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Montpelier Re Holdings Ltd. (NYSE:MRH)

Q4 2008 Earnings Call Transcript

February 18, 2009 8:30 am ET

Executives

Jonathan B. Kim – Senior Vice President and General Counsel and Secretary

Christopher Lloyd Harris – President and Chief Executive Officer

David S. Sinnott – Executive Vice President and Chief Underwriting Officer

Michael S. Paquette – Executive Vice President and Chief Financial Officer

Analysts

Matthew Heimermann – JPMorgan

Ian Gutterman – Adage Capital

Operator

Greetings ladies and gentlemen. And welcome to the Montpelier Re Holdings Limited conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Jonathan Kim, General Counsel and Secretary of Montpelier Re. Thank you Mr. Kim you may begin.

Jonathan Kim

Thank you. Good morning and welcome to Montpelier Re's fourth quarter and full year 2008 earnings conference call and webcast. A press release setting out our results, together with a detailed financial supplement have been posted to the company's website at www.montpelierre.bm. This call is being webcast live and will be available for replay until March 18, 2009.

Our speakers today are our Chris Harris, President and CEO; David Sinnott, Chief Underwriting Officer; and Mike Paquette, Chief Financial Officer. Chris and David will give their commentary on the quarter, and then Mike will present an overview of the financial results. We will then be pleased to take your questions.

During our discussion this morning, we may make forward-looking statements. Any such statements are based on the company’s current plans, estimates, and expectations. Actual results could differ materially from those projected in any forward-looking statements as a result of certain risk factors disclosed previously and from time-to-time in Montpelier's filings with the U.S. Securities and Exchange Commission. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

I would now like to turn the proceedings over to Chris.

Christopher Lloyd Harris

Good morning, ladies and gentlemen. Montpelier just completed its eighth January renewal season. While our underwriting focus has not changed, our operating model has matured. We don’t plan to be all things to all clients.

Our property catastrophe treaty business, where we are a recognized market leader remains our core focus, but we continually work to identify and build complementary opportunistic businesses around that core.

Both our internal and external capital requirements are predominantly driven by peak zone catastrophe exposures. Therefore we have the capacity to write substantial other business outside these areas, but if and only if it meets our pricing target only profit diversified.

In keeping with our maturity, we have delivered a solid underwriting profit for the year, despite a high level of individual risk and natural catastrophe losses for the industry. Our net Ike loss fell within the expected range embedded in our pricing and risk management metrics for a storm of that size.

Mike will provide details on our investment performance, which was a disappointment particularly in the alternative portfolio, but I would like to remind listeners of the other investments, we have made over the last few years to strengthen our franchise.

Investments in underwriting talent, investments in technology to improve our risk selection and investments in New London and U.S. platforms, all of these investments are aimed at allowing us to find and convert more profitable business opportunity. Our extended platform is now operational and units outside of Bermuda produce 20% of the groups’ premium in 2008. We expect that percentage to more than double by 2010.

Some people questioned our decision to expand in the face of what at the time was a declining rate environment. However, we have maintained a patient underwriting strategy, rather than chasing immediate growth and we’ve recruited new talents to the organization, while sticking to our consistent risk management approach.

As a result, we now entered 2009 in a much stronger competitive position with twin tailwinds of improved conditions within our core property catastrophe lines and increased access to other diversifying business. We are very well positioned for 2009 and we expect rates to continue to firm through the year. We expect to deliver net premium growth and higher expected returns with a reduced single event risk profile in most key catastrophe zones.

Our existing capital base is adequate to execute our plan, but we have the flexibility to access $89 million of contingent capital, if underwriting conditions improve as we believe they will.

With that I will turn it over to David, for more details on the underwriting.

David Sinnott

Thank you Chris, and good morning. Gross written premiums for the fourth quarter of 2008 came in at $73 million versus $76 million in the prior year, a decline of 5%. Gains in our property catastrophe and property specialty accounts were offset by a decline in the casualty portion of the other specialty business segment, the driver of which was premium adjustments to prior years on certain loss sensitive contracts.

Net premiums written for the full year were nearly flat at $541 million versus $549 million, a decline of 1%. The cumulative impact of price reductions was largely offset by new business generation and a lower amount of ceded reinsurance purchased in 2008 versus the prior year.

To recap the January 1 renewals, we observe positive pricing trends in the majority of our business segments. The premium weighted renewal price index across the whole portfolio in the month of January is 107, which ends a 22-month streak of composite price reductions. The RPI for Property CAT XL, our largest block of business to renew at year-end came in at 108 for January, which splits 110 and 105 between our U.S. and international treaty portfolios respectively.

