Endurance Specialty Holdings' (ENH) CEO John Charman on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Endurance Specialty (ENH)

Endurance Specialty Holdings Ltd. (NYSE:ENH)

Q2 2014 Earnings Conference Call

August 5 2014 8:30 AM ET

Executives

Gregory Schroeter - Senior Vice President, Investor Relations and Corporate Development

John Charman - Chairman and Chief Executive Officer

Michael McGuire - Chief Financial Officer

Analysts

Amit Kumar - Macquarie

Nawaz Suleman- Keefe, Bruyette & Woods

Ryan Byrnes - Janney Capital

Jay Cohen - Bank of America, Merrill Lynch.

Operator

Good morning, everyone, and welcome to the Endurance Specialty Holdings' Second Quarter Earnings Results Conference Call. This call is being recorded. (Operator Instructions) I would now like to turn the call over to Gregg Schroeder, Senior Vice President of Investor Relations and Corporate Development. Please go ahead, sir.

Gregory Schroeter

Thank you, Diana, and welcome to our call. John Charman, Chairman and Chief Executive Officer; and Mike McGuire, Chief Financial Officer will deliver our prepared remarks.

Before turning the call over to John, I would like to note that certain of the matters that we will be discussed here today are forward-looking statements. These statements are based on current plans, estimates and expectations and include but are not limited to various elements of our strategy, business plans, growth prospects, market conditions, capital management initiatives and information regarding our premiums, loss reserves, expenses and investment portfolio.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the market in which we operate the economy, and other future conditions and involved inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in the forward-looking statements and we therefore caution you against relying on any of these forward-looking statements.

Forward-looking statements are sensitive to many factors, including those identified in Endurance's most recent Annual Report on Form 10-K, and quarterly report on Form 10-Q that could cause actual results to differ materially from those contained in forward-looking statements. Forward-looking statements speak only as of the day on which they were made and Endurance undertakes no obligation publicly to update or revise any forward-looking statement, whether as a result of new information, future developments, or otherwise.

In addition, this presentation contains information regarding operating income and other measures that are non-GAAP financial measures. For reconciliation of these items to the most directly comparable GAAP financial measures, please refer to our press release, which can be found on our website at www.endurance.bm.

I would now like to turn the call over to John Charman.

John Charman

Thank you, Gregg. And a very good Bermuda morning to you all. And I am delighted to welcome you to our second quarter earnings call. Endurance generated very strong results in the second quarter with $75 million of net income, operating earnings per share of $1.61, a 10.9% annualized operation return on equity and growth in book value per share of 4.9% adjusted for dividends. Excluding $12.8 million of expenses related to our proposed acquisition of Aspen, our second quarter 2014 operating income per share would have been $1.90 with an annualized operating ROE of 12.9%. These strong results were driven by continued across the board improvement in core underwriting margins and favorable reserve development. While our transformation began a little over a year ago, our accident and calendar year loss ratios are already showing meaningful improvements across based insurance and reinsurance segments. Our efforts to rebalance and re-underwrite our portfolios are now largely complete under core of our global underwriting leadership is in place. The significant levels of industry leading specialty underwriters that we have added over the past 18 months are now firmly established and accepted in the market place. Our teams have fully integrated and coordinated. And are leveraging their extensive industry knowledge and relationships to bring attractive business to Endurance.

Strategically, we have positioned Endurance to succeed in a challenging and highly competitive environment. The investments we have made over the last year are already paying off with strong profitable growth, improved underwriting focus and increased market relevance across the board. With our industry leading underwriting talent, superior risk selection and continued strong enterprise risk management, we believe we can safely expand and diversify our business, while improving profitability. Even as market conditions remain challenging.

Later in the call, I'll discuss our current underwriting activities, market conditions and strategic initiatives in greater detail.

First though, I'll turn the call over to Mike to provide some additional comments on our second quarter results. Mike?

