Everest Re Group, Ltd. (RE)
Q1 2009 Earnings Call Transcript
April 30, 2009 8:30 am ET
Elizabeth Farrell – VP, IR
Joseph Taranto – Chairman and CEO
Ralph Jones – President and COO
Tom Gallagher – Vice Chairman and Chief Underwriting Officer
Craig Eisenacher – EVP and CFO
Matthew Heimermann – JPMorgan
Arthur Winston [ph] – Pilot Advisors
Good day everyone and welcome to the first quarter 2009 earnings release of Everest Re Group Limited. Just as a reminder, today's call is being recorded.
At this time, I would like to turn the conference over to your host for today, Ms. Beth Farrell, Vice President of Investor Relations. Please go ahead, ma'am.
Thank you, Sara. Good morning and welcome to Everest Re's first quarter 2009 earnings conference call. With me today are Joe Taranto, the company's Chairman and Chief Executive Officer; Tom Gallagher, Vice President and Chief Underwriting Officer; Ralph Jones, our President and Chief Operating Officer; and Craig Eisenacher, our Chief Financial Officer.
Before we begin, I will preface our comments by noting that our SEC filings include extensive disclosures with respect to forward-looking statements. In that regard, I note that statements made during today's call, which are forward-looking in nature such as statements about projections, estimates, expectations and the like are subject to various risks.
As you know, actual results could differ materially from current projections or expectations. Our SEC filings have a full listing of the risks that investors should consider in connection with such statements.
Now, let me turn the call over to Joe.
Thanks, Beth. Good morning. The reinsurance and insurance marketplace continues to transform itself very much as we had expected. Reinsurance rates for catastrophe products have gone up and are continuing to rise. Consequently, retro rates are up, energy rates are up and cat excess of loss rates are up.
The supply and demand curves dictate that this process will continue as buyers need to protect their capital with reinsurance and reinsurance providers will demand better and better prices to provide these protections.
In the next couple of months, most part of business will renew and we anticipate meaningful rate increases over last year’s rates. As reported last quarter, insurers that write property business would have to raise rates or be faced with the losing proposition of reinsurance costs they cannot pass on. Our underwriters are reporting this change has finally started. In April, we have seen a serious change in property insurance terms and conditions, and our property facultative department and property insurance operation in Florida experienced the best month that they’ve had in the long time.
Casualty reinsurance and insurance rates and terms are not changing as meaningfully as property with the exception of isolated pockets such as D&O for financial institutions. It’s unclear how this part of the market will respond as 2009 progresses. We stand ready to write more business if market improvements bring additional business up to our underwriting standards. Ralph and Tom will provide more color on this sector, including the California workers’ comp market.
Meanwhile on a macro level, the flight to security was more intense than ever before. This has been true both at the reinsurance level and at the insurance level and has greatly benefitted Everest. It has allowed us to attract new business and increased shares on existing deals. On the reinsurance level, some of our bigger competitors suffered loss of business from concerns about their economic status or ownership. At the insurance level, our A+ Best rating and financial stability has buyers putting us on the top tier of their preferred list.
All of these changes resulted in gross written premiums being up 14% in the first quarter with reinsurance premiums being up 19% despite foreign currency devaluations relative to the dollar. I expect top line production to remain robust for the remainder of the year.
Our underwriting result was solid with a combined ratio of 89.7 which affirms the underlying quality of the portfolio. Our investment results were disappointing as losses on limited partnerships significantly reduced overall investment income. Craig will later provide more color on investments.
Surplus grew $79 million in the quarter and their ROE was 8.3%. I would hope and expect to achieve a much higher ROE in succeeding quarters as I anticipate premiums to remain strong, underwriting results continuing to be solid and investment income beginning to normalize as the world economy stabilizes.
Thank you, Joe. As you can see from the first quarter results, we had a very strong January 1 renewal season with premiums up nearly 14% in the quarter. Much of the growth emanated from our overseas business that now makes up nearly half of our reinsurance premiums. We benefitted from opportunities in just about every region in which we participate.
Our Latin American business was up substantial, partly due to the new Office in Brazil, which we expect will write over $60 million in premium this year. Much of our strength overseas comes in the first party lines where catastrophe exposed property treaties show the most demand. We also benefitted from the uncertain future of several large competitors. Overall, rates for the overseas business were up between 5% and 10% during the first quarter.
Our Bermuda and UK book was up 14% coming from good opportunities presented in London and Brussels. Some of the growth came from quota share contracts written for two Lloyd syndicates that are looking for capital support partly due to the weakness of the pound versus the dollar. We see a distinct trend in clients focusing more on reinsurance for capital support.
