with our point of view on the Insurance and Reinsurance market today, give an update on pricing and market conditions, and finally update you on the underwriting that took place at January 1.
We all recognize that 2008 was a very tough year. At the same time, our underwriting results were good. Insurance generated a combined ratio of 93.5% for the year. Given hurricanes and commodity price challenges, 93.5% is a number we're very proud of.
Besides for Endurance's own experience, there's ample evidence of Insurance and Reinsurance companies experiencing truly awful results in 2008. Many large and previously credible peers have been pushed right to the edge and possibly beyond.
So the question becomes the following: Has the industry experienced enough pain that a market correction is imminent? It is our sense that while we are close to a full market turn, we're not there today. In the same ways the market began to turn in 2000, it was not until the World Trade Center and Enron World Com that we arrived at a truly hard market, and the time between 2000 and 2003, the industry reported some very large losses.
With that in mind, it's fair to describe Endurance as being quite cautious while still being optimistic for the future. Through all the challenges that the company has faced, our underwriting business remains profitable and our platforms are well positioned to grow.
In the short term, our underwriting posture is offensive. We have increased the stringency of our loss ratio hurdles and where appropriate have made targeted reductions of our book of business. In some instances we have taken steps to eliminate portions of our portfolio that are overexposed to competition with little near term change of a market condition bounce back. This would include California Workers Comp.
For catastrophe risks, we're being judicious in our use of cap capital. We raised our ROE targets meaningfully at January 1 and we focused on underwriting business familiar to us. Elsewhere, we are simply working to make sure we can not accumulate marginally quality risks through this phase of the market.
Aside from targeted reductions, we continue to invest in our businesses to insure we are ready to move when market conditions come around. For now, you should not expect a surge of underwriting activity; however if the market does revert back to hard conditions, you should expect to see such a move from us.
Moving to some specific comments on market conditions, we're seeing the following across our book of business. For large risk insurance, this is a very dynamic market. Pricing is both up and down. Where clients are willing to entertain quotes from damaged incumbents, pricing is down. Otherwise pricing is flat to up.
In this market we are seeing some aggressive competition from newer carriers and the market is clearly in transition. Even brokers are speaking about pricing increases. We are positioning our underwriters to grow in the space as market conditions improve.
Middle market insurance; this portion of the market remains stable with less pricing movement and less account churn. Pricing is likely to remain soft here for the foreseeable future. As a consequence, our posture is similar to a year ago. It is cautious. Our underwriting platforms are largely complete and we continue add underwriting talent where the opportunities present themselves.
For catastrophe reinsurance, pricing in this market is driven by the general cost of capital and as a consequence, pricing has been moving upwards. As January 1 price increases seen in the market were not as great as we might have hoped for, particularly international and Workers Comp, at the same time the overall returns on our portfolio are noticeably improved over 2008,
It is our belief that pricing will continue to increase through 2009. A recent U.S. win program from January 1 was re-priced upwards by 30%. The market will likely only get better as the year continues.
Non catastrophe reinsurance, to a lesser extent than catastrophe reinsurance, the general reinsurance market have seen price increases. Where reinsurers are looking for large price increases, or seeing commission reductions, clients are prepared to retain risk. In the past, the ability of insurers to retain risk was seen as a disadvantage for reinsurers. Today I tend to see this as something that will protect reinsurers of being similarly being overexposed to the bottom of the underwriting cycle.
Similar to middle market insurance, we remain cautious in this market. There will likely be real opportunities for reinsurers here but not until the market has well and truly turned.
Aside from my general comments on the market, we saw the following in our book in the fourth quarter and at January 1. As Mike McGuire pointed out, our agriculture, international property and Workers Compensation books of business will shrink in 2009.
Based on market conditions today in the catastrophe lines of business our book will likely hold steady for the first half of the year. Beginning in June in Florida, we expect to see opportunities to grow this book of business.
In the U.S. reinsurance market, the conditions were not strong enough to support overall growth at January 1. This is not a particularly large renewal base, this book of business and one should not read too much into that data point. At January 1, we saw reductions in several of our specialty lines of business such as aerospace, agriculture, personal action, security, and some increases in the casualty classes.
