Odyssey Re Holdings Q1 2009 Earnings Call Transcript

Odyssey Re Holdings Corp (ORH)

Q1 2009 Earnings Call

May 01, 2009 10:00 AM ET

Executives

Donald L. Smith - Senior Vice President, General Counsel & Corporate Secretary

Andrew A. Barnard - President & Chief Executive Officer

R. Scott Donovan - Executive Vice President, Chief Financial Officer

Analysts

Doug Mewhirter - RBC Capital Markets

Presentation

Operator

Good morning and welcome ladies and gentlemen to the Odyssey Re Holdings Corporation's First Quarter 2009 Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for a question and answer session after the presentation.

I will now turn the conference call over to Don Smith, General Counsel and Corporate Secretary. Please go ahead, sir.

Donald L. Smith

Thank you, good morning. Odyssey Re's results will be discussed this morning by our President and Chief Executive Officer, Andy Barnard and by Scott Donovan, Executive Vice President and Chief Financial Officer of the company.

The following discussion may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Some of these statements may relate to risks and uncertainties. Actual results may be materially different from those contained in or suggested by such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's filings with the Securities and Exchange Commission.

And now Andy Barnard will open with discussion. Andy?

Andrew A. Barnard

Good morning everyone, thank you Don. For the first time since 2005, Odyssey Re's book value per share declined this quarter. However, Scott will tell you in a few moments, in this volatile climate it doesn't take long for things to turn around.

Our combined ratio for the quarter of 96.5% included over 8 points from Windstorm Klaus Market trends remained on the tracks previously described. Pricing is strong for U.S. hurricane risk and improving for international and U.S. catastrophe risks. Offshore marine and the Gulf of Mexico is experiencing substantial price hikes. In the casualty markets, pricing for risks directly exposed to the financial prices are up significantly. Pricing for other risks is stabilizing. The rate of decline is leveling but has not yet begun to rise appreciably.

In Odyssey, our Americas reinsurance division experienced its combine ratio ever this quarter. Right catastrophes and the heavier mix of high margin property business explain the results of the Americas. We've began to see some additional opportunities from buyers of reinsurance who are motivated to increase their purchasing in light of capital issues affecting their balance sheets.

At the same time, the casualty treaty business remains challenging as primary rates continue to soften though it's mentioned not at the rate seen over the last several years. Positive signs were evident in our casualty facultative business, due to stabilizing rates and an expanding flow of opportunities. For example, in our casualty backed business in 2007 and 2008, we saw net rate erosion in the double-digits. In the first quarter of 2009, rate erosion was 2.5%, a significant improvement.

Our EuroAsia division generated an underwriting loss this quarter due to Windstorm Klaus. Given our concentration of exposure in France, besides of our Klaus loss, was not surprising. In fact, this is the first time our French catastrophe book has been hit the decade. At April 1st, we renewed our Japanese book rates per wind and quake covers in Japan were up 5 to 10% and we've modestly increased our exposure on some of the larger programs.

In our London market division, the insurance business we write out of our Lloyd syndicate has shown signs of improvement. Financial institution risks are now receiving substantial price increases, and pricing for other segments of the international liability insurance field are firming.

In our Europe's insurance division, premiums were flat. Healthcare premiums were down once again in response to continued high levels of price competition. Other lines of business have been holding steadier with the exception of our Gulf of Mexico offshore business which is experiencing sharp price increases.

We are excited by the prospects in our U.S. insurance business. In particular, we believe the build out of our directors and officers capability over the last six months were proved well timed. Other initiatives undertaken last year are also expected to build momentum in this division such as the Klaus business we acquired.

Our enhanced marketing efforts are expected to generate increased premium and spread of business notwithstanding the decline in commodity prices over the last 12 months. For the company as a whole, we view the market as we view the market and consider how best to deploy our capital, it is likely we will increase our allocation to catastrophe risk.