Our US reinsurance business was up 13% coming partly from several new crop hail quota share treaties which will amount to about $80 million on a full year basis. This is a relatively new segment for us where we see good margins available. For the US, reinsurance terms and conditions are tightening for casualty treaties. The trend we see is a switch to some degree from excess of loss to more quota share deals which we believe is often driven by the capital concerns of our ceding company customers where they are now looking for broader reinsurance support. The US insurance business was flat during the quarter. 80% of this business comes from niche casualty programs. Underlying rates on the primary casualty side were flat to down 5% during the quarter. While casualty reinsurance terms and conditions are improving a bit the underlying primary casualty business remains pretty stagnant.
As per California workers’ comp, the rate increases anticipated at year end based on competitors’ rate filing, their initiatives in the rate filings have been slow to materialize in the marketplace. If actual rates do not improve, we will slow down our growth plans for this line of business. We have established a new division in New York called Everest Specialty Underwriters led by Mark Herman. Mark is an experienced underwriting leader in the D&O, E&O product lines. He was formerly President of ACE Bermuda and more recently Chairman of Ariel’s Insurance Business. Mark and I worked together for several years during our Chubb days and we are thrilled to have him join us as President of this new division. This will help bolster our direct insurance operation Everest National where we look to match underwriting expertise to market opportunity.
I am certainly pleased with our first quarter underwriting results with a combined ratio under 90. This includes 33 million in cat losses emanating – resulting from the European storms and the Australian bush fires.
Tom Gallagher will now share some observations about the marketplace in which we expect some excitement as the June 1 Florida cat treaty season approaches.
Thanks, Ralph. As Joe noted in his opening comments, the transformation of the reinsurance market continues. The upward trend noted in January is showing signs of building momentum, which we also noted in April renewals and getting more pronounced as we head into midyear activity. Though the pace of change varies by line, industry, territory, and loss history, the theme is the same. It is an improved reinsurance environment. The strongest changes noted is in the US property and commercial and cat business, international, retro, and the energy area where there remains an increased demand for stable, high quality security in a turbulent market.
Also as Ralph noted, we have experienced growth from emerging markets such as Brazil, new lines such as crop, plus positive rate movement in many areas, a change in some buying habits from excess to proportional and obviously the flight to quality.
For casualty, it is much more of a mixed bag. With some improvements in rate terms and conditions, the general theme continues to be relatively flat. Overall, we are beginning to see their rates decline slow or stall, but it is a slow process. The only area which Joe noted where prices have moved greatly is in the financial area for D&O and E&O were cautious growth is the watchword. We would project that the casualty markets to remain challenging throughout 2009.
Though, there are some signs of positive change, as new submission activity has increased. And we see that most of them are not easily filled. We would expect this trend to continue also through the remainder of the year.
All participants in the markets are gaining a greater appreciation for the need to improve churns. Presently, it is evident that reinsurance market is firming much quicker. But that will filter through the primary sector as well over time. Everyone is dealing with the same market dynamics. Underwriting performance has deteriorated, investment income has diminished, the volatility of the exchange rates, capital constraints, profitability has declined, all leading to a new respect for the financial security. Capital preservation is a key item today. Both insureds and cedants are very focused on the financial security of their counter parties, and seeking much more diversification of placements, not putting all their eggs in one basket, all of which works quite well for us.
Another consequence of the current financial environment is that everyone is managing their exposure much more prudently, both as respects to the property and casualty underwriting, investments and the use of capacity.
Capacity remains a very precious commodity. It is an area where there is higher demand, but reduced supply in many segments end [ph] market, and that is for many reasons. Capital constraints, exchange rate fluctuations, limited retro-capacity, concerns about sub-prime. Specifically, cat capacity for critical zones remained tight. Some suggest a potential shortfall of 15% between the design curves and the availability with no immediate relief in sight in the near term. This was observed in January also in April. And we expect the stress level to increase as we head into the mid-year renewals with Florida issues which are still percolating at the top of the list, while you still have Australia, the Caribbean, Mexico, Central and South America as well.
As we look out to the remainder of the year, we expect the positive trends noted in the first quarter to continue and take a firmer hold. We are in a great position to reap the benefits of this transformation in the marketplace for the future.
Now, I will turn it over to Craig.
Thanks, Tom. As stated in our earnings release operating income for the quarter was $106 million, $1.73 per diluted share. Net income, including the gain on our debt repurchase and realized capital losses, was $109 million or $1.77 per diluted share. Our pretax underwriting gain was strong. Our combined ratio was just under 90%, about equivalent to last year’s first quarter. However our investment results were disappointing largely driven by our limited partnership investments. And I will talk a little bit more about that in a moment.
As well, we reported a $20 million loss on the equity index put options we wrote in 2001 and 2005. We had realized capital losses of $65 million before tax and $48 million after tax. Most of this loss emanates from sales of Banc of America and Wells Fargo fixed maturity securities. As a result of their acquisitions of Merrill and Wachovia, our aggregated debt holdings exceed our risk thresholds and we reduced our holdings accordingly. As well, we recorded other than temporary impairments of $8.3 million before tax and $7.6 million after tax.