In the U.S., the overall RPI masked significant differences by region and loss experienced. Loss affected accounts and portfolios exposing peak accumulation zones experienced real rate increases in excess of 25% in a number of instances whereas regional and lottery business registered more modest improvements.

In addition to experience in cost of capital considerations, increased demand helped to prop up CAT XL rates in this segment. So we believe budget pressures arising from competitive conditions in the original business prompted a number of carriers to assume large co-participations, thereby negatively impacting the flow of premium dollars to reinsurers.

Due to the high incidence of catastrophe activity in the U.S. Midwest during 2008, we witnessed increased demand for aggregate protection at 1/1. Historically, we have found it difficult to convert these opportunities however we were able to write several new contracts of this type at very reasonable terms.

As our RPI data suggests, achieving price increases in the non-U.S. territories prove more challenging. Generally non-loss affected buyers in Europe resisted paying more and established reinsurers were willing to oblige in an effort to retain business. With a few exceptions pricing offered on business outside the peak Europe wind zone still does not meet our requirements.

Despite the rate strengthening in our property catastrophe line, we took deliberate steps to reduce our gross exposures at January 1, anticipating a further tightening in rates for the remainder of the year. This action gives us the flexibility to redeploy aggregate at even better terms midyear, risk constraints permitting.

At the same time due to the wider disparity between reinsurance and retrocession pricing compared with a year ago, we non-renewed certain outwards protection at January 1 and anticipate making further reductions later in the year. We believe the premium savings resulting from retaining a higher proportion of exposure for our net position will more than offset the income decrease resulting from gross exposure cuts.

Switching to the non-CAT arena, in the specialty treaty segments, we saw some healthy new business generation and improved signings resulting from cedings opting to diversify more broadly their reinsurance panels.

These positive developments were offset to some extent by the non-renewal of a few quota share treaties not meeting our pricing hurdles. From a pricing perspective, most lines are stable. So we continue to observe modest erosion in the specialty casualty arena, which has yet to show signs of correction, despite an unfavorable interest rate environment.

In our Property Direct & Facultative segments, rates have now stabilized in nearly all classes for business originated by both our Bermuda and Lloyd platforms. While, January 1, is not a key renewal day, nearly all business renewed on this date registered a positive RPI. Terms and conditions remained competitive on facultative business written through our U.S. agency operation, so we are beginning to see some encouraging pricing trends.

Looking forward to the balance of 2009 our thesis for continued market tightening remains intact for U.S. property business, as demand for reinsurance should continue to expand with or without any major revisions to the Florida CAT fund, with supply growth being largely restricted to retained earnings. We are more guarded in our views of the international markets, which will be tested soon by the upcoming Japanese renewals at April 1.

I will now turn the discussion over to Mike Paquette, who will comment on the quarterly financial results.

Michael Paquette

Thank you, David. Our fourth quarter 2008 results were mixed with strong underwriting results being muted by investment losses. Fully converted book value per share ended the year at $15.94, a decrease of 3.6% for the quarter and 9.2% for the year inclusive of dividend.

Our operating income for the fourth quarter of 2008 was $57 million, or $0.68 per share. Our comprehensive loss for the fourth quarter of 2008 was $51 million, or $0.61 per share, which includes $50 million of net realized investment losses and $59 million of net unrealized investment losses.

The company's financial impact from Hurricane Gustav and Ike, net of reinsurance, reinstatements and reductions and incentive accruals did not change significantly during the quarter and currently stands at approximately $140 million.

During the 2008 fourth quarter, we experienced $32 million of favorable releases from prior year loss reserves. As of both December 31, 2008 and 2007, our growth IB&R reserves constituted 53% of our total loss and LAE reserves.

General and administrative expenses for the 2008 fourth quarter were $31 million versus $27 million for the comparable 2007 period. The net increase is comprised of a $50 million increase or $5 million increase in fixed expenses offset by $1 million in decrease in variable expenses.

The increase in fixed expenses is due mostly to incremental costs incurred by our newly established operation. The reduction in our variable expenses resulted from a decrease in incentive compensation accruals. Net investment income for the 2008 fourth quarter was $19 million versus $33 million for the comparable 2007 period. The decrease is the result of dramatically lower yields on a lower investment base.

Our consolidated net investment return for the 2008 fourth quarter was a negative 3.5%. While our alternative portfolio results were especially disappointing down 28% for the quarter, our fixed income in equity portfolios performed reasonably well, relative to their benchmark.