Michael McGuire

Thanks, John, and good morning, everyone. In the second quarter, Endurance generated improved net income to common shareholders of $75 million and $1.68 per diluted share, and operating income of $71.9 million and $1.61 per diluted share. Annualized operating ROE was 10.9% in the quarter. Our results were driven by strong underwriting improvements across segments, continued favorable reserve development and lower levels of catastrophe losses, partially offset by increased expenses related to our proposed transaction with Aspen. As John mentioned, excluding $12.8 million of Aspen related expenses, our second quarter result were even stronger with an operating income per share that would have been $1.90 with annualized operating ROE of 12.9%. We expect our third quarter to include $4 million to $5 million of final transaction related costs.

Premiums written in the second quarter were $689 million gross and $511 million net. An increase of 20.4% gross and 10.1% net compared to the second quarter last year. This growth has been driven by the strategic investments in underwriting talent that we've made over the last 18 months as our expanded underwriting capabilities are drawing attractive specialty business to Endurance.

In our Insurance segment, second quarter gross premiums written were $322 million, an increase of 16.1% from the second quarter of 2013. Within our non-crop U.S. insurance operations, $57 million of growth was generated by our professional, casualty and other specialty line teams. In our recently launched London based international insurance operation, our team generated $39 million of new gross written premium in the second quarter in energy, professional and property lines. Our insurance teams in the U.S and London have quickly achieved market acceptance and as we move to the remainder of the year, we expect this positive momentum to continue. Offsetting this growth was a $51 million decline in our agriculture insurance business as significant commodity price declined impacting the industry was partially offset by 5% growth in our policy counts.

Within the Reinsurance segment, second quarter gross premiums written were $368 million, an increase of 24.4% compared to a year ago. Within professional lines, strong growth from our recently expanded U.S. underwriting team including both new contracts as well as the extension of a large quota share contract written late last year. We also experienced strong growth in the quarter within our specialty lines as our global underwriting teams attracted new profitable opportunities both in surety, energy and international agriculture through leveraging their long standing client and distribution relationships. Offsetting this growth were targeted reductions within our property treaty and casualty lines of business as we continue to non- renew contracts that no longer meet our upgraded portfolios profitability targets.

In spite of the competitive environment, our property catastrophe portfolio grew selectively in Japan at April 1 and Florida at June 1, as we proactively negotiated preferential terms and increased participation with our key clients.

Turning to net writings. During the first quarter, we highlighted the purchase of additional reinsurance for our insurance portfolio which included a 10% multiyear whole account quota share treaty covering the entire insurance segment, a stop loss cover on our agriculture insurance book and a worldwide aggregate excess of loss catastrophe retro session. In the second quarter, we continue to strategically purchase greater levels of reinsurance across the portfolio to mitigate the impact of competitive market conditions, appropriately manage our limits and improve the risk reward characteristics of our net portfolio. For our catastrophe reinsurance business, our purchases included an additional $50 million of global aggregate excess of loss protection bringing our total retro program to a worldwide aggregate coverage of $150 million, excess of $100 million after event deductibles.

Within insurance, our purchases included an increase in our multiyear whole account share find additional 5% for non-crop business effective [71]. While all of our reinsurance purchases reduce our net written premium levels, they substantially improve the risk reward characteristics of our net portfolio and position us extremely well to continue to safe expansion of our underwriting portfolios in a challenging market.

Our combined ratio for the second quarter was 88.1% compared to 94.3% in the second quarter of 2013. The improvement was driven by lower accident year loss ratios in both segments. As a greater concentration in specialty business from our re-underwriting efforts is positively impacting our core profitability. In addition, the lower level of catastrophe losses year-over-year in a reinsurance segment drove some of the improvement. Partially offsetting this improvement was a higher general and administrative expense ratio from lower net and premiums and $12.1 million of expenses related to our proposed transaction with Aspen.

In the coming years, we remained determine to drive down our expense costs and ratios from the current levels as we see greater efficiencies throughout our operations. Acquisition expenses were also higher in the current quarter as our business mix continues to shift to more specialty lines of business which incur higher acquisition costs.

Moving to investments. Our portfolio's total return with a solid 1.52% in the first quarter and 2.78% year-to-date. Net investment income was $39.3 million, an increase of $6.8 million from a year ago, driven by a $4 million increase in income from other investments which had a challenging second quarter last year. We expect investment income from fixed income securities to remain around current level as reinvestment rates are close to our book yield.