Overall for January 1, our reinsurance portfolio showed a renewal rate of approximately 8% and with new business added in, we will likely find ourselves flat year over year.
For Insurance lines of business other than agriculture and Workers Comp, we continue to grow organically year over year. Even with soft market conditions we expect the casualty portion of our insurance book to grow. This is a result of increased staff levels and opportunities resulting from competitive stress. If market conditions harden, we would expect material growth in this area.
With that I will turn the call over to Ken for some closing remarks.
Although challenging underwriting conditions continue to exist in many markets, it is clear that capital constraints, lower investment yields and industry underwriting results are providing positive momentum towards improved pricing this year and next.
For the first time in several years, we see a stable to improving pricing environment across most sectors of insurance and reinsurance. We are beginning to see better opportunities in property, catastrophe reinsurance, our Bermuda Casualty Insurance lines and certain pockets of our U.S. insurance business.
We expect to achieve a 15% return on equity in 2009 and our current plans are calibrated against a generally stable market environment. If the hardening market continues to gain momentum, we are well positioned to be a significant beneficiary of that change.
Looking ahead to 2009 and beyond, we expect to continue to see a high degree of turbulence, volatility and change in the global economy, the financial sector and the insurance industry. We expect many challenges but we dominantly see this as a time of change and an opportunity to positively distinguish our performance as a company both strategically and financially.
We begin the year well positioned in our markets with a strong capital base, high quality people and the capabilities required to manage the heightened risks we see and to seize the opportunities we expect the changing markets will yield.
We will continue to build our global franchise and aggressively manage our portfolio of risks to achieve industry leading returns of capital.
We'd now like to open the lines for questions.
(Operator Instructions) Your first question comes from Ronald Bobman – Capital Return.
Ronald Bobman – Capital Return
With the exit from the California Workman's Comp insurance business, Ken you could discuss your view? I know you've been pulling back and I think for the planning, maybe already communicating an exit, but could you generally speak about your view on that market and why it prompted the pull back leading to a pull out? And then I had a question about that one comment that was made toward the end of the prepared remarks about the January 1 cap reinsurance program that priced up. I assume that you're talking about a program that just was recently completed as opposed to one that had been completed in a more timely December 31, January 1 fashion, and I was curious to know if a, my assumption is right about the time of that one being wrapped up, and b, was it a loss affected account?
With regard to California Worker Comp, we signaled when we entered this business that we viewed it as basically an opportunistic play. We were able to enter this business with a high quality partner and combined capabilities of our organization and theirs led us to grow quickly, very, very high quality book of business.
It was not a representative slice I would say of the California Workman's Compensation market in that the business we have been writing has been largely small business and business generated outside of the major metro areas in California, so we think we found a particularly pleasing pocket of the market.
So our results have been better than we would have anticipated for the time that we've been doing t his business. Looking forward however, I think the trends are not looking positive to us in terms of what likely experience will be generated in future periods of time.
I would be quick to say that I think the business today is performing well, but we have telegraphed to you and our partner, that we would rather leave early than stay too late in this marketplace.
Some of the things that I see, certainly in the general economic conditions are causing exposure basis to reduce, payrolls, low expectations when the business was written. We have not seen any loss trends per se that are concerning to us yet but we expect that will start to develop and we think with the changing environment economically and politically, the signals are that things are likely to get worse than stay stable or better so it's time for us to leave that business. It was a successful endeavor. Our partner has a new carrier and I think everyone was a winner in it.
In terms of the Florida win question you had, what's interesting to us is that the renewal season has begun pretty early. We have had and we will have a great many customers visiting us in Bermuda during the month of February and in fact, we started some discussions with some of our existing clients back in December.
The back drop is extremely dynamic, as you well know. The political climate in Florida as it relates to homeowners insurance and various interventions that the Florida State Government has had in the market are very, very important, and understanding the rules of the game and all those dynamics are a big part of the underwriting process.
