Platinum Underwriters CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.21.10 | About: Platinum Underwriters (PTP)

Platinum Underwriters Holdings Ltd. (NYSE:PTP)

Q3 2010 Earnings Call

October 21, 2010 8:00 am ET

Executives

Michael Price - CEO

Allan Decleir - EVP and CFO

Neal Schmidt - Chief Actuary

Analysts

Matthew Heimermann - JPMorgan

Dean Evans - KBW

Jay Cohen - Bank of America-Merrill Lynch

DeForest Hinman - Walthausen & Company

Ron Bobman - Capital Returns

Operator

Good morning and welcome to Platinum Underwriters third quarter 2010 earnings conference call and webcast. The company's earnings press release and financial supplement can be found on the Investor Relations section on the company's website at www.platinumre.com.

This call is being recorded. A replay of the call and webcast will be available from 11:00 a.m. Eastern Time today until midnight Eastern Time on Thursday, October 28, 2010. The replay can be accessed by dialing 888-203-1112 for U.S. callers and for international callers by dialing 719-457-0820. Please specify pass code 2242819.

Before we begin, please note that management believes certain statements on this 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 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. These uncertainties and risks include those disclosed in the company's filings with the U.S. Securities and Exchange Commission. Forward-looking statements speak only as of the date they are made and the company assumes no obligation to update or revise them in the 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 and financial supplement.

At this time, we will turn the call over to Mr. Michael Price, Chief Executive Officer of Platinum.

Michael Price

Thank you, operator. Welcome to this morning's call. With me today are Allan Decleir, our Chief Financial Officer; and Neal Schmidt, our Chief Actuary. After providing an overview of our results for the quarter, I'll ask Allen to discuss those results in more detail. Then I'll cover our recent underwriting activity, our outlook on market conditions, recent investment actions and capital management. Finally, we'll be happy to take your questions.

We produced net income of $93.7 million in the quarter which is $2.13 per diluted common share. Our tangible book value per share grew by 7.6% in the quarter to $55.13. These results reflect average catastrophe activity, including $28.5 million from the New Zealand earthquake, favorable reserve development, strong investment performance on a total return basis, active capital management and the favorable impact of a change to our estimate of the administrative costs of managing claims.

Net premiums earned were 20% lower than the same quarter last year, reflecting our disciplined approach to underwriting in difficult market conditions.

Allen will now take us through the numbers in more detail.

Allan Decleir

Thank you, Michael, for providing the highlights, and good morning to everyone. Four noteworthy items impacted our net income before taxes for the quarter. Net investment income and net realized investment gains generated $75.4 million of income. Net favorable development provided $34.6 million of income. Net losses arising from 2010 major catastrophes negatively impacted earnings by $30.5 million. And unallocated loss adjustment expense reserve factor changes contributed $15.8 million to income.

Regarding our investment results, we continue to adjust our investment portfolio to respond to changes in market conditions. During the third quarter of 2010, we realized net gains of $44.4 million. The gains this quarter were primarily from the sale of U.S. treasuries.

Net investment income was $31.1 million for the quarter compared with $44.7 million for the same quarter last year. The decrease primarily resulted from lower new money yields.

Net impairment losses on investments were $4 million for the quarter. The impairments were taken on non-agency RMBS and subprime asset-backed securities.

Focusing on prior year development, our Casualty segment had net favorable development of $36.6 million mainly in the North American claims made, North American class and financial lines classes. Our Property and Marine segment had net unfavorable development in the quarter of $4.1 million. Our Finite Risk segment had net favorable development of $2.1 million.

Looking at 2010 catastrophes, our catastrophe losses were $30.5 million during the quarter, substantially all relating to the September 4 earthquake in New Zealand. There was no significant adjustment to our estimate of losses related to the earthquake in Chile.

Regarding unallocated loss adjustment expense reserves, during the quarter, we conducted a review of our unallocated loss adjustment expense reserve factors across all lines of business. The review involved a detailed analysis of our administrative cost of managing clients resulting in a $15.8 million reduction of these reserves.

