Executives
Brenton Slade - CMO
David Brown - CEO
Gary Prestia - Chief Underwriting Officer, North America
Guy Swayne - Chief Underwriting Officer, International
Patrick Boisvert - CFO
Analysts
Sarah DeWitt - Barclays Capital
Ian Gutterman - Adage Capital
Amit Kumar - Macquarie Securities
Dean Evans - KBW
Flagstone Reinsurance Holdings Limited (FSR) Q3 2009 Earnings Call November 2, 2010 9:30 AM ET
Operator
Welcome to the Flagstone Reinsurance Holdings Limited Third Quarter 2010 Earnings Conference Call. My name is Regina and I’ll be your operator for today. At this time, all participants are in a listen-only mode.
We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator instructions) As a reminder, this call is being recorded for replay purposes.
It is now my pleasure to introduce you to your host for today's conference, Brenton Slade, Flagstone's Chief Marketing Officer. Brent, please proceed.
Brenton Slade
Thank you very much, Regina, and good morning, ladies and gentlemen. Thank you all for joining us on the call today. With me are our CEO, David Brown, Guy Swayne, Chief Underwriting Officer, International; Gary Prestia, Chief Underwriting Officer, North America; and Patrick Boisvert, our CFO.
Before I turn the call over to David, please let me remind everyone that statements made during this call, including the questions and answers, which are not historical facts, may be forward-looking statements within the meaning of the US Federal Securities Laws.
Forward-looking statements contained in this presentation may differ from actual results. We therefore caution that you should not place undue reliance on such statements. We speak only as of the dates on which the statements are made and the company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
On that note, I’d now like to turn the call over to David.
David Brown
Thank you, Brent. Good morning, ladies and gentlemen. This has been a positive quarter for Flagstone and I am pleased to report that our diluted value per share increased by 4.4% for the quarter, which is above our current targeted annualized rate of 14.5%.
This growth in value has occurred despite a material net loss of $52.5 million to our international cat book from Christchurch earthquake and one-off charges of $14.1 related to expense reductions.
We remain convinced that our cumulative underwriting results demonstrate the long-term attractiveness of our focus on highly technical underwriting, diversification and risk management.
Our conservative risk management is reflected in the moderate PML limits related to our capital and premiums. Our current 1-in-100 PML is 288 million and the 1-in-250 PML 363 million.
This quarter our underwriting operations produced a loss ratio of 59.9%, our loss ratio being impacted predominantly by the New Zealand earthquake.
Our combined ratio of 100.1% reflects the quake loss plus the one-off charges related to expense reduction.
Occasionally, our strategy results in losses that don’t necessarily impact less diversified peers and the New Zealand earthquake has been an example of this. It is important to note, however, that our loss from this event relates mainly to aggregate reinsurance contracts with clients who cover Australia as well as New Zealand.
We suffered a loss because the quake was the third large and the likely event to impact our clients. The first two being exceptionally large health loan losses in Perth and Melbourne. The muddled occurrence of three significant losses of these sizes within the risk period indicates a one in 40 year probability. Gary and Guy will update you with more details on the underwriting market conditions shortly.
Nearing our fifth anniversary and now a mature company, Flagstone’s global position is well established, and we remain committed to leveraging our existing business and operations to the best advantage. We continue to refine our platform and look at ways of extracting the best value from its potential, while optimizing our cost structure to achieve mean industry levels or better.
Our G&A currently runs around 19% and we expect this to move down to the 16% range in the next year resulting in enhanced profitability. In fact, excluding one-offs our G&A was down $4.2 million this quarter over last and we expect this trend to continue. Despite this optimization, we are as committed as ever to our focus on technical underwriting supported by industry leading, proprietary analytics and systems.
Our modeling and pricing technology, has been and continues to be a strategic differentiator for Flagstone. We have one of the largest modeling analytical teams in the market, supported by a deep and highly technical research and development team. We have developed a very sophisticated platform allowing us to provide fast, accurate pricing, which facilitates the excellent service that has become our hallmark.
To be clear, expense segments will come from the maturation of our platform as we’ve completed the design and development phase, and could now focus all our efforts on further research and enhancement, as we are continually finding ways in which we can innovate and push our technology forward. There is no reduction in our commitment to remain a technology leader in our industry.
Our focus on the global and technical platform enables our diversification as well as our ability to source business on a global basis. This puts our capital to work with one of the highest premium-to-capital ratios in the sector, which is one of our many strengths.
We see significant value in our franchise and view the recent share price levels as an historic opportunity to add shareholder value through continuing to buy back stock through our authorized repurchase plan. So far this year, we have repurchased over $72 million worth of our shares.