There's a great deal of uncertainty as to how all that will look when the business really in earnest gets done, more in May and June time frames. I'll pass it over to David.
I wasn't totally clear on that account when I spoke about it in the script. This is an account that's not a January 1 account. I think its February 1. I may not have the date precisely right.
It came into market, it's a wind exposed account. It had some exposure to the events of last year, not disproportionate. The client and the broker brought it to market. It was sort of a target price that represented an increase over last year, but not a material increase and that price if they had placed it, might well have been in line with what we saw at January 1.
What we actually saw was the market pushed back very hard on that particular risk and the pricing at the end looks like it's going to land quite a bit higher, as much as 30% higher than where the client thought it would land originally. The point I'm making there is actually when it comes to wind risk, the market is dynamic and the tendency is to be pushing prices up even now.
When you factor in some of the dysfunction that is very real in Florida, it's possible to end up with circumstances similar to 2006 when we get into May.
Another bit of color, one of the things that we use as a leading indicator is ILW or industry less warranty pricing and usually the month of February is a low point during the course of the year in terms of the pricing of ILW risk. And actually, it's quite high now. So given what we've seen in the past, I would expect that ILW pricing, retro pricing, things like that will continue to build in terms of price increases along with the underlying business.
Ronald Bobman – Capital Return
Because of all the uncertainty on the regulatory front in Florida, is this pending contract having any sort of structural additions put into it to provide for, to you benefit to reinsure protections, or sort of deal with that uncertainty.
Historically insurers have deemed that the FHF would be place and so that would still be the case this year. The political dynamic in Florida is pretty intense. I could easily see an environment where insurance companies are forced to hold rates flat, and suffer a real erosion in economics as a result of the price they can charge.
Reinsurers to some extent rise and fall with the underlying price base. Because you're pricing on the loss bases, you're not entirely locked to the economics of the underlying insurance company. You may suffer five points or ten points of erosion as a result of what the State does, but that's pretty minor in comparison with the economics being on an excess basis.
I think reinsurers in the main, look at Florida as being potentially politically dysfunctional. We've historically been able to protect ourselves reasonably well from that dynamic except to the extent that you might view a closed share, or actually have your own paper in that market. We don't have any of our paper out in that marketplace, and I would expect us to do no quota shares or possibly one very small one.
We're nervous about the political dynamic. We think our position is a pretty well protected one, but obviously you never say never in Florida. It's a unique market.
Your next question comes from Ian Gutterman – Adage Capital
Ian Gutterman – Adage Capital
Can you talk about how much capital is tied up in the Workman's Comp business and what the time period is for that to free up?
We have had a very cautious view on that risk in terms of its natural peril component which is really an industry wide under-appreciated exposure. What could happen if an earthquake hit LA or San Francisco during the work day in particular?
We have protected that book of business with a very, very significant sized XRO program that carries us up to pretty high PML levels. So the book of business with one or two fifty a year kind of view has not been particularly capital consumptive, but tail risk beyond that, we do attribute capital to that, and it's not inconsequential.
I think that as the business runs down, obviously we'll be moving our reinsurance purchases down in tandem with that.
Obviously the reserves are a source of capital utilization as well, and as you know Work Comp really has almost a bar bill effect. One side of the bar bill is much bigger and that is the attritional loss level that you see from minor injuries and things like that which represents the bulk of your expected loss ratio typically.
There is a component that goes out quite a bit. The tail on Workers Compensation I've seen where it goes out over 50 years. That's a relatively small proportion of our program, and we have projected ourselves against large individual and multiple employee exposures by buying a pro risk XRL cover.
So I think the capital impact won't be a ton, but releasing the capital will allow us to write more California quake property cap business for instance if we see that as an attractive opportunity.
Ian Gutterman – Adage Capital
I was trying to think more of a reserve nature not so much of a cap component. What's the duration of the Workers Comp? Maybe how much reserves do you have in that business and what's the duration of the reserves so I can think about how quickly those reserves come off the books and then you can write new business against it.