Turning to income taxes for the third quarter, income tax expense for the quarter was $20.2 million, reflecting a 17.7% effective tax rate. These are both higher than recent periods. The increases reflect a higher proportion of income generated from our U.S. based subsidiaries which resulted from favorable loss development and realized gains on the sale of investments.

Michael will now offer some additional commentary. Michael.

Michael Price

Thank you, Allan. The late season renewals constitute a small portion of our business. Overall, we had approximately $56 million of premium expiring since mid July. And we wrote approximately $51 million, a 9% decrease. Year-to-date, we had approximately $842 million of premium expiring, and we've written approximately $720 million. Plus we've written approximately14% less business this year as compared with last year.

The mix of business written has been 55% in Property and Marine, 42% Casualty and about 3% Finite Risk. For reference, there is approximately $18 million of business expiring between now and year end. In property and marine, we had approximately $4 million of business expiring since late July and we wrote approximately $4 million. Year-to-date, we had approximately $511 million of premium expiring and we've written approximately $397 million, a 22% decrease.

Currently, our 1-in-250 year net probable maximum catastrophe loss estimate remains within our stated risk tolerance at approximately 15% of total capital. This is consistent with the net level of natural catastrophe risk that we carried last year at this time. Despite losses from earthquakes in Chile and New Zealand, available capacity is high and we anticipate downward pricing pressure on catastrophe exposed business at January 1. Assuming only modest rate declines, we're likely to write a similar portfolio next year, compared with what is currently enforced.

In the Casualty Segment, we had approximately $52 million of business expiring, and we wrote approximately $47 million, a 10% decrease. For the year-to-date, we have written approximately $305 million of premium versus an expiring base of approximately $309 million. With rates broadly flat, positive trend and loss costs and low interest rate, our involvement in the casualty market is unlikely to increase until market conditions change for the better. We've written no finite business since January 1, and continue to expect little or no activity in this segment.

During the quarter, we were a net seller of U.S. treasury securities, resulting in approximately $38 million of realized gains. During the quarter, we repurchased 2,228,611 shares for $91.8 million at an average price of $41.19. On October 18, we repurchased six million options from Travelers for an aggregate cost of approximately $98.5 million.

Based on our current reserve position, our net enforced portfolio, our asset portfolio and our underwriting prospects for the near term, we believe that we're well capitalized with an acceptable margin above the rating agency targets for a company with our ratings. If the business performs as expected, we anticipate our capital cushion will grow overtime.

Under those conditions we would have the financial flexibility to expand our underwriting, hold riskier assets or buyback shares. Our decision making will be guided by the pricing we observe in the various markets. For 2010 year-to-date, we have repurchased 7,986,517 common shares for approximately $305 million and six million options for approximately $98.5 million.

We currently have approximately $60 million of buyback capacity remaining, and we will consider restoring the authorization to the $250 million level at our board meeting next week. During 2010, we developed an acceptable portfolio of treaty reinsurance risks. And through active management, we have better aligned our capital base with business opportunities.

And now we'll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Matthew Heimermann with JPMorgan.

Matthew Heimermann - JPMorgan

First, just in the Casualty segment, it looks like the accident year loss ratio fell pretty dramatically sequentially. Was that related to the ULAE reserve change? Just more color there would be great.

Neal Schmidt

Yes, Matt, you hit that right on the head. There's about $13.4 million in the ULAE reserve changing within the Casualty Segment.

Matthew Heimermann - JPMorgan

Okay. And that doesn't show up prior to your change just because of the unallocated nature? So there is no specific action here to put it in correct?

Neal Schmidt

Exactly.

Matthew Heimermann - JPMorgan

Okay. And then I guess on New Zealand, can you just give us some details? One; just whether there were any reinstatement premiums I am guessing that there might be giving the net number you gave in the press release was lower. But also just much of a loss came from commercial versus personally.