Although the short duration of our fixed income portfolio meant we didn’t benefit much from the significant downward shift in the Treasury Curve during the fourth quarter, we believe this conservative positioning will serve as well as treasury yield start to rise again, as they have thus far this year.

Realized losses during the 2008 fourth quarter included $16 million write-off of an investment in a leverage loan fund, which we preannounced in our last Form 10-Q and a $19 million write-off of an investment in a leverage distressed debt fund. As of year-end, we had either written off or redeemed these two investments in their entirety.

In terms of investment positioning, our highly liquid fixed income and cash portfolio currently has duration of 1.7 years and an average credit quality of AA+. Our financial supplement provides detailed disclosures on each of the components of our investment portfolio.

We did not repurchase any shares in the fourth quarter. However, we did issue 335,000 shares during the period under our long-term incentive plan. From a total capital perspective, we remain comfortable with our current level of $1.8 billion, which includes $353 million in debt and $89 million of contingent equity capital.

With my summary concluded, I will now turn to the operator for any questions that you may have for us.

Question-and-Answer Session

Operator

(Operator Instructions) We have a question from Matthew Heimermann of JP Morgan. Please go ahead.

Matthew Heimermann – JPMorgan

Hi, good morning everybody. The first question is can you just update us on your thinking with respect to reinsurance protection. You might buy in 2009, obviously the capital is much changed from a couple years ago when you became a heavier buyer, so just would be interested in thoughts there given the availability and price?

Christopher Lloyd Harris

Okay thanks Matt. This is Chris. I think it's fair to say you should expect to see our net earned to gross earned premium ratio go up during this year. I mean certainly at 1/1 we bought less retrocession protection than we had previously. And that was really as David noted in his script, just a function of the market pricing, we thought the cost of the retro, it was more efficient for us to retain it on our balance sheet and then to buy at those levels.

Matthew Heimermann – JP Morgan

And as part of the question you are getting from just frankly the fact that with exposures going down, net-net you’re just getting more than I mean that’s helping the equation to a large extent.

Christopher Lloyd Harris

Yeah.

Matthew Heimermann – JP Morgan

Okay, and then how about on that the diversifying businesses you are pushing in? Or how dependent are those on reinsurance if at all?

Christopher Lloyd Harris

Not vary is the answer, our big constraint there has been market conditions, it hasn’t really been capital or availability of reinsurance.

Matthew Heimermann – JP Morgan

Okay, and then can you remind us with the contingent capital is that capital that the rating agencies already contemplate with respect to their view of you?

Michael Paquette

It's Mike Paquette, the answer there is yes. They give us credit for having that back stuff.

Matthew Heimermann – JP Morgan

Okay.

Christopher Lloyd Harris

They kind of give you a partial credit, I would say it's a part qualitative and part quantitative, so if you draw, you would get full credit, so right now, we are getting a partial credit, I would say.

Matthew Heimermann – JP Morgan

Okay. I appreciate it. Thanks.

Operator

(Operator instructions). We have a question from Ian Gutterman of Adage Capital. Please go ahead.

Ian Gutterman – Adage Capital

Hi. Just quickly the combined ratio if I take apart development basically the accident year was in the high 80s, which is higher than normal. Was there any CAT loss that you can isolate out of large non-cap property losses, or something else that was driving that?

Christopher Lloyd Harris

Two things going on there, one there were a few large fire individual risk losses and some that was about $10 million that they contributed in the current accident quarter. And then also there were some Ike development, which was generally offset by reinstatement premium, but that tends to pushup the accident year ratio even though the dollar impact, if you get a dollar of reinstatement premium and a dollar loss coming, it's still at a 100% loss ratio to the quarter.

Ian Gutterman – Adage Capital

Sure, okay Kim, do you have the components of that loss versus reinstatement?

Christopher Lloyd Harris

For the quarter it would have been in roughly about $24 million of net loss, and call it about 11 of reinstatement premium.

Ian Gutterman – Adage Capital

Okay, great, that makes sense.

Christopher Lloyd Harris

Related to Ike, and then as I have said, there was about another $10 million of what we would call large risk losses. Larger or anything.

Ian Gutterman – Adage Capital

Perhaps I think that was my only question. Thank you.

Operator

There are no further questions at this time. Mr. Kim, please proceed with your closing remarks.

Jonathan Kim

That concludes the proceedings from the company's point of view. So, it only remains for me to thank you all very much for your participation and we hope you would join us again at our first quarter earnings call.

Operator

This concludes today's conference. Thank you for your participation.

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