I point you to our triangles that we released last night. We actually have separated the Workers Compensation out as a reserving class in the triangles. And when you look at our Workers Comp business in total, this would be the business we initially did to reinsure and then the direct operations, we've got about $120 million of case reserves and about $190 million of ID&R. We're booked at about a 65% loss ratio and the details are there.
From a duration perspective, we're looking at Workers Comp as Ken alluded to, it really is kind of a bar bell approach that you've got the attrition that comes in pretty quickly, and then you've got these cases that last for a long while. I would say the duration is somewhere in the four to six year range.
Ian Gutterman – Adage Capital
I was just trying to make sure there wasn't going to be too much dead capital that you're not writing business against what you have to hold for the reserves that might pressure ROE. See where I'm going?
We don't see that as a pressure point for our ROE.
When you hold reserves, you generate an investment income on those reserves.
Ian Gutterman – Adage Capital
On the ROE guidance, can you help me a little bit because the yield is so low, possibly be more risk on the alternative? It doesn't sound like pricing is up as much as you'd hoped so maybe the action is not improving as quickly as you'd hoped. Help me with the components of the 15. I was thinking you usually give that guidance with prior period, correct? So I thought some of the pressure on the NAI yields might pressure the actual ROE which is essentially what you're giving. Can you walk through that?
As you know, we bake a lot of variables into that valued risk over expected income curve and certainly investment income is an important component and we are planning for less relatively speaking investment income because of our shortening of duration and moving into basically U.S. Federal Government instruments in terms of safety.
We are expecting a crop year this year in terms of our assumptions that would be more in keeping with historical views of profitability which are good and strong but we also are mindful of the volatility that certainly is in that business from a natural peril perspective as well as commodity price perspective.
In terms of some of the other major components, we see an improved casualty environment in the U.S. business. Certainly we're seeing that in the Bermuda lines of business where pricing is basically stabilized and is improving as Mike Angelina reported. I don't know whether that trend will continue. We're watching it very carefully. The market dynamics are quite extraordinary with some of the distress that companies like AIG and some of our island competitors have experienced.
So when you add all of it up, it's a number that we're confident, and obviously we're sharing it publicly. As usual, I think there will be differences from our expectations from one component to another, but I think that when they all add up at the end of the year, they'll still come out to about a 15% return on equity.
Ian Gutterman – Adage Capital
I guess what I was going with it is to the extent that last years book was also about a 15%, do you have pressure on the NAI and you have parts of the market where there is still pressure on pricing, it seems like some things are getting better maybe quicker than expected, and maybe that's just a mix change. Maybe you could talk about outside of the, maybe the accounts you're bringing on maybe, you're bringing that on at a higher rate than the California Comp was or something where there's a mixed benefit, or is it just pricing?
It certainly is a mixed benefit. When you look at how our Workers Compensation has been booked, historically it's about 100 combined. We do have a loss ratio expectation and our acquisition costs do vary based upon experience in a pretty wide range.
I think you would see if you did all the math that our underwriting ratio for the '09 year is about two points better than the '08 year and there are lots of sells that we build up into those assumptions. I would rather not for a call like this go into all of the details but I do see an improving underwriting environment, certainly given the example that David shared and what we're seeing on pricing.
The property cap in the U.S. will certainly price better in '09 than we saw it in '08 and we've already seen the evidence of that.
Ian Gutterman – Adage Capital
That's priced to ROE to priced ROE, because obviously crop was worse than priced ROE in '08. Is that 2% including the worst crop in '08 or is that versus normal?
Year over year on expected pricing.
Ian Gutterman – Adage Capital
Can you review for me again the seven point increase in the accident year, '08 versus '07? I couldn't quite get all the components up to '07.
There are some things going up and down that's driving it. First of all if you take out the impact of hurricanes Ike and Gustaf, you get the seven point differential. First of all is the fact that I refer to this as mix changes. The agriculture insurance is a higher proportion of our total in '08 than it was in '07. That was booked at a 95, so that's accounting for about five points up.