Neal Schmidt

Sure, Matt. Our net figure includes no material reinstatement premiums. Our exposure to the New Zealand earthquake is fundamentally a residential exposure at this level of loss. So our loss is being driven by three main accounts and they are fundamentally residential in nature, one of them is focused on the first $100,000 per house if you will and the other account is focused primarily on the excess over $100,000, but for a given market loss size the more of it that goes to commercial the better for us as a general matter.

Matthew Heimermann - JPMorgan

Okay. And then just one question on the PML; it looks like PML for pan-European increased. And I'm guessing that's just commensurate with the increase in the international cat writings we filed this quarter?

Neal Schmidt

I would describe two reasons for that. One is the timing of some ILW protection, we had some ILWs that we allowed to run off that we may or may not purchase again. If we do it will be in the fourth quarter. And the other thing is changes in foreign exchange, as the dollar weakens against the euro or the pound that can have an impact on our European PMLs.

Operator

We'll take our next question from Dean Evans with KBW.

Dean Evans - KBW

I guess first I was hoping you'd discuss capital management a little bit. It does seem like you bought back a pretty substantial amount of shares so far this year, particularly including the warrant repurchase. And I am just wondering at some point when you guys slow down, I guess do you consider any other options or I guess just kind of frame the capital management discussion for us a bit.

Michael Price

Sure. Right now, our view is that the reinsurance market is overcapitalized. I think this is a natural consequence of companies having had strong earnings over recent years as well as a run-up in the asset prices for the types of investments that reinsurance companies make. And yet, you don't see demand for the product increasing at a commensurate rate.

So the natural outcome there is you've got more and more capital chasing more or less stagnant or even declining pool of risks. And that's putting, as we have talked about in the past, significant downward pressure on pricing. And our view is that there are only a few things that we can do for the benefit of shareholders. We can take insurance type risks. We can take investment type risks. And we can manage our capital base.

And we look at the opportunities that are available to us. And right now, our view is that there are diminishing opportunities in the reinsurance space over time. It's a challenging investment environment. You're not being paid a lot to take on investment risk right now. And we have valuations in our space such that it seems very attractive for us to buy back our own shares, particularly when they are trading at 15% or more off of our book value, a book value that obliviously we feel very confident in.

So we believe that if our objective is to grow book value per share, the best and safest way for us to do that right now is with an aggressive capital management program. And so you've seen year-to-date how we've repurchased either shares or options amounting to as much as $400 million for 2010. That follows on from three prior years where we bought back about $250 million a year for three years.

So is it peeking in 2010? Perhaps. As you point out, we can not keep buying back at such a high rate forever. And while we don't give specific guidance on our likely behavior, I will tell you that our predisposition right now, given everything we have seen, is to continue buying back shares.

Our shareholders equity has eclipsed $2 billion and has stayed elevated above $2 billion for an extended period now. I don't believe that we need in excess of $2 billion in order to support the risks on our balance sheet and the enforced book of business. I believe that we can be a viable participant in the reinsurance marketplace with significantly less capital than what we are carrying now.

And until we see reinsurance and/or investment opportunities that are going to generate for us the types of returns that are available from buying back shares or better, then we're just going to continue buying back shares at an aggressive rate.

Dean Evans - KBW

Second, I was wondering on the reserve movement side. There were two areas I wanted you to touch on. First, can you give a little color on what the additions were in the property line; and second, a little more detail on the casualty? You mentioned some of the business lines may be over the accident years that were the biggest components there as well?

Neal Schmidt

Starting with the property side, the major addition was in the catastrophe area. We increased our estimate for Hurricane Ike by about $10 million, and that's related to increase in litigation and reopened claims that we're hearing about from our ceding companies.

On the casualty side, the major items would be in our North American claims made, about $15 million, mainly from 2005 and 2006 underwriting year. I mentioned underwriting year because that's how we reserve.