Absence a large catastrophic event, we anticipate rates in our preferred lines of business will be flat to modestly lower in the coming renewals. And such, we plan to remain disciplined, not increase our risk or exposure and are likely to continue to repurchase shares where we see exceptional opportunities to do so.
We’ve one more piece of very good news. Flagstone was named Reinsurance Company of the Year by the Review Magazine this quarter. The judging panel highlighted our innovative approach and nimble response to market change and said that Flagstone's strategy has focused on world class underwriting, exemplary client service and building its expertise and reputation to secure its place as an industry leader. Our leadership in the area of identifying and responding to potential market changes was also highlighted.
For the past five years, we have worked hard to grow a sustainable, successful, modern and dynamic business, but a business where underwriting comes first. Being named the Reinsurance Company of the Year, is a testament to our ongoing aims to be the very best we can be and recognition of the hard work of all the staff of Flagstone.
Our Board, our Executive Team and I are very pleased with the direction and status of Flagstone. We expect our continued focused on maximizing value from the business we’ve built to result in an enhanced, long-term financial performance plus takeovers and continued security for our clients.
Now I will hand over to Gary to talk to you about the North American underwriting developments for this last quarter.
Gary Prestia
Thank you, David. Pricing for the July 1 and subsequent third quarter renewals mostly followed on from the June 1 renewals and experienced pricing reductions in the 10% to 12% range.
The business renewing at July 1 is predominantly Atlantic Hurricane exposed. Despite a very active Atlantic Hurricane season, with hurricanes Earl and Igor as being the primary threats, no major US landfall has occurred, resulting in no significant US hurricane losses this season to-date. Thus, our North American profitability for the third quarter and through nine months of 2010 remains quite strong.
This quarter, Flagstone’s North American aggregate capacity utilization was nearly flat and our premiums were down in line with the rate reductions I just mentioned.
Our focus has now turned to January 1 renewals where we anticipate reinsured underwriting and pricing discipline. We once again will be detected given broker and client expectations where material reductions as expressed at recent conferences such as PCI.
Pricing, as we see it, will be flat or close to it. There are some regional variations. In the North East, there has not been a major hurricane for 25 years. 1985 hurricane Gloria being the last major hurricane to hit the New York area, although the potential certainly exist when events like the 1938 New England hurricane caused substantial industry losses.
Pricing has been declining between 5% and 10% over the last few years, apart from an upsurge in 2006 following hurricane Katrina.
The cumulative effect of these reductions is now being felt and we are writing near a technical minimum level. So there is little room to give in terms of lower pricing.
Florida and the Gulf region are in better shape price wise but similarly don’t have much room for reduction. The very low interest rate environment, a number of international loss events, generally rising combined ratios due to attritional loss frequency and substantial reinsurers share buyback should definitely ensure result to maintain underwriting and pricing discipline in our view.
It is also anticipated that [RMS] 11 version will increase some of the inland coastal consol loss PMLs due to higher inland wind speeds while slightly reducing the coastal PMLs.
We have received increased client-broker interest in catastrophe aggregate products as well as multiyear solutions and may allocate more aggregate towards these on a selective basis at one-one with final terms and conditions permitting.
However CAT reinsurance will likely not be written at the level of price reduction that brokers and cedents maybe looking for it this coming January 1. At Flagstone we pride ourselves on technical excellence and feel we lead the industry in utilization of proprietary analytics. With this in mind we expect to continue to maintain underwriting any discipline.
Now for an overview of pricing and renewals from the international book, I will pass the call over to Guy.
Guy Swayne
Thanks Gary, let me first follow-up briefly on David’s comments regarding New Zealand earthquake. As you know we issued a early loss assessment as we knew our involvement in this event remaining full. Mostly perhaps that some of the reinsurers are not to diversified widely as us. We have now received initial loss advices from all our clients and we are comfortable with our initial estimate.
As we have mentioned a significant portion of our loss emanates from aggregate contracts we write to our core Australian plants and the region has experienced unprecedented large loss activity in the last 12 months.
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Please note that we would be writing business in this region since Flagstone’s inception in addition to having developed strong relationships and having valued clients in the region, we have made a profit in every previous year and our cumulative results are placed at break-even despite this unprecedented loss. We are convinced that our continued strategy of diversification of geography and by line will bring us the very best opportunities.
Moving on to international overview as in North America, markets have generally continued to soften with signs that the reinsurance market is remaining disciplined with modest rate reductions and tight conditions continuing.
Share buybacks in the industry which are a positive use for excess capital along with employees applying good governance are good sign that mitigates softening trends.