Then almost mitigating that, point for point are two things that are taking it back down and these two would be basically you have restructured within the insurance segment property business, the third party reinsurance programs from quota share or proportional coverage to excess of loss, and then the other part of that would be we've seen accident improvement in the professional liability lines of business on the insurance side. Again that's been a five point change.
So now we're back to zero. And then there's another five to six points that's basically due to increase of loss ratios due to pricing has softened from '07 levels to '08 levels. So it's three five digits kind of, two fives go up and one five goes down. There's some rounding going on so it might be 5.5 and 5.4.
Ian Gutterman – Adage Capital
I wanted to make sure I heard it right, you said an improvement in professional lines, because that seems kind of intuitive to what's going on in the world.
When you think of that, basically in '07 you had the credit crisis losses that were affecting the accident year that to the same extent are not affecting the '08 accident year.
Ian Gutterman – Adage Capital
So you're basically weren't exposed to the financials that had losses in '08?
A lot of the noise from '08 will find its way back to the '07 accident year. The nature of that policy will put it back to a prior period.
Ian Gutterman – Adage Capital
It sounds then that you feel pretty comfortable that you '08 accident year wasn't exposed to a lot of the stuff that went on last year or pending stuff that could come in through claims this year.
There will have been events in 2008 that were continuations of events first noticed in 2007 that result in a loss. Arguably the kind of headline event was the 2008 event. It will find its way to the 2007 action year because the initial notice on that occurred in that year.
Your next question comes from Jay Cohen – Bank of America, Merrill Lynch.
Jay Cohen – Bank of America, Merrill Lynch
On the alternative investments, as you look out to 2009, what are your expectations for this portfolio? I know no one has a good crystal ball here, but what are you building in and related to that, and I just don't remember what the case is with you, is that business reported on any sort of lag?
Actually the alternative performance is no longer at Endurance reported with the lag. In prior years we had had about a one quarter lag just in terms of how the reports came to us. We've been able to tighten that up and we're confident in reporting the full quarter. We did basically have a month lag in prior periods. So that is an up to date view through December 21, 2008.
Looking forward to the alternatives, this is an area of our portfolio that's rather modest and yet it has created a fair bit of volatility for us in '08. It's been a very nice source in previous periods. It's something that we're looking at in terms of our investment strategy going forward.
I think it's important to know that these investments for us are not funded from investments. Each investment has been hand selected and we monitor them very, very carefully. We select them for their level of transparency, generally little use of leverage and generally are looking at people who are operating in credit markets less so in equity markets.
So given that the credit markets were kind of at the heart of many of the issues in '08, perhaps the results are not terrifically surprising.
In terms of the balance at the end of the year, we have between our alternative investments and our high performance, about $286 million there and in terms of forecasting, we generally seek to achieve a 500 basis point spread above risk free rates on that asset class.
Obviously there's a fair bit of volatility that would come with that return expectation but in terms of how we expect over periods of time, look at 500 basis points over a risk free rate. So in terms of the yield I would translate that into mid to high single digit return expectations.
Jay Cohen – Bank of America, Merrill Lynch
Do you have any sense so far this year what has happened to these assets?
Obviously it's still early and we've only received some very initial preliminary indications from our alternative funds and higher bond funds, but actually for the whole portfolio it looks like January is going to be a positive performance month. Obviously there's a lot of time between now and the end of the first quarter, but certainly initial signs that we've received for the month of January, it looks to be a positive return.
Jay Cohen – Bank of America, Merrill Lynch
With you onshore specialty platform, you suggested that you've obviously added to the underwriting team. My assumption is you're seeing a lot more submission activity. Can you talk about two things; one is where these submissions are coming from and secondly, what's happened to your hit ratio, you're binding relative to the submissions?
I'll give a little bit of history. I'll try to be concise. Going back really to the end of '04, we made a choice here at Endurance. It was an important choice. First was that we needed to get into the U.S. specialty business in order to accomplish our goals as a company, and we chose to do it organically rather than through acquisition.
