Lancashire Holdings Limited (OTCPK:LCSHF) Q1 2010 Earnings Call Transcript May 5, 2010 8:00 AM ET
Richard Brindle – CEO
Alex Maloney – Chief Underwriting Officer
Neil McConachie – President & CFO
Elaine Wheaton – Deputy CFO
Ben Cohen – Collins Stewart
Tom Dorner – Oriel Securities
Fahad Changazi – UBS
Nick Johnson – Numis Securities
Good day, ladies and gentlemen, and welcome to today’s Lancashire Holdings Ltd. conference call. For your information this call is being recorded. I’d now like to turn the call over for your host today, Mr. Richard Brindle. Please go ahead, sir.
Good morning, good afternoon, everybody, and thank you for calling in, 2010 has certainly not been dull so far. A massive earthquake in Chile, whose ramifications for our industry are still far from clear; the largest energy risk lost in Piper Alpha and numerous smaller natural catastrophe events have tested us all, but arguably Lancashire in particular.
I remember going around raising money for the IPO in late 2005 and telling people that if Lancashire had a big loss it would be on the front pages within hours or days. Such is the short tail and specialty nature of our account. That has once again been borne out by events. We have demonstrated our ability to deliver industry-leading combined ratios at ROE in the good times; I feel we have now demonstrated our ability to withstand major losses where we might be expected to suffer disproportionately.
And in that context I’m pleased that we made a modest profit in Q1 and pleased that the Deepwater Horizon is a loss which will impact one month’s earnings, but no more than that, and with that I’m going to hand over to our Chief Underwriting Officer, Alex Maloney.
Richard, thank you. Good morning, ladies and gentlemen. After a challenging quarter I believe our combined ratio of 99.1 is an acceptable result for the Group. Our underwriting model has once again been tested with the Chilean earthquake coupled with cat events in the Northeast of America, Western Europe, Australia and China. I would like to highlight a couple of key drivers which make up this quarter’s results and then comment on our underwriting outlook for the rest of 2010.
We have achieved strong premium growth compared to the corresponding quarter in 2009. This has mainly been driven by our property cat writings, our quarter-on-quarter premium growth is up 60%. At the January renewal season, we secured property cat opportunities which we believe give Lancashire the best return for the capital which we deployed. We have secured the majority of these writings on a multi-year basis.
Our expectation is that pricing for the mid-year U.S. property cat renewals will come under pressure to a level which may not meet our technical pricing hurdles. Where pricing is acceptable, we will write less business at mid-year. We are now experiencing pricing pressure across the majority of our portfolio. Our renewal pricing index measure, which tracks the rating levels achieved for renewable contracts within the first quarter of 2010, is currently showing 96%.
We have yet to see any increase in pricing resulting from the Chilean earthquake and other cat losses which affected this quarter as the majority of these contracts renew in the middle of 2010. We’re experiencing an increase in our submission counts as the world appears to recover from the financial crisis. Our energy clients have an increased appetite to consider Gulf of Mexico cat coverage; although it’s too early to say at this point if this increased activity will lead to material new business for the Group.
Our terrorism line continues to grow, we have construction projects requiring lender driven insurance coverage. We continue to see dislocation within our D&F property line with some deals being dramatically under priced and others being more adequate. Our portfolio is more weighed towards capacity purchases, the middle market which has seen the greatest pricing pressure. Our aviation 52 account and marine portfolios remain stable.
We believe that the 2010 pricing environment will remain challenging for the majority of the markets we operate in. Policies which have been affected by the Chilean earthquake should create some opportunities for Lancashire as pricing hardens at the mid-year renewal dates.
We also expect the recent loss of Deepwater Horizon in the Gulf of Mexico and the subsequent cleanup cost to have a hardening effect on pricing for our worldwide energy account. As a leading energy underwriter, Lancashire is well positioned to take advantage of any increased rating environment or any change in legislation following this event.
