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Third Point Reinsurance (NYSE:TPRE)

Q4 2013 Earnings Conference Call

February 27, 2014 08:30 am ET

Executives

John Berger – Chief Executive Officer & Chief Underwriting Officer

Rob Bredahl – Chief Financial Officer & Chief Operating Officer

Daniel Loeb – Chief Executive Officer, Third Point LLC

Analysts

Erik Bass – Citigroup

Kai Pan – Morgan Stanley

Brett Shirreffs – Keefe, Bruyette & Woods

Jay Cohen – Bank of America Merrill Lynch

Operator

Greetings and welcome to the Third Point Reinsurance Q4 and Year-End Conference Call. (Operator instructions.) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Mr. Rob Bredahl, Chief Financial Officer and Chief Operating Officer for Third Point Reinsurance. Thank you, Mr. Bredahl, you may begin.

Rob Bredahl

Thank you, Operator. Welcome to Third Point Reinsurance Ltd.’s Earnings Call for Q4 and Full-Year 2013. We hope you had an opportunity to review our earnings press release which we released after the markets closed yesterday afternoon. If not a copy is available on our website, www.thirdpointre.bm under “Investors.”

Leading today’s call will be John Berger, Chairman, CEO and Chief Underwriting Officer of Third Point Re. But before we begin please note that management believes certain statements in the teleconference may constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements about expectations, estimates, and assumptions concerning future events and the financial performance of the company and are subject to significant uncertainties and risks that could cause current plans, anticipated actions and the company’s future financial condition and results to differ materially from expectations.

Those uncertainties and risks include those disclosed in the company’s filings with the US Securities and Exchange Commission including those risks and factors listed under “Risk Factors” in the prospectus on Form 424(b) dated as of August 14, 2013, and filed with the Securities and Exchange Commission on August 19, 2013. Forward-looking statements speak only as of the date they are made and the company assumes no obligation to update or revise them in light of new information, future events, or otherwise.

In addition, management will refer to certain non-GAAP measures which management believes allow for a more complete understanding of the company’s financial results. A reconciliation of these measures to the most comparable GAAP measures is presented in the company’s earnings press release which is posted on our website under “Investors.”

With that at this time I’ll turn the call over to John Berger.

John Berger

Thanks, Rob. Good morning and thank you for taking the time to join our Q4 and year-end 2013 earnings call. In addition to Rob Bredahl, CFO and COO of Third Point Re, with us today is Daniel Loeb, CEO of Third Point LLC, our investment manager. I will provide an overview of our financial results and progress in developing Third Point Re. Daniel will discuss the performance of our investment portfolio and then Rob will discuss our results in more detail.

I’m very pleased with our financial performance in Q4 and for the full year and believe our results demonstrate the benefits of our total return business model. It is also gratifying to produce strong results following our IPO.

In our second year of operation and before we have reached full scale we increased our diluted booked value per share by 20.5%. Our 2013 growth in booked value per share was driven by outstanding investment returns produced by our investment manager, Third Point LLC, and a reinsurance operation that is developing according to plan and already contributing to net income.

In Q4 we produced $80.1 million in net income or $0.75 per diluted share which brought our net income for the full year up to $227.3 million or $2.54 per diluted share. In last year’s Q4 and full year we generated net income of $60.7 million and $99.4 million respectively.

The return on our investment portfolio managed by Third Point LLC was 6% in Q4 and 23.9% for the full year. As a reminder, our strategy is to write reinsurance contracts with attractive risk-adjusted returns and to invest the float generated from this activity in a separate investment account managed by Third Point LLC. We do not write excess of loss property catastrophe business on our rated balance sheet but rather write cat reinsurance on behalf of a separate cat risk fund.

In our property and casualty segment we generated an underwriting loss of $3.6 million for the quarter and $15.8 million for the year, but after including investment income generated by float of $11.8 million and $27.0 million for those periods respectively the property and casualty segment contributed to net income.

Our reinsurance portfolio continued to perform as expected as we had no meaningful reserve movements in Q4 or for the full year. Our combined ratio for the year was 107.5% versus 129.7% in 2012. The improvement was due to a drop in crop-related losses – not good but better than last year – and a drop in overhead expenses as a percentage of earned premium.

As we continue to grow and assuming we maintain current underwriting margins our underwriting results will continue to improve as the general and administrative expense ratio drops.

While the reinsurance market remains extremely competitive we have seen a large flow of business from our reinsurance broker partners and continue to identify attractive opportunities. Given today’s competitive market we focus mostly on what we consider to be less volatile lines of business and types of transactions where the insurance company clients are in need of capital in the form of reinsurance.

We are seeing opportunities that meet our underwriting standards from smaller homeowner companies, nonstandard auto writers, mortgage insurers and worker’s compensation insurance company’s in select states. In addition, we are considering a number of transactions that combine a loss portfolio reserve with a reserve cover.