As our duration relatively short at 2.9 years we are well positioned to reinvest at higher yields when rates rise. In the quarter, we incrementally added to our equity and alternative investment portfolios.

Our reserve position of nearly $4 billion remains strong as 64% of total reserves are IBNR. $2.1 billion or 73% of our casualty and professional line reserves are IBNR and we maintain $370 million of IBNR and non agriculture short tail lines of business. Consistent with prior periods, the majority of our favorable development this quarter was driven by short tail lines of business. Our capital position continue to strengthen as total shareholders equity ended the quarter at $3.1 billion and total capital reached $3.6 billion. Diluted book value per share ended the quarter at a record high of $60 per share, up from $55.18 per share at the end of 2013. Risk-based capital levels continue to improve as our shareholders equity grew and our net risk profile improved. We have very strong financial flexibility to pursue our strategic objectives and to grow our business.

I'll now turn the call back to John for some additional comments.

John Charman

Thank you, Mike. Ladies and gentlemen, I'll conclude our prepared remarks with our perspective on our current underwriting activities and market conditions. As expected, during the second quarter we saw an increased to the competitive pressures observed in the first quarter. Competition is increasing across most classes of business. With a greater concentration in the short tail lines. Against this backdrop, we continue to generate profitable business as the substantial global underwriting expertise we've added over the past 18 months has broaden Endurance's market leadership and relevance. Our underwriting teams are competing with their product knowledge, client focus and long-standing relationships rather than solely on price reductions or broadening terms and conditions. Starting first with the pricing environment. Insurance conditions are generally mixed with smaller casualty products continuing to show positive rate changes. Professional and liability prices are generally flat although some deterioration is emerging in certain sectors. Property and short tail rates continue to experience pricing pressure as losses have been relatively benign. Reinsurance conditions are generally much more competitive than insurance. With short tail and catastrophe exposures facing the brunt of pricing pressures. Longer tail reinsurance lines while less competitive continues to see margin compression from expanded ceding commission and terms. Being mindful of these pricing conditions in our insurance segment we continue to successfully leverage newly high specialty underwriters to achieve prudent gross written premium growth.

During the second quarter, non-crop U.S. specialty underwriters generated $57 million of growth in gross premiums written. With strong production within our casualty, specialty and professional lines. Within our London office, a nearly 20 senior underwriters are now fully integrated into our global underwriting operations. And they have a very successful launch generating $39 million of new gross written premiums in the second quarter across energy, professional lines and property lines of business. We expect our industry leading expertise in the London market to continue generating substantial and sustainable attractive business for Endurance.

In our strategically important agricultural insurance business, while industry premium levels were significantly impacted by decline in commodity prices, thus far ground conditions have been favorable. Our team generated healthy organic growth in policy counts as our industry leading service and technology platform continues to increase our market share.

Within our reinsurance operations, we had very successful property cap renewals in Japan on April 1, in the U.S. on June 1 and in Australia on July 1. Within these very competitive catastrophe markets, primary companies have been retaining more risk and also consolidating their reinsurance panel. We approached renewals with an early focus on improving our position with long-standing select key clients where we can achieve preferential terms and avoid those products that are heavily commoditized and targeted by alternative capacity. This strategy allowed us to benefit from reinsurance panel consolidation and to successfully expand our writings with many of our targeted clients while reducing or exceeding contracts that experienced the worst deterioration in pricing and terms that were reported widely.

Overall, we modestly grew our gross catastrophe premiums in the quarter and improved the overall quality of our portfolio. In other lines of reinsurance, we continued and largely completed the deliberate rebalancing and re-underwriting of the portfolio that we initiated a year ago. In the second quarter, this translated into some further reductions of our property and casualty portfolios. But we increased our business actively, activity with high quality ceding in the U.S. professional lines and international specialty line portfolio where we believe there are higher expected margins. While the strategic build out of our underwriting capabilities across both segments is generating attractive growth in gross written premiums, we are very mindful of the highly competitive landscape we are operating in. And we've therefore strategically increased our purchases of reinsurance and retro session protection across our portfolios. Although, this clearly impacts net written premiums, these purchases enable us to build a more attractive net portfolio with greater balance and improved net risk written characteristics while providing strong capacity and flexibility to continue to safe, long-term expansion of our underwriting activities for the benefit of our shareholders.