Recent October pricings in Europe were encouraging with very modest rate easing. Obviously the focus is now shifting to the January renewals, where as Gary mentioned we are expecting pricing to remain flat to up a few points. If pricing deteriorates more than expected than we will likely reduce the capacity we offer accordingly.
Conversations at the recent industry meeting in Baden-Baden indicated that some of the northern and the western European cedents are already well under way with renewals particularly with regards to a portion of treaties.
It seemed at this stage that no great changes are being requested but some degree of increased retention is being envisioned. We will continue to load mostly retention levels of cedents and will continue to move away from lower layers if we feel pricing is inadequate for the risk covered as we have being doing for the last few years where we considered it necessarily.
We are committed to the long-term success of our company and will continue to maintain disciplined underwriting that pricing does not reach technical levels.
Now Patrick will review this quarter’s financials results in greater detail.
Patrick Boisvert
Thank you Guy and good morning to you all, I would like to share with you some of the main third quarter highlights starting with our reinsurance segment.
When compared to the same quarter last year our premiums written and earned have decreased slightly this is mainly due to negative premium adjustments and a few large proportional treaties based on new estimates from our underwriters and reports from our cedents had an impact on the bottom line was small as these adjustments also impacted favorably our acquisition costs as we lowered commission expenses accordingly, I would expect premium and acquisition costs to turn back up in the next quarters.
The reinsurance segment was also negatively impacted by $12.9 million of one-time expenses, as we had mentioned in last quarterly recall.
Finally we incurred a net loss of $51.2 million from the New Zealand earthquake in this segment. But despite the loss and higher expenses this segment generated $4 million of underwriting income and a combined ratio of 97.6% in Q3 2010 as our platform continue to generate a significant amount of premiums to offset those expenses.
In our Lloyd segment gross premiums written for the current quarter were 46% higher than in the same period last year and the catching up with the writings as they increased 102% from Q3 2009. Our Lloyd segment had a net exposure of $1.3 million to the New Zealand quake.
We continue to develop our Lloyd platform and increase our diversifying exposures to the special fees and direct and far [cat] markets. Our third segment Island Heritage had a quarter in line with our expectations.
Across all our segments reinstatement premiums for the third quarter of 2010 were $9 million and net unfavorable reserves development from prior years event worth $3.7 million.
The negative development comes from small net adverse development on a few property and marine and energy treaties.
Moving onto investments, our portfolio had a good quarter with a total return of 2.6% as the allocation to equities and commodities rebounded positively from the second quarter.
Under risk basis 90% of our portfolios are invested in high-grade fixed income securities with an average credit rating of AA+ and duration of 2.1 years.
Finally, during the quarter we repurchase 1.4 million shares for consideration of $14.8 million and we still have unused authority of $11.2 million under our Board approved share repurchase plan.
And with that summary of the financials I would now pass it over to the operator to open the lines for question and answers
Question-and-Answer Session
Operator
Thank you Patrick. (Operators instructions) Your first question today comes from the line of Sarah DeWitt with Barclay’s capital.
Sarah DeWitt - Barclays Capital
Good morning. You had mentioned that you are now looking to increase your risk exposure next year. Can you clarify, does that mean you do not expect the top-line in terms of the gross in premiums to grow in 2011?.
David Brown
Yes Sarah, I think that given the color that Gary and Guy gave you of the markets where we do think it’s going to be flat to softening rates. We don’t think that’s an environment where one wants to be growing your business.
It just exacerbates the kind of market pressure to our expectations is that we won’t grow and I have to say we are a fundamental ground up underwriters, so the premium number that we eventually show is going to be based on the business we find in the market. We are just telling what our expectation is based up on what we see today.
Sarah DeWitt - Barclays Capital
Okay and that includes the Lloyds business as well?
David Brown
Yes. I think you might see some modest growth and diversification of business but overall at kind of top-line, I think we expect to see a flattish number. We’ve had growth in excess of 30% in our business since we started and I just don’t see that kind growth continuing in the stock market.
Sarah DeWitt - Barclays Capital
Okay, fair enough. And then on share buyback, how much do you expect to repurchase in 2011 and when do you think you could refresh the authorization?
David Brown
We have as Pat mentioned some of our remaining authorization is relatively modest. We have a Board meeting in a couple of weeks. So I expect we will discuss that again. I do expect to be granted another authorization and I don’t know how much that will be but I think as I said the share prices has to be seen and the last little while if the continue I think it’s a very attractive I thing to do with the excess capital.
Sarah DeWitt - Barclays Capital
Okay. And just given the float and the trading volume, how much do you think you could buy back? Or is there some opportunity to buy back shares from insiders?
