Argo Group CEO Discusses Q3 2010 Results - Earnings Call Transcript

| About: Argo Group (AGII)

Argo Group International Holdings, Ltd (NASDAQ:AGII)

Q3 2010 Earnings Call

November 03, 2010 09:30 a.m. ET


Michael Russell - Director, IR

Mark Watson - President & CEO

Jay Bullock - CFO


Amit Kumar - Macquarie

Scott Heleniak - Royal Bank of Canada Capital Markets


Good day ladies and gentlemen and welcome to the third quarter 2010 Argo Group Earnings Conference call. My name is Francine, and I am your operator for today. (Operators Instructions).

I would like to now turn the presentation over to your host for today's call Mr. Mr. Michael Russell, Director of Investor Relations, you may proceed sir.

Michael Russell

Thank you Francine and good morning, welcome to Argo Groups conference call for the third quarter of 2010. On the call today is Mark Watson, Chief Executive Officer; and Jay Bullock, Chief Financial Officer. We are pleased to review the company's results for the quarter as well as provide management's perspective on the business.

I would like to remind you this conference call is being recorded. Following management's opening remarks, the operator will provide instructions on how you may queue in to ask questions.

As a result of this conference call, Argo Group management may make comments that reflect their intentions, beliefs and expectations for the future. Such forward-looking statements are qualified by the inherent risks and uncertainties surrounding future expectations generally and may materially differ from actual future results involving any one or more of such statements. Argo Group undertakes no obligation to publicly update forward-looking statements as a result of events or developments subsequent to this conference call. For a more detailed discussion of such risks and uncertainties, please see Argo Group's filings with the SEC.

With that, I'd like to introduce Mark Watson, CEO of Argo Group, Mark.

Mark Watson

Thank you, Mike, and hello everyone. We appreciate you taking the time to join us today. In a moment, our Chief Financial Officer, Jay Bullock, will provide you with additional financial details for the quarter, and then we'll take your questions. But for now I would like to just make a few general remarks.

Argo Group reported positive results for the third quarter despite continuation of the challenging market environment and another major earthquake occurring during the three month period.

We generated diluted earnings per share of $0.77 and net after tax operating income per share of $0.69. Results for the quarter ending September 30 produced record book value per share $58.38, which was up 6.5% from June 30th and up 14.2% over the last 12 months.

Items of note during the quarter included the earthquake in New Zealand, continuing a trend of significant though isolated 2010 events affecting financial results in each of the first recorders. For the insurance market place these events individually or taken in total have lacked the significance to produce a meaningful impact on the industry capacity or pricing, but have been significant enough to measurable impact financial results.

Or to say it differently, we keep having a number of event hit us during the course of the year. Unfortunately because they seem to happen sequentially instead of all at the same time, none of them seem to be enough to move the market.

Our exposure to the New Zealand quake was both in our reinsurance and international specialty segments resulting in total net losses of $11.3 million or 3.9 points on our third quarter combined ratio of a 101.3.

During what can be a cap row in third quarter, we experienced a benign hurricane season in both the Atlantic base and in Gulf of Mexico with no major storms hitting the US coastline. Our excess in surplus lines and commercial specialty businesses both generate sub 100 combined ratios, which in the current environment reflects the scrutiny of our underwriters have embraced in selecting businesses they believe will produce profitable margins. As was the case during the first half of the year with decline in written premiums in the third quarter was a logical reaction to intense competition writing business was as easier as unrealistic levels.

Additionally, our lower top line reflects the planned reduction in certain classes within the international specialty and commercial specialty segments. As our top lines continue to decline we have been squarely focused on the advocacy of our capital position.

In reaction, we have continue to return capital to shareholders through share repurchases and payment of cash dividend. Year-to-date we have repurchased $81.5 million or 2.6 million shares of our outstanding common stock. In the first nine months of this year our Board has approved total cash dividend payments of $0.36 per share.

Given our strong financial position, combined with a highly competitive market environment. Our current business strategy revolves around three primary tenants. First we are streamlining our infrastructure by realigning some of our business units to better position how we go to market, interact with our distribution partners and be more responsive to customer needs and I will talk more about that in just a minute.

This includes more effectively leveraging available technologies that reduce the cost of doing business and make our platform more efficient overall.

Second, as we pursue our top line growth objectives we are judiciously deploying available capital in new areas of the market, those were which we believe will produce the highest returns.

This element of our strategy often is investing in the new underwriting team that understands the industries and risk profiles of business they pursue and benefit from the resources of our international platform and have demonstrated a track record of success and I would again just point out that over the last two years we have spent a fair amount of our time attracting new talented people to our company in lieu with making acquisition.

