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Alterra Capital Holdings Limited. (NASDAQ:ALTE)

Q3 2010 Earnings Call

November 03, 2010 05:00 am ET

Executives

Susan Spivak - SVP, IR

John Berger - Vice Chairman of the Board & CEO, Reinsurance

Joe Roberts - EVP & CFO

Analysts

Josh Shanker - Deutsche Bank

Jay Cohen - Bank of America Merrill Lynch

Dan Farrell - Stern Agee

Mark Dwelle - RBC Capital Markets

Jay Cohen - Bank of America Merrill Lynch

Operator

Good day ladies and gentlemen and welcome to the third quarter 2010 Alterra Capital Holdings Limited earnings conference call. My name is Brandy, and I will be your operator for today. At this time all attendees are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference call is being recorded for replay purposes.

I’ll turn the call over to your host for today, Ms. Susan Spivak, Senior Vice President, Investor Relations. Please proceed, ma’am.

Susan Spivak

Thank you. Good morning and welcome to Alterra's third quarter 2010 earnings conference call. Last night we issued our press release and financial supplement, both of which are available on our website www.alterracap.com.

Joining us for today’s call will be Marty Becker, President and Chief Executive Officer; John Berger, Vice Chairman and CEO of Reinsurance Operations; and Joe Roberts, Chief Financial Officer. Following the prepared remarks, we’ll open it up to questions and answers.

Before proceeding with the discussion Alterra reminds you that this call may include forward looking statements that reflect its current views with respect to future events and financial performance. Statements that include words such as expect, intend, plan, believe, project, anticipate, will, may and similar statements of a forward-looking nature identify forward-looking statements. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements, and you should not place undue reliance on any such statements. Any forward-looking statements made in this call are qualified by these cautionary statements and there can be no assurance that the actual results or developments anticipated by Alterra will be realized or even substantially realized that they will have the expected consequences or effect on Alterra or its businesses or operations.

Alterra undertakes no obligation to update publicly or revise any forward-looking statement whether as a result of new information, future developments or otherwise. With that, I’ll now turn the call over to Marty.

Marty Becker

Thank you Susan and good morning, and welcome everyone to our third quarter call, which is our first full quarter as Alterra, with global specialty insurance and reinsurance enterprise formed last May by the merger of Max Capital and Harbor Point.

Alterra had a very solid quarter and we believe that the integration from the merger of Harbor Point Max is largely complete. On a pro forma basis, our gross premiums written were down from a year ago principally due to our continued underwriting discipline in the face of a softening market and a related trend among primary companies to retain a greater share of business in our reinsurance segment. Our balance sheet is very strong and we expect to be well positioned to respond to market changes as they arrive.

Post merger, Alterra has less leveraged in both assets and reserves to equity. Our recent public tenure senior note offering added some financial leverage and flexibility to our balance sheet and our debt-to-equity ratio remains below our peer group average.

For the third quarter of 2010, our reported net operating income was 76 million or $0.64 per diluted share compared to net operating income of 53 million or $0.92 per diluted share last year. Fully diluted book value per share was $25.88 up 5.4% for the quarter with booked value growth of 7.4% if you include our held the maturity asset portfolio.

On a reported basis, our overall property and cash, the gross premiums grew 21.9% in the third quarter to 324 million. However on a pro forma basis, including Harbor Point premiums in 2009, our overall property and cash the gross premiums written were down 15% for the quarter and 6% year-to-date. Our insurance segment produced lower premium in 2010 and then in 2009 reflecting the continued competitive market conditions. Our excess liability, professional lines and aviation premium have declined both in the quarter and year-to-date.

Property lines premium was modestly higher. Rates remained under pressure with declines of between 3 to 5% in our excess liability class on business we renewed and professional lines D&O rate decreases have accelerated to near 10% while E&O and EPL rates are showing positive momentum and are now modestly up. Property rates on the other hand have effectively reversed the increases of 2009 and in the third quarter were off close to 15%. Aviation rate declines range from 6 to 8% with aerospace on the high end.

We believe we have effectively protected our underwriting margins even as the top line has declined. All four of our property and casualty underwriting segments produced favorable underwriting results with a consolidated third quarter combined ratio of 86% and it was even 97% excluding reserve releases. We are somewhat surprised as the seeming complacency in our industry at the moment regarding price, present market pricing combined with historically low investment yields will make earning a true double digit ROE extremely challenging and traditional 15% ROE targets unrealistic, absent an unusually fortuitous last year.