David Brown
So far most of our repurchases have been private purchased from individuals who we’ve found on unknown blocks. So its not really affected very much the kind of market floats out there, they traded in daily volume.
Sarah DeWitt - Barclays Capital
And based on your discussions with them, is there more opportunity to do that?
David Brown
I don’t know Sarah. All I can do is look at the share price, look at our excess capital position and make that call on any given date, depending on both the share price and whether any existing owners are prepared to sell at that price?.
Operator
Your next question is from the line of Ian Gutterman of Adage Capital.
Ian Gutterman - Adage Capital
Hi guys. Can I just clarify two numbers first, then I have a question on cap pricing. The New Zealand losses of $51.2 million in the reinsurance, should I assume the other $1.3 million is at Lloyd's?
David Brown
Correct Ian.
Ian Gutterman - Adage Capital
Okay. And the adverse development. Was that in the reinsurance segment only, or was some of that at Lloyd's, too?
David Brown
All reinsurance.
Ian Gutterman - Adage Capital
All reinsurance? Okay, great. David, on the cap pricing, I guess I was a little bit surprised that it sounds like there's not much room above technical pricing, I guess, just what I'm used to hearing from some of your competitors is that cap pricing, at least for US wind, or your [balance sheet] focus is still pretty healthy and, while down off the peaks, is still very attractive. It sounds like you're a little bit more cautious than others. Is that fair?
David Brown
I think there is still room enough in North Americas that Gary alluded to. And we obviously don’t want to push rates down. We’ve also got some fairly significant model changes coming up in the near, which need to be reviewed and based on those models we’ll consider how to do the pricing.
We fairly made the change in Florida with the AR model. We would not get the RMS model until February. So there are some changes. At present there is uncertainty around that, which is I guess why we are being a little cautious.
Gary Prestia
And I should mention it is really the North East, that’s the tightest zone, given lack of hurricane activity. So that’s the one that’s pressing closer to minimum technical levels. Other zones I mentioned Florida and Gulf do have some room but certainly it’s probably less than the extent of what brokers maybe looking for. They are probably targeting in the 7.5% to 10% level of rate reduction whereas we think this will be close to flat.
Ian Gutterman - Adage Capital
Got it. Okay. And then, what does technical pricing imply for an ROE today, given where interest rates are?
David Brown
Low double digits.
Ian Gutterman - Adage Capital
I think this more lower then made and that’s mainly due to [potential] investment income? Historically you would have thought technical pricing being more in the mid teens. Is that fair?
Patrick Boisvert
I think it’s probably that. Obviously investment income but on short-term business, it doesn’t make much difference typically. And as a company our leverage is relatively modest, 1.6 to one, asset leverage to capital. So there is some impact on us but as big as say a long-term.
Ian Gutterman - Adage Capital
Right. Yes, you know, that's kind of what I was coming at, this 1.5 to 1, you've given up 150 bps of return. That's (inaudible) high yield, that's about 2 or 3 points off the return. That's low versus mid. That's kind of the math I was doing. Okay, great. I think that's all I had. I'll let someone else take over. Thanks.
Operator
Your next question is coming from the line of Amit Kumar with Macquarie.
Amit Kumar - Macquarie Securities
Good morning, and thanks. Just quickly, going back to the New Zealand earthquake. You know, you mentioned the aggregate cover. What would need to happen for your estimate to sort of develop adversely? Or is it capped now?
David Brown
Amit, this is David. All our contracts are capped, so there is a upper limit to how which we can pay in every contract. And as Guy said, when we first came out with our numbers based upon some very initial analysis and the model runs and we now have more input from cedents recently, which mean we are actually more comfortable with our reserve number now, because the numbers coming off from my clients are certainly in line with what our expectation were.
Amit Kumar - Macquarie Securities
Okay. That's helpful. And then, just sort of moving on, maybe changing gears a bit. In terms of that expense number which you mentioned, that $4.2 million saving. Can you sort of break that out? What exactly is that $4.2 million?
Patrick Boisvert
It’s a lot of things, I mean -- I think it’s just a reduction in the staff force, reduction in travel and entertainment, a bit like David had mentioned our platform maturing. So less focus on development more on maintenance of some our systems. So it’s nothing specific, just the normal trend of things.
Amit Kumar - Macquarie Securities
I guess, what I'm trying to ask is, you have the sale of the airplane, you have these expense reductions. What sort of run rate should we assume going forward for further expense reductions?
David Brown
As I said earlier we have been running about 19 and I think the industry average is 16, 15 maybe, and our expectation is that just because of the natural maturation of our business we will see our expense ratio head down to the 16% level or maybe little lower but that’s what we are seeing based up on our projections.
