Aspen Insurance Holdings Limited (NYSE:AHL)
Bank of America Merrill Lynch 2014 Insurance Conference Call
February 13, 2014 1:45 PM ET
Chris O’Kane – CEO
John Worth – Group CFO
Jay Cohen – Bank of America Merrill Lynch
Jay Cohen – Bank of America Merrill Lynch
We have once again with us Aspen. We’ve got CEO Chris O’Kane and John Worth, the CFO. I’ve been able to at least observe this company really since its founding. And what’s remarkable is, over that time, the amount of change that has occurred in the organization, but it didn’t happen at once. It wasn’t revolutionary change, been a consistent amount of change as this company has responded to various industry conditions.
I’m going to turn it over to Chris, with some comments. And then we’ll be able to do some Q&A after.
Jay, thank you very much for that pleasant introduction. I’m not very good with technology let’s see if I – looks like mic. Here is a lovely slide with a lot of words that I’m sure you’ll read and digest, but we’ll pass on.
Aspen is a specialty insurance and reinsurance company founded about 12 years ago headquartered in Bermuda, substantial amount of operations out of London. U.S. is our second biggest market, we’ve about 40%, 35% of our people in the U.S. but we do both insurance and reinsurance.
We have always believed in diversification. Our origins line being predominantly reinsurance predominantly property, I think that is possible but a suboptimal way to run a business. So, what we’ve been doing over the lifetime of the company is building a really robust, great capital model, understanding the correlations between our exposures, and the clashes between our exposures, understanding how best to build our capital efficient book of diversified bookings.
And we’ve taken the news that diversification involves doing both insurance and reinsurance, property and casualty, marines and non-marines and forms. We find ourselves very drawn to small pockets of exposure, niches of exposure, areas that are less well known, less competed for and a lot of diversification is taken into areas such as kidnap and run some piracy terrorism, or ask people who write those apart from us.
Sometimes we’ve been lucky enough to be the first people or one of the main people writing. We spotted the problem in Somalia couple of years ago, which was marine piracy. We devised some insurance solutions to that. And one of those powerful things we’ve done in the last three or four years has been pulling that opportunity.
It’s a tough world piracy and I won’t go into the detail unless anybody ask any question on it. But essentially competitors have moved in there and we caught our volume by about 60%. That’s typical Aspen characters as well.
Spot the opportunity exploit the opportunity and when the best time for opportunities found, we’re pretty happy to get out of the way of it. So, zero to about $55 million in about a year and half. And then down $20 million odd within further year and half, that’s kind of our history. And a good example of the way we think, the way we ask.
I said that we started off as predominantly reinsurance but you can see from the pie-charts, today the majority of our business is actually insurance. And I would say our insurance business has a higher growth potential than our reinsurance business, I think our reinsurance is very solid and very profitable. And it’s superb year last year. But I think reinsurance as a business has some challenges, we’ll come on to those challenges later on.
Some of the usual, some of the hygiene stuff, we have great relations with S&P, with Moody’s, and with AM Best. Those ratings, is usually A rating, A2 for Moody’s are absolutely good enough to meet the expectations and needs of our clients. One thing we’re very proud of though is that from S&P we also have a strong rating for risk management.
We have invested significantly in risk management. No one published this bigger than this, but I would say above and beyond what appears to reinvest in, we take risk management very seriously. It’s everyone in Aspen’s job to understand risk to manage it intelligently.
But we do have a substantial head of group. And all of our entities have their own CROs. We have a Group Chief Risk Officer and every entity in addition has a CRO. And we do explain to underwriters, and many of whom have joined us relatively recently, other places. Obviously, we want them to write well to get profit, to do the right things by customers and claims.
But the approach, the Aspen approach is vital, if you’re making profits but not doing it the Aspen way that’s not really welcome in our organization. And I think we kind of got 1,000 employees. I think you ask anyone, they’ve got that message, they have to understand there is an Aspen way of doing business.
So, I talked a little bit about diversification in general. Just to put a little more granularity on it, we think about our reinsurance business, just having two property components, one being property cat, largely for top property catastrophe, catastrophe loss reinsurance. Other property would include facultative individual risk property, pro-rata treaty or quota share and risk excess, and then the casualty component and a specialty component.
