Executive
Jon Levenson - Senior Vice President
Ed Noonan - Chairman and Chief Executive Officer
Jeff Consolino - Chief Financial Officer
Analyst
Jay Cohen - Bank of America/Merrill Lynch
Keith Alexander - J.P. Morgan
Validus Holdings Limited (VR) Q4 2008 Earnings Call February 13, 2009 10:00 AM ET
Operator
Hello and welcome to the Validus Holdings Limited Fourth Quarter and Year-End 2008 Conference Call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator Instructions) Now I would like to turn the call over to Mr. John Levinson. Mr. Levinson, you may begin.
John Levinson
Thank you, good morning and welcome to the Validus Holdings Limited earnings call for the quarter and year ended December 31, 2008. After the market close yesterday, we issued earnings press release and financial supplement both of which are available on our website validusre.bm. Today’s call is being webcast and will be available for replay, details are provided on our website.
As a reminder, certain comments made during this call maybe considered forward-looking statements within the meaning of U.S. Securities Laws. These statements address matters that involve risks and uncertainties and reflect our review and future events and financial performance. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements and therefore you should not place undue reliance on any such statements.
More detail on these factors can be found in our most recent annual report on Form 10-K and quarterly report on Form 10-Q, both filed with the U.S. Securities and Exchange Commission. Management will also refer to some non-GAAP financial measurements describing the Company’s performance. These items are explained and reconciled in our earnings release and financial supplement.
Now I’ll introduce the speakers on today’s call. Ed Noonan is the Chairman and Chief Executive Officer of Validus Holdings Limited, Jeff Consolino is the Executive Vice President and Chief Financial Officer of Validus Holdings Limited. Following the prepared remarks Ed and Jeff will take questions from participants.
With that I’ll turn the call over to Ed Noonan.
Ed Noonan
Thank you, Camille and John and good morning to everyone, thanks for taking the time to join us today. For those of you who followed the company since our IPO or even before, you will recognize our mantra. We make our money as underwriters and we manage our assets for capital preservation in liquidity. By remaining true to this fundamental principle in 2008, we’ve enjoyed tough quartile performance in almost every area, we’ve grown our book value and a very challenging environment and we’ve outperformed our peer group in most financial measures.
We all know that 2008 was a year with very significant cap losses, yet Validus generated $98 million in underwriting profits. Both of our operating companies had solid underwriting gains with Validus Re reporting an 86% combined ratio and Talbot a 93.3% combined ratio.
By investing conservatively, we’re able to protect our capital, which is more precious today than certainly at anytime in my career. We grew our shareholder equity for the year with net income of $53 million a return on average equity of 2.7% and annualized operating return on average equity of 8.9%.
I think we were more bullish than most during our third quarter call. But the market has moved very much inline with our expectations. The current environment clearly favors our business model. Rates are moving smartly on demand-driven products such as catastrophe and energy both onshore and offshore. These lines are a significant driver of our business and we continue to add talent around the world to capitalize on the environment.
Short-tail severity-driven products behave in a more economically rational manner than liability and frequency driven products. I’ll provide some segment level comments after Jeff is finished. But I think it’s clear to us that we remain in the sweet spot of the market. Having managed our risk and assets prudently, we are in a very strong position to press our advantages and in fact, we’ve begun doing so at January 1.
So, with that, let me turn the call over to Jeff Consolino.
Jeff Consolino
I’m going to provide additional details in the fourth quarter and full year results. Let me start by referring you to our quarterly disclosure package, which is posted on our website. It consists of our earnings release, investor financial supplement, investment 8-K and investment portfolio and schedule of the format. We updated our estimate of the net adverse effective hurricane Ike in a pressure release we issued on January 20.
This is a significant driver in the fourth-quarter results and that amount is unchanged. We were significantly affected in 2008 by the same issues that adversely impacted the industry. However, despite hurricanes Ike and Gustav and the extraordinary volatility in the investment markets, we leave 2008 with a very strong low-risk balance sheet and an increase in the shareholders equity.
Our diluted book value per common share at December 31 was $23.78. Our preferred measure in growth of financial network for our shareholders is growth in diluted book value per share plus accumulated dividends. We pay a $0.20 quarterly dividend, which provides a meaningful 3.6% cash yield on our share. Adjusted for the annual $0.80 dividend we paid in 2008, our diluted book value per share plus accumulated dividend increased by 2.4% in 2008.