Overall, I am very pleased with what we've all achieved and accomplished at Endurance over the last 12 to 18 months. But we still have much to do. The core of our underwriting leadership and talent is now firmly embedded throughout our operations. The significant re-underwriting and rebalancing of our entire portfolio is now largely complete. And we are at last trading globally as an integrated company. These meaningful investments are already paying dividends and we now have a stronger foundation upon which to build our highly successful, market leading, global specialty insurance and reinsurance business.

And with that Diana we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will go first to Amit Kumar of Macquarie.

Amit Kumar - Macquarie

Thanks and good morning, and congratulation on quarter. Just quickly going back I guess to the discussion on the steps you have taken. Now your implied guidance based on your July presentation is roughly 10% to 12% ROE for 2015, the streak is right now as 9%. I am sort of wondering if you look at the pieces of that is margin the biggest piece from here or is it expense ratio or should we also throw in a bit of capital management in that picture?

John Charman

It is not many as throw in but Mike is going to tell you.

Michael McGuire

Amit, how are you this morning? There is couple -- it's not really just one factor, there are three primary areas that would be leading to improved return on equity expectations. First you need to look at the growth trajectory of our global businesses as the profitable growth and diversification of our portfolio should add margin and increase return on equity to us over the coming years. From an underwriting profitability point of view, the improvements that we've made in our underwriting capabilities, the improvements in risk selection, the product and geographic diversification and our enhanced reinsurance purchasing across the portfolio should improve our net underwriting margins. And then we also would be expecting increased efficiency across our operations from an expense ratio point of view as our business growth comes through as well as the efficiency initiatives that we are pursuing. So you really have to look at all three of those drivers when you think about return expectations for next year and the years forward.

John Charman

I can't stress enough. The importance over the next two or three years in a highly competitive market place where there is no hiding place. The importance of our underwriters and their ability to have the best risk selection within the industry is going to fundamentally continue to differentiate and strengthen our figures.

Michael McGuire

Amit, you also refer to capital management and our plan does not rely on or depend on aggressive capital management to achieve our goals, nor they assume any unusual change in the investment landscape.

Amit Kumar - Macquarie

Got it, that's very helpful. I guess the only other question I'll come back, I want to go back to the discussion before Aspen, last year we were talking about I guess the focus on Asian partners and among some of the comments were they were integral to accelerate this strategic expansion and I am just wondering is that now where you would sort of refocus efforts after the abandonment or how should we think about I guess the standalone strategy now.

John Charman

Well, what I will do is comment on our Asians strategy which I think I said to you last year, was a strategy that we would continue to work on over the next couple of years. That strategy is still in place. And I would expect us to continue within that timetable.

Operator

Thank you. We will take our next question from Nawaz Sulemani [ph] of Keefe, Bruyette & Woods.

Nawaz Suleman- Keefe, Bruyette & Woods

Hi, thank you. Just a couple questions. In terms of your P&L I noticed that some of them may have either -- for example decrease on 100 basis but went the opposite direction on one and 250 basis, and I saw that in a few cases where kind of one in opposite direction, is there any reasons for that?

Michael McGuire

We did purchase a pretty significant catastrophe excessive loss program that would have probably had a more of direct impact on the 100 year return period than the 250 return period. And we didn't buy unlimited cover there. So there could be some of that going on. But I had to say it made an aggregate level --

Nawaz Suleman- Keefe, Bruyette & Woods

My other question, you mentioned you were growing in Florida, so I guess is there anyway you can sort of quantify on the program, I guess your participating in, here the market numbers where down 20% on average so obviously I am assuming with your book, it is probably a bid different than that you are getting specific channels and so forth. I guess can you talk about how is it affecting your book more specifically.

John Charman

I think we did broad level that we have long standing and limited number of long-standing high quality clients so we are very close to. And so once there was a huge amount of noise about the Florida renewals, what we did was to engage our clients early position ourselves early and applied their merit capacity that we felt was appropriate given the risk reward characteristics. But we did not play extensively through the Florida market.

Operator

Thank you. (Operator Instructions). We'll go next to Ryan Byrnes of Janney Capital.