It isn't but we have been looking for them but we think that with the platform we have today we finally have an opportunity to grow organically as well as we do through M&A and then third we are renewing our focus initiatives.

As we work to secure a profitable market position across our existing platform. We are directing our attention and resources on understood market niches, those that call the potential load for producing near term upside while expanding our business reach for the long term.

This improves expanding our geographic footprint as well as in addition innovated products and programs that better meet the needs of our insurers.

Let me talk about each business segment in a little bit more detail, again I will leave a lot of the financial metrics to Jay and his part of the presentation. Overall, the performance of our U.S. business segments improved in the third quarter compared to the same period a year ago. Although it's fair too early to call a bottom we have seen over the course of 2010 and a moderation of rate declines in the U.S. with selected site improvements and pricing quarter-over-quarter for certain product line.

Doesn't mean I am optimistic it just means that I think we are starting to see things moderate. Having said that, the Excess & Surplus Lines marketplace continue to experience a highly competitive environment.

Our E&S segment produced slightly improved operating results in the third quarter but written premiums were down meaningfully. Much of this decline is a result of the market conditions that I have mentioned on previous calls including the state of the U.S. economy resulting in a lack of startup as well as business closures in our typical customer base.

Standard line carriers expanding their risk appetite and writing accounts in what have traditionally been E&S territory. Retailers going direct whenever possible, new entrance emerging into the E&S marketplace still and our discipline to turn away from unprofitable business. It really is the combination of all of these.

Given these factors we expect the competitive market for E&S to continue. With that backdrop we've made adjustments to remain competitive. We are furthering our penetration in the profitable business classes and geographies while exiting un-performing classes.

Significant in the third quarter was our combination of Colony and Argonaut Specialty into Colony Specialty, the formation for which we announced in early October. So this again is what I was talking about earlier in terms of some of our reorganization of our business and streamlining it.

This new entity allows us to maintain the respected Colony brand and makes it easier for our wholesale distribution partners to access our more simplified line of products. Internally the realignment makes us more nimble so that we can quickly respond to customer needs and changes in the marketplace.

It promotes efficiencies within our E&S operation and better leverages the strength of the entire Argo Group platform. Finally E&S President, Lou Levinson, has named a very strong and experienced team to lead E&S, which we also announced in October.

As regards to our Commercial Specialty segment, with market conditions as they are, our admitted business has performed well in the third quarter. Commercial Specialties rich selection has produced a combined ratio of 93.7% in Q3 with prior year losses developing favorably.

Lower written premiums for both renewals and new business reflect intense marketplace competition and the impact that the continued sluggish U.S economy is having on the small to medium sized businesses. National and regional carriers continue to lower pricing and using terms and conditions to keep renewals and acquire new business.

However we have reason for optimism in some commercial specialty niche markets. For instance the outlook is positive in the coal mining and grocery store inventories. Further we haven't seen demand for public entity coverage changing even though state and local governments have curtailed spending.

Internally our Commercial Specialty segment has fostered a culture of innovation and creativity aimed at increasing written premiums ensuring that risk selections meet margin requirements and improving loss selections. We also have implemented IT solutions that streamline policy administration, claims and billing and we continue to do more of this in the fourth quarter and all of next year.

Let's move onto our Bermuda and London based segments. The reinsurance segment in Bermuda which includes our casualty and professional risks businesses reported positive results in the third quarter. As I mentioned earlier in my remarks the segments results were impacted by the New Zealand earthquake and sustained $5.8 million in net cap losses.

The segment produced $8.4 million in operating profit including favorable prior year loss development of $2.6 million. The combined ratio for the third quarter was 72.2% which includes 23.4 percentage points due to Cat losses. In the reinsurance market competition for third quarter renewals intensified with new competition moving into the space. However Argo lease client retention remained high.

The increase in the re-insurance segment's written and earned premiums over the last year's third quarter was primarily due to business written by our casualty and professional risks business. Finally, in our international specialty segment, I am pleased that the work we've done over the last several quarters is starting to produce better underwriting results. The improvement in the third quarter however was overshadowed by the effects of the New Zealand earthquake which produced $6.1 million in losses. The net effect of Cat losses or in International Specialties third quarter loss ratio was 7.4 percentage points on a combined ratio of 106.9.

As we mentioned last quarter, International Specialty's reduction in written premium is due primarily to a planned reduction of the property book, both the binder book and the direct and facultative book. We reduced our volatility and we gun to add diversifying classes in business, typical of the Lloyd's market.