Shareholder’s equity increased modestly in 2008 to approximately $1.94 billion, while many companies in our industry and the overall financial sector had declines. Our 2008 net income was $53.1 million. We report our net income with all unrealized gains and losses on investments above the line rather than below the net income line through comprehensive income. This is consistent with our adoption of FAS 159 in January 2007.
Our net operating income, which excludes realized and unrealized investment gains and losses as well as, foreign exchange and other non-recurring items, was a $175.1 million in 2008. Our 2008 combined ratio was 92.2%, 86.0% in the Validus Re segment and 93.2% in the Talbot segment. We were profitable in an underwriting basis in both segments.
We experienced positive total return on our investment portfolio in 2008 of 1.8%. Fourth quarter net income was $37.0 million or $0.47 a share on a diluted basis. Our net operating income in the fourth quarter was $50.9 million, or $0.65 per diluted share. Net operating income in the quarter was lower than our stellar result in the fourth quarter of 2007 by $80.6 million. This is largely due to the net movement in the quarter of hurricane Ike, which equaled $70.1 million or 24.4 points on our loss ratio.
We benefited in the quarter from $19.7 million of favorable loss reserve development which equaled 6.2 loss ratio points. This $19.7 million breaks down to $6.1 million for the Validus Re segment and $13.6 million for Talbot. Please note, that as a result of higher syndicate profits in the Talbot segment, the Talbot expense is correspondingly higher.
In Net Op the corresponding Talbot expense, the total benefit of prior year releases in the quarter is $16.5 million, which is $0.22 per diluted share. Finally, our annualized return on average equity in the quarter was 7.7% and our annualized net operating return in average equity on an operating basis was 10.6%.
Turning to our investment portfolio, our consolidated investment portfolio at December 31, 2008 is $3.28 billion. We continue to follow our very conservative strategy emphasizing liquidity and preservation of investment assets. Our portfolio is all fixed income. It’s approximately 65% in cash, short-term investments, agency paper and sovereign securities.
The portfolio remains well diversified to liquid and has a short duration of 1.8 years. Its average credit quality is AAA. We have no investment in equities. No investments in hedge funds, no investments in funds-of-funds, we have no investments in any alternative asset class. Through the latter half of 2008, we have been building our cash. We increased our short-term investments, cash and cash equivalents balance by $166 million in the fourth quarter.
Looking forward, we plan to increase our investment emphasis towards U.S. agencies, mortgage-backed securities; FDIC guaranteed bank debt and selected high quality corporate credits. Some of this shift commenced in the fourth quarter of 2008.
Our fourth quarter realized investment gains were driven in part by gains on sales of U.S. Treasury Securities and purchases of FDIC-guaranteed bank debt on proceeds. At December 31, 2008, we had $85.9 million of FDIC guaranteed debt.
As I've said previously, in the aggregate, our investment portfolio experienced a positive 1.8% total return for the year. Still we encouraged some unrealized losses due to the dramatic increasing credit spreads for non-agency RMBS and CMBS. Due to the negative trends in the underlying commercial real estate market and the associated volatility experienced in our portfolio in the fourth quarter in CMBS, we determine to reduce our overall exposure to CMBS by approximately 50%.
Pricing and liquidity improved towards the end of January and we sold selected CMBS at immaterial gains to their December 31, carrying value. The CMBS we sold were more recent 2006, 2007 vintage years, which have benefited from much real estate price depreciation and may have less stringent underwriting standards.
We also sold the longer weighted-average life securities, which had exhibited greater price volatility. With this disposition, our CMBS position falls from a $192.3 million at December 31, 2008 to approximately $96 million. The weighted-average life of our CMBS portfolio decreases from 2.8 years to 1.1 years and we have almost entirely expunged the 2006 and 2007 vintage year CMBS from our portfolio.
Hybrid securities with European financial institutions have also recently been in the news. As of December 31, I can state that we had only $5.1 million invested in hybrids via three positions. All of these positions have been sold in January. We closed the year with a very clean and liquid investment portfolio. Since then, we've taken steps to further cleanse it. We have the proper balance sheet and capital position to pursue the opportunities presenting themselves in 2009, which Ed will now describe in further detail.