The temptation to stretch or reach for a magic bullet by lowering underwriting standards, entering more risky classes of business without sufficient internal knowledge or stretching for yield by lengthening duration or adding non-traditional asset classes generally has not worked out well in the past. The good news is these conditions cannot persist forever. In the interim we are and will remain committed to disciplined underwriting and investing in high quality assets. Further if present share price levels continue, we expect it to continue to be a meaningful repurchaser of our shares given the strength of our balance sheet and the quality of tangible book value per share.

Through these softer market conditions Alterra has expanded our global footprint while maintaining attractive underwriting margins and adding minimal goodwill to our balance sheet. Looking back four years ago, the old Max Capital wrote over 800 million of premium, had three offices in three countries. This year on a pro forma basis, Alterra is on target to write over 1.8 billion of premium from 19 offices in 11 countries.

We are extremely pleased with the early results of our expansion into Latin America and the continued strong performance of our late 2008 acquisition at Lloyd’s. When combined with the quality underwriting teams from our recent merger, we now have proven insurance and reinsurance capabilities in Bermuda, Dublin, London, the US, with Latin America being focused solely on reinsurance. This expansion has added significant management and industry expertise to our organization, and we are better positioned to capture rate and market opportunities wherever they may arrive.

Today reinsurance is 60% of Alterra’s gross written premium. Let me now turn it over to John Berger, the CEO of our reinsurance operations to discuss the current trends in this marketplace.

John Berger

Thank you, Marty, and good morning. The reinsurance market remains challenging, with strong economic headwinds and seeding companies continue to retain more of their business and buy less reinsurance. In addition, we are seeing a continuing deterioration of underlying rates. For many lines of business this will be the fifth consecutive year of rate decline.

Our reinsurance business is comprised of a portfolio of 12 lines of business. Of the 12 lines, we are only seeing positive rate movements in marine and energy and workers comp and the rate increases there are not more than 5%. Everywhere else rate declines range from 1 to 3% in agriculture, auto and aviation to a reductions of 6 to 8% and general casualty and professional liability. Medical malpractice rates declines are in excess of 10% and property climbs are now double digit nearing 15%. Faced with this dotting scenario, our resolve remains strong. On a pro forma basis, reinsurance premiums were down 41% in the third quarter and declined 16% year-to-date. I expect this downward trend to continue as our pro forma 2010 gross written premium will be lower than 2009.

However we do remain committed to our long term relationships and we place a great emphasis on protecting our renewal business. Good new opportunities remain hard to find although underwriters are actively searching for them. Most importantly, our resolve remains strong to obtain the appropriate margins for the risk we are taking as we have demonstrated if we have to reduce writings we will.

The integration of the Max and Harbor Point reinsurance underwriting operation is complete and has gone very smoothly. The personnel and books of business are complementary and we've had virtually no fallout either fund.

With that, I will turn it over to Joe to review the financials.

Joe Roberts

Thank you John and good morning. To assist readers in modeling our financial statements when they are making more meaningful comparisons to prior period results. We've included in our financial supplements, a set of pro forma financials broken out on a quarterly basis as though the merger had been completed on January 1, 2009. As a reminder to all, these are unaudited pro forma financials that are being provided for information purposes only.

Alterra's overall gross premiums written from property and causality operations in the third quarter increased 22% to $324 million. As Marty indicated, this growth primarily reflects the inclusion of Harbor Point premium for the first time as well as 30 million generated by our new team in Latin America. The business in Latin America is new to us, but essentially a renewable portfolio for a highly experienced underwriting team and relatively small comparative business day written in the past. 90% approximately of this business is in the short tail lines of business.

The mix of our overall business has shifted to 51% short tail and 49% long tail from 40% short tail and 60% long tail in the third quarter of 2009. Our underwriting results remain solid across the open addition with a third quarter of 2010 combined ratio of 86%. Favorable reserve development in the third quarter was $36.4 million reducing our combined ratio by 10.6%. Property to tax free and significant pro-risk losses were $14.1 million mostly from the New Zealand earthquake.

Turning to our insurance segment. Third quarter gross premiums written declined 70.3 million from 81.1 million in 2009. In a tough underwriting environment we remain pleased with our strong renewal retention and our positive development on prior year reserves. The combined ratio for our insurance operations was a favorable 56.5% in the quarter compared to 80.2% in the prior year. The improvement reflects favorable development on prior reserves reducing the combined ratio by 32.2 points and primarily rate to the professional liability lines of business in the 2005 and the 2006 underwriting years.