These are transactions where we receive a transfer of reserves and investable cash that backs those reserves in exchange for providing protection against adverse reserve development. To maximize the amount of float these transactions generate we focus on reserves with long payout patterns.

Again, I’m thrilled with our long results, pleased that we have already realized the benefits of our total return model, and grateful to our investment manager for their outstanding performance. I will now hand the call over to Daniel Loeb who will discuss the performance of our investment portfolio during Q4 and year.

Daniel Loeb

Thanks John, and good morning everyone. The Third Point Reinsurance investment portfolio managed by Third Point LLC returned 6% in Q4 resulting in 2013 total year’s returns of 23.9% net of fees of expenses. The Third Point Reinsurance account represents approximately 11% of assets managed by Third Point LLC.

For both Q4 and the year we generated positive results in each of our investment strategies – long/short equities, corporate and structured credit, and macro investments.

Consistent with the first three quarters of the year the equity portfolio drove returns in Q4, contributing 4.7% of roughly 80% of total gain. At year-end our equity investments returned 41.1% on average exposure versus the S&P 500’s 32.4%, with about half of the value at risk. Performance for the quarter was led by several core equity positions but smaller equity positions across sectors in both corporate and mortgage credit contributed meaningfully to our results.

Equity returns were driven by positive performance in several of our largest positions including newly announced investments in Allied Financial and Dow Chemical. [ID velocity] in our equity book was strong in Q4 and we increased both gross and net exposure heading into year end.

We concentrated on identifying companies that have been under earning relative to normalized earnings power and as a result added a few positions to our portfolio. Japan continued to be a high beta trade and our Sony position disappointed in Q4.

Solid performance from our corporate credit strategy contributed another 0.7% to Q4 profits. Performing credit positions were responsible for approximately two thirds of the gains in corporate credit, outpacing our distressed credit portfolio. For the year, the Third Point corporate credit book returned 25.4% on average exposure or more than 3x its CS High Yield Index.

Positions in sovereign credit and other macro or [tail-related] investments also performed well in Q4, bringing contribution from our macro portfolio to 0.5% for the quarter. Our mortgage portfolio returned 0.1% in Q4, bringing total return on average exposure to 21.1% for 2013 versus the HSN Hedge Fund Mortgage Index Return of 8.8% for the year.

Portfolio composition shifted throughout the year and we ended 2013 with increased exposure in several areas including CMBS and non-US RMBS. In 2014 we will continue to focus on event-driven situations and expect the environment for activist and constructivist investment to remain positive. We believe the market will experience increased volatility this year and so we will look for opportunities where market drawdowns create attractive entry points.

Now I’d like to turn the call over to Rob to discuss the financial results.

Rob Bredahl

Thanks, Daniel. As John mentioned we generated $80.1 million of net income in Q4 which translates into earnings per diluted share of $0.75.

For the 2013 full year we reported net income of $227.3 million or $2.54 per diluted share compared with $99.4 million or $1.26 per diluted share in 2012, an increase of 128.7%. Diluted booked value per share increased by $0.77 or 6.2% for Q4 and $2.23 or 20.5% for the 2013 full year.

In our property and casualty reinsurance segment gross premiums written increased 482% to $162.4 million for Q4 2013 from $27.9 million the prior year’s Q4. For the full year 2013 gross premiums written increased 106.7% to $393.6 million from $190.4 million for the full year 2012. We are pleased with the amount of attractive opportunities we are seeing in our premium growth but we must stress, actually stress again, that we write a limited number of larger contracts and therefore we can experience large swings in premium from one period to the next.

Net premiums earned during Q4 2013 increased 69.5% to $56.8 million reflecting a large in-force underwriting portfolio compared to the three months and year ended December 31, 2012. For the full year we saw net premiums earned increased $116.1 million or 120.4% to $212.6 million.

The underwriting losses from the property and casualty reinsurance segment for Q4 and full year 2013 were $3.6 million and $15.8 million respectively. These results compare to underwriting losses of $9.0 million and $28.7 million respectively for the three months and year ended December 31, 2012.

Our combined ratio for the year ended 2013 was 107.5% compared to 129.7% for the year ended 2012. The improvement was due to a decrease in general and administrative expenses as a percentage of our net earned premium and a decrease in losses from our crop reinsurance portfolio.

In 2012 we recorded a $10.0 million underwriting loss on our crop insurance portfolio due to the severe drought in the US. In Q4 2013 we increased reserves on our crop reinsurance contract and recognized an underwriting loss from crop of $700,000. Our crop contract is now booked at a combined ratio of 102% - that’s up from 98%. The reserve increase was due to poor growing conditions in Iowa and Minnesota, cold weather that destroyed citrus crops in California, and low corn prices which produced losses on certain underlying revenue protection policies. No other reinsurance contract produced a loss before G&A expenses in 2013.