Now, it’s worth dwelling these one of those for few minutes. Property cat is one of the areas that gets the most news. We have been for many years leading reinsurance in property cash area. It is an area that has seen some of the biggest challenges. It’s historically one of the more profitable areas of our business.
And indeed I would say for the industry property cat is very, very attractive, very profitable, clearly also very highly volatile. Very reactive historically to storms and earthquakes, losses produce massive price hikes. The absence in losses produces very rapid price reduction. You have to accept that if you want to be in the property cat business. Stability, a safe quiet life is no part of being a cat re-insurer.
In the last 18 months or so, prices have been falling, particularly for peak zone cat. This is quite interesting. Let’s call peak zone essentially Florida in the U.S. to some extent the Gulf of Mexico in the North East. And maybe you could add in California quake as well, but that’s smaller insured peril in the U.S.
And our internal calculations about the industry, say two years ago would have said property cat is about 18% ROE business. We generally like to beat our competitors and do a bit better than that. But we thought cost indices, but we’ve seen price reductions of 10%, 15%, 15% to 20% several times a year of the two years.
So, we still, I would say objectively and absolutely quite a well-priced business. Certainly it’s comfortably in double-digit ROE business. But a lot of that excess margin has gone from it. The reason it’s gone, is that many funds and this is well-known, particularly pension funds recently but some hedge funds, have looked at this as a ways the best part of portfolio.
And perhaps their cost of capital is cheaper than those of us who trade on the back of publicly quoted common equity holders. And so, as long as there was that perception of excess margin, I think people have been fairly happy to compete it away.
And my guess is that prices will fall again in April, and fall again in June this year. I don’t know that it’s just my professional judgment. I think the interesting question is when will they stop falling and no one knows the answer to that.
I think there is, however, some evidence that unlike previous softening markets, which were driven by a lack of transparency, a lack of technical understanding and excessive supply of capital, this time the new capital is actually quite intelligent. It’s probably more quantitatively driven, more numerous and more dictated on getting right returns than the traditional capital is.
So, some would predict and I might be sympathetic to this point of view, some would predict that prices will fall to a certain flow. That flow might be in the 10 or 11 ROE area, I don’t really know but it might be around. And at that point competition has carried on non-profit. It’s going to be on service, it may be on terms and conditions coverage issues, maybe the next day.
One thing about property cat, it’s nothing is ever the same for long. Soon, there will be another major loss, some of the naïve capital will be destroyed, some people would make mistake, we’ll find out the mistake they’ve made and they’ll be cutting back or eliminating it from business.
At the same time very quickly, the rest of the world will be looking at cat as a new opportunity again, our job is really to anticipate the market. So like the best reason to underwrite and keep in our book.
Recently, a number of funds have approached us and said, can you source some risk for us? We started doing that last year. We raised about $100 million of capital for the third-party or underwriting, it’s the very, very same figure. It’s not bad from a standing start I think.
Many people will say you need to really get track record to actually attract serious capital and that’s true. We’re pleased to be on 100 in less than the first year. But after three years, I think we could then well expand that part of our business quite significantly. To this, so, we have to change our disposition to property cat. There will be times when we underwrite and keep tremendous amount of program to count.
There will be other times when we want to underwrite and keep only a part of it for accounting and pass the lot on to third-party capital. That’s the new model in property cat reinsurance. And I see no reason why we can’t be as successful in new model as we’ve been in the old model.
A few words on the other segments, other property as I said is facultative, pro-rata treaty and risk excess. We took some new initiative this year under our very, very successful areas is individual risk property facultative excessive loss.
It’s not a big business for us, it’s typically U.S. and international combined maybe in the sort of $45 million to $60 million of premium range. The returns we get out of it are absolutely superb, we love to do more. We don’t think there is more of a, well, we just don’t think we can grow. But it’s in there, and it’s very valuable.
That business, the facultative business I just referred to in the U.S. was traditionally done on a direct basis without broker involvement. Now we’ve established Rock Re, which will do the same thing but for the broker’s clients as well. And business would be a little bit more exposed to catastrophe hazards but not significantly.