We expect pricing for the mid-year wind renewal to be very robust and accordingly, we are likely to raise our risk tolerance from its current level of 15% of statutory surplus. Pricing for direct reinsurance covers as well as for retro session and industry loss warranty covers are at historic levels. While pricing and the casualty arena remained less exciting.

We are enthusiastic about Odyssey's prospects, both on the underwriting side as well as from investments. Our company is well positioned to benefit from an improved underwriting environment and we see an investment landscape teeming with opportunities. Of course, in any given quarter, our book value may not grow at a historic pace, however, the long term ... over the long term, we are confident that the combination of our disciplined opportunistic underwriting with the value investing skills of our investment arm, will result in a superior rate of book value growth.

Now, let me turn the call over to our Chief Financial Officer, Scott Donovan.

R. Scott Donovan

Thank you Andy and good morning. First quarter financial results include an after tax profit of 1 million and a book value per share decrease of 3.5% or $1.57 per share to $43.80 per common share. Our total shareholders equity declined from 2.8 billion to 2.7 billion. After tax operating income for the first quarter was 57.5 million or $0.95 per diluted share, compared to after tax operating income of 39.1 million or $0.57 per share in the first quarter of 2008.

Our operating earnings compared to first quarter 2008 benefited from improved underwriting results, favorable foreign exchange rate movements and a reduction in our effective tax rate, partially offset by an 8% decline in net investment income, mostly due to reduced income from our other invested assets and lower yields on cash, cash equivalents and short-term investments.

Net income available to common shareholders for the quarter was 1 million or $0.01 per share, compared to net income of 249 million or $3.61 per share in the first quarter of last year. The decrease in net income was caused by investment impairments, mark-to-market losses and lower investment income, partially offset by improved underwriting result.

Looking at premium activity for the first quarter of 2009 compared to 2008, gross premiums written were 555 million, a decrease of 4%. Our insurance business was the primary contributor to the decline. Gross premiums written decreased in the London market and the U.S. insurance divisions, partially offset by modest increases in the Americas and EuroAsia divisions.

The decrease of 28% in the London market division was principally related to the timing of the recording of medical malpractice business and to a lesser extent, foreign exchange movements. The gross premium decrease of 2% in U.S. insurance was primarily attributable to the healthcare business. These declines were partially offset by a 3% increase in the Americas division which benefited from participation on new treaties and a 2% increase in the EuroAsia division due to change in our premium estimation methodology partially offset by a weakening euro.

In terms of premium composition, 50% of our gross premium was derived from non-U.S. markets, compared to 53% in the first quarter of 2008. Regarding product mix, 50% of our business in the quarter was in casualty lines, 42% was in property and 8% was in marine, aviation, surety and other specialty classes. Insurance as a percentage of our business volume was 30%, compared to 33% a year ago.

For the quarter, our combined ratio was 96.5% versus 98.4% in the first quarter of 2008. Included in the combined ratio for the quarter, were 43 million or 9.1 points of current year CAT losses, net of reinstatement premium. These losses include 39 million or 8.3 points for Windstorm Klaus. Also included in the quarter was 12.9 million or 2.7 points of favorable prior year development compared to 4 million or 0.8 points in the first quarter of 2008. The first quarter of 2008 was also adversely impacted by approximately 10 million or 2 points attributable to a higher frequency of large risk losses.

Looking to our four operating divisions, in the Americas, gross premiums written increased by 3% from the first quarter of 2008. The combined ratio for the quarter was 91.1%, compared to 99.9% for the first quarter of 2008, and included 1.6 points of current year CAT losses and 1 point of favorable loss development versus 5.9 points current year CAT losses and 1.9 points of adverse loss development in the first quarter of 2008.

In EuroAsia, gross premiums written increased by 1.5% from the first quarter of 2008. The combined ratio for the quarter was 105.2%, compared to 103.3% for the first quarter of 2008, and included 28.3 points from current year CAT losses, net of reinstatement premiums, principally due to Windstorm Klaus, compared to 16.9 points of current year CAT losses in the first quarter of 2008.