Ed Noonan
Thank you, Jeff. I'll spend a few minutes on market conditions on our major classes and I’ll start with our reinsurance business. As you've seen in our press release, our gross written premiums of January 1, for Validus Re have grown by 26% year-over-year. The U.S. cap market saw rate increases in all areas. We actually held our capacity well into December, as we believe that market rates were developing slowly.
As a result, we're extremely well positioned when coverage needed to be reprised to be completed and we wrote a number of private programs at significantly higher rate increases than the balance of the placement. Some general observations on the U.S. cap market, loss affected accounts saw increases in 25% to 35% in general with some with some asides 80%.
Nationwide coverage was up 10% to 15%, regional accounts 7.5 % to 15%. North-east was disappointing to us, as rates rose only 5% to 7% and as a result, we reduced our exposures to that. Retention increases weren’t the major fact at January 1, although the supply demand imbalance persists in the marketplace and we think there's a pretty good chance it will become even more exacerbated as we get closer to June 1 and July 1. Validus rewrote $138.2 million in our U.S. property unit, an increase of 23.4% year-over-year and our risk adjusted pricing improved by 14% year-on-year.
In the international property reinsurance market, we saw several key dynamics. Interestingly, the Pan-European coverage didn't get placed as easily this year and several programs needed to be reprised to be completed. Security issues also rose both around downgraded reinsurance and also around single counter party credit exposures to very large reinsurance.
As a result, we saw full signings on virtually all authorized programs for the first time. Validus Re is being recognized for its analytical insights by a number of the largest European carriers resulting in broader participation as the [reporting] market.
Margins in the European pro rata market continue to fall well below our return requirements and so and once again we've opted not to play. And in Asia, we've added a Validus representative to open our Validus Re Singapore office and as a result, we saw significant increase in submissions at January 1.
In the aggregate, the international property unit wrote $82.9 million in premium in January 1, an increase of 15.2% over January 1 2008 and our risk adjusted pricing improved by 11% year-over-year.
In the Marine treaty market outside of the Gulf of Mexico, we saw a high single-digit effective rate increases and some cleaning up of contract wording particularly around Marine liability exposures. Additionally, we saw Gulf of Mexico exposures removed from a number of programs creating attractive non-correlating opportunities for us.
Regarding the Gulf of Mexico, there is clearly insufficient reinsurance capacity available. We saw pure rate increases of 25% to 30%, with significant increases in retention and coverage limitations imposed. As a result, we see exposure adjusted rate increases in the 40% to 60% range with some programs higher still.
The growth in our marine premiums at January 1 reflects this outstanding rate environment as we’ve actually decreased our net exposures a bit in the Gulf of Mexico while dramatically increasing premiums. We wrote $105.8 million in our marine business unit in January 1, an increase of 44.5% year-over-year and the risk adjusted pricing improved by 11%.
Finally, our other specialty treaty business wrote $39.8 million at January 1, an increase of $5 million over 2008. I’ll turn now to Talbot, our Lloyd Syndicate, which as you know, writes the global portfolio of direct insurance in facultative business. Talbot’s business is written evenly throughout the year and as a result, January 1 isn’t as momentous as to-date for Talbot as it is in our reinsurance business. Talbot is a leader in the London market for most of its major classes including the Marine account.
In the Marine whole segment, rates were up 5% at January 1; and we expect to see the trend to increase into the high-single-digits over the course of the year. In Cargo, rates are up 2.6% with positive underlying trends. However, we expect the global economy to have a meaningful impact on the Cargo market, which will tend to dampen rate increase activity.
In the Marine war account, rates continue to be competitive, but at relatively attractive levels. As a result of the piracy in the Gulf of Aden, the market is moving to exclude piracy from the whole policy and push it into the war policy, which we think is clearly more appropriate. This allows us to charge specifically for the exposure and in fact, we’re currently seeing some attractive additional premiums as a result.