Tom Luning, a real, superb industry veteran, real – one of the best known underwriters of U.S. regional accounts joined us about six or eight months ago. And Tom is building our regional offering, the U.S. I think there has been historically a slight bias in our U.S. booked, would be bigger companies, the Northeast companies and the Eastern seaboard companies.
We want to address that balance a bit. And we’re seeing some growth in fact from regional accounts, some of that will be property some of the regional stuff actually will be casualty as well, maybe actually predominantly casualty.
Casualty itself is a very successful line for us. But we have – we’ve stepped back quite meaningfully over the last three, four, five years as everyone runs. And the business of casualty is a game of accepting premium and ultimately paying claims but holding premiums for a long time.
Therefore investment return is vital and the investment trends on the casualty is a tough business to be in reinsurance. We’ve cut back that 40% to 50%, I think just over 40% from our peak in casualty REIT five years ago. But it continues to be highly lucrative for us on this pruned-back basis.
Specialty side is more exciting story. We hired Michael Dicker, of course in 2013. He’s an expert in agriculture insurance and reinsurance worldwide, very well connected individual, knows all the brokers and all the clients, those times derive the risk. And we’re going to see some growth globally there. This would include U.S. prop. I know this audience may know a lot about U.S. prop insurance.
We will do some reinsurance of U.S. prop, but our ambit is much, much bigger. Did you know, for example, what whereas the U.S. prop insurance has been not just the biggest single market but almost a bigger than the rest of the world combined when it comes to prop insurance historically.
And now there are those who particularly, that just within the next couple of years, China will be a bigger prop insurance market that the U.S. is, so we’re looking at that amongst many opportunities.
We’re in specialty also in marine, aviation, surety, lots of interesting niche lines there are. It is our most profitable sub segment actually not withstanding what I said about property cat is in very good form. We do even better in terms of return in allocated capital, specialty REIT.
Picking up the pace a little bit, because I intend to sit down and we’ll have some Q&A afterwards. I wanted to say some things about our insurance operation. I’ll show them here by segments and we essentially think about our businesses four parts plus program. The marine energy transportation little one I think is a growth area for us.
We’ve had a strong operation in London for nine years, and very pleased with Tony Carroll joined us last year to focus on the U.S. side of our energy operation, Tony is particularly well known for his expertise in onshore and issue property. But he has some knowledge and good knowledge of everything else.
We also had a new underwriter in our London operations he’ll be looking after the energy property, done out of London, that includes the highly volatile but highly profitable Gulf of Mexico exposures.
What we call FINPRO, financial and personal lines and other growth areas for us, we do that both in the U.K. and in the U.S. we write globally. We have some very good numbers there. The growth rate is slower than in marine energy but still meaningful.
Property casualty, we do on both side of the Atlantic Program. That’s worth mentioning because it’s one of our growth areas. A lot of people have justifiable fear of program business. We got some very good numbers, why, because we do very key program. I don’t think we added new program in 2013 at all.
And if we don’t add a new program in 2014 that could be okay, but we would like to add one or two. The key is, that a few programs to know them intimately to order them, to provide the right kind of incentives to the program manager, to get the right kind of our business forward and then control of it. Always be close to manage it.
The mistakes that have been made pro and home business have related to too many programs with insufficient governance and insufficiently closed to provision what was going on. That’s what I think enables us to get some very good numbers in an area of the industry that’s not always reputed for, reached some very good numbers.
A few words on our performance last year, improved ROEs from 8.5% to 9.7%. Operating EPS, as you can see 388, we were pretty happy with that. Book value per share grew but there were some negatives there, mainly to do with increasing interesting rates – above the AOC line I think, book value were also something more like 7% or 11% with which we were all pleased, questions on that to John Worth, later if you have any.
We also on our call, which took place on Friday, apart from viewing 2013 totaled about the future. And then the last few minutes, I was going to focus on that.
In February 2013, we offered guidance for 2014 of 10% return on equity. That was at a time when many analysts thought that was rather on a high side. The gap between what we think and analysts just closed, hopefully this and that’s fine.