Our commitment to continue with our core client strategy remains unaltered. These clients make up 70% of our portfolio. As we have always commented, we do not believe in volume underwriting; we still believe that managing our underwriting risk, our daily underwriting call means that risk selection will remain key. I will now hand over to Neil McConachie, our President and Group CFO.
Thanks, Alex. Hello, everybody. This is Neil, we have also got Elaine Whelan, Deputy CFO, and Denise O’Donoghue, our Treasurer, available for questions as well. Specific details of our results are in our financial supplement on the website.
So, as you’ve heard, we made a small profit in Q1, obviously less than expected, but given the circumstances a small positive return is fine. More importantly though is the long-term performance. We are sitting at a compound annual return on equity of 19%, which is somewhere above our target of basically above 13.
I wanted to talk about three things – the Chile earthquake and then a little bit on capital management and investments. So, first of all, the earthquake, as we’ve disclosed, the loss came from different areas of the portfolio with the lion’s share from our property retrocession portfolio.
Making estimates from earthquakes is always difficult, especially in more remote bits of the world. It takes a long time for reliable estimates, or damage to filter through. And that takes the longest to filter through to companies writing property retro contracts like us.
But just to give a bit of background, when we were coming up with reserves we’re basically doing four things. The first thing is to identify the number of contracts with theoretical exposure to the loss, contracts that somehow or other could cover losses from earthquakes in the affected region. We have 17 such contracts.
Secondly, we narrowed down the number of contracts which realistically could have exposure to the loss and we have identified nine such contracts.
Thirdly, we gather what information we can on those, we talk to brokers and we talk directly to the companies we ensure, and we also run losses through our internal model.
And then lastly, we apply that information to the contracts themselves. In some cases, it’s very obvious the limit is blown, in the other cases it’s very obviously the limit is highly unlikely to be blown. It’s the stuff in between that’s tricky and that’s why we come out with ranges rather than point estimates. We try to – are on the side of caution, we are adding loadings to estimates being given to us and we are continuing to assume an industry loss larger than most people.
Some companies are announcing point estimates above the midpoint of the range. At this time, we are still holding an estimate which is the midpoint of our range. And so all this comes back to the question of our confidence in that number and that’s a very, very good question. We do have a high level of confidence in the range that we’ve got, which is 65 to 125, but it’s far too early to have that level of confidence in the point estimate of 95.
What we can say is we’ve talked to brokers and ensured again, we talk to them all the time, we talked to them as recently as Friday, last week. And we’re still comfortable with our industry loss of $6 billion to $10 billion. It’s still above the total reported losses which appear to be about just under $5 billion and the modeling agencies are in the range of $3 billion to $8.5 billion, so we’re comfortable with $6 billion to $10 billion.
Our ultimate loss will of course end up being different to our estimate from today; it could move down if losses from our cedents do come in at the levels we’re being told, because we are still adding loads, and it could end up higher if the industry loss ends up nearer $10 billion although obviously everyone else will be putting their numbers up then as well. So, we do think it’s reasonable, but please, please be aware we’re continuing to work with limited information.
Okay, so quickly on investments. One change we have made since the end of the year is we invested about $80 million in emerging market debt in the first quarter that is 63% sovereign debt, 26% quasi sovereign and 11% corporate debt in those emerging market countries. Our largest holding is Brazil with $21 million in Brazil.
We decided to invest in EMD because, quite frankly, the long-term prospects for these economies look better than the long-term prospects for western countries. It is a very high-quality EMD portfolio, it’s less volatile than equities and it’s held up very well in recent weeks, we have no European countries in there and it’s all hedged back to U.S. dollars and it’s really performed pretty well.
We continue to actively manage capital, we’ve been buying back shares in the open market and privately. We bought back $13 million in Q1 and we bought back a further $45 million in the second quarter so far. In 2010, to-date the shares have been bought back on average at 98%, are fully converted book value per share. We expect to continue to buy back shares, but the pace will be dictated by the underwriting opportunities we see.
