Flagstone Reinsurance Holdings Limited Q4 2008 Earnings Call Transcript

Flagstone Reinsurance Holdings Limited (FSR)

Q4 2008 Earnings Call

February 17, 2009 9:30 am

Executives

Brenton Slade – Director, Investor Relations

Mark Byrne - Chairman

David Brown – Chief Executive Officer

Patrick Boisvert – Chief Financial Officer

David Beckman – Chief Actuary

Analysts

Jay Gelb – Barclays Capital

Joshua Shanker – Citi

[Phillipe Farhan – Montero Teachers]

Presentation

Operator

Welcome to Flagstone Reinsurance Holdings fourth quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce you to your host for today's conference, Brenton Slade, Flagstone's Director of Investor Relations.

Brenton Slade

Good morning ladies and gentlemen. Thank you all for joining us on the call today. With me are Chairman Mark Byrne, David Brown, our CEO and Patrick Boisvert, our CFO. Before I turn the call over to Mark, please let me remind everyone that statements made during this call including the questions and answers which are not historical facts may be forward-looking statements within the meaning of the U.S. Federal Securities laws.

Forward-looking statements contained in this presentation may differ from actual results. We therefore caution that you should not place undue reliance upon such statements. We speak only as of the date on which the statements are made and the company undertakes no obligation to update or revise publicly any forward-looking statement whether as a result of new information, future events or otherwise.

On that note, I would now like to turn the call over to Mark Byrne, our Chairman.

Mark Byrne

Folks, 2008 was obviously a challenging year. Our book value declined due to investment losses with the majority of those losses occurring in the third quarter and the first two weeks of the fourth quarter, all of which is old news. We saw that in mid October.

2008 was also a successful year for us organizationally with our acquisitions in South Africa, Cyprus and London and our restructuring into a Swiss operating company. Despite the macro economic global environment, we were able to continue to build and add to the quality of the platform. We now have over 400 people in 13 offices in 10 countries.

We believe this gives us a tangible edge in sourcing more risks in a diversified manner, analyzing those risks and making more informed decisions about underwriting. Ultimately this results in a diversified and high quality portfolio.

We believe our core underwriting results are strong in a highly active cat year with an 89.4% combined ratio. This clearly demonstrates the value created by our investment in industry leading technologies and a large staff, and our strong operating results are a direct result of this quality and efficiency in the global platform. Furthermore, we're pleased and excited about the continued diversification of our book and the further growth of our specialty line business.

In the early part of the fourth quarter, we announced the agreement to acquire Marlborough Underwriting Agency, operators of Syndicate 1861 at Lloyd's. That transaction has closed now and we are very pleased at the speed of integration. In fact, we expect Marlborough to add a nicely diversified book of business to our overall portfolio as of January 1. Marlborough writes a profitable book of specialty insurance and reinsurance; mainly engineering, aviation and marine and energy.

2008 organizational highlights also include purchasing and rebranding Imperial Re in South Africa, now called Flagstone Insurance Africa, an independently rate A- by AM Best and the purchase and integration of Alliance Re in Cyprus which is now named Flagstone Alliance Insurance and Reinsurance.

In the capital markets, we continue to make money and operate our side car business and have renewed those vehicles for another term as well as successfully issuing a very innovative UNL based self modeled cap on called Valley Re.

Perhaps our most significant move in 2008 however, was the merger of our Bermuda operating subsidiary into our Swiss operating subsidiary, Flagstone Re Assurance Swiss SA. This merger gives us increased capital efficiency, text to text treaties and a larger degree of jurisdictional certainty.

As I mentioned earlier, our book value decline was a result of investment losses in the third quarter and in the first two weeks of the fourth. We had no material exposure or losses from sub prime all day securities. Our losses were essentially due to our 23% allocation for the indices and the worst performance of those indices in a century, when our internal circuit breakers were tripped in early October, we made the decision to reallocate our asset portfolio to a very risk diverse portfolio where we remain today.

Our investment portfolio is now conservative, allowing us to take advantage of the hardening cycle in the reinsurance market and removing the uncertainly associated with the capital markets.

In hindsight, it was a good move and despite the further losses in October, we were able to avoid some of the further deterioration toward the end of the year. We expect to stay conservatively positioned on the investment side in 2009 with 90% of our assets in high grade fixed income securities. The proactive risk management was viewed in a positive context by our rating agencies.

We're disappointed in our financial results for 2008, but we're very encouraged at the bright prospects for 2009 given the favorable environment for our pricing and our move to conservatively position the balance sheet in preparation to take advantage of the opportunity.

With that summary, I'll turn the call over to David.

