Argo Group International Holdings, Ltd. (NASDAQ:AGII)
Bank of America Merrill Lynch 2014 Insurance Conference Call
February 13, 2014 3:30 PM ET
Mark Watson – CEO
Jay Cohen – Bank of America/Merrill Lynch
Jay Cohen – Bank of America/Merrill Lynch
[Call Starts Abruptly] already few left. Thank you for sticking it out given the weather, but you will be rewarded because we have a very interesting story to hear. Mark Watson who runs Argo is here for the third year in a row -- second year? And it’s a story that has changed a lot over the years and I’m sure Mark will give you some of that history, but more importantly, we want to have a sense of where it’s going in the future. Mark?
Thank you, Jay and good afternoon everyone. Usually everybody wants to start by saying something spiffy and I know you’re here because there’s nowhere to go. I don’t know how we’re all going to go home but anyway. So, I’m going to talk a little bit about Argo. Most of you all have heard our story in the past and so I’m here to kind of just fill everybody in and talk about how we did for the year. And for those of you who don’t know much about us, tell you who we are. Some of the things that I may say are forward-looking, so just keep in mind the Safe Harbor Act of 1995 applies. So Argo Group is a global, international specialty company. We’re used to just say specialty, but that’s really changed and that’s a little bit about our story when we used to talk about being a specialty underwriter it was here in the U.S. And then the markets became much more globalized and we found ourselves becoming a part of that, and again that’s part of our story. Our market cap is about 1.2 billion, with a capital base of 2 billion, 1.5 billion of that is equity. And as you can see have offices in a lot of different places around the world where we trade and we’ll talk more about the rationale for that, as I go through this.
We’ve really liked our business. We have risk in over 60 countries around the world, much of that is through our syndicated Lloyd’s as well as our reinsurance and insurance operation in Bermuda. We have one of the leading Excess and Surplus lines underwriters in the U.S. We trade under the name of both Colony and Argo Pro I’ll tell you more about those in a little bit. In terms of stamp capacity, we have one of the top syndicates at Lloyd’s. We also have a strong retail business in the U.S. that we refer to as our Commercial Specialty business, which is much more of a client centric model. And we also have a pretty robust platform in Bermuda, which I’ll tell you about and operation that we started in Brazil several years ago. Just a couple of things to keep in mind, we’re mainly a casualty driven company. Today about 62% of our premium is casualty versus 38% being property. If you’d heard the story or looked at us 10 years ago, it was about 85% liability, 15% property. And we’ve been consciously trying to shorten the tail of our liabilities by writing more property risks over that time. And also you’ll notice that we really are an insurance company as opposed to a reinsurance company. I think sometimes that people confuse us with being a typical Bermuda reinsurance company because our corporate office is based in Bermuda. The only reinsurance we do is property cat reinsurance and we think that we get a better return on our property cat exposed insurance business, and I’ll get to that in a minute.
So that’s kind of who we are. Let me talk about how we go about and what we do. We try and be very focused on niche markets, or our underwriter expertise or to the extent that we have a customer centric model in some of our subsidiaries, providing superior customer service. And we try really hard to be innovative in how we run our business, not just product innovation but also we structure our company. And we find that we can do one or more of these things, it does allow us to differentiate in that market. We focus on growing profitably and hopefully, organically, but sometimes we will look at M&A. And you’ll see in another slide in a minute that, that growth is a little bit lumpy and the reason for that is market place is two. We don’t try and grow in the soft market. We only grow where we think market conditions merit that. We have really strong underwriters and teams and we’re pretty good we think in managing our capital. So hopefully, you put all those things together and our goal is of course to maximize shareholder value. And particularly book value per share that’s really how we measure our financial performance.