The catastrophe risk management segment, which includes the combined results of our catastrophe fund, our catastrophe fund manager and our special purpose cat reinsurer generated net income of $797,000 in Q4 and $3.4 million for the year. Since our cat segment began operations in January, 2013, there are no comparable results from 2012. The cat fund generated an 11.4% return for investors in 2013 and net assets under management as of December 31, 2013, were $104.0 million.

Overall, investment returns were very strong in 2013. As Daniel mentioned, the return on investments managed by Third Point LLC was 6.0% during Q4 2013 compared to 8.3% for the prior year period. For the 2013 full year the return on investments managed by Third Point LLC was 23.9% compared to 17.7% for the year ended December 31, 2012.

For Q4 Third Point Re recorded net investment income of $87.1 million compared to $72.5 million for the three months ended December 31, 2012. During Q4 and year we also benefited from higher average investments managed by Third Point LLC compared to the prior year periods due to the net proceeds generated by Third Point Re’s IPO, float contributed by its reinsurance operations, and retained earnings. For the full year the company recorded net investment income of $253.2 million compared to $136.4 million for the year ended December 31, 2012.

I will now hand the call back to John Berger.

John Berger

Thanks, Rob. We had a solid quarter and continue to develop according to plan and demonstrate the benefits of our business model. Third Point LLC’s performance as our investment manager has been outstanding, and while the reinsurance market remains very competitive we are pleased that we’ve been able to source opportunities that meet our underwriting standards and continue to grow according to plan.

I will now open the call up to questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session (Operator instructions.) Our first question is from Erik Bass of Citi. Please go ahead.

Erik Bass – Citigroup

Hi, thank you. Can you talk a little bit more about the new business growth you saw this quarter, which lines it was concentrated in? And I think you still are describing obviously market conditions as challenging but has there been any incremental change in the environment, either positive or negative over the course of the quarter?

John Berger

For the types of business we’re looking at, the homeowner quota shares with limited cat exposure and nonstandard auto. While they’re competitive, a lot of the dynamics in those deals are the relationships that we have with those companies, where we have a history in the past. So once the terms and conditions are set and a clearing price for the market it becomes more of an exercise of access – can you get the business that you think is attractive? And because of the staff we have, the relationships we have, we’re happy with the success we’ve had.

And remember what we say and what we’ll continue to say: we write a fewer number of large deals so any given quarter the volumes can go up and down, can swing in a pretty big way. We’re not in the property cat market to speak of. We have a cat fund that’s relatively small that writes regional cat, not the retrocessional cat, and we thought the prices there were down – rates were down about 10% which is less than the overall market. But we’re not out in the general market slugging it out with everybody.

Erik Bass – Citigroup

Got it, thank you. And then maybe if you could update us on how you’re thinking about the G&A leverage in the business as you add more premiums, and is that what you would view as a key lever to begin generating an underwriting profit? And I guess maybe when you do you think is a reasonable timeframe to target for starting to generate an underwriting profit?

John Berger

So our G&A expenses in Q4 were close to $9 million which is a little bit higher than our run rate. There were some one-time legal expenses, but that’s about the run rate. It’ll grow gradually over time whereas our earned premium is going to grow rapidly in the next couple of years. And in fact, if you look at 2013 our gross premium grew by much more than our earned premium because a lot of it was backend-loaded. So as the earned premium catches up you’ll see improvements in our underwriting results just from that relationship and that timing difference.

As far as breaking even I think we have always said that we expect that to be probably in 2015. When I say breakeven I mean on an underwriting basis.

Erik Bass – Citigroup

Right. Okay, thank you very much.

Operator

Thank you. (Operator instructions.) The next question is from Kai Pan of Morgan Stanley. Please go ahead.

Kai Pan – Morgan Stanley

Good morning. My first question is for Daniel. You had another banner year, 24% return on the investment fund. I just wanted to understand a little bit better about your incentive compensation structure for your employees and also talk a little bit about your employee retention.

Daniel Loeb

I’m sorry, you want me to talk about the incentive compensation? We pay our employees a relative to what they end up making – and by employees are you asking about all of my employees or the investment professionals?

Kai Pan – Morgan Stanley

More about the investment professionals.

Daniel Loeb

Right, so we have a bonus pool that is composed of the fees generated by the fund and we don’t differentiate between the TP Re fees which is basically as you know managed in the same way as the other funds that we manage. And we have a bonus pool composed of those fees and we have a fixed and a discretionary portion of incentives that get paid out to our employees based on their performance.

Kai Pan – Morgan Stanley

Okay, so the base case is sort of the great performance in 2013, like that – you had a few years of good performance, that would be translated into sort of that higher bonus pool and compensation for the employees?

Daniel Loeb

Yes.