Moving to Talbot’s energy account, which is predominantly offshore with very, very limited Gulf of Mexico exposure, we’re seeing average rate increases of 12% year-on-year. Increases will be significantly higher in the Gulf, but very little direct insurance coverage is renewed yet. As we mentioned in our third-quarter call, we’ve added David Hawksby and his team to underwrite an onshore energy portfolio for us.
We’re really gratified by the market reception globally and we feel like we’ve gotten off to a strong start. David’s team brings us a market leader in the energy business with an experienced team of underwriters and engineers as well as relationships around the world that are already paying dividends in other parts of our portfolio.
Terrorism and political violence are important classes for the Syndicate and Talbot is also a leader in these areas. In general, the market here feels like it’s reaching a bottom, although rate decreases can still be seen. There is just generally a bit more discipline. This is a class in which AIG has been a very large player and has been very competitive to hold on to market share. Talbot tends to write smaller risks with a very broad spread in over 140 countries, which gives us some pricing insulation.
The global property market is showing positive rate movement, although the U.S. market is still lagging. We expect the U.S. to accelerate as higher reinsurance costs begin to have an effect on the line pricing. However, with a large number of losses in the international market, we see more attractive conditions outside the U.S. as the market reacts to adverse experience.
Both, Talbot and Validus really focus on short-tail business and a key goal for us is building product and geographic diversification into our overall portfolio. 2008 was a great example of the benefit of the strategy. While we sustained a significant loss in Hurricane Ike, we reported very strong underwriting profits due to our diversification. We also have a goal of providing the greatest possible transparency to investors.
In this quarter, we’ve released the Lloyd’s Realistic Disaster Scenarios applied to our entire portfolio both Talbot and Validus. This is intended to help investors gain a sense of the risks that we take on in non-natural catastrophe areas as a result of our diversification strategy.
The estimates of the result of applying specific guidelines of Lloyds across our portfolios. We’ll be happy to answer any questions you may have on them and you can also find the Lloyds website link on page 35 of our investor supplement.
Turning to claims activity, the fourth quarter was extremely quiet with very few notable losses. In terms of recent events, based on client feedback, we don’t expect extra tropical storm clouds to be a significant event to us. We tend not to be a big player on low-level European [inaudible].
In Australia, we’ve declined to write the underlying covers on aggregate programs purchased by the two large market players. And so, we don’t expect to see significant claims activity from the brushfires, wind storms or floods. Although, clearly there will be loses in our reinsurance market from Australia.
In closing, one of the benefits of our flexible and efficient global operating platform is the ability to quickly move into lines of business, which present the greatest opportunity. Our Talbot platform is a key to this execution ability as the Lloyds global licensing, strong ratings and reputation allows to establish a presence without committing significant capital to new balance sheets and multiple jurisdictions.
Our experience and well-respected management team is another asset in this strategy. As we know, and have worked with many of the best in the business during our various carriers. The talent that we’ve been able to attract in recent months is impressive and we already seeing good business flow from our new operations. I’d like to just take a minute to list our new operations and also to welcome our new colleagues.
Our most recent appointment was Marc Haushofer, as the Validus Re Singapore Representative Office Executive. Validus Underwriting Risk Services is an MGA we set up, writing on behalf of Talbot led by David Hawksby and his onshore energy team and also in the fourth quarter we have added Peter Bilsby, as Head of Global Aerospace. Peter and his team will bring another market leader to us at a time when aviation pricing is improving.
Now, with that, we’ll be pleased to answer any questions you may have and I’ll turn the call back over to Camille.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Jay Cohen - Bank of America/Merrill Lynch.
Jay Cohen - Bank of America/Merrill Lynch
Two questions, first is you mentioned that in the renewal season, for the first time you’re able to get, I guess you described it as full signings and I guess my question is do you want to get full signings? Does it mean maybe that you could charge a higher price? Just I guess it’s more of a basic reinsurance question, but if you could give me some color on that?
Ed Noonan
Yes, actually in Europe, basically we do pursue full signings. There’s strategy involved and tactics and market tactics involved, but when I referenced us getting full signings effectively, we got the signings that we hoped to get on every program, which as a relatively new company it has taken us a couple of years to get to, but we’ve spent so much time working with some of the biggest European companies and helping them analyze their data, look at it relative to peers, right down from the street level address, helping them think about reinsurance structures and strategies that, it’s just very rewarding to have them offer to us whatever we’d like to have on the program.