Reinsurance gross premiums written for the quarter were a 124 million, up from 94.1 million in 2009. The increase reflects the inclusion of the Harbor Point reinsurance portfolio. However on a pro forma basis, premiums were approximately 41% down in the third quarter and 16% down year-to-date. Our largest decline in the portfolio related to worker’s comp, professional lines, general casualty and medical malpractice, largely due to reduced line sizes and increases in private pensions.

In worker’s compensation we had a downward premium, an adjustment of $10 million in the quarter, totaled by a reduction to the lawsuit on a contract for a similar amount. We also did not renew a contract representing $22 million of premium in the quarter. We wrote $19 million of business in Latin America in the quarter and had modest increases in the credit/surety and property lines business.

As market conditions have dictated, we have reduced our writings of longer tail lines in favor of shorter tail products, further returns are more attractive. Despite lower premium volume, we have maintained favorable levels of profitability. We have a third quarter combined ratio of 91.1%.

Property, cash and other significant pro-risk losses were $11.6 million in the quarter, principally from the New Zealand earthquake. On a reported basis, favorable development on prior year reserves reduced combined ratio by 7.2 points for the third quarter. Favorable development was primarily in the workers comp and general casualty lines of business for the 2004, 2006 underwriting years.

Turning to our Lloyd’s operations, gross premiums written rose to 57.7 million, compared to 21.1 million in 2009. Higher premiums in the quarter reflect new business written from regionally higher teens. We wrote $12 million of business in Brazil and our international casualty business contributed $9 million. Gross premiums written also reflect the transfer of aviation business to Lloyd’s that was previously written in our insurance segment in Dublin.

Generally, the market is softening with rates continuing to fall in most lines of business by approximately 5% year-on-year. The exception is this financial institutions business where rates remain approximately 2 to 3%.

The third quarter of 2010 combined ratio was 90.4%, compared to 84.2% in the prior year. The loss ratio deteriorated to 48.1% from 40.8 in the third quarter, the higher loss ratio reflecting the addition of international casualty and aviation through our business mix.

Favorable development improved combined ratio by 12 points and was primarily in our financial institutions from the professional liability line. Catastrophe and other significant per losses were $3 million in the quarter. Our US specialty gross premiums written grew 3.6% to $72 million in the third quarter, compared to $69 million a year ago.

Growth in our professional liability line added for the first time this year, offset by flight declines in our general casualty and marine lines of business as the market continues to soften. The combined ratio improved to 95.4% in the third quarter, compared to 99.7% in 2009. Our loss ratio improved to 62.6% from 68.4 a year ago. There were minimal reserve relations in this year’s third quarter, compared to adverse development of 9 points in 2009. Our overall expense ratio was 32.8%, compared to 31.3% in the 2009 period.

Our G&A expense ratio improved to 19.4% in the third quarter from 25.1% a year ago, principally by adding additional net premiums earned. The up-tick in our acquisition cost ratio up to 13.4% from 6% a year ago due to lower overwrite commission as we’ve retained more of our business and ceded less to reinsurers. That’s part of our strategy to retain more risk in the lines of the business that we are seeing better long-term potential. That investment income was 59.7 million for the quarter at 39.4% increase compared to prior year. The increase includes income from the additional cash and investment assets resulting from the merger and also a shift from our fixed income securities that were previously in cash.

In the third quarter, our hedge funds produced a 4.8 million gain or a return of 1.35%. Our annualized investment yield on cash and fixed maturity portfolio was approximately 3.23% for the quarter compared to 3.35% in the prior quarter and 3.53 for the same quarter a year ago. The duration of our cash and fixed income portfolio is 4.1 years.

Historically, the yields on Harbor Point fixed income portfolios has been lower than that of Max due a shorter liability duration. Consequently our combined yield declined due to the addition of these lower yielding securities. It is worth noting that if yields continue to decline, it will have a significant impact on 2011 results. To put this into some context, we estimate a decline in our book yield of 10 basis points equates to approximately 7 million in annual income or approximately $0.06 per share.

We have no plans to sacrifice the high credit quality of our investment portfolio in order to chase higher yields. Turning to our balance sheet and capital management. We ended the quarter with over 3 billion in shareholder’s equity. Book value per diluted share was 25.88 at the end of the quarter or 5.4% from June 30, 2010.