But it’s worth explaining why we believe that we’re running a business that not only can reduce 10 ROE which will be an improvement on 2013, it’s self-improving than 2012 but also a continuing upward arc in terms of ROE. We’re working very, very hard to make this business more efficient, to optimize the underwriting mix, to improve the investment mix, to think about the expense level and so on. And to get a better return on the investments we’ve made in the U.S.
The capital commitment we have is to maintain a safe an efficient level of capital. We bought back well over $300 million of shares last year. We’ve bought back just over 20 million shares this year to date. We will continue our share buyback program. We have $200 million of – little less than $200 million of our board authorization outstanding. In the course of this year, we’re going to use some of that.
There are some considerations we always have to monitor losses, especially cat losses as we go into cat season. And we do have to think about interest rate volatility and the effect of that has on capital. However, we will continue to buy back shares this year.
The idea is to hold the right amount of capital in business and enough capital to deal with nasty surprises that can come out of any P&C business but not more than that.
Historically we bought back shares. At a certain point our share price would move above book value, significantly above. We might want to think about special dividend, it’s on the technique is not the important thing. The principle is to capital efficiency rather than quoting it unnecessarily.
About investment return, I would say little other that we’ve diversified from being a very pure fixed income stage having something in the region of 10% in alternative. I may be wrong it would seem to me a lot of the capital models were built by fixed income people. They do favor fixed income, they don’t much like equity in our investments.
There are some significant fair customers as part of our portfolio. It is not in fixed income which make it less efficient to diversify. So the trick here is not really what would you do if it’s your money and you wanted to protect and grow that money in the long-term? The trick is to blame that type of considerations with what makes the rating agency kind of model most efficient.
Then, two quarters ago, we introduced the notion of retaining more of our business, buying less reinsurance. We have grown quite rapidly in U.S. in the last few years. We’ve hired some very, very good teams. One we hired and we believed in legal teams, but we didn’t know because they hadn’t delivered for us. And so we bought a lot of reinsurance.
After several years, we’ve got to know that business better we got to know the teams better. Our level of confidence is higher. We see less and less need to buy reinsurance. So, we’re making a major change in reducing the amount of reinsurance we buy in each line of business.
As we said already, we have a very specific capital model. And it’s actually a very complex process to work out, exactly what the optimal retention in each reinsurance program, for each of our lines of business are. We are doing this on a diversified base.
We’re not retaining more cat risk cat risk is a very hungry risk for capital. We have enough cat risk on our balance sheet. But the diversifying non cat lines, we will maintain more of. This will mean that our expected profitability is higher and we identified on our call that we actually believe that the expected change in net income for 2014 is $25 million increasing to $45 million next year. This given, that our capital is in the region $3 billion make the very, very significant change to expected ROE.
It will come with some increased volatility. I don’t think its balance sheet volatility. I think its earnings volatility. And so I would say to probably five or six possibly seven or eight quarters, out of eight, we’ll be telling you that we’ve made more money because of this policy.
But one quarter in six, seven, eight quarters, we’ll be saying there was a bit of loss. We now have the $20 million retention at loss. Otherwise it might have been $10 million. We think that that slightly enhanced earnings volatility is more than compensated for by the greater profitability over time.
The other thing I want to draw your attention to here is, the net premium levels, which is quite significant growth. There are many ways to grow, usually in both doing things you haven’t done before but trying to find some other business from outside that you haven’t already underwritten.
What we’re doing is taking the business we already have. It’s already proven. They’re underwriters are already in control of and maintaining a bigger share of it. So it’s about the safest form of growth, imagine, we think it’s a very important innovation. We think that you ought to consider that as you try and understand our company, it’s a such profound from last year.
I’ve run on slightly longer than I told Jay. So I’m going to stop here and welcome any questions.
Jay Cohen – Bank of America Merrill Lynch
I asked this question of a competitor in a prior session, so I’ll ask you. From the credit side, S&P I guess you saw the report they put out talking about the effect of third-party capital on the reinsured sector. Some of the paragraph headlines again were – no place to hide, and those who don’t find their way may lose their footing, etcetera, etcetera.
And it’s that I believe that this could lead to either a consolidation or ratings pressure. With respect to aspen, do you feel that your diversification efforts are enough I guess that’s one way about seeing. Do you think they were talking about you?