For 2011, we believe the segment's book is right sized with an acceptable risk profile and I remain optimistic about the potential of our Lloyd's operation for the coming years.

With that, I'll turn the call over to Jay.

Jay Bullock

Thanks Mark. I'll take a few minutes to add some additional detail on the quarter and after that we'll take your questions.

Consistent with our comments over the last several quarters, market conditions for both our underwriting and investment businesses remain quite challenging. We continue to focus on intelligent use of our capital, responding accordingly to the market with reductions in our underwriting businesses while investing in new underwriting teams, modest reallocation of our investment portfolio and return of capital with shareholders.

These actions are reflected in a period-over-period reduction in gross written premiums of approximately 20%, a sequential although modest increase in net investment income despite the continuing decline of portfolio yield.

The realization of approximately 9 million in gains from the investment portfolio in the quarter and almost 29 million for the year-to-date and in the return of just over 92 million in capital to shareholders during the year.

The resulting financial impact is a continued increase in our book value per share which is compounded at an annual rate of 12.5% since 2002. We continue to view this as a compelling track record over a period of time which included significant industry wide loss events and the most challenging economic environment in recent memory.

Our performance highlights our focus on risk management and generating long-term shareholder value. Now, I would like to add to Mark's comments, regarding commentary on our operating performance by segment in the third quarter of 2010.

In the Excess and Surplus Lines segment, the decline in premium was driven by intense competition and by underwriting the actions taken in our casualty division and the repositioning of some of our property exposures in this book.

We reported positive prior year development of 1.5 million for the quarter, and have reported 9.3 million, a positive development year-to-date.

Our E&S segment was not impacted by any significant catastrophe activity in the quarter. In Commercial Specialty, the decline in premium is largely a function of increased competition in our public entity business. The exit late last year of certain classes in Argo Select, mainly religious institutions and hotel, motel, risk, offset by increases in our mining operation and our surety business.

In this segment, we reported positive, prior-year development of 1.9 million, mainly from our mining operation and have reported positive prior year development of 5.4 million for the year-to-date. Likewise, the segment did not experience any losses related to the storm activity occurring during the quarter.

Consistent with our communications last quarter, the premium written in our International Specialty segment reflects the planned reduction of certain property classes and the significant competition in our direct and facultative market.

Further distorting the decline in premium however is the fact that the 2009 period result included 40 million in additional gross written premium, related to property binder business, stemming from late reported premium, from prior periods.

Prior-year development for the quarter was negligible, at positive 800,000, offset by prior-year negative premium development of 3.5 million. As Mark mentioned, the segment did experience a loss from the Earthquake in New Zealand of approximately 6 million.

In the reinsurance segment, we saw an increase in premium, primarily related to the continued development of our Excess Casualty business as well as an increase from a third party relationship we have in the Middle East region.

Prior year development was positive $2.6 million, as the most recent accident year continues to develop favorably. So for the quarter for the group in total prior year reserve development was favorable at $3 million year-to-date we stand at approximately $26 million of favorable prior year development.

In addition to our quarterly review of prior accident years, our reviews always incorporate a look at current accident years as well to make sure we are responding appropriately to changes in business, the eternal environment and market conditions.

We continue to focus our attention on infrastructure and have several initiatives underway which we expect to have a meaningful impact on the expense ratio in the future. These initiatives however continue to require investment in system and process redesign in the near term.

Now let me comment on Argo's investment results, the global trend in year of decline continued in the quarter. Argo's investment income for the third quarter however increased slightly to $33.6 million from $33.2 million in the second quarter and $31.9 million in the third quarter of 2009. This result was achieved by a modest re allocation of the portfolio in the first nine months of the year, to credit and to a lesser extent on high yield credit.

Total return performance for our portfolio was 2.9% for the quarter and 5.4% year-to-date, supported in part by strong performance in out equity allocation. The book yield on our fixed income portfolio decreased slightly during the quarter from 4.1% to 3.9%. The duration of our portfolio has not changed significantly and was approximately three slightly shorter than our expected liability duration.

Argo's investment portfolios remain conservatively positioned with a weighted average rating of AA and with 91% of our assets in total invested in investment grade bonds.

Argo's unreleased gain for the third quarter increased to $268 million, up from $180 million at the end of the second quarter. This appreciation reflects the decline in real and absolute yields during the quarter. Our portfolio generated $9 million in net realized gains for the quarter coming from the number of our different strategies.