Including the unrecognized change in fair value on our held to maturity portfolio, book value would have increased by an additional $0.47 in the quarter or resulting in a growth of 7.4% over the prior period number.

Year-to-date including yesterday’s dividend declaration, we have declared $351 million in dividend and have repurchased $113 million of our common shares. In aggregate we have returned capital shareholders of over $460 million or more than 15% of our pro form opening shareholders equity. Going forward we believe that share repurchase will continue to be upfront towards the managed excess capital levels. With that, yesterday our Board authorized an additional $200 million to share repurchases, bringing outstanding share repurchase authorization of the $223 million.

With that, I’d like to turn it over to our operator for any questions.

Question-and-Answer Session

Operator

(Operator Instructions). And the first question comes from Josh Shanker with Deutsche Bank. Please proceed.

Josh Shanker - Deutsche Bank

A couple of questions. First one involves the $200 million share repurchase, and just thought of using that for open market transactions versus one-off sort of negotiated transactions given the news for lock-up coming to an end.

Joe Roberts

We're really flexible on any mains Josh. We will be in the open market once our window opens. We obviously have been open to doing some block trades this year and have done a couple which we have announced. In addition to that, we like the ability to use the 10b-5 programs. So you'll see some combination of all of that from us.

Josh Shanker - Deutsche Bank

And to the extent which I realize you can't say too much, but have you been reaching out to potential shareholders who might be interested in the block trade or do you wait for the shareholders to come to you?

Joe Roberts

We've not had any formal program of reaching out.

Josh Shanker - Deutsche Bank

Okay, and second question is for John, I'm wondering may be you have some thoughts about the renewal season. One of the comments was that which we found to be off the case that we see a lot of decreased sessions of risk. Do you think that price and good come to a level during the 1/1 renewal season where primary it's to be more prone to CD but not because it's not for charity, because they actually are finding their prices attractive at this point in time.

John Berger

Josh, you'd certainly think that that would be the economically correct thing to do. We're seeing very little of that. I think people are still really focused on their top line and CD more reinsurance right now, I don’t think is going to be a common theme.

Operator

And the next question comes from Jay Cohen with Bank of America Merrill Lynch. Please proceed.

Jay Cohen - Bank of America Merrill Lynch

I guess a question on capital and buybacks. The question is, are you limited with your buyback activity just given the level of your shareholders equity. In other words would you be able to buyback stock maybe to bring your equity even down below 3 billion. And was the buyback more than your earnings.

John Berger

We would have no constraints mathematically or regulatory to doing that Jay

Jay Cohen - Bank of America Merrill Lynch

Okay and then I guess from a catastrophe standpoint and maybe in the supplement I could have missed it, but you are say one in one hundred and one in fifty PML relative to your shareholder’s equity, where do you stand now and what kind of constraints are there from that standpoint.

John Berger

Of course all of your rating agency models have you factor in the one in 250 of them through various scenarios, so whenever you are looking at your capital, you are pretty well funded for the worst of the worst I guess is what comes in. Our present levels are not much different than they have been for the past year. We are about 11% of opening equity expose 101 in a 100 and about 18% of opening equity exposed on our 1 and 250.

Jay Cohen - Bank of America Merrill Lynch

And the last question, the company has been acquisitive in the past. That is clearly something that you can do with your excess capital. I imagine hard to find something to beat your own stock even where it is trading, but are you interested in deals and then secondly are you seeing more potential deals to do, you are just seeing more deals out there in the market?

John Berger

We have proven our self to be builders, so you are always open to opportunistic situations whatever they maybe, whether attiring teams or whether in fact it is a transaction. In the current market, recruiting talent of people has generally been more cost effective transaction than most M&A, but as the cycle continues to lengthen, you are seeing and as higher expectation, you are going to see M&A pick up. And, we’ve got a wonderful platform here with a very strong balance sheet and the talent of a group of people and we expect to continue to building it.

Operator

And the next question comes from Dan Farrell with Stern Agee. Please proceed.

Dan Farrell - Stern Agee

Can you just remind us the lines of business within the Latin America reinsurance platform that you are growing in currently?

Joe Roberts

Sure Dan. I would say that probably 70% of the business is in property. We have about 15% in surety. We do some marine, a little bit of motor and a little bit of general of the liability, but property and surety will be the biggest lines. And that would be approximately 50% in Brazil and 50% outside of Brazil.

Marty Becker

And Dan, that is somewhat of a reflection of what the market is down there.