It is, I suppose, an overall softening market that from some signs of life in some of the areas that Lancashire focuses on. So, we’ll balance those. Often a very large market turning event, we do still expect, however, to have less capital at the end of the year than we do at the start and we’ll do that through capital management.
One quick point on the letter of credit facility. There appears to be a little bit of confusion in some places in the UK with this letter of credit facility we announced. It has nothing to do with capital raising, nothing to do with Lloyds which we’re not involved in, and it’s simply to allow us to provide collateral for U.S. cedents. If there’s a big loss it’s completely standard run-of-the-mill stuff.
And then our Deepwater Horizon loss, as Richard said; it is more or less one month’s earnings, more or less what we made in April. And so our book value per share today is pretty close to the number it was at the end of March.
That’s all I’ve got to say. I’ve probably talked too much already, so we’ll hand back to the operator for questions. Thank you.
(Operator Instructions) And our first question which comes from Ben Cohen from Collins Stewart.
Ben Cohen – Collins Stewart
Hi, guys. I wanted to ask two things. Firstly on the Deepwater Horizon loss, could you just sort of say your – or give some description around your confidence in that loss estimate? I presume it’s because you’ve just written the property piece there. And maybe you could also comment in terms of the impact on the liability market there.
And the second thing was in terms of the opportunities for the rest of the year coming out of Chile or coming out of wherever, how would you rate it in the different lines that you’re looking at? I note that you didn’t really say very much about the prospects in retro, but presumably that is a market where one is going to see more demand going forward. Thanks.
Okay, thanks. I’ll probably double tag this one with Alex. Alex, I’ll start then hand over to you if that’s okay.
The Deepwater Horizon is a massive loss. We don’t write standalone liabilities as a company. We sometimes have to accept some liability exposure for our energy clients, where they buy what we call packages in the market where they’ll often put normally quite a small percentage of their overall liability program into the package because the amount of premium on the package gives them a certain amount of muscle.
It’s not an exposure we would ideally write, but it’s simply not possible to write a physical damage earning energy portfolio. However, we are preponderantly a physical damage player.
So, we do not write the translation standalone 1 billion loads [ph] of liabilities. Which frankly, with all the name calling going on now that between BP, Transocean, Halliburton, et al is really looking pretty threatened? I think we all know that BP don’t buy insurance, but there is other people like Halliburton and the co-venturers, Anadarko and – I forget the Japanese co-venturer who also buy insurance in the market.
It’s a bigger loss; the physical damage component will be the minority of the loss. Its public information now that the rig was insured for $560 million, we have a 7.5% line on that contract. There is provision within that policy for removal of wreck.
We think it’s very, very unlikely that the MMS, the UK government – I’m sorry, the U.S. government agency responsible for the Gulf of Mexico Waters will require the wreck to be raised, it’s in such deep water that would certainly be unprecedented. But even if that were to happen there’s a sub limit on the policy and the combination of our physical damage loss and that loss and some very minor liability exposures accepted by packages for the joint venture partners would mean that it would be fully contained within our outwards reinsurance.
We did drop the attachments on our reinsurance down this year which has enabled us to collect in excess of $25 million, and that should be it for us. Like Neil and I both said, it’s a month earnings. I think, Alex, it might be interesting if you’d talk about – this is the biggest loss since Piper Alpha; it could be even bigger than Piper Alpha at this rate – you know, what you think this might do to the market?
Yes, sure. I think as Richard said, this is an incredibly large loss for the energy market at a time when there have been probably a high number of losses that haven’t hit the front page of the newspapers. I think for the liability market it’s probably again the timing is absolutely not ideal, there have been some big liability losses in the marine market.
If you remember the California wildfires, the Sempra liability loss ended up in the marine market. And this loss looks like it will – effectively every client that’s involved with this rig will probably run out of liability coverage.
A lot of the excess liability market is in Bermuda; there are some new carriers here that have been entering that market. I think those excess lives will fully be exposed. And as you would expect, this will get highly political, there will probably be some serious fines. As well I believe quite a lot of the liability load includes fines and punitive damages. So, it could really change the market.