EuroAsia benefited by 3.7 points from favorable loss development in the first quarter of 2009 as compared to 3.1 points of adverse loss development in the first quarter of 2008.

For the London market division, gross premiums written decreased 28% for the quarter compared to the first quarter of 2008, primarily related to the timing difference in medical malpractice business, and to a lesser extent, foreign exchange movements as previously mentioned.

The decrease reflects a 36% decline in insurance and a 14% decline in reinsurance. Net premiums written decreased by 38% during the quarter, a greater rate of reduction in gross premium due to the increased use of reinsurance. As a result, net retention decreased to 72% from 83%.

London market division had a combined ratio of 92% for the first quarter, compared to 89.8% for the first quarter of 2008, and included 4.1 points of favorable loss development which was net of an 8 million additional provision for Hurricane Ike marine losses. For the first quarter of 2008, there were 12 points of favorable loss development.

Our US insurance division gross premiums written decreased 2% in the quarter, compared to the first quarter of 2008. We experienced increases in several programs offset by a continued reduction in our healthcare business. Net premiums written declined 16% during the quarter due to the decline of gross premiums and the increased utilization of reinsurance. As a result, the net retention ratio declined to 65% from 76% in the first quarter of 2008.

The divisions combined ratio of 97.8% for the quarter included 3.6 million or 4.4 points of favorable loss development as compared to 94.8% combined ratio for the first quarter of 2008, which included 3 million of 3.2 points of favorable loss development.

Investment income, net of expenses for the first quarter was $67.5 million pre-tax, which represents in decrease of 8% compared to the first quarter of 2008. The decrease is mainly attributable to reported losses from other invested assets and from lower yields on cash, cash equivalents and short-term investments.

Our portfolio yield on average invested assets for the first quarter was 3.55%, which represents a decline from 3.7% in the year ago quarter. However, the yield increased from 2.75% in the fourth quarter of 2008 resulting from the repositioning of our portfolio from shorter term investments and U.S. Government securities to a higher portion of tax exempts and equity securities.

In the first quarter of 2009, the tax equivalent yield on our portfolio was 4.54%. Net investment realized losses in the quarter were 99 million pre-tax or $1.07 per share, compared to gains of 323 million pre-tax or $3.04 per share in the first quarter of 2008. The current quarter included impairments of 81 million and mark-to-market and foreign currency losses of 25 million, offset by net realized gains under disposal on investments of 7 million.

For the quarter ended March 31, 2009, cash flow from operations was a negative 76 million, compared to positive cash flow from operations of 107 million for the quarter ended March 31, 2008.

The first quarter of 2009 includes an increase in tax payments of 177 million, compared to the first quarter of 2008, primarily related to the closing of credit default and total return swaps during the fourth quarter 2008, which had accumulated significant gains.

Total invested assets and cash were 7.5 billion at March 31, 2009, invested assets to common shareholders equity currently stands at 2.8 to 1 and our investment portfolio now equals $123.91 per common share outstanding.

Our fixed income portfolio valued at 4.3 billion as of March 31, includes 2.4 billion of municipal securities, 805 million of foreign government securities and 163 million of U.S. Government securities. 72% of the fixed income portfolio is rated AAA and 10% of our fixed income securities are rated below investment grade.

Equities, including equity investees, were 1.6 billion as of March 31st, representing 22% of the portfolio.

As of March 31, 2009, the carrying value of the remaining credit default swaps portfolio was 49 million with a notional amount of 1.3 billion. The average term to maturity was 2.4 years.

At the end of the quarter, our after-tax unrealized loss position was 10 million, compared to a gain of 75 million at December 31, 2008. The change was primarily attributable to unrealized losses on our equity portfolio, partially offset by unrealized gains in our fixed income portfolio and OTTI realized losses.