Ryan Byrnes - Janney Capital

Great, thanks. Good morning, everybody. Question on the reinsurance segment. Obviously, there has been some business mix shift there but the underlying attrition loss ratio excluding catastrophe is improved pretty meaningfully year-over-year, and that's in light of top cad and property both down little bit and growth in profession lines. But usually the way we would think about that is top cad would have a lower attrition loss ratio and is same as property. Just wanted to see how you guys are able to improve the overall segment with the business mix shift.

John Charman

Well, let me just give an overview. We made some fundamental changes within the reinsurance portfolio over the last 12 months. And it has taken a 12 months cycle for that to work through. And we've changed the balance of the portfolio to what we believe to be a much more sustainable, much higher quality through better cede that we have known for many, many years and we have a lot of respect for. So it is a very different portfolio than you have seen before. It is much better balanced and we believe it is much less volatile than we have previously.

Ryan Byrnes - Janney Capital

Okay, great, thanks for that. And then my last one is I know another thing -- another one the big issues when you came on Board was you were going to try to get Endurance to a market leading expense ratio going forward, and obviously there bunch of one timers going-- happening in the last couple of years, but when should the expense ratio kind of hit a reasonable run rate because obviously there is a lot of growth on the insurance side. But when we should be -- is it the back half of next year we should expect that to reach an adequate run ratio -- run rate?

John Charman

We got up at the strength that as you are going to imagine Ryan on the expense side through not only my appointment but also company called Aspen. But once we get through that our goal is still exactly the same. And our goal is to reduce our G&A expenses to that 11%, 12% number that we believe is much more appropriate for company like Endurance. And I can assure you that in spite of the other activity we've been undertaking, we are continuing to drive our activity towards that type of expense base.

Michael McGuire

And Ryan, I would just add to that. We should start to see stability in the G&A dollars. I did mention in my prepared remarks $4 million to $5 million of additional transaction cost that will come into third quarter, but absent those items in the back half of this year we should start to see more stability in the dollar expense levels and as our business grow as next year and we start to see some of our efficiency initiatives play through, you will start to see that ratio come down in the next year.

John Charman

Yes. I just think of it as a jigsaw puzzle. We are dealing with all of the relevant thoughts of the jigsaw puzzle. We are fundamentally growing our business. We have fundamentally improved the portfolios, the quality of the portfolios that we are underwriting. And we have much greater global expertise and capability. We are utilizing reinsurance in a much, much more proactive way to enhance our risk reward characteristics of the portfolio. We are fighting very, very hard to make sure that the acquisition costs that we pay to acquire that business are as reasonable as they can be within the market place. We are also making sure that our underwriting performance is better than it has been before at Endurance and actually is moving towards the top quota of underwriting performance in the industry. And then of course we are addressing our own cost base. So if you think of that jigsaw puzzle and you see where we are trying to drive it, I hope you will see what impact that will have on our long-term financial performance.

Operator

Thank you. We'll go next to Jay Cohen of Bank of America, Merrill Lynch.

Jay Cohen - Bank of America, Merrill Lynch.

Thank you. Let me apologize ahead of time because I literally -- good morning, John, good morning. I wondered about because I just joined the call and asking question that you may have addressed already and so let me apologize ahead of time. But one thing I did notice is that the accident year loss ratio in the insurance segment while nicely improved from a year ago, did deteriorate from the first quarter and I was wondering what the reason was?

Michael McGuire

Jay, looking at sequential quarters you will get a mix picture because of the impact of the agriculture business. The earned premiums and Ag in the first quarter are quite low. We really don't see those earned premiums coming until the second and third quarter. And as you know the loss ratios in crop insurance are much higher than other businesses given their much large expense ratio. So you really need to look at that year-to-date picture of the insurance segment. And the accident your loss ratio year-to-date are improved quite a bit in the insurance segment.

Operator

Thank you. We will go next to Amit Kumar of Macquarie.

Amit Kumar - Macquarie

Oh wow, that was quick. I guess just going back to the previous question on the crop book. So I guess 85% is a loss ratio right where this top loss kicks in 67% of it is the expense ratio, add a few points of top loss, so net-net is the crop book running at mid to lower -- mid to upper 90s right now. Is that the right way?