Amit Kumar - Macquarie Securities
Okay. That's helpful. And final question. I think in your opening, you mentioned, and I might have missed this, multi-year solutions. Can you just expand on that a bit?
Gary Prestia
Yes, that was in the North American area in particular, but also I would say we have seen that around the world. There has been increased interest in extending out from a single year contract to multi-year.
Our preference tends to be more to look at two year kind of solution rather then three. We think two has more viability for both sides to maintain that over the period. So we have seen some requests for that and I think as companies want to diversify the way they buy their reinsurance, not have all of it come up in a single year.
Therefore put some of that on multi-year basis and that can be attractive for us as well in the sense of the way that we can segment our lines, such that some of it is multi-year, some of it is single year.
But we are looking at the renewals of programs every single year. So that’s in line and we are going to look at that on a selective basis. As you can imagine those are going to be areas that we feel pricing is adequate and it’s attractive for us to put some of that capacity out multi year.
Amit Kumar - Macquarie Securities
So I guess what you're saying is, it'll be more so on a selective basis than sort of being an avenue of growth for you based on the market conditions right now.
Gary Prestia
Correct. I think at the end of the day, some buyers are looking at the alternative to cat bonds and cat bonds do have the attraction of generally a three year term. So if they chose to go the alternative route of traditional re-insurance, they may lack the attraction or feature of multi-year, but not want to commit to the additional expenses and so forth related to issuing a cat bond. So I think that interest generally speaking in cat bonds, any awareness of that has increased buyer interest in having some of the reinsurance plays multi year.
Amit Kumar - Macquarie Securities
And in what portion of your book is currently multi year?
Gary Prestia
It's a small percent, certainly even of North American. It’s a probably less then 15% of our premium volume comes from multi-year.
Operator
(Operator instruction) Next question comes from the line of Dean Evans with KBW.
Dean Evans - KBW
Yes, thanks for taking my questions. I guess, first, I wanted to touch on the Lloyds segment, and sort of two things there. First off, could you give a little more color on exactly what the impairment charge relates to?
And, second, just sort of looking at the overall segment, it does seem like it's been running above 100% combined ratio for a while now. Any thoughts on go-forward profitability there, and what we can sort of think about?
Patrick Boisvert
Sure. Dean, it’s Patrick. Regarding your first question on the impairment, it’s some small intangible that we recorded as part of our initial purchase price and that we felt needed to be writing off during the quarter.
And your second question, just to be clear was why we are running above the 100% combined ratio in the Lloyd segment?
Dean Evans - KBW
Well, I guess, obviously there are some things like, for instance, the intangible charge impacted this quarter. But I guess less what are you running there and more sort of when can we expect it to be profitable or what are you thinking about for profitability for next year in that segment?
Guy Swayne
Hi, it’s Guy. Obviously we are not thrilled by how it’s running in the last couple of years at that combined and we’ve spent a lot of time in the last couple of months looking at our future plan for the syndicate, which is very much to bring it to profitability. And two action points is, one to look at the lines of business that have been driving that loss ratio and reducing the impact of those lines on the overall result. And the syndicate (inaudible) dominated by one or two specific lines of business.
And going forward our intention is to as David said diversify and add some non-attritional lines of business we think will improve the profitability of the company. And one thing I have to mention is that premiums, the earned premiums are still ramping up from our acquisitions. So you will continue to see earned premiums develop over future quarters.
Dean Evans - KBW
Okay. And I guess, touching back on the expense-savings initiatives. Is there anything else in the pipeline that, right now, as far as one-off charges or one-off items that we can expect to flow through results?
David Brown
Dean, this is David. Nothing specific and we continue to look at everything we do and make sure we are doing it as efficient as we can. So I expect you will be see a relatively smooth progress in driving down the expense ratio really as a result of maturation of the company.
We’ll also integrate Lloyds better and we will save some costs there that will come through and as we do less systems development we have effectively built or modified 44 systems in the five year since we started. And many of those systems are now effectively, they are running, we are using them all day, and now our effort is less on building and more on improving the science and tweaking them and so the cost of doing that is just naturally much lower than having all sorts of people around to build them, which was the case in the first four or five years.
Operator
(Operators instructions) As there are no further questions I would like to turn the call back to Brenton for closing remarks.
Brenton Slade
Thank you once again ladies and gentlemen. The replay of this webcast will be available on our website from 12 noon today until midnight on December 2nd. Please visit the Investor Relation section of our website at www. flagstonere.com for further details.
That concludes the proceedings for today. We look forward to speaking to you again at the end of the next quarter. Thank you very much.
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