We continue to believe our conservative investment strategy provides us flexibility to take advantage of investment opportunities as they arise. Other than the repurchase of common stock which we have mentioned there was no material change to our capital structure in the quarter. But we find the composition of our capital base provides us flexibility and we believe that as a group, we remain well capitalized.

Operator, that concludes or prepared remarks and we are ready to take questions.

Question-and-Answer Session


Yes sir, (Operators Instructions). We have a question from the line of Amit Kumar of Macquarie.

Amit Kumar - Macquarie

Thanks and good morning. Just going back to the discussion on -- on you're -- on the market conditions; I get the sense that you're more pessimistic than a large specialty company. That company had in fact noted that audit premiums were turning positive and standard lines and new entrants had started reducing or exiting the movement from E and S and what I'm hearing today from you is that it's as bad as it was in the past few quarters. Can you just expand on that a bit more? You know, is it a function on the specific segments or is there something else going on?

Mark Watson

Well, actually I'm not sure that -- that our comments are that inconsistent. I think you've now seen signs of being at the bottom of the market as opposed to getting to the bottom of the market. I'm not more pessimistic today than I was last quarter or the quarter before.

I'm probably and slight more optimistic actually. I say that because we are seeing some of the same things which is, we're seeing rates flattening out. We are seeing some competitors exit the E&S marketplace either completely or by line adjustments.

Having said that, we are still seeing new competition coming into the marketplace. I'm not sure the best nets this early offsetting those that are exiting. But so far, the companies that had exited the business are either very small or they're just – the larger they're exiting a particular line of business.

I think that you're going to start appearing next commentary from a number of us over the next few quarters as we bump along the bottom of the cycle but I think that we have kind of flatten out but we flattened out at the bottom right, that doesn't mean things are moving up and so I just -- well, I think this don't appear to be declining. I don't think that investor should think that means at all of a sudden hard markets here and things are moving. So I'm airing on the side of being cautious in my comment.

Amit Kumar - Macquarie

And this new entrance, who are these? Are these public companies or are these non-public companies?

Mark Watson

Most of what I've seen coming in this has been small non-public companies that has been quietly setting up for the last year or two, or a new start ups within existing public companies.

Amit Kumar - Macquarie

Okay. Thanks, that's actually quite helpful. Secondly, in your opening comments you mentioned that you are streamlining units and I'm just wondering would there be any pack on expenses going forward from doing that?

Mark Watson

I think the answer is yes. I mentioned in my remarks earlier today that we had streamlined a fair amount of our Excess and Surplus Lines operations that went to a negligible expense front. As we continue looking at ways to consolidate many of our back office operations at a good level, so not just within E&S. I think that in a short while that will lead to additional expense.

Obviously, we wouldn't do it if we didn't think they were long-term gains should be had and I think that as we become a little bit closer to doing some of these things, we'll have more to say on our earnings call at the end of the fourth quarter.

Amit Kumar - Macquarie

Okay, that's actually quite helpful. Just moving on and then I'll be in queue. In terms of this start up here overall premium picture, if I – so what you're saying is that E&S will likely be down for '11; Commercial Specialty would like be down, regions could be flat from that Excess casualty and International Specialty will also be down. Is it fair to say that in 2011 premiums might be down maybe mid-single digits and maybe also can you talk about that and maybe minus regarding your stand capacity for Lloyd's.

Mark Watson

So, I think it's possible that premium will be down next year depending up on market conditions because again we are slow at the bottom of the market.

I think we have to keep in context that while part of the decline this year is a function of competitive market place that a significant amount of the decline in premium was intentional and I think we also need to keep perspective that during 2007. 2008, 2009 when many of our competitors were holding flat and/or declining their premium base, ours grew rather dramatically.

And so 2010 has been a year to reset the risk that we have on our portfolio given market condition and I think with that done I think we look for 2011 to be probably flat from 2010. It's possible that any one of the segments can see a single digit decline in premium. It's also equally possible that we could see an increase in premium.

It wouldn't surprise if our London, it wouldn't surprise if the syndicate actually grew premium double digits.

Our staying capacity at Lloyd's is 350 million sterling. We originally were planning to reduce that to 325, but given some of the opportunities that we believe that we will be able to execute on a 2011, we are actually going to keep the staying capacity flat.

So a lot of the initiatives that we have been working on the last couple of years to grow even in this market are starting to take hold and so I think it's likely that you would see it's growing next year as declining but again some of that is going to be dependent up on how competitive the marketplace is.

Amit Kumar - Macquarie

Okay that was helpful. That's all for now. Thanks so much.