I think it’s an industry-wide phenomenon. I think if you’re in the property cat business, you cannot be other than affected by this. And there is that expression, if you can’t beat them join them. I think many of us have taken that view that new funds to capital, new funds through transfer there.
And that for the point is, if you have expertise, technical ability, some brand in a place, how do you continue to benefit from that? So, what we at Aspen have done is, establish Aspen capital market. I just said a few minutes ago, I think in a period of six or seven months, to find $100 million of funds was quite pleasing. We think there is more capital there. So, I think the future part of our business we’ll be underwriting risk to third party.
Some people say this is here to say. Some people say it’s flash-in-the-pan. My view is that the new capital or much of the new capital is very sophisticated, it’s long-term, it’s cautious for sensible people and I think it’s profound in terms of change.
I don’t believe that’s simply going to replace for traditional capital and traditional ways of transferring risk. I think the new capital finds peak zone cat and most attractive thing to do. I think the buyers were interested on the lawsuit and most sophisticated by the biggest buyers in America, in Japan, in Europe or the State fund who want to shift huge amounts of risk.
Medium sized funds, smaller funds, clients in emerging markets do not have the same need or interest in this new form of risk transfer. They really do want a traditional re-insurer but with Aspen.
And when we relate to those clients, we may be selling the property cat product, we may be selling a homeowners’ quote share, we may be selling maturity contract and engineering contract, maybe many, many things. We actually like to send a lot of different things. And that part of our business model, as far as I can see is quite un-impacted by what S&P were talking about there.
So, I think the trick is business has changed the world to distant. Let’s change our technique but not forget the old value that got us through where we are today.
I think you mentioned that you grew the reinsurance business or you’re growing the reinsurance business premiums even in the declining rate environment and while other competitors may have scaled back on certain lines. Is there a different approach to your strategy that you see fit continuing to grow at a higher pace?
I think the growth in reinsurance came from two sources, one I mentioned the U.S. region. And here we are rather taking bigger share because of new personnel and better relationships on existing clients, clients we like in process we find, or in some cases we’re meeting with new customers. That’s a relatively modest contributor, but that is a contributor, particularly showing up in the other property reinsurance sub-segment.
The more profound is in the cat business that I’ve mentioned ACM as for capital market. At a growth level before reinsurance, before the effects of Aspen capital markets, our peak zone wind exposures increased by $100 million.
After we have passed some of that business on to the third party capital, we represent at ACM. And after we have bought more retrocession faced with a much cheaper more retrocession market, our net exposures are down by about $50 million.
So, it is a little paradox but I have to say to you we’re growing and shrinking at the same time. Or to go back to previous question what we’re doing is structuring ourselves in a way that our gross position business can be as big or bigger. But our net position will reflect prevailing change in pricing which is negative.
Worth making one other comment though – I would say to the property cat pricing objectively today is still pretty good. If we were riding at 18% ROE two years ago, and a year ago we’re riding at 15% say in the cat line. I’d be perfectly happy about that. I prefer 18% to 15% but I wouldn’t cancel the business because it was only 15% so it’s an element of that.
Chris, maybe you could talk a little bit about consolidation in Bermuda. There seems to be a lot of excess capital and what your thoughts are M&A and maybe over the next five years you’re more likely to be a buyer or a seller?
Sure. As you know, we have spent 12 years engaged in organic growth. I think we’ve been pretty successful with that. To me it is a fairly low risk form of growth. I think everybody knows that most mergers destroying not create value. And we’re very conscious of that when we have to consider acquisitions and consolidations.
They have for many years consolidation as quite right in Bermuda has been discussed and it will be more discussed, talked about and speculated. It has been achieved and I don’t know what’s around the corner. But I would say Aspen is very committed to the organic growth path that we’ve been pursuing. That said, if opportunities come along that are worthy of consideration, of course we’re going to consider them. We’ve given open minded objective review but with an appropriate level skepticism.
Jay Cohen – Bank of America Merrill Lynch
We’re going to end it here unfortunately. We’re bumping up against the next presentation which is being done via phone because the person couldn’t get here. But I wanted to thank you for coming, telling your story. Once again, please join me in thanking the management team.
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