As Richard said, it’s probably the largest risk loss, the largest offshore risk loss since Piper Alpha. Inevitably the reinsurance market will end up paying a lot of this loss and that’s obviously what will drive rating increases. We, as you know, are a major energy market. We will be at the forefront of pushing for raises on our energy account. Rating reductions have stopped already and the first of June renewals are expected to get fully re-rated.
As for your question on Chile, Ben. As I said in my script, mid-year is the time where we look at the sort of Chile (inaudible). I think retro is a difficult one to call at the moment in that some of the retro contracts are paying substantial rates on lines already. So, if you’re at 30 online for a client there’s probably not too much you can go in excess of that. But the specific property cat renewals for the affected Chile policies or Chile in general, we probably believe will increase by about 100%. So, again, there should be some opportunities for Lancashire there.
Yes, and just to clarify, as Alex said, the low – I’m talking about property cat now, the lower layers are already paying very fat rates online, they probably won’t move much. But at the top end where they’re pretty cheap frankly, we think they could double this year and we’ll have a good hard look at those.
Retro, like Alex says, it’s almost a non-market because the normal dynamics where supply and demand don’t apply, for a long time now there’s been insufficient supply to meet clients’ needs. So, you’re up against self-insurance. So, again, there’s a limit to how far you can push pricing.
But, we will adjust pricing on our retro portfolio, and if that means that we get less deals and so be it because there has to be a reaction to the Chile loss. And we may trade attachment points instead of rate online to keep some sort of deal going with our clients. But we certainly won’t be renewing business as before.
Ben Cohen – Collins Stewart
Okay, that’s very helpful. Thank you.
Thank you. We will move to our next question from Tom Dorner, Oriel Securities. Please go ahead.
Tom Dorner – Oriel Securities
Hi there, two questions please. The first one is about pricing again. I think in the past you said that you expect in 2010 rates for your portfolio overall to be down roughly 10%. I just wondered whether you thought as a result of all these losses that there’s a possibility of that being better. And then the second question is about your mix between core and non-core customers. I just thought perhaps the fact that you shifted more towards property cat business at the beginning of the year that that would have affected your 70-30 split between core and non-core. Maybe, you could say something about that. Thanks.
Okay, good question, Tom. Alex, do you want to talk about RPIs?
Yes, sure. Yes, Tom, when we gave the guidance earlier in the year about we thought that our outwards would be up 10%, I think what we’re seeing so far this year, our IPOs are currently at 4% but our expectation was that the rating, decreases if you like, would accelerate as the year continued. Obviously Chile has now happened, this energy loss has happened, it’s still in little bit early to say. But I think that maybe at the current point, we’re at the moment is probably where we’ll track through the rest of the year.
But I think one thing that I’d like to make clear is that we pride ourselves on being nimble, we pride ourselves on acting quickly to market situations now. If what comes out of Chile or this energy loss means that there are some big rate increases Lancashire will be at the forefront of those and we’ll be looking to write as much business as we can.
Obviously things can change. We think that there will be opportunities where in Chile and our energy account. But equally if you look at things like our property account out – our D&F property account there appears to be still quite a lot of competition for that business. But, I think that, yes, maybe we won’t be a 10% reduction for the year, but it’s a little bit early to say at this point.
I might just say on the core, it’s actually a good question, Tom, we’ve not been asked that before. You might expect on the face of it for that number to shift. But there are a number of offsetting factors. First of all, not all of the property cat business is just sort of if you like easy come, easy go business. Some of it is founded on strong relationships, not least Charters.
Now we didn’t actually mention them by name in Alex’s remarks, but I think its public knowledge with you guys that, that would have been a big part of our January number. Charters are people who we have a very close relationship with now. We have many meetings with them, many visits, reciprocal visits either way, and they were in a position where they were bringing together a pretty desperate organization and their buyer, Dave Field [ph] had a big job on his hands and he rightly realized there was a need to purchase cover for certain severity of events and that entailed big dollars.