David Brown

Good morning everybody. The fourth quarter is pleasing from an underwriting perspective. We achieved a 44.6% loss ratio and a 75.8% combined ratio that produced an underwriting profit of $46.9 million for the quarter despite the negative developments of $25.5 million loss.

For the year, our loss ratio was 58.1% on a combined ratio of 89.4% producing underwriting profits of $73.4 million. This was achieved in one of the worst years ever for natural catastrophes and was actually benefits of releases from prior year's reserves.

Our net combined Ike and Gustaf loss now stands at $140 million, up from $115 million at the end of the third quarter. Although we're pleased that this adverse change of approximately 22%, it's less severe than reported by many of our peers, we're nevertheless disappointed with this development.

The increase comes predominantly from Midwest clients who have been late in reporting losses as they deal with what is a very unusual event for them.

Our written premium in the fourth quarter was $95.2 million which represents an increase of $46 over the same quarter last year and brings our total premium for the year to $781.9 million which is a 35% increase over 2007.

This acceleration of premium growth in the fourth quarter reflects the significant business production we are seeing from our global platform as well as falling prices, but it's important to note that it includes nothing from our newest and largest acquisition, Marlborough.

This growth in business continues into 2009 and we were very pleased with our business at January 1 as we were able to capitalize on the hardening market caused in general by the losses of 2008 and in particular, the difficulties being experienced by some of the major market participants.

We were able to grow our business into attractive markets; for example, the U.S. where so far in 2009 our premiums are up about 23% over the same period last year whilst the related aggregate exposure is down 3%.

We fully expect the market trend to continue as demand for U.S. cat reinsurance materially outstrips available supply as mid year approaches. This demand will be exacerbated by the continued material gap in the FACS' ability to provide subsidized reinsurance as well as new interest in frequency driven covers.

Our international book benefited from several of the larger players experiencing capital impairments and we found that in general, European win buyers paid up to 10% more on their rates. We took the opportunity to reshape our portfolio and we cut back on programs that were not attracting reasonable increases or being pursued by markets which are more aggressive in their pricing.

Our written premiums decreased very slightly in outlook terms due to the shifting currency as a major portion of our international portfolio is either in Euro or British Pounds. Overall, we were very pleased with this book of business as our aggregate exposure is lower by about 10% while our premiums are down only 3% with book reduction reflecting recent currency movements.

Looking at our overall portfolio, our current 1 in 100 net P&L is $244 million and our 1 in 250 is $323 million. Our book continues to diversify and this is reflected in the moderate P&L mix relative to our capital premiums.

Although we are not typically major users of retro sectional cover, in anticipation of the capacity crunch, we were proactive in arranging such covers early in the fourth quarter. We now have significant retro sectional protection covering losses on both an event and aggregate basis. This protection on some of our existing capital and our conservative investment portfolio positions us well to participate fully in the attractive markets we believe 2009 will present.

I'll now pass the microphone over to Patrick to discuss our financials.

Patrick Boisvert

Good morning ladies and gentlemen. I'm going to discuss some of the financial aspects of our fourth quarter results and of our current financial position. Let me start by referring you all to our investor financial supplement which is now posted on our website.

During Q4, our two business segments contributed in line with our expectations. Overall, our gross premiums written were $95 million, an increase of $30 million or 46% compared to the same period last year.

The increase was mostly driven by growth in specialty lines where premiums written totaled $35 million in Q4 2008 compared to $17 million in Q4 2007. As David mentioned, our combined ratio for the quarter was 26% including net adverse development on Ike and Gustaf of $25 million or 14 points. Excluding Ike and Gustaf, our consolidated net favorable reserve development for cat events was $6 million for the quarter.

Our operating income for Q4 was $44 million, generating an annualized net operating return on average equity of 17% for the quarter.

On the investment side, as you're all aware, we add up to FAS 159 and as a result, our realized and unrealized gains and losses on our investment assets are booked directly to the income statement. The metric we focused on is the total return of our investment portfolio.

Our total return for the quarter was negative 7.8%, most of which came from our losses on equities and commodities incurred early in October and before we took steps to reduce or eliminate our exposure to these asset classes. Our total return for the year 2008 was negative 13.9%.

Our year end diluted book value was $11.30, increasing by 10% in Q4 and by 17% in 2008 adjusted for dividends.

I would like to highlight that the return on our portfolio impacted our book value negatively by 12% in Q4 and 21% for the year. This was offset by positive impact on the book value from our underwriting result despite the significant cat activity.