We’ve been running this company for a while. I’ve been the CEO now for 13 years and we’ve been on a bit of journey during that time, but Argo actually just celebrated its 65th year of business. It started as Argonaut Insurance Company in the Bay Area late in the 40s, and at the time focused on workers’ compensation. So, we’ve kind of come a long way since then, and if you look at the gray piece on the chart that was the original legacy business of what was then Argo insurance company its risk management business which we actually sold at the end of 2005. You can see that in the beginning, our Excess and Surplus lines business was not very big, in fact, when we acquired it in 2001, the premium base was $100 million and we grew that to over $700 million in 2006, both from organic growth and also from a number of acquisitions that we made at the time. And yes this was the height of the hard market. And I think also, if you’ll look here and you could see the premium ramp up and then start to decline and come back again, and you’ll notice that actually that tracks the market pricing of the E&S marketplace pretty closely. Perhaps even a proxy for market pricing. The light blue piece is our Commercial Specialty business. Again that’s our retail business in the U.S. but has much more of a customer centric model. The purple piece is the syndicated Lloyd’s and you’ll notice that we added that in 2008, that was by acquisition. And you’ll also notice the green piece which is our international operation that started in 2008 as well. And that is primarily our Bermuda operations which are reinsurance business Argo Re, our excess casualty and excess professional businesses in Bermuda, and then most recently our operation in Brazil.
And so you can see that now, today got a pretty diversified platform for all four of our business groups. During that time, in our premium grew from just under $300 million to almost $2 billion in 2009, and then you’ll see it dropped pretty substantially in 2010 as we reset our portfolio and realize that the market had gotten pretty competitive and we didn’t think we were really getting paid for some of the risks we were putting on our books, particularly tail risks. And you’ll now see that we’re growing again and probably in 2014 this year, we’ll get back over the 2 billion mark. So I just talked about our portfolio in a couple of different ways for a minute. Again, just a reminder, in the bottom left that we’re primarily an insurance company, not a reinsurance company. And if you look in the top right, you will see that we have a pretty diversified product set. In the top right of the donut, you’ll see where it says Excess and Surplus lines, that piece is almost entirely casualty. Special property as a group makes up 21% and then you’ll see other specialties marine and aerospace, mining, our exposure to emerging markets which is energy related and property, but basically a pretty good spread of risks by product. And if you look in the bottom right, a pretty good spread of risk by geography. We originate almost half of our risks outside of the United States today, mainly in London and Bermuda, and then to a lesser extent some of the emerging markets where we operate, Brazil being the largest.
Part of the reason we have different businesses, because we approach the market in different ways. And so this chart just gives you a good example of just how broad our distribution platform is both here in the United States and abroad it’s probably pretty hard to see each little bit. But the point I’m trying to get across here is that we have, I think a pretty broad distribution platform. It allows us to deliver our product in many different ways, and it allows us to be competitive in many markets, again both here in the United States and in other big trading centers as well whether it’s London, Bermuda or Zurich as examples. Over the last 11 years, we have grown book value including dividends at over 10%. I think this is our scorecard. It’s been fairly consistent growth with little bit of lumpiness. We were down slightly in 2008 during the financial crisis, and down slightly in 2011 from all the natural catastrophes that happened around the world, mainly outside of the U.S. So that was one time where being diversified wasn’t necessarily our friend, but as you can see, we’ve recovered from that. And the line that you see is the share prices in multiple of book value, and you’ll see that it peaked when the market peaked in 2007 and has trended down and finally moved back up between 2012 and ‘13.
Just to kind of again put some more numbers out to think about how we’ve grown. Gross written premiums have gone up 10 times in the last 13 years; net written premiums have gone eight times in that period, earned premium up 10.5 times. Assets are four times what they were, total invested assets just less than four, capital is about 3x and we have added a bit of debt to our balance sheet, but we’re still sitting at 20% debt to total capital. A whole lot of that is actually trust preferred which is equity like capital debt structure, at least as far as the rating agencies are concerned and we’re A12 by AM Best. If you look at our four business segments, you’ll see that three of the four grew -- sorry two of the four –sorry for the fourth quarter, two of the four grew for the whole year, three of the four business segments grew. There was one account that didn’t renew in the same period within our reinsurance business, but skews the international business. Other than -- but for the year, it grew and this was kind of by design. We have a real opportunity to turn the dial up in our E&S business and at the syndicate. We’ve been re-underwriting part of our portfolio in Commercial Specialty, that will probably continue a little bit more in the first half of 2014, but we think we’re in a good place to grow our other three business segments again this year. So let’s talk about each one of them in a little bit more detail.