And we, in my view, absolutely correctly realized that this was probably some of the best priced business that was going to be around in 2010. Some of the stuff is multi-year too so it impacts 2011, and we also felt that the Floridian renewals could be pretty disappointing and I have to say all the signs are that they will be. So, I think our move in going early was correct. But I think it’s also absolutely legitimate to regard Charters as a core (inaudible) now. And we look forward to doing business with them for many years to come.
Other offsetting factors of course are that as the market softens, as we said to you in prior chats or meetings, you tend to come off some of the less – the non-core insurance business because obviously that’s the stuff you have to let go as the cycle softens.
A third factor is that as Lancashire continues to grow our relationships with those core clients get stronger so we tend to find that we can sell them more lines of business, sometimes increase lines or stuff we really like. So, whilst your question was a very good one, it’s actually the offsetting factors meaning that the number more or less stays where it is.
Tom Dorner – Oriel Securities
(Operator Instructions) We will move to our next question from Fahad Changazi from UBS.
Fahad Changazi – UBS
Hi, there. Can I just follow up on Tom’s question? When you talk about, that more capital will be returned at the and of the year, before when you said that you were expecting rates to be down 10% and now you expect them to be down 4%. So, qualitatively has that affected the level of capital you could probably return? And secondly, could you incorporate some comments on how shift in business mix will affect that decision given that you might be writing more capital intensive business given what’s happening with certain aspects of the energy markets?
Hi, Fahad, it’s Neil. I’ll take the last bit of your question first, risk levels I suppose in the business. Yes, the property cat business has gone up, but we will, even with what we’ve seen on Deepwater in terms of the cat exposed energy premium that’s done in the second quarter, that will be down from where it was a couple years ago. So, we don’t expect our overall risk to hurricane loss to change. It’s just a reallocation between the first quarter and the second quarter.
I think what you might see is perhaps, very early days, us making a bit more energy risk business, the foreign exposure stuff. So, yes, I mean, in terms of capital returns, barring a large event, we still do expect prices to gradually go down, meaning we think overall we won’t need quite as much capital next year than this year. Very early days, just a guess and that’s why we have the caveat in there. That if we do see opportunities gradually decreasing then we will likely need less capital.
So, I think overall the conclusion is the same. Maybe it’s not quite as clear as it was three months ago, but overall our conclusion would probably still be that we’ll need less capital at the and of the year than the start. At Lancashire, we do it day by day.
Fahad Changazi – UBS
Thank you, that’s helpful.
Thank you and I will move to our next question from Nick Johnson from Numis Securities. Please go ahead.
Nick Johnson – Numis Securities
Afternoon, all. Could you possibly give a bit more detail around the multi-year contracts that you wrote in the first quarter? You mentioned Charters just previously. But I’d be interested to know the duration of those contracts and in particular what flexibility you’ve got to adjust if there’s a sudden increase in pricing? Thanks very much.
Elaine, do you want to take that first bit?
Sure. We wrote those contracts on a two-year basis, so about half of the premium that we wrote in the first quarter will enter into 2011. And there’s about $30 odd million – just over $30 million in there for the first quarter.
And as to the second part, Nick, no, there is no ability for either party to renegotiate, that is the beauty of proper long-term deals, they’re not worth the paper they’re written on unless all parties stick it out for the duration. What I would say – and Charters wouldn’t mind us saying this because it’s again stuff they’ve gone public on – is they are looking to reduce their PMLs across the key natural perils. And therefore it’s pretty – it’s always a good deal for a reinsurer, if you will, to strike a deal on a reducing portfolio for a longer tenure. So, that dynamic works well for us.
Nick Johnson – Numis Securities
Great, thanks very much.
Thank you. (Operator Instructions) It appears we have no further questions at this time, sir.
Okay, well thank you very much, everybody, for dialing in and we’ll see you in three months.
Thank you. That will conclude today’s conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.
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