Kai Pan – Morgan Stanley

Okay. Any thoughts about employee retention? Has there been any sort of turnovers?

Daniel Loeb

We, I’m trying to think… We definitely haven’t had any employees resign in the last… Yeah, we really haven’t had any resignations. We didn’t have any year-end resignations as a result of compensation if that’s your question or for any other reason.

Kai Pan – Morgan Stanley

Okay, that’s great. And the bonus pool, is there any sort of like vesting period?

Daniel Loeb

We did previously and we actually did away with vesting periods. We just pay people. We feel like we have very strong loyalty from our partners and employees and we didn’t feel like it was necessary for us to have any kind of artifice to tie them to us financially. So at least thus far it hasn’t been an issue.

Kai Pan – Morgan Stanley

Okay, that’s great. Just to follow up as we’re close to the end of February do you have any update on the returns for the fund?

Daniel Loeb

I don’t disclose any fees outside of what we disclose normally in the normal course at month-end. So I can’t say anything about our February month-to-date that isn’t already out there.

Kai Pan – Morgan Stanley

Great, thank you so much.

John Berger

And we’ll be posting the February month-end results Friday night.

Kai Pan – Morgan Stanley

Okay, great. Then my next question is for John or Rob: it looks like in the press release there’s information about the miscalculation of share counts in the past quarters, so can you elaborate a little bit more on that? It looks like the differential is about 9 million shares.

John Berger

So from the inception of the company we were using an incorrect methodology for calculating diluted earnings per share – it was overly conservative; and on average the difference was around 10% between the numbers we were using and the correct numbers. And in the 10(k) which we expect to file in the next 24 hours we have a table that corrects that and shows you the differences.

Rob Bredahl

Yeah, and I guess the key point there is we understated earnings per share – we did not overstate them.

Kai Pan – Morgan Stanley

Yeah, I mean the book value growth is much better, sort of like basically after you reduced the share counts for the diluted shares.

Rob Bredahl

No, no, it’s only an earnings issue. It’s only earnings per share where the incorrect calculation was made. Diluted book value per share has always been correct.

Kai Pan – Morgan Stanley

Okay, then the last question on float: do you have a balance for the float at year end?

Rob Bredahl

I don’t have a precise number. It’s very close to $200 million.

Kai Pan – Morgan Stanley

Okay, thank you so much.

Operator

Thank you. (Operator instructions.) And the next question is from Brett Shirreffs of Keefe, Bruyette & Woods. Please go ahead.

Brett Shirreffs – Keefe, Bruyette & Woods

Yeah, good morning. John, I was wondering if you could just touch on the submissions a little bit at [Gen 1] and just wondering if you’re seeing a lot more business this year versus last year.

John Berger

Yeah, the submission flow is up substantially as we’re established and we’re out and people understand what we’re trying to do. So the flow has increased nicely. We expect that to level off as people… It’s a two-way sword – people understanding what we want to do and then not sending us things that they know we’re not going to do. So the first year we saw a lot of things that we were just not going to entertain, so I think we’re getting our message out well and we’re seeing a good flow of business of the types of things we want to write.

Brett Shirreffs – Keefe, Bruyette & Woods

Okay. And then on the premium number in Q4, was there anything… I mean I know the large deals can be lumpy. Was there anything that was pulled forward that might have been normally in Q1?

John Berger

No.

Brett Shirreffs – Keefe, Bruyette & Woods

No, okay. Thank you very much.

Operator

Thank you. The next question is from Jay Cohen of Bank of America Merrill Lynch. Please go ahead.

Jay Cohen – Bank of America Merrill Lynch

Yes, thank you. I guess another question about the premiums, maybe two questions: one, are you doing any multiyear deals?

John Berger

Yes, we do have some multiyear deals, Jay.

Jay Cohen – Bank of America Merrill Lynch

Did that contribute to the very significant premium growth in the quarter?

John Berger

It did, not to a large extent. Jay, we’re conservative in how we book the premiums so we’re only booking premium that we’re certain to receive. And as our confidence increases we take additional premium into our P&L over time and under the terms and conditions of the contracts.

Jay Cohen – Bank of America Merrill Lynch

Got it, got it. And I guess also related to the premium was a meaningful amount of the growth coming from some of these loss portfolio transfer deals that you’ve talked about in the past?

John Berger

We had none, no loss (inaudible) deals in Q4, and Rob, I think the number for the year was $37 million? About $30 million. And we’re seeing an increasing flow of these opportunities, Jay. We’re hopeful that we hit on some of them in 2014 but we didn’t have any in Q4.

Jay Cohen – Bank of America Merrill Lynch

Got it, that’s helpful Thank you.

Operator

Thank you. We have no further questions in the queue at this time. I would like to turn the floor back over to management for any closing remarks.

John Berger

I want to thank everybody for dialing in today and we look forward to our next call. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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