(Operator Instructions). We have a question from the line of Scott Heleniak from Royal Bank of Canada Capital Markets.

Scott Heleniak - Royal Bank of Canada Capital Markets

Hi, good morning. Just wondering investment income was up for the quarter I guess it was about the first time that it was up about five quarters and I know you guys are doing some repositioning there. You mentioned credit and higher credit.

Just wondering is that completed or should we expect that to continue over the next couple of quarters and do you think it will be enough to generate positive investment income growth for next year?

Jay Bullock

I guess there is kind of rallying one is we are taking a modest part of our portfolio and as an example just how modest it is so we just kind of size it for everybody. The portfolio is about 4 billion, we allocated a 100 million out of that 4 billion to high yield but that was taking something that was otherwise generating. We actually took most of it out of our equity portfolio. So generating a 2% dividend yield to something generating a 6% or 7% coupon has a pretty immediate and meaningful impact on investment income.

So there are couple of other strategies that were in the process of moving towards that would be more income oriented and have slightly better yield than what we are getting on the core portfolio.

But I don't think that you will see, certainly you want to see a change in overall quality and probably won't see much a change away from it through 90% total investment grade bond number that I mentioned.

So, that's one thing that we are doing to try to offset it. The kind of really wind is that quarter-over-quarter the portfolio yield continues to get down. Our durations through years, yields are down. New money yields are down around 3% right now. Roll the clock forward for everybody and, in 18 months if the world hasn't changed we will be, our portfolio yield would have gone from 3.9 to 3 as the math would take you there.

So, we are doing what we think is prudent, we are paying a lot of attention to the capital that we allocate to various strategies so the rest of any sort of risk relations that are there and I think the things that we are doing are modest.

We are seeing some benefit from that but we got this other pressure on the portfolio and we will see how long it takes for us now how long it takes for the market to change and start to get over the tail end.

Scott Heleniak - Royal Bank of Canada Capital Markets

Okay but do you expect to do more of that in the fourth quarter though if reallocating some of the capital to the higher yielding investments?

Mark Watson

The answer is yes, it's in $50 million increments in total. If we had at the start of this year 250 million in our equity portfolio and the rest of the investment grade bonds at the end of this year we will have in round numbers 400 million in equity and higher yield in fixed income.

However, that might -- whatever form it might come in and the rest in investment grade bonds. So not a significantly shift.

Jay Bullock

And also with the global capital markets debt end equity moving around so much I think there is going to be continued repositioning in the portfolio every quarter next year.

Scott Heleniak - Royal Bank of Canada Capital Markets

And then next question is just on the E&S segment, the premiums were down pretty significantly and I know you guys mentioned in commercial specialty that there are two particular areas that religious institutions in hotel, motel business. Were there any specific areas in E&S that were similar, you may have really paired back or existed any particular class this year or last quarter that drove that decline?

Jay Bullock

We pulled back substantially in our excess causality booking business particularly our transportation exposure and I think we'll continue to see that perhaps not the same magnitude but we will continue to see some of that in the fourth quarter of this year. I would not expect to see a lot of that in 2011.

Scott Heleniak - Royal Bank of Canada Capital Markets

Okay. The only other question I have was just international specialty just wondering if you can give just some quick detail on the reserve building there of $3 million, any particular class or was it several different classes or just any more color on that?

Mark Watson

Just to be clear so that the positive development was 800,000 offset by a revision in premium estimates. We call it premium development. The local description is premium development. And so, the $3.5 million, in effect, reduced our premium, was related to the property binder book. And so, it's again, its late reported business. And so, last year we reported $40 million of positive development. So, the good news is that the changes are getting much more modest.

But there wasn't anything in the book in quarter that was specifically negatively related to any sort of reserve development.

Scott Heleniak - Royal Bank of Canada Capital Markets

Okay. Thanks.

Mark Watson



Ladies and gentlemen, (Operator Instructions). And there are no further questions in the queue. That concludes Q-and-A portion of our presentation. I would like to turn the call over to Mr. Mark Watson for closing remarks.

Mark Watson

Thank you and thank you everyone for calling in today. I think what you've seen is that we have completed making a number of the changes that we've been working on over the last year and a half as a respect to underwriting. We're now shifting the focus of our attention to streamlining our operation and that would be the theme for the next couple of quarters. And we also will have a very actively, managing our capital base and you should expect us to continue doing that in the foreseeable future as well.

Thank you again for your time and we look forward to talking to you again at the end of the fourth quarter.


Ladies and gentlemen, thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!