Our largest and most profitable segment is our Excess and Surplus lines business. The majority of the risk is produced through wholesalers in the U.S. If you look at the chart in the top left hand part of the slide, you’ll see that, if you kind of start from I guess going clockwise, everything up until contract is underwritten exclusively through wholesalers under the brand, Colony Specialty, which was the original part of our E&S business. And we realized a few years ago that actually, our E&S business ought to be two, and we set aside all of the professional liability business under a separate brand called Argo Pro, which operates in an open brokerage model which means that we originate risk both through wholesalers and through retail brokers. We have, again, a pretty platform as you can see. We have a pre-deep relationship with all of our producers that we work with, at a geographic level that we multiple offices around the U.S. so our underwriters can internationally go down the street to work with our brokers. They don’t just sit at their desk and wait for the phone to ring. We think that also has a lot to do with why we’ve been able to grow our premium base. Hopefully, we’re easy to deal with at least that’s part of our selling plan.
If you look on the bottom left, you’ll see our financial results and you’ll see that they declined from 2007 to ‘09 and they have been steadily increasing. Part of that tracks return premium, but part of it also tracks some underwriting initiatives that we’ve had underway in our E&S business a few years ago. And actually, if you look at the next slide, we track improvement in the combined ratio from 2010 through 2013. Each one of these years has had some positive reserve development in them, so that certainly skews the number a little bit particularly this last year at an 88 combined ratio. But the real point is that, we’ve seen a substantial improvement and it’s been a systematic improvement kind of from the end of what was the bottom of the soft market, I’m not willing to say that we’re out of the soft market, but certainly we’re off the bottom of it. And I think our underwriting results and the changes that we’ve made in our portfolio mix have really pushed us in the right direction. And I think if you compare our underwriting results with our competitors, you’ll find that we’re in the top quartile. In fact, our underwriting income I’ll go back one slide, it doesn’t have it broken down, but our underwriting income for the year was just short of the record that we’ve set in 2007. The difference of course is we have a little less investment income now than we did then, because yields are much lower. So we’re really happy where this business is and we’re seeing opportunity for it to continue growing in the current marketplace.
Let me talk about our other business. Here we go. Okay. So let me talk about the other half of the U.S. and that’s what we refer to as Commercial Specialty. The majority of the business within Commercial Specialty is client basing, meaning we interact directly with the policyholders and our value proposition to the policyholder is that we actually help them manage their risks. For much of our E&S business that small account driven, was not that much claims activity for one year to the next for a policyholder. For our Commercial Specialty business, typically they have a lot of claims over the course of the year. And so we’re helping them to manage their risks, directly with through our claim organization or our safety or loss control businesses. And then the last part of Commercial Specialty that last quarter is more program related business, some of which is underwritten on behalf of Argo and some of which is underwritten on behalf of other insurance companies in the U.S.
If you just to take a couple of examples, we’re the second largest insurer of mining operators in U.S.; we’re the second or third largest underwriter of small to medium public entities in the U.S. and it may not sound very fancy, but we are also one of the largest insurers of drycleaners. By the way that was a really good thing Hurricane Sandy hit New York a year ago. If you look at our financial results, they were a bit challenging in 2011 and ‘12, that was impart from natural catastrophe activities not just hurricanes but tornadoes in the Midwest. And also we found that we had to do a bit of re-underwriting in one of our subsidiaries called Argo Insurance back at 2012. But you’ll see that we returned not only the profitability in 2013, but we had generated an underwriting profit in Commercial Specialty as well. As I mentioned earlier, our premium volume was down year-over-year, probably that stays about flat we could be down slightly in this segment again in 2014, as we try and re-optimize our portfolio a little bit more.