As you know, we repurchased via tender offer $161 million of our outstanding subordinated debt for $83 million, including the transaction costs. This produced a pretax gain of $78 million and an after tax gain of $51 million. We like the outcome, the tender offer was at its core an opportunistic play. We have the liquidity, capital and earnings power to easily handle this transaction. So we repurchased 40% of the issue and in so doing reduced our leverage a bit, although it’s already very conservative, book to gain, and reduced our interest expense going forward.
From a cash perspective, the opportunity return is roundly 13%, so well in excess of investment market opportunities, even very long opportunities. Tom and Ralph have described the quarter’s production and written premiums and outlook. I would like to add a couple comments on our underwriting results.
Our underwriting profitability was strong in the quarter with a combined ratio of 89.7%, up very slightly compared to the first quarter of 2008. Catastrophe losses were light at $33 million. We continue to closely monitor our reserves for hurricanes Gustav and Ike and they continue to look very good. As a result, we are staying with our original estimate. We experienced a small amount of adverse development in the quarter, $18 million. There were some small increases and decreases in our US treaty and Bermuda operations. We didn’t receive any new reports of credit crisis losses and reported losses to date are still less than $5 million. Nevertheless, we did add a bit to our IBNR, in fact more than half of the increase relates to this as activity in that arena continues to build.
The current year attritional loss ratio at 55.6% was up just a bit from last year as one might expect. Corporate expenses were about level with last year’s first quarter and the commission ratio was a bit lower. So all in, we are quite pleased with our underwriting result.
On the other hand, our investment income was very negatively impacted by the results of our limited partnership investments, which in total lost $73 million. This compares to losses of $5 million in last year’s first quarter and $73 million in last year’s fourth quarter. The losses in the fourth quarter of last year came principally from funds invested in public securities that generally report one month in arrears. The losses this quarter came principally from the partnerships invested in non-public securities, both equity and debt. These funds generally report to us a quarter in arrears, so the results reported in our first quarter reflect their results from the fourth quarter of last year.
The preponderance, 75% of our limited partnership portfolio is non-public equity with concentrations in energy, which is about 25% of the portfolio; health care, about 7% of the portfolio; and real estate, about 10% of the portfolio. Also about 16% is in funds with the country or region-specific focus. As well, we own some mezzanine debt early stage and LBO funds. We have no part [ph] funds and no leverage funds per se although a couple of our funds do employ modest leverage. As of March 31, 2009, the market value on our balance sheet was $563 million.
It is difficult to forecast future results for these investments, each has its own unique strategy and portfolios consisting of a few too many investments. So any one fund’s results can vary significantly from financial market trends.
It seems clear though that the last couple of quarters results of these investments were heavily impacted by the sizable declines in the equity markets. And with some improvement in the general climate, we might expect better results in the future. Over time, except in the last couple of quarters, these investments have done well for us, and we would expect that to continue to be the case although obviously we can expect a great deal of variability on a quarter to quarter basis.
Otherwise, our net investment income was down somewhat compared to the first quarter of last year as our invested asset base is somewhat smaller and short term yields are lower. As well, in this uncertain financial environment, we have been holding more liquidity, and longer term investments we have been making have been in very short, very high quality paper.
We recorded derivative expense of $20 million in the quarter, that’s on the equity put options principally because the S&P 500 Index declined in the quarter. Our cash flow from operations was $181 million in the quarter, about $70 million lower than in last year’s first quarter. Paid losses were quite low in last year’s first quarter, and hence trended higher in this year's first quarter. We paid out $83 million for the debt repurchase and $30 million in dividends. So, net cash flow to the investment portfolio was just under $70 million.
Our investment portfolio continues to be very high quality. AA2 on average. Short duration and liquid. Our public equity exposure, including public equity oriented limited partnerships remains light at about 2% of the portfolio in total. At this point, I would like to give you a note on the presentation. We give you the embedded yield on our portfolio in the supplement. Prior to this quarter and I think I noted that on prior calls, we’ve been using 8.5% for our limited partnership investments. We dropped that to zero this quarter and that’s what caused the 30 basis point decline in the overall yield.
Our capital position is very strong and increased by $79 million in the quarter and our financial leverage continues to be very conservative with a debt-to-cap ratio of 16.8%. So all in, we feel we are in a strong financial position to capitalize on market opportunities as they rise. Underwriting trends are favorable, and if financial markets cooperate, we should be reporting some better net income numbers in future quarters.
And now we would like to open it up for questions.
(Operator instructions) We'll go first to Matthew Heimermann of JPMorgan.