We also took a look at our class portfolio on North American casualty class portfolio, looked at the experience of all the years and concluded that our expected loss ratios needed to be lowered. And that had about a $13 million effect, most of that within '06 and prior underwriting years. And we also had about $6 million of reductions within financial lines, mostly '08 and prior on the surety bond side and '05 and prior on political risk.

Operator

We'll take our next question from Jay Cohen with Bank of America-Merrill Lynch.

Jay Cohen - Bank of America-Merrill Lynch

The $15.8 million, Allen, that you cited for the ULAE change, that was pre-tax or after-tax?

Allan Decleir

That is pre-tax.

Jay Cohen - Bank of America-Merrill Lynch

Does that change impact how you book the business going forward?

Neal Schmidt

Yes, it does. We changed our what's known in the business as paid-to-paid factors for determining ULAE, and we lowered those based on looking at our own experience over the last few years. So we'll resolve it on a lower level of reserves for ULAE going forward. The calendar year change is unlikely to be material though.

Jay Cohen - Bank of America-Merrill Lynch

And then lastly, I guess if I look at the casualty business in the quarter and I kick out the $30.4 million from this impact, it looks like the accident year loss ratio I am calculating to be a little over 72%. That number would be the lowest number in probably six or seven quarters, quite a bit lower than the first half. And I am wondering what's that related to? One would expect, all else being equal, that number to probably rise a little bit just given the pricing pressures.

Neal Schmidt

Accident year, again, we do it by underwriting year. Loss ratios on the casualty side are in the low 70s, and combined ratios excluding internal costs are in the mid-90s. With a slight mix difference in the current period that favorably impacted the calendar year numbers, there is a little more or less North American occurrence-based business, a little more trade credit business with lower combined ratios.

In addition, we did, in our current planning process, lower our international casualty and clash combined ratios slightly, which had about 2.5 to 3 point impact in the quarter.

Operator

We'll go next to DeForest Hinman with Walthausen & Company.

DeForest Hinman - Walthausen & Company

I had a few questions on the capital management side. Can you talk about what type of new money yields you're seeing and where you're finding attractive investment opportunities?

Michael Price

Sure. Our investments into fixed income securities have tended to focus on taxable municipal bond0, which we see as offering a good combination of spread over treasuries for a commensurate duration as well as attractive credit profile.

The issue with those bonds is that they tend to be longer term in nature, extending 10, 15, 20, sometimes more years. And so for us to be able to purchase those securities and maintain an overall duration target of around four, it means that we have to build our cash position over time to balance that out.

And so the net activity in the quarter has for the most part been a reduction in U.S. treasuries as rates have come down, particularly up the shorter end of the curve, and an increase in these taxable municipal bonds paired with cash.

Operator

We'll go next to Ian Gutterman with Adage Capital.

Ian Gutterman - Adage Capital

Just to clarify the last point, I look at you saw the $500 million in treasuries including cash this quarter. Why was this so dramatic this quarter?

Michael Price

I don't know if it's dramatic per se in light of the overall portfolio duration, maintaining its position of around four. So we have added about $120 million of these longer-term taxable municipal bonds that carry a significantly large duration. So every dollar of long-term munis that we pick up has to be paired with several dollars of cash in order for that portfolio duration to remain down around four.

Ian Gutterman - Adage Capital

And on a net basis, that swap, I assuming what you're doing is probably NAI accretive or what you're looking was totally a return accretive?

Michael Price

We are thinking on a total return basis, but we're also cognizant of risk, and in particular risk of rising rates, and we think that the type of barbelling strategy that we are adopting would position us well in the sense that long return rates we think are more anchored and that the vulnerable part of the yield curve is the shorter end of the yield curve.

So rather than having everything in five-year treasury securities, we would rather have longer dated securities that are paying some kind of a spread over treasuries and then pair that with cash.

Ian Gutterman - Adage Capital

On the ULAE, can you just give a little more color on that? I understand the concept of that, but I guess I never thought of that as being that significant for a reinsurer. I always thought of that as being more like auto where you have constant frequency and adjustments. I always thought of reinsurance as more (inaudible). So why would there be a meaningful deviation in your expectations in ULAE for a reinsurer?