So let’s talk about the syndicate next. Again, a pretty diversified portfolio. All of the business comes to us by wholesalers, mainly Lloyd’s brokers and you’ll see that our financial results were a little lumpy in 2010 and 2011 and that was entirely driven from natural catastrophe activity. If that would have happened again today, you would see a much different picture. We’ve reduced our exposure quite substantially, and as far as the property cat reinsurance business goes, we’ve moved that from the syndicate to the Bermuda reinsurance company exclusively. So, we’ve taken a lot of the volatility out of it. Now, we’re pretty happy with our financial results this year. We generated a combined ratio of just over 92%, which is a little higher than some of our competitors but that’s because many of our competitors who have a syndicate have a lot of their property cat exposure in the syndicate, and since the wind didn’t blow, they have the benefit of that this year. You’ll see that since we cut back some of our tail risk in 2010, that we’ve steadily grown our written premium over the last three years, and we would expect that steady increase to continue again in 2014.
And then the last piece, our international specialty probably has the most amount of things going on worth talking about. From a premium perspective, our reinsurance business is still the largest piece. It’s just over $100 million of property cat reinsurance, followed by the excess casualty and professional liability businesses underwritten in Bermuda. And then the remainder is primarily, our operation in Brazil, which is a multi-class strategy that looks a lot like the risks that we underwrite at the syndicate and to a lesser extent in Bermuda. We’re still getting that business up and running, and it probably takes a couple of years frankly to get it to critical math[ph]. If you look at our financial results, you’ll again see that in 2011, we had a fair amount of loss from natural catastrophes. If those were to happen again, we would expect to see probably less than half of loss in 2014, than we did in 2011. It’s hard to imagine that many events happening again, but I didn’t think it would happen at the time. So, I would knock out some wood up here but all I see is a [inaudible]. Anyway, we’re in a much better place today, and may be it would be good for us if wind blows because we have so much reinsurance and retro capacity this year in the marketplace. I would expect that our international segment would grow again in 2013, probably driven by Brazil more than what we’re doing in Bermuda.
So just to look at some fourth quarter and full year numbers for a minute, again, we finished the year with almost a 1.9 billion in gross written premium which equated to 1.3 billion in earned premium. We finished the year with a combined ratio of 97.5% versus 104.6% a year ago. Included in that number, is a fair amount of compensation related to, I should say equity compensation and because of the way it was structured and because our share price moved up so much over the course of last year, it generated more than $15 million worth of expense beyond what we would have expected which did equate two points on the combined ratio, but it was pretty close. So we’re getting much closer to our target of 95. First the wind didn’t blow, that did have some impact as well in a positive way. You’ll also notice that we had a substantial amount of realized gains over the course of the year. That mainly came from reallocating our investment portfolio and selling a fair amount of equities at the end of the year. It’s also driven by a change in our investment strategy moved away from some of our fixed income investments into alternative investments, and the income generated from them runs through realized gain in the P&L instead of investment income. And for the year, that was about $17 million versus $4 million had we left it in the fixed income portfolio or a benefit of about $13 million. To look at our investment portfolio, you’ll see that we’ve got, we think, a pretty good spread of risks about 69% of the portfolio was in fixed income, and the remainder is in either public equities or alternative strategies. In 2014, the fixed income portfolio was down about 50 basis points and the remainder of the portfolio in the aggregate was up 15%. So, that really helped us a lot last year. I don’t see it changing too much between this and where I think will be at the end of 2014, but we’re still looking for a little bit more diversification and risk. The bond portfolio duration is down to 2.8 years and the book yield -- I think it’s actually a little closer to 2.9%.
Lastly, let’s talk about capital management. Over the last few years, we’ve repatriated over $300 million to shareholders, primarily through share repurchases and then to a lesser extent, dividends. I would expect this to continue in 2014 as well. If you look at our share price, over the last year, we’ve outperformed our peer group in the market. If you look at our share price relative to book, over the last 13 years or so, you’ll see that in 2006, we finally narrowed the gap between our peer group, and since then we kind of attracted through the beginning of the financial crisis and then we gapped away, and the difference is starting to narrow again. So I view this as the opportunity, not a challenge. And I think we’re in a really good spot to move ahead. We’ve done a lot of hard work. We have a really good balanced portfolio. We’ve made some tough decisions. We’re getting traction in some of the new markets that we’ve entered Brazil being an example of that. We don’t have a lot of leverage in the company, and I think we’re in a really good spot for the future.
And with that I’ll open it up for question, Jay. And Jay Bullock, our CFO is here in the audience so he can take some questions too.