Moving on to our balance sheet, our liquidity position is very strong with cash and cash equivalents at December 31, 2008 of $826 million. We continue to have no exposure to sub prime backed investments or collateralized debt obligations of sub prime backed investments and our holdings of securities at December 31, 2008 were $3 million with an average rating of triple A.

Finally, during the fourth quarter, we purchased 698,000 shares for a total consideration of $6.6 million. The timing and amount of future repurchase transactions will be based on our evaluation of a number of factors including share price and market conditions. We may decide at any time to suspend or discontinue the program.

And with that summary of the financials, I will now pass it over to the moderator to open the lines for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jay Gelb – Barclays Capital.

Jay Gelb – Barclays Capital

I want to touch base first on the capital position as you see it heading into 2009 and given the sort of upward boundary of being able to write 60% of premiums relative to your capital, is that still the ratio we should keep in mind because my understanding is that would reduce gross written premiums in 2009 versus 2008?

David Brown

I think the metric we used in the past to report that to you, the 40% to 60% is a little different now because as I mentioned in my comments, we bought significant retro cover, and that has the impact on a top line basis allowing us to write at the higher end of that range or even beyond that range particularly now as we are diversifying our businesses.

As you know, the 40% to 60% range was based on us being primarily in the cat business, particularly with the acquisition of Marlborough, we're now much more involved in the specialty business and therefore that spread of risk means we would expect to see at least on a gross basis, and probably on a net basis, that proportion increasing.

Mark Byrne

Let me add a little to that. Jay I think the insurance business also in the facultative will also give upside to percentages. So I guess if someone asked me to cast that range today, I would say 55% to 95% or something would be a better place to put it.

Jay Gelb – Barclays Capital

In terms of gross written premiums, the beginning capital?

Mark Byrne

Right.

Jay Gelb – Barclays Capital

What was the reinstatement premiums for the full year of 2008 and also the fourth quarter of 2008?

Mark Byrne

Stand by one. I'm standing with our actuary. For the year it was $40 million and for the fourth quarter is was under $6 million.

Jay Gelb – Barclays Capital

In terms of investment returns, can you give us a sense of what the total return on the portfolio has been so far in 2009 and what you think a reasonable run rate is going forward given the shift in the portfolio?

Mark Byrne

About one for 2009 so far, and sadly, I think the answer is the expected return on the portfolio that we hold today is around 4% on our models and that's the double edged sword that we live with here. We can't have a portfolio as conservative as we have and expect to have a very high return to it of course, and we're not the only people facing that situation, but 4% is the model return we're using right now.

Jay Gelb – Barclays Capital

The P&L relative to capital has gone up a bit. I'm just trying to determine how you're looking at that relative to your internal constraints in terms of where you can grow the business going forward.

Mark Byrne

Our P&L to capital ratio limit is 40%, and we're pretty comfortably inside that. I think the answer to that question relates to the fact that we're buying more reinsurance than we used to. If we look at all of the ways we could raise capital, the equity markets, they feel a bit closed at this moment with our stock trading at 75% of a very hard book value. We obviously wouldn't raise equity capital now.

The markets are certainly closed. The cap on and side car markets we're trying hard to keep open, and we've been able to renew our side car's which is great, but in terms of raising fresh ones, that's been difficult. So really the main source of capital for us now is the retrocessional market. That's the one market that's still open.

We have definitely bought more retro than we've bought in any prior year that we've ever considered to be core to the strategy and that's really the way that we've been able to try to take advantage of the fact that we're now in a position where we have a platform that could write well over $1 billion of premium, but we don't have the capital to support that level of premium at this stage. What we're doing for the moment is using retro to fill in the gap there for 2009.

Jay Gelb – Barclays Capital

How should we think of the retention ratio in terms of net to gross for the year? What's a reasonable range?

Mark Byrne

80% is probably a pretty reasonable estimate of net to gross.

Operator

Your next question comes from Joshua Shanker – Citi.

Joshua Shanker – Citi

I was wondering if you could describe to me your experience this year compared with last year in the renewal season and what do you think the advantages and shortcomings are of your position in the market place right now?

David Brown

The difference is both this year and last year our submissions came to us relatively early in the process and there was quite a delay this year between us giving out indications which we do fairly rapidly and brokers getting back with a good lot of terms. I think in many respects, people didn't want to be first. They didn't want to pay increases and then find out everybody else got reductions. So there's a little bit of timidity in the market.

That worked itself out with as you now realize, a reasonable increases generally in the market for pricing, so that was one big difference this year over last year when things were closing slightly down or flat, this year we were generally up as I reported earlier. That was a difference.