Michael McGuire

Amit, through the first half of the year it would be mid up or 90s, obviously in the first half of the year where we book relatively prudently, it has been widely reported that crop conditions are excellent right now in most areas of the country. The one factor that the industry will be looking at is the impact of price, corn prices are down into 15% to 20% range versus base prices. But unlike last year, this year this is best of reflection of the expectations of bumper crop. So there is that interplay between price and yield that we'll need to see how that plays out. But as this currently expected, we would imagine that price decline is going to be offset materially by much higher than covered yields. So we were expecting right now possibly given the fact that we have a stop loss for the attach is 85% even if we had incremental price driven losses in the portfolio that's going to be well contained within our stop loss protection.

Amit Kumar - Macquarie

Got it. And how much is -- or percent of your book is revenue?

Michael McGuire

We are pretty consistent with the industry. And it's probably two thirds of industry premium are revenue covers which covers both yield and price.

Amit Kumar - Macquarie

Got it, that's helpful. I guess the two other questions I had; the first question is going back to the initial comment regarding the discussion on the insurance segment on pricing. Can you sort of talk about what your expectations would be on pricing versus loss cost from here on the insurance front? And then I have a follow up.

John Charman

All right. Amit, I think that I just need to drop you back a year when we first started talking under the new Endurance banner. And we predicated out three year business plan on the basis that insurance pricing will continue to soften throughout that period. And we expected very, very competitive and challenging market conditions across the board. So we were under no illusions and we are under no illusion at all about what we are seeing today and how it is deteriorated since the middle of last year. Our people are prepared for that, the industry leaders, they have great experience that is why I stressed that you will see our differentiations will come from our risk selection through our underwriters who have extremely good market connections and market following. And I believe through that risk selection that loss that will be obvious erosion of margin over the next two or three years. Our risk selection will more than ably offset that. I think other companies that are just in the market, in the premium volumes, you will get half problems with that margin erosion.

Amit Kumar - Macquarie

Got it. The only other question I had was the broader discussion on using reinsurance and it makes perfect sense. Can you sort of broadly talk about how much -- what the difference in rate on line would have been if you compare to the previous quarter? I guess what I am trying to figure out is how much did that piece of pricing fall which obviously benefited you.

Michael McGuire

Amit, are you speaking of aggregate retro covered that we purchased?

Amit Kumar - Macquarie

Yes.

John Charman

So we don't discuss individual reinsurance purchasing because that's inappropriate. What we do say is the fact that we have very, very good reinsurance partners who value the business that we underwrite and the business that we produce. And they are prepared to give us very, very competitive terms because they know that we are very good business -- we are very good people to do business with over a long period of time.

Amit Kumar - Macquarie

Fair enough. And just one clean up question and I'll stop. I would imagine that you would not have that much exposure to the Malaysian losses and some of the other losses; can you just talk about that? Thanks.

John Charman

Yes. We have minimal, absolutely minimal exposures to those dreadful losses. But obviously the aviation market in both the war market as well as the -- or risk market, they have a risk market; again to they have some pretty heavy burdens from those losses. And in my long experience when losses start to come it is always at the bottom end of the cycle. When the pricing across the board is under a lot of pressure, suddenly you get a lot of these losses regrettably occurring. And it is --these things can either be straws that break the camel's back or they can be Giant Haystacks. So we are going to get them. And we are prepared for them that is why the use of reinsurance at the bottom end of our cycle is a critical factor in managing the portfolios. And anybody who thinks that they can retain larger amounts of their business unprotected at this stage of the cycle, I think you should suggest they need some medical attention.

Amit Kumar - Macquarie

I am actually struggling to whom you are referring to but thanks for the answers and good luck for the future.

John Charman

And you guys are far smarter than me. Thank you very much, take care.

Operator

Thank you. With no further questions, I would like to turn the conference back over to Mr. John Charman for any additional or closing remarks.

John Charman

Well, thank you, Diana. And thank you ladies and gentlemen, again for taking the time to listen to us. We wish you well. We hope you have a great summer. And we very much look forward to discussing our third quarter numbers with you in the near future. Thank you.

Operator

That does conclude today's conference. Thank you for your participation.

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