Michael Price

You are correct that ULAE is generally not a significant item for a reinsurer. It's our own internal expense of settling claims. Historically, we'd relied on our predecessors' expense structure in determining what we thought the appropriate ULAE reserves were. We thought we had reached a time where we had a significant number of years behind us of significant amounts of paid claims in order to make a judgment based on our own internal expense structure. And it turned out to be a significantly lower number.

Ian Gutterman - Adage Capital

Then moving on to the Ike addition, I am guessing that the TWIA is taking its estimate back up to the full limits.

Michael Price

It's actually from a number of ceding companies.

Ian Gutterman - Adage Capital

I guess I'm wondering to the extent some of it's from TWIA, I am a little surprised that you've released that when they lowered their number the prior time. It would just seem more prudent to say where we know they are lowering it a little bit, but we're going to more cautious and hold it and see how this plays out.

Michael Price

Yes, we said our aggregate reserves from any one event to be consistent with our view of the event, we take into account what ceding companies say. And sometimes what that means is we are carrying more than our ceding companies tell us. And in another situation, we might be carrying less than what our ceding companies tell us. We are not just accepting their numbers without imposing our own judgments on them. So as Neal said, we are responding to a phenomenon that we see, not a change in one ceding company's estimate of its own losses.

Ian Gutterman - Adage Capital

I just want to make sure that that's the case. And then in my last one is just numbers. One, the Travelers options that were purchased, and I was backing into the share side impact of that is about $2.2 million in this quarter that goes away. Is that about right?

Neal Schmidt

That's right. It's about $2.2 million or $2.3 million.

Operator

We'll go next to Ron Bobman with Capital Returns.

Ron Bobman - Capital Returns

I just had a question about the energy market and your participation in it. I guess there are two initiatives that markets are talking about. That's really Gulf of Mexico and liabilities exposures. I was wondering what your views were on the broker-sponsored facility as well as the Munich sort of consortium-sponsored facility.

Michael Price

Sure, Ron. We are aware of both proposals, not favoring one over the other, but as a general matter have come to the view that this is a market segment that for various reasons, some structural and some analytical, just has not performed well and certainly not performed well in comparison to other ways that we can deploy cap capacity.

So as we are now eight years into this project, we look back and say where have we made money, where have we been surprised and what do we think are the best areas for us to be applying ourselves in the future. And the offshore energy market has not surprised us in a favorable way over time. If anything, it's surprised us in an unfavorable way. And we think it's inherently more difficult to make decent returns over any extended period of time. So as a result, we're just not emphasizing it in the same way that some other people are.

It's never been a particularly large element of our book. But based on historical analysis, you might conclude that even at the relatively modest level that we did participate was still too high. So our appetite for cap risk remains strong, but it's going to be focused on areas that we think we can do well, and offshore energy is not at the top of that list.

Operator

(Operator Instructions) Well now go to a follow up from Jay Cohen with Bank of America-Merrill Lynch.

Jay Cohen - Bank of America-Merrill Lynch

So I had a question which I think you guys now have answered. I was looking at the cash position, but I guess it's fair to say that the cash position at the end of the quarter is not unnecessarily high then. In other words, that cash will be redeployed so quickly other than, obviously, the money if used to buyback the options.

Allen Decleir

I think that's right Jay. Technically at the end of the quarter our overall portfolio duration was down around 3.6, and we'll allow it to be as high as four. So you could see some redeployment of cash, but I don't think it's going to be a significant move.

Jay Cohen - Bank of America-Merrill Lynch

And then a second question, I'm wondering, Michael, if you could talk a little bit more about the competitive environment. What are you seeing companies do out there, is there any direction, I think as obviously, we hear things are competitive. Do you sense they're getting more competitive, less competitive? And obviously that would vary by line of business. So answer it anyway you want to. But just to give us a better qualitative feel for what you're saying.