Jay Cohen - Bank of America/Merrill Lynch
Okay, so that net-net, you’re happy with that. That’s the main point I guess.
Ed Noonan
Yes.
Jay Cohen - Bank of America/Merrill Lynch
And the second question on the asset side, so you moved a lot of the assets more into shorter duration, cash and cash equivalents. Is the plan at some point to move that back into riskier assets when yields are better or the world is safer?
Ed Noonan
I think Jay; the concept of going into riskier assets is one we’d like to stay away from. Our principal’s are not really to take a lot of investment risk. It wouldn’t really add to our REIT’s, we don’t have the investment leverage to make it pay off. Our intention is to focus really on the underwriting as a source of ROE. What I did allude to in my comments I think is a step in the direction, although again I would not use the word riskier.
Our investment yield in the quarter obviously has come down substantially since last quarter as we built up the cash position and as cash yields have hurdled towards zero. Actually, our fixed income portfolio yield has held up pretty well and there was not a declining [glide] path, what we’re looking to do is take some of that cash, and we’re looking to buy agency pass-throughs, we are looking to buy selected very high-quality corporates and also the FDIC guaranteed bank debt as mainly a treasury substitute. So we’ll work down the cash position through the course of 2009 and replace it with those types of assets, which we think will defend our portfolio yield and even without increasing our overall risk levels.
Jay Cohen - Bank of America/Merrill Lynch
That’s great and last question, can you talk about the status of any side-car vehicles that you used in the past and may not be available on the Marine side?
Ed Noonan
Yes, Jim. We didn’t renew the collateralized quarter share thus year and we’ve had opportunities. We’ve had capital offered to us but more on a permanent basis and we don’t see that as being the right step at this point and so, we continue to explore it. We may put something in place. It’ll depend on the terms and conditions, and clearly the opportunity is robust from a pricing standpoint, but capital is more dear today. So, as I say, I wouldn’t commit that we’re likely to put something in place. If we can reach the right deal, then I think we would.
Jay Cohen - Bank of America/Merrill Lynch
And the rating agencies are obviously okay with your assumption and more of this risk.
Ed Noonan
Well, we’re not actually. Last year, we wrote our net line under the collateralized quarter share and this year we simply wrote our net line again and, in fact, we reduced our aggregates in the Gulf of Mexico just a little bit, so we’re not actually taking on more risk.
Operator
(Operator Instructions) Our next question will come from Keith Alexander – J.P. Morgan. Please go ahead.
Keith Alexander – J.P. Morgan
Just wondering if you could provide some more detail on file expense going forward?
Jeff Consolino
Sure. I know there have been intense interested people since we acquired Talbot and we did take the step last year to put forward a very detailed analysis of the source of file expense. We have funds at Lloyd’s participations from third-parties in our 2007 and 2006 years of account. We do not have third-party providers in 2008. With the end of 2008, we’ve now closed the 2006 year and so the 2007 year of account is the last relevant year for file expense.
The way our earned premium is expected to be allocated between the 2008 and 2009 year account for the year 2009 calendar year, they’ll cut take the lions share of the earned premium in 2009 calendar year with only a modest amount from 2007. What you would see profit potentially emerging from 2007 depending on how the year of account reserves develop either favorably or unfavorably. So, when we put forward that 8-K, I think the conclusion when to draw would be that the file expense would be tailing off to a very low-level calendar year 2009, the only caveat again would be the closing of the 2007 year of account at the end of this year.
Operator
We show no further questions at this time. I’d like to turn the conference back over to management for any closing remarks.
Ed Noonan
Thanks a million. It is a very busy earnings release day and week and so I’m not surprised that people are off writing up their analyses. I appreciate the interest and attendance from so many people today though. Just to reiterate, in general, we’re extremely bullish about our business. We just feel like we’re positioned in exactly the right spots. We have the ability to continue to grow in a very capital-efficient manner by attracting new teams of talent in the areas where rates are moving more smartly. So, it feels like a very good time to be Validus and we appreciate everybody’s participation this morning. Thank you.
Operator
The conference is now concluded. Thank you for attending today's presentation. You may not disconnect.
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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
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