The other thing we have is the benefit of being in so many different markets. We really do look at the business we're seeing around the world and we have to make choices given our capital position and given how much business is out there today. We're generating an awful lot of premium potential that we could write and we have to pick which business we do write.

So we are able to look around the world and make those decisions selectively as to where we deploy our capital. And that's a big advantage we have. We're not looking at a narrow market; we're looking at a very broad one. Slightly frustrating is there's a lot of business out there we'd like to write and we can't hence the growth in use of retro capacity to effectively increase our underwriting capital.

Joshua Shanker – Citi

Have you participated in any lines of business this year that last year you didn't have the opportunity to do so?

David Brown

Yes we have. Obviously the big part of that is Marlborough. As I mentioned in my comments, the number of 2008 recognize zero income from Marlborough. We weren't underwriting through Marlborough at that point, and now we have a lot of marine and energy business, some engineering risks that are new to us and also some of the highly technical risks that we do out of Marlborough so there's a lot of new business in terms of specialty and to give a number of that, Marlborough has 100 million pounds stamp at Lloyds and roughly as of today, we're probably about 25% deployed with that capacity.

Obviously that's net new premium to us and will substantially change the mix of our business with a skew away from the cap business to more of a specialty business.

Joshua Shanker – Citi

What do you think is the longest tailed business that you're writing today?

David Brown

I wouldn't describe any of it very long tail. Some of the engineering risks, it's a three year construction process and then there's a bit of tail on that, so probably if I was saying anything, I would say the engineering business has the longest reporting tail.

Mark Byrne

Workers Comp cat doesn't have a long reporting tail, but it can have a long development tail and that's another line of business that we're building, particularly in the United States. We look at the average duration of our liabilities as well under six months.

Joshua Shanker – Citi

In terms of the pricing of the Worker's Comp cat, is it a model? Is it an issuing line of business that's difficult to price? Can you go into detail a little bit about how you think about that line?

Mark Byrne

Effectively, Worker's comp cat would be a loss of more than 50 lives or more than 100 lives at the same time would typically be the definition of the exposure. What we would do, we would look at it and price it off of a cat model on the basis that if we could get the price implied by property cat prices, since roughly three-quarters of the time there's nobody in the office building that you're writing, you'd be getting paid very well if you could get about the same price as property cat pricing for the Worker's comp cat and typically, you get a little bit less.

The objective is to get pretty close to what you'd get for writing the building in terms of expected loss and then you have a big miss factor because obviously earthquakes and terrible events happen at weekends and at night when Worker's aren't in the building.

Operator

Your next question comes from [Phillipe Farhan – Montero Teachers].

[Phillipe Farhan – Montero Teachers]

I'm just curious to get a comment as to the results of the casualty class and to get a sense as to whether within the confines of the specialty division you have any exposure to trade credit surety, financial guarantees and whatever is labeled something else but really smells of financial guarantee.

David Beckman

Our casualty class exposure is fairly limited. Effectively, we've only written a couple million over the last couple of years and it's averaged about a 30 loss ratio. We don't really write too much of financial guarantee area. We have one trade credit treaty that's European source that's performing pretty well and we've taken a pretty conservative loss ratio, but we're pretty bearish on credit these days.

Mark Byrne

We have tiny positions in our South African subsidiary and our Cyprus subsidiary based on their Legacy portfolios before the acquisition, but our general view has been not to write credit. Now that view may change. It may become an interesting business based on pricing over the next 12 months and it's in the list of things we're looking at.

An example also would be we're spending a fair amount of time and energy looking at the carbon market and if you write carbon, you've got a kind of interesting mix of political risk and project risk and trade credit built into carbon insurance.

We're not going to do carbon insurance in 2009. We're monitoring that market and we've made a decision for the moment not to do it, but we will certainly be reviewing that decision every six months or a year and when there's a market there, we would expect to be participants. We're not saying we would never do it, but at the moment our exposures are extremely small.

[Phillipe Farhan – Montero Teachers]

Anything on the surety or these asset protection classes?

Mark Byrne

Again, there might be $1 million of premium and $20 million of limit in the whole company and that would be in our South African and Cyprus subsidiaries from their Legacy portfolios, but rather than that the answer would be no.

Operator

There are no further questions in queue at this time. I'd like to turn the call back over to Brenton Slade for closing remarks.

Brenton Slade

Thank you once again ladies and gentlemen. Before I let you go, please let me remind you that a replay of this webcast will be available on our website from noon today until midnight on March 17 of this year. Please visit the investor relations section of our website at www.flagstonere.com for further details.

That concludes the proceedings for today. We look forward to speaking to you again at the end of the next quarter. Thank you very much.

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.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!