Matthew Heimermann – JPMorgan
Hi, good morning everybody. You talked, Joe, about expecting growth to remain pretty healthy over the balance of the year. With respect to some of the growth you saw in the international sector, there wasn't any – was there any front end loading with respect to business you are writing this year. I know you had the S&P review going on. But I just wanted to make sure there wasn’t anything unusual on any of those numbers.
No. There wasn't anything unusual about the numbers.
Matthew Heimermann – JPMorgan
Okay. Easy enough. And then could you just revisit either you or Tom the comments with respect to buyer changes? On one hand, I thought you mentioned people shifting to excess of loss versus proportional which I've heard in other places but in another comment, I thought I heard that there were some shifts from excess to proportional. So if you could just flesh that out a little bit.
Sure. Let me give you a more broad answer to that, Matt. First of all, I think there's just a lot of positive things going on in the marketplace that have benefited us and that we’re capitalizing on. Part of that is a flight to security. Part of it is some of our competitors having some difficulty and even some of our customers having some difficulty when it comes to protecting their surplus. I think what we probably were referring to on some of the shift to quota share was at least in some cases where clients wanted essentially more surplus relief. Ease their balance sheet a little bit, and that's something that we could provide since we have a strong balance sheet. You are right at any particular point in time, different lines, different countries. There's an ebb and flow, as clients move between excessive loss and pro rata. But we did see, at least with regard to surplus strain some clients moving more to the pro rata side. But between pockets that are hardening very nicely, where we have some very unique opportunities, and the flight to security and some of the troubles that others have had, we have just had had a lot to operate with in the first quarter and I see most of those drivers being opportunities that we have to capitalize on for the remainder of the year.
Matthew Heimermann – JPMorgan
Okay. That's helpful. The other question, just with respect to some of the surplus relief you are providing customers, as well as the quota share to some of the Lloyd’s entities. How is that affecting the PML? Or your risk tolerance, your ability to take more risk has to move into the midyear renewals if at all.
This is Tom. As with respects to accumulations, let me go back for a moment on the question of proportional versus excess loss. Most of the activity we’ve seen on the proportional side has been related to the casualty more so than property. So accumulation is not necessarily affected. Now with respect to accumulation, since the beginning of the year we’ve taken a pretty conservative stance on our accumulations, both in the US as well as internationally. And at this point in time, from 1/1, we have in the US shrunk our accumulation by zone in almost every one of the individual zones. In the international market, we have seen declines as well in our overall. We will have some limited growth in PMLs? Well, all within our willing to risk capabilities.
Matthew Heimermann – JPMorgan
Perfect. All right, thanks very much.
We'll go next to Arthur Winston [ph] of Pilot Advisors.
Arthur Winston – Pilot Advisors
In terms of the investment portfolio, it seems like there's a barbell approach. You take these very risky investments on one hand and then buy very conservative securities and I wonder two things, if you can estimate the future – how the future risk compared to the past risk on these partnerships, derivatives, S&P puts. And, two, are you going to continue to be conservative on the investment portfolio after being so aggressive and risk taking on these partnership situations?
It sounds to me like there are three questions here. The S&P puts, the partnerships and the portfolio structure, correct?
Arthur Winston – Pilot Advisors
With respect to the S&P puts, they react to the S&P index and they react to interest rates as well. So in looking at them, I tend to look at them as a long investment in equities and short on bonds, if you will. So even though it runs through our income statement, it's in effect a bit of a hedge against interest rates. To the extent that the indexes are better we should have no loss or gains going forward. And hopefully that will be the case. With respect to the partnership investments, we started investing in these things probably 2001, although maybe our first investment was a little earlier than that.
Generally speaking, they’ve been very – they've produced very good returns for us over time. We have several that we’ve completely exited. And I think we invested $125 million roundly in the ones that we exited and they have returned over $200 million to us. Having said that, they are equity or equity like investments. And they do vary with the equity markets. Having said that they haven’t varied as much or as negatively as the indexes have. So, we will see going forward, again, with a better financial environment, we would expect better results. With respect to the portfolio structure we tend to run highly liquid short duration, high quality portfolio, and we're willing to give up some level of income to obtain those results.
On the other hand, we do invest in equities looking over time to get a better return in the equity markets, recognizing that they are more volatile than the bond markets. We have backed off our equity exposure, particularly our public equity exposure over the last six months, and really our remaining equity exposures in public and private equities are in the limited partnerships, which represent a very small portion of our investment. So, net-net, I would say that we’ve lowered the risk in our portfolio. Does that answer your question?
Arthur Winston – Pilot Advisors
For the near term, that's our strategy.
Arthur Winston – Pilot Advisors
And it appears we have no further questions at this time. I will turn the conference back over to our speakers for closing remarks.
I would like to thank everybody for participating and certainly if you have any questions, please feel free to call myself or Craig Eisenacher. Again thank you.
And that concludes today’s conference. Again, thank you all for joining us.
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