Dan Farrell - Stern Agee

And then also, can you just comment on what your view is for your own purchases of reinsurance for 2011 and what you think your premium retention might be, and maybe if you could touch on each of the segments, your insurance specialty and then also the (inaudible) business?

Marty Becker

We probably take a little contrarian point of view to what John was expressing. We are seeing from many of our (inaudible) and that our view is that this stage of the cycle, as long as you can obtain attractive terms and conditions is a pretty attractive time to buy reinsurance economically. So, I think you'll continue to see our retention levels for 2011 mirror somewhat closely our retention levels for 2010.

Joe Roberts

It's probably worth saying though on the reinsurance business that we have, typically the legacy Harbor Point folks retained a little bit more of their business than the Max folks did. So I think you may see the retention as long as the aggregate go up a little bit there and in addition Dan you may recall in the second quarter of this year, on our specialty business that we started to move to retain a little bit more of that business, so I would expect that to continue, we'll CD out a little less next year than we did this year but we put that in place in the second quarter where we're seeding out a little less.

John Berger

On the specialty booked, early on we had bought a pretty low level point share program that (inaudible) was developed we thought it was more economic to keep. So that’s the adjustment you're seeing there.

Operator

And the next question comes from Mark Dwelle with RBC Capital Markets. Please proceed.

Mark Dwelle - RBC Capital Markets

You had commented in terms of Alterra Lloyd’s that some portion of the business volume there was the transfer of the Dublin Insurance. Can you say how much that was?

Joe Roberts

It was actually our aviation and it’s a small piece. We had a team of aviation underwriters who were principally operating out of Dublin on our insurance portfolio and some of the opportunities were better placed in Lloyd’s so we moved approximately half the business across the year. We don’t write a ton of premium over there.

Mark Dwelle - RBC Capital Markets

So if then if that wasn’t a very substantial portion, was there something timing wise or otherwise that caused the premiums there to jump so much year-over-year?

John Berger

Well there are two main drivers of the growth in Lloyd’s is first of all, the Brazil portion of Latin America is all recorded through our Lloyd’s platform. We are underwriting in Brazil through Lloyd’s’ satellite operation in Rio. In addition to that we have been on a concerted effort to add teams to the Lloyd’s operation and some recruiting that we did in late 2008, early 2009 after (inaudible) has actually positively impacted 2010. We have brought over a very high quality international casualty team. We brought over an accident and health insurance underwriting group and then we did add to our own financial institutions area with some additional talent, you should remember that in Lloyd’s all of this is non-US business in those categories.

Mark Dwelle - RBC Capital Markets

But on the reinsurance segment, John you had commented in terms of all the various rate pressures and then at the same time trying to maintain your longstanding relationships, is that, re-incurring the lines is that point to using more retro or something like that in order to be kind of keep the relationships, but not necessarily the exposure. No historically, the Harbor Point side bought very, very little reinsurance and the Max people bought more and that the majority positions were still retained. Over the years you develop more respect for some of your seeding companies than others, when you see people maintaining their discipline, reducing where they should reduce, really fighting every day to maintain the quality of the report. You try to maintain that relationship as long as you can.

Operator

(Operator Instructions). And a follow-up question from Jay Cohen with Bank of America Merrill Lynch. Please proceed.

Jay Cohen - Bank of America Merrill Lynch

Just as a short numbers question. In the reinsurance segment, there were several lines where you reported negative gross premiums, active culture which I think I understand, but also medical malpractice. And I’m wondering if you could just give a quick explanation why that was?

Joe Roberts

With reinsurance Jay, we typically have some adjustments that come through later in the year, and I also know there was one in workers compensation, whereby a particular large one there where we had, I was looking in the loses which will be the corresponding result in premiums. So, you’ll see more in the reinsurance division than in any other division, because you tend to have obviously more treaty business than you have more quarter share and estimates used in that segment. So you will see from time-to-time adjustments coming through the quarters.

The other thing to mention on agriculture is typically written in the first half of the year. So you typically only see it just in the second half of the year.

Operator

And that concludes our question-and-answer session today. I’m going to turn the call over to Marty Becker for closing remarks.

Marty Becker

Thank you very much operator, and we especially appreciate each of you taking time during this busy season to be with us on our call. We're very bullish on our platform and what we've done in the combination of our two companies to create Alterra, we look forward to talking to you next quarter. Take care.

Operator

Thank you for joining today's conference call. That concludes the presentation. You may now disconnect and have a great day.

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