You know that we're very concerned about the potential for Legacy liabilities when we do acquisitions, things like that, operational risk as well. So we went out and found a team of executives that we knew quite well and had a wonderful track record, and we set them to building our U.S. specialty business starting at the beginning of '05.
We needed to acquire onshore paper so we have acquired over time three shell companies to do the business in and we also felt that developing technology was going to be important in terms of generating the scalability of this operation that we wanted.
In the old days, you had to add people to add business. With the technology available today, you can build a lot of scalability into an operation if the technology is up to current standards. We don't any Legacy technology there, is the point.
So we built that business and we have invested in it. And it's grown frankly less quickly than we would have expected when we started this initiative and that's purely a function of market conditions as we've seen them since then. We've seen a steady decline in prices. I've seen that part of the market high single digit year on year on average, and we chose to be cautious and build our business well rather than try to generate revenue.
So as we complete '08, we have basically the platform that we're looking for. We can and will add underwriting teams to it for different parts of the business that we see as attractive opportunities, but the foundation and the structure is all there and we can add to it quite easily.
So in terms of what we're seeing in terms of submissions, submissions are up quite a bit year over year. I would say about twice on average. It varies somewhat from segment to segment. I would say that most of this submission surge that we're seeing is coming from the wholesale network of distribution, but we are also seeing an influx particularly in our Bermuda businesses of retail submissions which I think have been 50% to 75% of year over year on average.
The data that I see would indicate that our success ratio on renewals has improved somewhat. The competitive posture of the Bermuda market has changed and onshore, I would say our renewal retentions which have always been pretty good are holding up well and actually our hit ratios on new business are about the same, maybe a little bit better, but on a much bigger base of submission activity.
I suppose the other point to make, new submissions are up. Our hit ratio is about level on new submissions, but for new submissions our hit ratio is low and I think others in the industry would say something similar to that.
If I work my way across some different lines of businesses, health care I think is looking good for us. There was a very competitive moment last year which made us quite cautious but we're seeing hit ratios go up, submission ratios go up, hit ratios go up. That's pleasing. That's book to Bermuda and that's a U.S. phenomenon.
On the professional liability side, submissions and hit ratios are both up, and that's true of large professional liability risk and also miscellaneous E&L, so that's a positive story there.
Casualty is a pretty turbulent market. You see a lot of business that flows simultaneously both retail and wholesale and distribution channels at the same time. You can get a very competitive dynamic programs we layer a lot, so you can get some whacky things going on with submission ratios and hit ratios there, so it's hard to call.
I think the overall trend there is we expect growth there in that book of business, but trying to kind of pin it down to an overall submission ratio and hit ratio and retention ratio, that's a hard one to do.
Moving away from there, we have some smaller books of business. We have an environmental book of business right now which is growing nicely and that seems to be somewhat out of the turbulence in some ways so we're just seeing steady accumulation of premium there that I think would sort of mimic what we would have imagined when we brought that book of business on to our balance sheet.
In the wholesale market, it's pretty turbulent. The underwriters are very busy. It's a very dynamic environment where you're being asked to quote a lot of things and brokers respond very quickly to layering and I think the overall trend there I would imagine, I would say is growth.
But actually again, trying to pin it down to a series of specific levers is very hard. The underwriters are working incredibly hard in that area right now. Hopefully that helps you.
Jay Cohen – Bank of America, Merrill Lynch
Trade credit and political risk. My assumption is you are just not in those businesses?
We are to a modest degree as a reinsurer. Actually our first year David and I brought on board a few political risks, I think it was three in early days and we have two now and one significant trade credit relationship.
We're talking about $20 million of political risk trade credit, very skewed towards political risk. We cut back pretty aggressively on trade credit at January 1. It used to be that we would probably balance between those two books of business. We're probably 75% political risk at this point, very little trade credit.
There are no further questions. do you have any closing remarks?
Thank you for everybody that attended the call, a great set of questions as always and we're busy working this year. We see it as a very interesting year and a year where we can really differentiate our company's performance build our strategy and size of company as well. So we'll be reporting our first quarter in a few months and look forward to talking to you again then.
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