From April 1st through April 24, 2009, the fair value of the company's fixed income securities, common stocks, derivatives and short-term investments appreciated by a meaningful amount in excess of the declines recorded in the first quarter. The fair value of the company's investments is volatile, and therefore, may vary dramatically either up or down in short periods. The ultimate values of the investments will only be known over the long term.

Our total capital amounted to approximately 3.2 billion at March 31, 2009 with debt representing approximately 15% of total capital, which is well within our acceptable levels.

Our senior notes mature in 2013 through 2021 and our preferred stock is perpetual. Finally, with respect to capital management, during the quarter, we did not purchase any shares of common stock under our remaining authorization.

I will now turn the call over to Connie (ph) for your questions.

Question-and-Answer Session

Operator

Thank you, sir. The question and answer session will being at this time. (Operator Instructions). And we will go first to Doug Mewhirter with RBC Capital Markets.

Doug Mewhirter - RBC Capital Markets

Hi, good morning. The first question was about tax rate and relating you investment mix. If you back out of your tax benefit or credit from your realized losses and then also back out your realized losses, so, you just have an operating tax rate, it appear to be ... although my calculations maybe incorrect, it appear to be less than 20%. Is it because your municipal mix, is that high or did you have some other ... was there a favorable geographic mix to your profits or I guess, to take it off the chest, what was you operating tax rate for the first quarter?

R. Scott Donovan

Hey, Doug, it's Scott. Our operating tax rate was approximately 18%, and let me speak as to why it's 18%. You've got three things that are going on. First, you got a large composition of tax exempt securities which is generating tax preferred income. We also have a large component of dividends received on our equity portfolio, that too is tax preference. So we are receiving preferences on both of those components, and then offsetting that would be on the underwriting results, Doug, which would be at a flat 35%. So there's no geographic issue within the underwriting performance.

Doug Mewhirter - RBC Capital Markets

Okay, so it sounds like ... if it's a function investment mix then that would be a rough, very rough proxy for maybe the next couple quarters what your operating tax would be holding underwriting ... the proportion of underwriting profits is you investment income equal (ph)?

R. Scott Donovan

Doug, it think that's a fair representation of what would we expect to see going forward.

Doug Mewhirter - RBC Capital Markets

Okay, thanks for that. The other question is also related to investments. Obviously, your effective yield has ticked up as in handling losses put (ph) some of that excess cash to work; is there still an ongoing asset allocation where there might be a slightly more upward trajectory to your effective yield, so went from 2.7 to about 3.5. But if there have been more activity, that may tick it up in the next quarter again including everything else equal.

R. Scott Donovan

Yeah, Doug, I think we're comfortable at this point with the mix within the portfolio. Now, there maybe changes, but I wouldn't expect them to be significant over the short term.

Doug Mewhirter - RBC Capital Markets

And just one last question about the, your insurance business; you mentioned that the London premiums suffered from a timing difference. Was that timing because you had a one-quarter contract renewed early in the fourth quarter so it was basically borrowed from this quarter early or was there a contract that you feel will renew but it won't renew until next quarter in which your postponing it?

Andrew Barnard

Hey, Doug, let me explain what happened in the fourth quarter of '07, very late in the fourth quarter approximately $20 million of medical mal business was presented to the London operation. That was booked in the first quarter of '08. The renewal premium on that book, again around 20 million, was booked in the fourth quarter of '08. So comparatively, the first quarter of '08 had the premium, the first quarter did not because it was reported in the fourth quarter of last year.

Doug Mewhirter - RBC Capital Markets

Okay, thanks. That's all of my questions.

Andrew Barnard

Okay.

Operator

(Operator Instructions). And at this time we have no further questions. This concludes our conference call for today.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 888-203-1112 domestic, or 719-457-0820 internationally, with an ID number of 2648300.

This concludes our conference call for today. Thank you for your participation. Have a nice day.

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