Michael Price

Sure. As a general matter we see an abundance of capacity, I've described it as over capitalized. The competition seems for the most part be on price, not so much on terms and conditions. We see underlying commissions creeping up, and companies trying to pass that additional cost on to their reinsurers. Most reinsurers, not all, but most reinsurers appear to be acting in a somewhat restrained manner. But we see a lot of aggressive behavior on the part of primary companies.

And in particular, we see standard markets absorbing risks that were previously underwritten in the surplus lines markets. And when you get that transfer from surplus lines over to standard lines, you're getting an expansion of terms and conditions of broadening of coverage and generally a lower price. So that's an overall weakening, I would say.

Companies are hungry for premium. Those that are writing more business are doing it through new teams that they take on. They're doing it through new lines of business that they're entering into, where they take a look at what they have done and say it's not good enough, no growth prospect, so let's go and do something new, something that they haven't previously been involved with.

So couple that with the idea that primary companies are retaining more of their business net-to-net, overall means a dwindling supply of seeded reinsurance dollars to be competed for. And as we've said earlier, if you've got capital growing at a double-digit rate, which it has been now for some time, and you've got a pool of seeded business that's stagnant or shrinking.

To me, the only way for those markets to clear is prices go down. And when price goes down, profitability follows it down. And as we've said, our response to what we're seeing has been to pull back. We're now in our fifth or sixth year of shrinking the size of our reinsurance portfolio. We have not taken on an extraordinary amount of insurance risk, but we have been aggressive in returning capital to shareholders. And that is the configuration that we think represents a rational response to the market environment as we see it. And that's the profile that we're going to sustain going forward.

Operator

We'll now go to a follow up from Ian Gutterman with Adage Capital.

Ian Gutterman - Adage Capital

I guess I was just thinking about your casualty book, and the decision to shrink it earlier than most. I'm just wondering in hindsight as you look at that, and it surely needs as to be at the time, in hindsight given that now your loss trends continuing and the degree of reserve leases you've seen from it. Do you look back at that and say maybe we shrunk it a little bit too fast, too soon or you're still comfortable with that decision?

Allen Decleir

To answer that question from a financial perspective, I think you would have to compare the profitability of that business that we didn't write versus the value created by buying back in excess of $1 billion of capital during that same period, much of which was done at prices that are much lower than our current $55 book value per share.

So my guess and I haven't tried to do that analysis explicitly, but my intuition is that we've done better for shareholders by pulling back when we did, and returning the capital through share repurchase. It's true that we could have stayed in that game longer and made money for shareholders through underwriting, but I don't know that it wouldn't have generated as much growth in book value per share, nor do I think it would have been as certain of a bet as the one that we have made. We obviously have a lot of knowledge and comfort with our current reserves, and that comfort level exceeded the confidence that we had in the underwriting opportunities that we were seeing at the time.

So we were making an explicit choice of leveraging up the company's balance sheet through share repurchase versus taking on uncertain new business at a time when rates were declining and trend in loss cost was still positive. So I think we have stuck to our pricing hurdles of 10% return on committed capital. Our decision has been to maintain those levels of pricing expectation. And if we can't write as much business as we have capital to support it, then we would return the capital.

If we had stayed in the business longer, I think it necessarily means that we would have had to lower those pricing thresholds and intentionally take on business that was expected to produce results in the mid single digits. Obviously, there are companies doing that and happy to do it. But what we have communicated to shareholders from the outside was we were seeking to compound book value per share, at a double digit annualized rate and we think the way to do that is not to add business that we know is producing single digit returns, but instead achieve it through share repurchase.

Ian Gutterman - Adage Capital

Excellent answer Michael, I just wished more companies thought of it that way, thank you.

Operator

And having no further questions in the queue, I'd like to turn the call back over to Mr. Michael Price for any additional or closing remarks.

Michael Price

Thank you, operator. Thank you all for your participation and we look forward to speaking with you next quarter.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation and you may now disconnect.

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