Jay Cohen – Bank of America/Merrill Lynch
I guess if you look at the 2013 results clearly nicely improved around the last several years. As you look forward, what are the biggest strategic challenges for you? What are the things you’re focused on that you want to achieve say in ‘14 or ‘15?
Yeah, I think strategically, I think we’ve made some of the tough decisions already. I think for us the challenge in the near term is actually execution. One of the things that I didn’t talk about in my presentation was, because much of what we did over the last decade involves acquisitions. We’ve now got a lot of systems that we’re trying to integrate, we began a project three years ago to really bring all of the systems together and try and create one enterprise wide solution in the U.S. We’re a little more than half way through that. We’ve begun delivering it, which is in part of why you’ve seen our expense ratio improve. And by the end of this year, we’ll probably be 75% done, may be even a little bit farther. So, focusing on that, focusing on continuing to optimize the portfolio of risks that we already have, I think those are the things that move the needle the most. I don’t see us doing too much strategically in the next 18 months, I think it’s just execution on what we have.
Jay Cohen – Bank of America/Merrill Lynch
My other question was on reinsurance, not a big business for you I understand that, you’re focused on high margin, cap business. But that’s a business where we’re hearing more and more that it’s heading towards the larger players. The smaller cat writers are seeing less business. You may disagree with that, but where does that leave you? And why are you in this business at all at this point?
So let me answer the last question first. We’re in that business because when we look at -- sorry let me rewind the clock to 2005 when we had all of the -- the hurricane hit the United States on the back of 2004. And we realized that we’re under actually underexposed and we ought to take more property cat risks. But we looked at the return we were getting in our insurance portfolio versus the return that our reinsurers were getting. You might remember price went up substantially, and we said okay let’s go, we ought to be reinsured for property cat risk not an insurer for property cat risks. To the extent that we’re writing on a mono line business where it’s part of the package of coverage that we provide within Commercial Specialty, the client centric part of our business, well that’s really important. But if we’re just trading risk, then the return that we’re getting in the reinsurance portfolio is much more than in the insurance portfolio.
So that’s why we started the reinsurance business in 2007 – by the end of 2007. Even with prices coming down today, the margin that we have in our reinsurance book is still better than in the insurance portfolio. As far as you got to be big to stay in the game, we put in place the sidecar called Harambee Re, which allowed us to double the line size, if we wanted to, not only for our reinsurance portfolio but our insurance portfolio as well it supports both of those books of business. We finished the 1st of January with about the same premium volume as we had a year ago. So, I don’t know if that means that we’re on the right side of the trade or not, but our portfolio certainly didn’t evaporate, in fact, I think we have more accounts today than we did a year ago, even if it’s only by just the margin. I think our team has a lot of respect in the marketplace. And while they may not lead a lot of risk, I think that when they participate, it validates our market.
Jay Cohen – Bank of America/Merrill Lynch
Is it written in a separate legal entity or you’re using another balance sheet within the company?
Yeah so the Bermuda has one balance sheet. So we underwrite the property cat risk as well as the excess casualty and excess professional liability. But also that same balance sheet reinsures the syndicate and it reinsures the U.S. businesses, and it reinsures the Brazilian operations or --
Jay Cohen – Bank of America/Merrill Lynch
Mark, why Brazil and I guess it’s a twofold question. Why you find it attractive? And then secondly, what do you think you bring to the table in terms of competitive market?
Yeah, so when we were thinking it was Brazil five years ago, the market here in the U.S. and in Europe was not as well priced than as it is today. The economy wasn’t growing here and we were thinking about where we might have an opportunity to grow our platform in the future. At the time, Brazil was growing high-single digit, insurance as a percent of GDP was growing almost twice as fast. So, it’s always nice to enter a market with a tailwind. As far as what we thought we would bring to the table, it was the same specialty underwriting expertise that we have in the main parts of our company. Brazil opened as a market, I think seven years ago, and so the variety of insurance product was very limited at the time. And so we thought that we could bring new product to the table and get paid to do so.
Jay Cohen – Bank of America/Merrill Lynch
Okay. That wraps it up. Finishing a two day conference. Mark, thank you very much for a good presentation as usual.
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